HNNA

Hennessy Advisors, Inc. 10-Q Summary

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Hennessy Advisors, Inc., a smaller reporting company incorporated in California. The report covers the quarterly period ended June 30, 2010, and the nine-month period ended June 30, 2010. The Company provides investment management and shareholder services to ten open-end mutual funds and one private pooled investment fund (Hennessy Micro Cap Growth Fund, LLC). As of July 15, 2010, there were 5,799,907 shares of common stock outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 25.3% for the quarter and 40.9% for the nine-month period compared to the prior year. This was driven by a 18.4% increase in average daily net assets for the quarter, attributed to market appreciation and acquisitions (specifically the SPARX Funds in late 2009).
• Profitability Turnaround: The Company reported a net income of $275,000 for the quarter, a 1,095.7% increase from the $23,000 net income in the prior year quarter. For the nine months, the Company turned a net loss of $184,000 in the prior year into a net income of $689,000.
• Expense Management: Total operating expenses decreased 1.3% for the quarter despite revenue growth, primarily due to a 6.1% reduction in compensation and benefits (elimination of a position) and a 15.8% drop in general and administrative expenses (lease renegotiation). However, sub-advisor fees increased 67.9% due to higher sub-advised assets.
• Assets Under Management: Ending AUM was $812.6 million, a 4.9% increase from the prior year period. This growth was offset by significant redemptions ($270.6 million over nine months) driven by investor apprehension regarding equity market volatility.

Outlook, Risks, and Management Commentary

• Outlook: Management anticipates that current cash and liquid assets ($5.9 million) are sufficient for short-term capital requirements. Long-term capital needs may be met through debt or equity markets, though no assurance is given.
• Debt Status: The Company has a bank loan with a current balance of $1.3 million. The final installment of principal and interest is due September 30, 2010. The loan bears interest at the prime rate less 1% (effectively 2.25%).
• Risks: Key risks include continued net outflows from funds due to market volatility and economic conditions, which directly impact revenue. The Company notes that performance relative to benchmarks is a major factor in retaining investors.
• Fee Waivers: The Company waived fees of $0.10 million for the nine months ended June 30, 2010, to comply with contractual expense ratio limitations. These waivers are expected to decrease as specific contractual waivers expire.
• Impairment: Management concluded that management contract assets (valued at $22.3 million) are not impaired as of June 30, 2010, based on projected revenues exceeding expenses.

Investor Verification Checklist

• Debt Maturity: Verify the repayment of the $1.3 million bank loan principal due September 30, 2010, and confirm no covenant violations exist.
• Net Flows: Monitor the trend of redemptions versus organic inflows, as net outflows have been significant ($270.6M over nine months) despite market appreciation.
• Sub-advisor Costs: Review the impact of rising sub-advisor fees (up 356% year-over-year for nine months) on net margins as sub-advised assets grow.
• Fee Waiver Expirations: Confirm the expiration of contractual fee waivers for the Select Large Value and Cornerstone Large Growth funds (expired March 31, 2010) and the impact on future revenue.
• Concentration Risk: Note that approximately 25% of average daily net assets are concentrated in the Hennessy Cornerstone Growth Fund, which has experienced significant outflows.