Hennessy Advisors, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2012; comparisons are with the three months ended December 31, 2011 unless noted. The company provides investment management and shareholder services to mutual funds. Financial statements are unaudited.
Financial performance and position
- Revenue: $4.703 million, up 173.9%. Investment advisory fees were $4.489 million; shareholder service fees were $214,000.
- Profitability: Operating income was $1.600 million versus $332,000; operating margin was 34.0% versus 19.3%. Net income was $768,000 versus $152,000; net margin was 16.3% versus 8.9%. Basic and diluted EPS were both $0.13, versus $0.03.
- Expenses: Operating expenses rose 124.0% to $3.103 million, but declined to 66.0% of revenue from 80.7%. Interest expense was $138,000 versus $14,000. Other expense was $110,000, principally a realized loss on liquidation of an investment.
- Cash flow: Operating cash flow was negative $115,000; investing cash flow was negative $19.603 million, largely reflecting the fund-management asset acquisition; financing cash flow was positive $15.915 million. Cash declined $3.803 million to $4.927 million.
- Balance sheet and debt: Total assets were $50.563 million and stockholders’ equity was $25.924 million at December 31. Bank debt totaled approximately $18.2 million ($1.840 million current and $16.406 million long-term). The loan bears interest at prime plus 0.75% (4.00% then current), is secured by company assets, and matures October 26, 2017. The company reported compliance with loan covenants.
- Dividend: A quarterly cash dividend of $0.03125 per share was paid; total dividends were $180,000.
Material changes and drivers
- On October 26, 2012, the company acquired assets related to management of ten former FBR funds, adding approximately $2.2 billion in assets under management (AUM). The acquisition was funded with additional bank borrowing and company cash.
- Quarter-end AUM was $3.024 billion, compared with $780.950 million a year earlier; average AUM was $2.46 billion versus $777.1 million. The acquisition was the principal driver of revenue growth.
- For the quarter, organic inflows were $156.4 million, redemptions were $287.5 million, and market appreciation was $13.0 million. Management cited increased redemptions and net outflows of $114.5 million in discussing the period’s average AUM; outflows were concentrated in the Focus and Gas Utility Index funds.
- Expenses increased with the expanded business: compensation and benefits rose to $1.412 million, sub-advisor fees to $711,000, and distribution expenses to $268,000. Three additional sub-advised funds contributed to higher sub-advisor fees.
Outlook, risks, and unusual items
- Management said cash and other liquid assets should meet short-term requirements. It may seek additional debt or equity for long-term needs, including the possible remaining acquisition payment; management cautioned that financing may not be available.
- The FBR purchase agreement provides for a remaining 40% payment on the first anniversary of closing, calculated using relevant AUM as of October 25, 2013. The amount was not reasonably estimable, and the company recorded no contingent liability at December 31, 2012.
- Management described improving investor sentiment and positive returns across all sixteen funds for the year ended December 31, 2012, but also cited market volatility, investor redemptions, economic and political uncertainty, competition, and dependence on fund AUM. It provided no quantified earnings or revenue guidance.
- The $110,000 realized loss followed closure and liquidation of the company’s Micro Cap Fund investment. The quarter’s effective tax rate was 43.2%, which management said was unusually high in part because of a valuation allowance on the resulting capital-loss carryforward.
- Management reported no indication of impairment of management contracts and no other commitments or contingencies at quarter-end. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Retention, redemptions, and subsequent AUM trends in the former FBR funds and across the existing fund lineup.
- The eventual amount and funding plan for the contingent 40% acquisition payment, and the related effect on liquidity and debt.
- Debt repayment capacity, covenant compliance, and sensitivity to the variable interest rate.
- Whether revenue growth translates into durable margins given higher sub-advisor, distribution, and compensation costs.
- Management-contract impairment assumptions and the effect of market declines or sustained fund outflows.