Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
Forward Looking Statements
Certain statements in this report are forward-looking within the meaning of the federal securities laws. Although management believes that the expectations reflected in the forward-looking statements are
reasonable, future levels of activity, performance or achievements cannot be guaranteed. Additionally, management does not assume responsibility for the accuracy or completeness of these statements. There is no regulation requiring an update of any
of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations.
Our business activities are affected by many factors, including, without limitation, redemptions by mutual fund shareholders, general economic and financial conditions, movement of interest rates,
competitive conditions, industry regulation, fluctuation in the stock market, and others, many of which are beyond the control of our management.
Statements regarding the following subjects are forward-looking by their nature:
|
|
our business strategy, including our ability to identify and complete future acquisitions;
|
|
|
market trends and risks;
|
|
|
our assumptions about changes in the market place, especially with the extreme volatility in the global and US financial markets;
|
|
|
our estimates for future performance;
|
|
|
our estimates regarding anticipated revenues and operating expenses; and
|
|
|
our ability to retain the mutual fund assets we currently manage.
|
Although we seek to maintain cost controls, a significant portion of our expenses are fixed and do not vary greatly. As a result,
substantial fluctuations in our revenue can directly impact our net income from period to period.
Overview
We derive our operating revenue from investment advisory fees and shareholder servicing fees paid to us by the Hennessy Funds. These fees
are calculated as a percentage of the average daily net assets in our mutual funds and vary from fund to fund. The
- 16 -
fees we receive fluctuate with changes in the total net asset value of the assets in our mutual funds, which are affected by our investment performance, redemptions, completed purchases of the
rights to manage mutual funds, market conditions and the success of our marketing efforts. Average assets under management were $3.23 billion and $809.5 million for the three months ended March 31, 2013 and 2012, respectively. Average assets
under management were $2.84 billion and $793.2 million for the six months ended March 31, 2013 and 2012, respectively.
Total assets under management were $3.41 billion as of March 31, 2013. Our total assets under management have increased since
March 31, 2012 mainly due to our purchase of assets related to the management of the former FBR funds, which had approximately $2.2 billion in assets under management. The following table illustrates the changes in assets under management from
March 31, 2012 through March 31, 2013:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Assets Under Management
At Each Quarter End,
March 31, 2012 through March 31, 2013
|
|
|
|
3/31/2012
|
|
|
6/30/2012
|
|
|
9/30/2012
|
|
|
12/31/2012
|
|
|
3/31/2013
|
|
|
|
(In Thousands)
|
|
Beginning assets under management
|
|
$
|
780,950
|
|
|
$
|
814,944
|
|
|
$
|
821,406
|
|
|
$
|
919,262
|
|
|
$
|
3,024,068
|
|
Acquisition inflows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,222,961
|
|
|
|
|
|
Organic inflows
|
|
|
28,167
|
|
|
|
80,366
|
|
|
|
78,949
|
|
|
|
156,362
|
|
|
|
312,272
|
|
Redemptions
|
|
|
(75,389
|
)
|
|
|
(40,381
|
)
|
|
|
(55,355
|
)
|
|
|
(287,467
|
)
|
|
|
(297,363
|
)
|
Market appreciation (depreciation)
|
|
|
81,216
|
|
|
|
(33,523
|
)
|
|
|
74,262
|
|
|
|
12,950
|
|
|
|
367,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending assets under management
|
|
$
|
814,944
|
|
|
$
|
821,406
|
|
|
$
|
919,262
|
|
|
$
|
3,024,068
|
|
|
$
|
3,406,426
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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|
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The principal asset on our balance sheet, management contracts - net of accumulated amortization,
represents the capitalized costs incurred in connection with the purchase of assets related to management of mutual funds. As of March 31, 2013, this asset had a net balance of $42.5 million.
The principal liability on our balance sheet is the bank debt incurred in connection with the purchase of assets related to management of
mutual funds. As of March 31, 2013, this liability had a balance of $17.8 million.
- 17 -
Results of Operations
The following table displays items in the statements of income and comprehensive income as dollar amounts and as percentages of total revenue for the three months ended March 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
(In thousands, except percentages)
|
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory fees
|
|
$
|
5,726
|
|
|
|
96.3
|
%
|
|
$
|
1,538
|
|
|
|
89.0
|
%
|
Shareholder service fees
|
|
|
221
|
|
|
|
3.7
|
|
|
|
191
|
|
|
|
11.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
5,947
|
|
|
|
100.0
|
|
|
|
1,729
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
|
1,850
|
|
|
|
31.1
|
|
|
|
586
|
|
|
|
33.9
|
|
General and administrative
|
|
|
698
|
|
|
|
11.7
|
|
|
|
387
|
|
|
|
22.4
|
|
Mutual fund distribution
|
|
|
351
|
|
|
|
5.9
|
|
|
|
149
|
|
|
|
8.6
|
|
Sub-advisor fees
|
|
|
950
|
|
|
|
16.0
|
|
|
|
142
|
|
|
|
8.2
|
|
Amortization and depreciation
|
|
|
45
|
|
|
|
0.8
|
|
|
|
25
|
|
|
|
1.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
3,894
|
|
|
|
65.5
|
|
|
|
1,289
|
|
|
|
74.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
2,053
|
|
|
|
34.5
|
|
|
|
440
|
|
|
|
25.4
|
|
|
|
|
|
|
Interest expense
|
|
|
179
|
|
|
|
3.0
|
|
|
|
13
|
|
|
|
0.7
|
|
Other income
|
|
|
(1
|
)
|
|
|
(0.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
1,875
|
|
|
|
31.5
|
|
|
|
427
|
|
|
|
24.7
|
|
|
|
|
|
|
Income tax expense
|
|
|
758
|
|
|
|
12.7
|
|
|
|
181
|
|
|
|
10.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,117
|
|
|
|
18.8
|
%
|
|
$
|
246
|
|
|
|
14.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
: Total revenue increased 244% from the prior comparable period to $5.9 million in the
three months ended March 31, 2013, due to increased average assets under management. Investment advisory fees increased 272.3% from the prior comparable period to $5.7 million in the three months ended March 31, 2013, and shareholder
servicing fees increased 15.7% from the prior comparable period to $0.2 million in the three months ended March 31, 2013. The increase in investment advisory fees is due to increased average daily net assets in our mutual funds. However, not
all of the Hennessy Funds earn shareholder servicing fees. The increase in shareholder servicing fees is due to increased average daily net assets in our mutual funds that earn shareholder servicing fees.
Average daily net assets in our mutual funds for the three months ended March 31, 2013 increased by $2.4 billion, or 299%, to $3.23
billion from $809.5 million in the prior comparable period. The increase is mainly attributable to the purchase of assets related to the management of the former FBR Funds, which had approximately $2.2 billion in assets under management. The
increase is augmented by market appreciation.
About 25.8%, or $833.5 million, is in the Hennessy Focus Fund, which generates
revenue at a rate of 0.90% of daily average assets. However, the Company pays a sub-advisor fee of 0.29% of average daily net assets of the Hennessy Focus Fund, which reduces the net impact to the Companys financial operations. The second
largest concentration of average daily net assets, at 24.5%, or $792 million, is in the Hennessy Gas Utility Index Fund, which generates revenue at a rate of 0.40% of daily average assets.
- 18 -
Total net assets in our mutual funds increased by $2.59 billion, or 318%, from $814.9
million as of the end of the prior comparable period to $3.4 billion as of March 31, 2013. The $2.59 billion increase in net mutual fund assets is attributable to the purchase of assets related to the management of the former FBR Funds, which
had approximately $2.2 billion in assets under management. Redemptions as a percentage of assets under management increased from an average of 3.1% per month to 3.2% per month during the same period due to increased outflows.
The net outflows are relatively negligible at approximately $50 million. There has been market appreciation of $421 million since the
prior comparable period, and investors are seeking positive returns over the relatively flat or negative returns in other investment markets.
Redemptions from the funds were due, among other factors, to the following:
Although the economic environment remains turbulent, we are finally seeing investors returning to the equity markets. For
the quarter ended March 31, 2013, every one of our sixteen Hennessy Funds had positive returns, which has encouraged inflows.
There is continued political and economic uncertainty due to: continued unemployment, rising US debt and continued volatility in Europe, among other things. However, Americans have poured record amounts
into their savings, despite interest rates being at record lows. Also, the U.S. Government is beginning to provide clarity, and we believe this will allow a sustained recovery to begin in earnest.
We offer two sub-advised funds that are invested in the Japanese equity market. These funds experienced outflows as Japan
continued to recover from the earthquake and tsunami of March, 2011. However, we continue to believe in the resiliency and aptitude of the Japanese people and of Japanese companies, and investors have shown they agree. The Hennessy Japan Fund and
the Hennessy Japan Small Cap Fund experienced net inflows of $2.7 million and $2.2 million, respectively, in the quarter ended March 31, 2013.
The market appreciation was due, among other factors, to the following:
This year ended March 31, 2013, the financial markets showed great resiliency despite the consistently negative news that drive consumer and investor fear. We are finally seeing indications that the
confidence of the individual investor is returning, and there is nothing like positive returns to convince even the greatest market bears to invest in the US equity markets.
The fundamentals continue to support viable markets: Price to Sales, Price to Earnings, Price to Book, and Price to Cash
Flow ratios are below their historical averages, and corporate profits were at an all-time high during the fiscal year, with companies sitting on over $2 trillion in cash on their balance sheets. If investors stay the course and focus on the
fundamentals, we expect to see the success in the stock market continue.
- 19 -
The Company has contractual expense ratio limitations for the following Funds:
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|
|
|
|
|
|
|
|
Fund
|
|
Expense Ratio
Limitation
(as a % of fund assets)
|
|
|
Expenses Waived for
the 3-months ended
3/31/2013
(in $)
|
|
Investor Class Shares
|
|
|
|
|
|
|
|
|
Hennessy Large Cap Financial Fund*
|
|
|
1.95
|
%
|
|
$
|
|
|
Hennessy Small Cap Financial Fund*
|
|
|
1.95
|
%
|
|
|
|
|
Hennessy Technology Fund*
|
|
|
1.95
|
%
|
|
|
10,261
|
|
Hennessy Focus Fund*
|
|
|
1.95
|
%
|
|
|
|
|
Hennessy Gas Utility Index Fund*
|
|
|
0.80
|
%
|
|
|
|
|
Hennessy Equity and Income Fund*
|
|
|
1.08
|
%
|
|
|
17
|
|
Hennessy Core Bond Fund*
|
|
|
1.05
|
%
|
|
|
5,255
|
|
Institutional Class Shares
|
|
|
|
|
|
|
|
|
Hennessy Cornerstone Growth Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Mid Cap 30 Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Value Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Large Growth Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Large Value Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Small Cap Financial Fund*
|
|
|
1.70
|
%
|
|
|
|
|
Hennessy Technology Fund*
|
|
|
1.70
|
%
|
|
|
2,550
|
|
Hennessy Focus Fund*
|
|
|
1.70
|
%
|
|
|
|
|
Hennessy Equity and Income Fund*
|
|
|
1.08
|
%
|
|
|
|
|
Hennessy Core Bond Fund*
|
|
|
1.05
|
%
|
|
|
14,499
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$
|
32,582
|
|
|
|
|
|
|
|
|
|
|
*
|
Expense ratio limitations expire on February 28, 2015.
|
The Company does not normally waive fees (other than for contractual expense ratio limitations), nor does it anticipate waiving fees, on a voluntary basis.
Operating Expenses
: Total operating expenses increased 202.1% to $3.9 million in the three months ended March 31, 2013, from
$1.3 million in the prior comparable period. The increase is due to increases in all expense categories due to management of seven additional mutual funds. As a percentage of total revenue, total operating expenses decreased 9.1% to 65.5% in the
three months ended March 31, 2013, as compared to 74.6% in the prior comparable period.
Compensation and
Benefits
: Compensation and benefits increased 215.7% to $1.9 million in the three months ended March 31, 2013, from $0.6 million in the prior comparable period. The increase is primarily due to new employees hired to manage mutual funds and
increase our sales and marketing efforts. As a percentage of total revenue, compensation and benefits decreased 2.8% to 31.1% for the three months ended March 31, 2013, compared to 33.9% in the prior comparable period.
General and Administrative Expenses
: General and administrative expense increased 80.4% to $0.7 million in the three months ended
March 31, 2013, from $0.4 million in the prior comparable period. The increase resulted primarily from an increase in marketing, sales and distribution efforts in the current period. As a percentage of total revenue, general and administrative
expense decreased 10.7% to 11.7% in the three months ended March 31, 2013, from 22.4% in the prior comparable period.
- 20 -
Mutual Fund Distribution Expenses
: Distribution expense increased 135.6% to $0.4
million in the three months ended March 31, 2013, from $0.1 million in the prior comparable period. As a percentage of total revenue, distribution expense decreased 2.7% to 5.9% for the three months ended March 31, 2013, compared to 8.6%
in the prior comparable period.
The mutual fund distribution expense consists of fees paid for our mutual funds to be offered
on various financial platforms. The platforms allow consumers to purchase shares from numerous mutual fund companies through a single location, which provides those customers with a single statement of investments and a single source for
mutual fund information and customer service. When our funds are purchased through one of these platforms, such as Charles Schwab, Fidelity, TD Ameritrade or Morgan Stanley Smith Barney, the platform typically charges us an asset based fee which is
recorded in mutual fund distribution expense in our statement of operations. The fees increase or decrease in line with the value of the funds held on the platforms, which can be affected by inflows, outflows and market performance.
The increased costs in the current period are due to an increase in the value of average assets held through mutual fund
platforms such as Charles Schwab, Fidelity and TD Ameritrade. For the three months ended March 31, 2013, the value of the mutual funds held on Charles Schwab (the platform to which we pay almost half of our total mutual fund distribution fees)
increased by about 95% from the prior comparable period.
The incremental assets purchased through the mutual fund platforms
are not as profitable as those purchased in direct shareholder accounts due to the participation fees paid on assets held in the various mutual fund platforms. All of our funds are impacted by activity on the financial platforms as they are all
available on several platforms.
Sub-advisor Fee Expense
: Sub-advisor fee expense increased 569% to $0.7 million in the
three months ended March 31, 2013, from $0.1 million in the prior comparable period. The increase is a result of the addition of three new sub-advised funds in the current period: the Hennessy Focus Fund, the Hennessy Core Bond Fund and the
Hennessy Equity and Income Fund. As a percentage of total revenue, sub-advisor fee expense increased 7.8% to 16% for the three months ended March 31, 2013, compared to 8.2% in the prior comparable period.
Amortization and Depreciation Expense
: Amortization and depreciation expense increased 80% to $0.05 million in the three months
ended March 31, 2013, from $0.03 million in the prior comparable period. As a percentage of total revenue, amortization and depreciation expense decreased 0.7% to 0.8% for the three months ended March 31, 2013, compared to 1.5% in the
prior comparable period.
Interest Expense
: Interest expense increased by 1,276.9% from the prior comparable period due
to a loan amendment adding a net amount of $15.9 million to the principal loan balance since the prior comparable period. As a percentage of total revenue, interest expense increased 2.3% to 3% for the three months ended March 31, 2013,
compared to 0.7% in the prior comparable period.
- 21 -
Other Income
: Other income increased 100% to $0.001 million from the prior comparable
period income of $0. The increased income is due to dividends and unrealized gains on marketable securities. As a percentage of total revenue, other income remained the same at 0%.
Income Taxes
: The provision for income taxes increased 318.8% to $0.8 million in the three months ended March 31, 2013, from
$0.2 million in the prior comparable period. The change is due to increased income before income tax expense in the current period, as well as a valuation allowance on the capital loss carryforward in the current period.
Net Income
: Net income increased by 354.1% to $1.1 million in the three months ended March 31, 2013, from $0.2 million in the
prior comparable period, as a result of the factors discussed above.
The following table displays items in the statements of
income and comprehensive income as dollar amounts and as percentages of total revenue for the six months ended March 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended March 31,
|
|
|
|
2013
|
|
|
2012
|
|
|
|
(In thousands, except percentages)
|
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
|
Amounts
|
|
|
Percent
of Total
Revenue
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment advisory fees
|
|
$
|
10,215
|
|
|
|
95.9
|
%
|
|
$
|
3,068
|
|
|
|
89.0
|
%
|
Shareholder service fees
|
|
|
435
|
|
|
|
4.1
|
|
|
|
378
|
|
|
|
11.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
10,650
|
|
|
|
100.0
|
|
|
|
3,446
|
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
|
3,262
|
|
|
|
30.6
|
|
|
|
1,120
|
|
|
|
32.5
|
|
General and administrative
|
|
|
1,372
|
|
|
|
12.9
|
|
|
|
935
|
|
|
|
27.1
|
|
Mutual fund distribution
|
|
|
619
|
|
|
|
5.8
|
|
|
|
291
|
|
|
|
8.4
|
|
Sub-advisor fees
|
|
|
1,661
|
|
|
|
15.6
|
|
|
|
282
|
|
|
|
8.2
|
|
Amortization and depreciation
|
|
|
83
|
|
|
|
0.8
|
|
|
|
46
|
|
|
|
1.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
6,997
|
|
|
|
65.7
|
|
|
|
2,674
|
|
|
|
77.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
3,653
|
|
|
|
34.3
|
|
|
|
772
|
|
|
|
22.4
|
|
|
|
|
|
|
Interest expense
|
|
|
317
|
|
|
|
3.0
|
|
|
|
27
|
|
|
|
0.9
|
|
Other expense (income), net
|
|
|
109
|
|
|
|
1.0
|
|
|
|
(1
|
)
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
3,227
|
|
|
|
30.3
|
|
|
|
746
|
|
|
|
21.6
|
|
|
|
|
|
|
Income tax expense
|
|
|
1,342
|
|
|
|
12.6
|
|
|
|
348
|
|
|
|
10.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,885
|
|
|
|
17.7
|
%
|
|
$
|
398
|
|
|
|
11.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
- 22 -
Revenues
: Total revenue increased 209.1% from the prior comparable period to $10.7
million in the six months ended March 31, 2013, due to increased average assets under management. Investment advisory fees increased 233% from the prior comparable period to $10.2 million in the six months ended March 31, 2013, and
shareholder servicing fees increased 15.1% from the prior comparable period to $0.4 million in the six months ended March 31, 2013. The increase in investment advisory fees is due to increased average daily net assets in our mutual funds.
However, not all of the Hennessy Funds earn shareholder servicing fees. The increase in shareholder servicing fees is due to increased average daily net assets in our mutual funds that earn shareholder servicing fees.
Average daily net assets in our mutual funds for the six months ended March 31, 2013 increased by $2.0 billion, or 258%, to $2.84
billion from $793.2 million in the prior comparable period. The increase is attributable to the purchase of assets related to the management of the former FBR Funds, which had approximately $2.2 billion in assets under management.
About 24.5%, or $694.9 million, of the total average daily net assets for the period are concentrated in the Hennessy Focus Fund, which
generates revenue at a rate of 0.90% of daily average assets. However, the Company pays a sub-advisor fee of 0.29% of average daily net assets of the Hennessy Focus Fund, which reduces the net impact to the Companys financial operations. The
second largest concentration of average daily net assets at 22.9%, or $651.3 million, is in the Hennessy Gas Utility Index Fund, which generates revenue at a rate of 0.40% of daily average assets.
Total net assets in our mutual funds increased by $2.59 billion, or 318%, from $814.9 million as of the end of the prior comparable
period to $3.4 billion as of March 31, 2013. The $2.59 billion increase in net mutual fund assets is mainly attributable to the purchase of assets related to the management of the former FBR Funds, which had approximately $2.2 billion in assets
under management. Redemptions as a percentage of assets under management increased from an average of 2.9% per month to 3.6% per month during the same period due to increased outflows.
The net outflows are relatively negligible at approximately $50 million. There has been market appreciation of $421 million since the
prior comparable period, and investors are seeking positive returns over the relatively flat or negative returns in other investment markets.
Redemptions from the funds were due, among other factors, to the following:
Although the economic environment remains turbulent, we are finally seeing investors returning to the equity markets. For
the year ended March 31, 2013, every one of our sixteen Hennessy Funds had positive returns, which has encouraged inflows.
There is continued political and economic uncertainty due to: continued unemployment, rising US debt and continued volatility in Europe, among other things. However, Americans have poured record amounts
into their savings, despite interest rates being at record lows. Also, the U.S. Government is beginning to provide clarity, and we believe this will allow a sustained recovery to begin in earnest.
We offer two sub-advised funds that are invested in the Japanese equity market. These funds experienced outflows as Japan
continued to recover from the earthquake and tsunami of March, 2011. However, we
- 23 -
continue to believe in the resiliency and aptitude of the Japanese people and of Japanese companies, and investors have shown they agree. The Hennessy Japan Fund and the Hennessy Japan Small Cap
Fund experienced net inflows of $2.7 million and $2.2 million, respectively, in the quarter ended March 31, 2013.
The market
appreciation was due, among other factors, to the following:
This year ended March 31, 2013, the
financial markets showed great resiliency despite the consistently negative news that drive consumer and investor fear. We are finally seeing indications that the confidence of the individual investor is returning, and there is nothing like positive
returns to convince even the greatest market bears to invest in the US equity markets.
The fundamentals
continue to support viable markets: Price to Sales, Price to Earnings, Price to Book, and Price to Cash Flow ratios are below their historical averages, and corporate profits were at an all-time high during the fiscal year, with companies sitting on
over $2 trillion in cash on their balance sheets. If investors stay the course and focus on the fundamentals, we expect to see the success in the stock market continue.
The Company has contractual expense ratio limitations for the following Funds:
|
|
|
|
|
|
|
|
|
Fund
|
|
Expense Ratio
Limitation
(as a % of fund assets)
|
|
|
Expenses Waived for
the 6-months ended
3/31/2013
(in $)
|
|
Investor Class Shares
|
|
|
|
|
|
|
|
|
Hennessy Large Cap Financial Fund*
|
|
|
1.95
|
%
|
|
$
|
|
|
Hennessy Small Cap Financial Fund*
|
|
|
1.95
|
%
|
|
|
|
|
Hennessy Technology Fund*
|
|
|
1.95
|
%
|
|
|
19,167
|
|
Hennessy Focus Fund*
|
|
|
1.95
|
%
|
|
|
|
|
Hennessy Gas Utility Index Fund*
|
|
|
0.80
|
%
|
|
|
|
|
Hennessy Equity and Income Fund*
|
|
|
1.08
|
%
|
|
|
17
|
|
Hennessy Core Bond Fund*
|
|
|
1.05
|
%
|
|
|
7,767
|
|
Institutional Class Shares
|
|
|
|
|
|
|
|
|
Hennessy Cornerstone Growth Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Mid Cap 30 Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Value Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Cornerstone Large Growth Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Large Value Fund
|
|
|
0.98
|
%
|
|
|
|
|
Hennessy Small Cap Financial Fund*
|
|
|
1.70
|
%
|
|
|
|
|
Hennessy Technology Fund*
|
|
|
1.70
|
%
|
|
|
4,115
|
|
Hennessy Focus Fund*
|
|
|
1.70
|
%
|
|
|
|
|
Hennessy Equity and Income Fund*
|
|
|
1.08
|
%
|
|
|
|
|
Hennessy Core Bond Fund*
|
|
|
1.05
|
%
|
|
|
22,259
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$
|
53,325
|
|
|
|
|
|
|
|
|
|
|
*
|
Expense ratio limitations expire on February 28, 2015.
|
The Company does not normally waive fees (other than for contractual expense ratio limitations), nor does it anticipate waiving fees, on a voluntary basis.
- 24 -
Operating Expenses
: Total operating expenses increased 161.7% to $7 million in the
six months ended March 31, 2013, from $2.7 million in the prior comparable period. The increase is due to increases in all expense categories due to management of seven additional mutual funds. As a percentage of total revenue, total operating
expenses decreased 11.9% to 65.7% in the six months ended March 31, 2013, as compared to 77.6% in the prior comparable period.
Compensation and Benefits
: Compensation and benefits increased 191.3% to $3.3 million in the six months ended March 31, 2013, from $1.1 million in the prior comparable period. The increase is
primarily due to new employees hired to manage mutual funds and increase our sales and marketing efforts. As a percentage of total revenue, compensation and benefits decreased 1.9% to 30.6% for the six months ended March 31, 2013, compared to
32.5% in the prior comparable period.
General and Administrative Expenses
: General and administrative expense
increased 46.7% to $1.4 million in the six months ended March 31, 2013, from $0.9 million in the prior comparable period. The increase resulted primarily from an increase in marketing, sales and distribution efforts in the current period. As a
percentage of total revenue, general and administrative expense decreased 14.2% to 12.9% in the six months ended March 31, 2013, from 27.1% in the prior comparable period.
Mutual Fund Distribution Expenses
: Distribution expense increased 112.7% to $0.6 million in the six months ended March 31,
2013, from $0.3 million in the prior comparable period. As a percentage of total revenue, distribution expense decreased 2.6% to 5.8% for the six months ended March 31, 2013, compared to 8.4% in the prior comparable period.
The mutual fund distribution expense consists of fees paid for our mutual funds to be offered on various financial platforms.
The platforms allow consumers to purchase shares from numerous mutual fund companies through a single location, which provides those customers with a single statement of investments and a single source for mutual fund information and customer
service. When our funds are purchased through one of these platforms, such as Charles Schwab, Fidelity, TD Ameritrade or Morgan Stanley Smith Barney, the platform typically charges us an asset based fee which is recorded in mutual fund
distribution expense in our statement of operations. The fees increase or decrease in line with the value of the funds held on the platforms, which can be affected by inflows, outflows and market performance.
The increased costs in the current period are due to an increase in the value of average assets held through mutual fund platforms such
as Charles Schwab, Fidelity and TD Ameritrade. For the six months ended March 31, 2013, the value of the mutual funds held on Charles Schwab (the platform to which we pay almost half of our total mutual fund distribution fees) increased by
about 81% from the prior comparable period.
The incremental assets purchased through the mutual fund platforms are not as
profitable as those purchased in direct shareholder accounts due to the participation fees paid on assets held in the various mutual fund platforms. All of our funds are impacted by activity on the financial platforms as they are all available on
several platforms.
Sub-advisor Fee Expense
: Sub-advisor fee expense increased 489% to $1.7 million in the six months
ended March 31, 2013, from $0.3 million in the prior comparable period. The increase is a result of the addition of three new sub-advised funds in the
- 25 -
current period: the Hennessy Focus Fund, the Hennessy Core Bond Fund and the Hennessy Equity and Income Fund. As a percentage of total revenue, sub-advisor fee expense increased 7.4% to 15.6% for
the six months ended March 31, 2013, compared to 8.2% in the prior comparable period.
Amortization and Depreciation
Expense
: Amortization and depreciation increased 80.4% to $0.08 million in the six months ended March 31, 2013, from $0.05 million in the prior comparable period. As a percentage of total revenue, amortization and depreciation expense
decreased 0.6% to 0.8% for the six months ended March 31, 2013, compared to 1.4% in the prior comparable period.
Interest Expense
: Interest expense increased by 1,074.1% from the prior comparable period due to a loan amendment adding a net
amount of $15.5 million to the principal loan balance since the prior comparable period. As a percentage of total revenue, interest expense increased 2.1% to 3.0% for the six months ended March 31, 2013, compared to 0.9% in the prior comparable
period.
Other Income or Expense
: Other income or expense increased 11,100% to an expense of $0.1 million from the
prior comparable period income of $.001 million. The increased expense is due to the realized loss of $0.1 million on the sale of the available for sale investment on December 14, 2012. As a percentage of total revenue, other expense increased
1.1% to 1.0% for the six months ended March 31, 2013, compared to (0.1%) in the prior comparable period.
Income
Taxes
: The provision for income taxes increased 285.6% to $1.3 million in the six months ended March 31, 2013, from $0.3 million in the prior comparable period. The change is due to increased income before income tax expense in the current
period, as well as a valuation allowance on the capital loss carryforward in the current period.
Net Income
: Net
income increased by 373.6% to $1.9 million in the six months ended March 31, 2013, from $0.4 million in the prior comparable period, as a result of the factors discussed above.
Critical Accounting Policies
Accounting policies, methods, and estimates are an
integral part of the financial statements prepared by management and are based upon managements current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about
future events. Certain accounting policies, methods, and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from
managements current judgment.
Our operating revenues consist of contractual management and shareholder servicing
fees. We earn our management fees principally through portfolio management of our mutual funds, and we earn our shareholder servicing fees by assisting customers in
- 26 -
purchases, sales, distribution and customer service. The revenues are earned and calculated daily by our fund accountant. In accordance with the FASB guidance on revenue recognition,
the fees are recognized monthly by the Company. Our contractual agreements provide persuasive evidence that an arrangement exists with fixed and determinable fees, and the services are rendered daily. The collectability is probable as the fees
are received from our fund accountant in the month subsequent to the month in which the services are provided.
The management
agreements acquired by the Company are considered intangible assets with an indefinite life. In June 2001, the Financial Accounting Standards Board issued the FASB guidance Intangibles - Goodwill and Other. It states that goodwill and
intangible assets with indefinite useful lives are not amortized, but are tested at least annually for impairment. We fully implemented the provisions of the FASB guidance on October 1, 2002, at which time we ceased amortization of these
intangible assets. Impairment analysis is conducted quarterly and coincides with our quarterly and annual financial reporting.
In conducting the impairment analysis, the future revenues are calculated as a percent of assets under management based on our existing
management agreements with the Hennessy Funds. The future expenses are based on projections of our current expenses, adjusted for changes in the assets under management. For example, variable expenses such as platform fees and sub-advisor fees grow
in direct proportion with our assets under management. Other semi-variable expenses, such as office rent and professional services, grow at a rate slower than the growth in assets under management. Specifically, the projected revenues and expenses
are based on assumptions about the growth of our assets under management. Since our management contracts have an indefinite life, the projections of revenues and expenses in theory are calculated into perpetuity. The actual values, however, were
calculated over the future 15 years, and the value developed for the periods beyond the 15 year forecast is reflected in the terminal value calculation. Ultimately, growth rates of equities over the long-term were used in estimating future rates,
primarily based on the consistent tendency of returns to center about the 11% range, as evidenced by annual S&P returns from 1928 to 2011. In addition, studies have concluded that in general, flows into various mutual fund groups are highly
correlated with market performance, which suggests the Hennessy Funds will average reasonable inflows over the future 15 years in response to market appreciation.
We measured the fair value of the management contracts by incorporating our estimates and assumptions into a projection of future revenues, based in part upon estimates of assets under management growth
and client attrition, and expenses. Based on the analysis, we concluded that projected revenues exceed projected expenses by an amount that is greater than the current carrying value of the management contracts. We therefore concluded that the
management contract assets are not impaired as of September 30, 2012. We continually evaluate whether events or circumstances have occurred that indicate the management contracts may be impaired. If future valuations in the marketplace decline,
the valuation of management agreements acquired may become impaired and net earnings would be negatively impacted by the resulting impairment adjustment. As of March 31, 2013, no events or circumstances occurred that indicated potential
impairment of the management contracts.
The costs related to the Companys purchase of assets related to the management
of mutual funds are capitalized as incurred. The costs are defined as an intangible asset per FASB standard Intangibles - Goodwill and Other. The acquisition costs include legal fees, fees for soliciting shareholder approval
and percent of asset costs. The amounts are included in the management contract asset totaling $42.5 million, net as of March 31, 2013.
- 27 -
Significant Estimate
In accordance with the Asset Purchase Agreement, we will make a subsequent payment upon the first anniversary of closing constituting the remaining forty percent of the purchase price. The subsequent
payment will be calculated on total assets under management as of October 25, 2013, which is an unknown number. Based on net asset values of the former FBR Funds on March 31, 2013, the second payment would be approximately $14 million.
However, positive market impact has contributed significantly to the increase in net asset values of the former FBR Funds since the purchase date, and the calculation can therefore change immensely prior to the valuation date of October 25,
2013 due to market volatility. There is no maximum payment due, and it is possible that zero payment will be due. Therefore, although the second payment is probable, it is not estimable, and we are therefore booking zero contingent liability as of
March 31, 2013.
Liquidity and Capital Resources
We continually review our capital requirements to ensure that we have sufficient funding available to support our growth strategies. Management anticipates that cash and other liquid assets on hand as of
March 31, 2013 will be sufficient to meet our short-term capital requirements. To the extent that liquid resources and cash provided by operations are not adequate to meet long-term capital requirements, such as a possible subsequent payment on
the purchase of assets related to management of the former FBR Funds, management plans to raise additional capital through debt or equity markets. There can be no assurance that we will be able to borrow funds or raise additional equity.
Total assets under management as of March 31, 2013 were $3.41 billion, which was an increase of $2.5 billion, or 270.6%, from
September 30, 2012. The primary source of our revenue, liquidity and cash flow are our fees, which are based on and generated by our average assets under management. Fixed assets and management agreements purchased totaled $42.7 million as of
March 31, 2013. Our remaining assets are very liquid, consisting primarily of cash and receivables derived from mutual fund asset management activities. As of March 31, 2013, we had cash and cash equivalents of $6.1 million.
- 28 -
The following table summarizes key financial data relating to our liquidity and use of cash
for the three months ended March 31, 2013 and 2012:
|
|
|
|
|
|
|
|
|
|
|
For the Six Months
Ended March 31,
(unaudited, in thousands)
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
Cash flow data:
|
|
|
|
|
|
|
|
|
Operating cash flows
|
|
$
|
1,837
|
|
|
$
|
496
|
|
Investing cash flows
|
|
|
(19,701
|
)
|
|
|
(64
|
)
|
Financing cash flows
|
|
|
15,279
|
|
|
|
(621
|
)
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
$
|
(2,585
|
)
|
|
$
|
(189
|
)
|
|
|
|
|
|
|
|
|
|
The increase in cash provided by operating activities of $1.3 million is due to the effects of the
purchase of assets related to the management agreements of mutual funds which increased net income.
The increase in cash used
in investing activities is due to $20 million related to the purchase of assets related to the management of the former FBR Funds, partly offset by the proceeds related to the liquidation of the available for sale investment.
The increase in cash provided by financing activities is due to a loan amendment to finance the purchase of assets related to the
management of the former FBR Funds.
Our Bank Loan: We have an outstanding bank loan with U.S. Bank National Association. On
October 26, 2012, the $1.9 million loan was amended to provide an additional $16.3 million to purchase the assets related to the management of the former FBR funds and an additional $0.2 million in loan fees for a new balance of $18.4 million.
The loan agreement requires fifty-nine (59) monthly payments in the amount of $153,333 plus interest at the banks prime rate (currently 3.25%, in effect since December 17, 2008) plus 0.75% (effective interest rate of 4.00%) and is
secured by the Companys assets. The final installment of the then outstanding principal and its interest are due October 26, 2017. The loan agreement includes certain reporting requirements and loan covenants requiring the maintenance of
certain financial ratios. We are in compliance with our loan covenants as of March 31, 2013. As of March 31, 2013, we had $17.8 million outstanding under our bank loan.