Hennessy Advisors, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2014. The interim financial statements are unaudited. Hennessy provides investment advisory services to 16 open-end mutual funds and earns primarily asset-based advisory fees.
Financial performance
| Metric | Three months ended June 30, 2014 | Year-over-year | Nine months ended June 30, 2014 | Year-over-year |
|---|---|---|---|---|
| Revenue | $8.784 million | +35.0% | $25.015 million | +45.8% |
| Operating income | $3.713 million | +49.9% | $9.968 million | +62.7% |
| Operating margin | 42.3% | 38.1% prior year | 39.8% | 35.7% prior year |
| Net income | $2.045 million | +49.3% | $5.261 million | +61.6% |
| Diluted EPS | $0.35 | $0.24 prior year | $0.89 | $0.56 prior year |
- Quarterly advisory fees rose 36.2% to $8.550 million; shareholder service fees were $0.234 million. Nine-month advisory fees rose 47.5% to $24.326 million; service fees were $0.689 million.
- Nine-month operating expenses increased 36.5% to $15.047 million, but declined as a share of revenue to 60.2% from 64.3%. General and administrative costs rose 54.6%, mutual fund distribution costs 68.1%, and sub-advisor fees 60.1%, reflecting higher marketing/distribution activity and assets in sub-advised funds.
- For the nine months, operating cash flow was $6.083 million, investing cash flow was negative $19.231 million, and financing cash flow was $11.240 million. Cash decreased $1.908 million to $6.498 million.
- At June 30, cash was $6.498 million, current assets $10.357 million, and current liabilities $7.572 million. Total assets were $73.701 million and stockholders’ equity $35.125 million.
- Bank debt was $27.659 million, including $3.750 million current and $23.909 million long-term. The $30 million loan bears interest at prime plus 0.75% (4.00% effective rate at filing), is secured by company assets, and is scheduled to mature in October 2017. The company reported compliance with loan covenants.
Material changes and business drivers
- Average assets under management (AUM) were $5.01 billion for the quarter, up 40.3%, and $4.63 billion for the nine months, up 50.2%. Period-end AUM was $5.38 billion, up 49.7% from June 30, 2013.
- Management attributed the AUM increase to net inflows and market appreciation. For the year ended June 30, 2014, it reported $872 million of net purchases and $915 million of market appreciation. Redemptions averaged 2.2% of AUM per month in the quarter, compared with 3.2% a year earlier.
- Operating margin and net income improved as revenue growth outpaced expense growth. Platform distribution and sub-advisory expenses also rose with assets; management noted platform-sourced assets are less profitable because of participation fees.
- The company completed an internal reorganization effective February 28, 2014, placing all 16 funds in Hennessy Funds Trust. Nine-month investment cash outflows included $19.152 million of payments related to purchased management contracts, principally the FBR Funds acquisition.
Outlook, risks and unusual items
- Management expressed optimism about U.S. markets, corporate fundamentals and continued investor return to equities, while acknowledging possible short-term market volatility. It provided no numerical earnings or AUM guidance.
- Revenue depends on fund AUM, which can change with investment performance, market conditions, fund purchases and redemptions, competition and marketing success. Management also cited regulatory complexity and expected additional administrative and compliance costs.
- A one-time prior-year tax provision true-up increased nine-month tax expense by approximately $0.23 million, or $0.04 per diluted share, because certain compensation expenses were not deductible under Section 162(m). The nine-month effective tax rate was 42.5%, versus 41.1% a year earlier.
- Contractual fund expense-ratio waivers totaled $131,193 for the nine months; some limits expire February 28, 2015. Management said it did not anticipate voluntary fee waivers.
- Management contracts, recorded at $62.489 million, are indefinite-lived intangible assets subject to impairment assessment. The filing reported no June 30, 2014 impairment indicators. Contracts are subject to renewal and termination provisions.
- The company reported no other commitments or contingencies as of June 30, 2014 beyond its leases, and management concluded disclosure controls were effective.
Key facts for investors to verify
- Whether AUM growth and net inflows persist, and how much future fee revenue depends on market appreciation versus net sales.
- Debt repayment capacity, interest costs, covenant compliance and the impact of the $27.7 million outstanding loan.
- Whether rising platform and sub-advisory expenses continue to pressure profitability, and the effect of expense-waiver limits expiring in 2015.
- Performance and retention of acquired fund assets, renewal of advisory contracts, and the assumptions supporting the carrying value of management contracts.
- Tax effects of the Section 162(m) limitation and whether the higher effective tax rate recurs.