Business context and reporting period
Hennessy Advisors, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2013, covering the three and nine months ended June 30, 2013, compared with the same periods in 2012. The company earns investment advisory and shareholder service fees from 16 open-end mutual funds. Unless stated otherwise, financial amounts below are in U.S. dollars.
The principal business change was the October 2012 acquisition of the management rights for ten former FBR funds, adding about $2.2 billion of assets under management (AUM). Average AUM was $3.57 billion for the quarter and $3.08 billion for the nine-month period; AUM at June 30 was $3.59 billion.
Financial results and liquidity
| Metric | Three months ended June 30, 2013 | Three months ended June 30, 2012 | Nine months ended June 30, 2013 | Nine months ended June 30, 2012 |
|---|---|---|---|---|
| Revenue | $6.506 million | $1.715 million | $17.156 million | $5.161 million |
| Operating income | $2.476 million | $0.532 million | $6.129 million | $1.304 million |
| Net income | $1.370 million | $0.303 million | $3.255 million | $0.701 million |
| Diluted earnings per share | $0.24 | $0.05 | $0.56 | $0.12 |
Quarterly revenue increased 279% year over year and nine-month revenue increased 232%. Investment advisory fees accounted for most revenue. Operating margin was 38.1% for the quarter and 35.7% for nine months, versus 31.0% and 25.3%, respectively, in the prior-year periods. Net margin was 21.1% for the quarter and 19.0% for nine months, versus 17.7% and 13.6%.
For the nine months, operating cash flow was $3.841 million, investing cash flow was negative $20.446 million, and financing cash flow was positive $14.636 million. Cash declined $1.969 million to $6.761 million. The investment outflow primarily reflected $20.652 million of acquisition-related payments; financing included $16.525 million of amended-loan proceeds.
At June 30, cash and cash equivalents were $6.761 million, current assets $10.333 million, and current liabilities $4.766 million. Total debt was $17.327 million, comprising $1.840 million current and $15.487 million long-term; stockholders’ equity was $28.349 million. The bank loan bears interest at prime plus 0.75% (4.00% then-current rate), is secured by company assets, and matures October 26, 2017. The company reported compliance with its financial covenants.
Material changes versus the prior comparable period
- Growth in revenue and earnings primarily reflected the addition of the former FBR funds, along with market appreciation and net inflows. Total AUM rose from $821.4 million at June 30, 2012 to $3.59 billion at June 30, 2013.
- Operating expenses increased substantially in dollars as the company added funds, staff, marketing and distribution activity. As a percentage of revenue, operating expenses fell to 61.9% for the quarter from 69.0%, and to 64.3% for nine months from 74.7%.
- Sub-advisor fees, distribution costs, and interest expense rose with the expanded fund base and acquisition financing. Nine-month interest expense was $494,000, versus $39,000 a year earlier.
- Debt increased to $17.327 million at quarter-end from $1.927 million at September 30, 2012. Management contracts, net, increased to $43.209 million from $22.557 million.
- Cash dividends of $0.03125 per share were paid in each of three quarters during the nine-month period.
Outlook, commentary, risks and unusual items
The filing gives no numerical earnings or revenue guidance. Management said it expected market performance and fund flows to affect AUM and revenue, and expressed optimism about equity markets and fund flows. These views are not guarantees. The company’s advisory fees depend on fund AUM, which can be affected by market movements, redemptions, investment performance, competition and regulation. Management reported higher redemption rates than in the prior comparable period, though subscriptions offset redemptions.
A significant unresolved acquisition obligation is the second payment to FBR Fund Advisers, due after the first anniversary of closing and calculated using former FBR fund AUM at October 28, 2013. Based on June 30 values, management estimated it would be about $15.5 million, but the amount could change materially; there is no stated maximum and zero could be due. Although management considered payment probable, it said the amount was not estimable and recorded no contingent liability. Management said available liquidity and operating cash might not cover such a payment and that additional debt or equity financing may be needed; there is no assurance financing will be available.
The company recorded a $108,000 realized loss on liquidation of an available-for-sale investment, which also contributed to a disallowed capital-loss carryforward and a higher effective tax rate. Management reported no indicators of impairment for its management contracts as of June 30, 2013, but noted that a decline in valuations could result in an impairment charge. Contractual fee waivers were $60,000 for the quarter and $113,000 for nine months; specified expense-ratio limitations run through February 28, 2015. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the final FBR acquisition payment, its funding source, and the related effect on debt, liquidity and cash flow.
- Track AUM, market returns, subscriptions and redemptions, particularly whether inflows continue to offset rising redemptions.
- Assess the sustainability and economics of acquired AUM, including sub-advisor and platform distribution costs and the revenue mix across funds.
- Monitor loan amortization, interest expense, covenant compliance and available cash relative to near-term obligations.
- Review future management-contract impairment assessments, fee waivers and the effect of fund expense limitations.