FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
Commission File Number 000-49872
HENNESSY ADVISORS, INC.
(Exact name of registrant as specified in its charter)
California 68-0176227
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
750 Grant Avenue, Suite 100
Novato, California 94945
(Address of principal executive offices) (Zip Code)
(415) 899-1555
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X ; No .
The number of shares outstanding of each of the issuer's classes of common
equity as of June 30, 2005 was 2,459,213.
Transitional Small Business Disclosure Format: Yes ; No X
------- -------
HENNESSY ADVISORS, INC.
INDEX
Page
Number
PART I. Financial Information
Item 1. Financial Statements
Balance Sheets as of June 30, 2005 and
September 30, 2004 3
Statements of Income for the three and nine
months ended June 30, 2005 and 2004 4
Statement of Changes in Stockholders' Equity
for the nine months ended June 30, 2005 5
Statements of Cash Flows for the nine months
ended June 30, 2005 and 2004 6
Notes to Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis 13
Item 3. Controls and Procedures 20
PART II. Other Information 21
Item 6. Exhibits 21
Signatures 21
2
Hennessy Advisors, Inc.
Balance Sheets
June 30, September 30,
2005 2004
---- ----
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 5,705,788 $ 4,568,323
Investments in marketable securities, at fair value 4,684 4,582
Investment fee income receivable 933,364 831,371
Prepaid expenses 81,706 65,004
Other current assets 23,677 24,413
--------------- ----------------
Total current assets 6,749,219 5,493,693
--------------- ----------------
Property and equipment, net of accumulated depreciation
of $91,463 and $100,200 90,924 88,092
Management contracts, net of accumulated amortization
of $628,627 14,142,520 14,142,520
Deferred income tax assets 126,900 126,900
Other assets 180,580 62,674
--------------- ----------------
Total assets $ 21,290,143 $ 19,913,879
=============== ================
Liabilities and Stockholders' Equity
Current liabilities:
Accrued liabilities and accounts payable $ 1,123,160 $ 1,416,505
Income taxes payable 11,830 772
Current portion of long-term debt 1,128,721 1,128,721
--------------- ----------------
Total current liabilities 2,263,711 2,545,998
--------------- ----------------
Long-term debt 5,361,426 6,207,967
Deferred income tax liabilities 733,138 452,200
--------------- ----------------
Total liabilities 8,358,275 9,206,165
--------------- ----------------
Stockholders' equity:
Adjustable rate preferred stock, $25 stated value, 5,000,000 shares
authorized: zero shares issued and outstanding - -
Common stock, no par value, 15,000,000 shares authorized:
2,459,213 shares issued and outstanding at June 30, 2005
and 2,452,713 at September 30, 2004 6,935,050 6,881,205
Additional paid-in capital 45,138 37,098
Retained earnings 5,951,680 3,789,411
--------------- ----------------
Total stockholders' equity 12,931,868 10,707,714
--------------- ----------------
Total liabilities and stockholders' equity $ 21,290,143 $ 19,913,879
=============== ================
See accompanying notes to condensed financial statements
3
Hennessy Advisors, Inc.
Statements of Income
Three and Nine Months Ended June 30, 2005 and 2004
(Unaudited)
Three Months Nine Months
2005 2004 2005 2004
---- ---- ---- ----
Revenue
Investment advisory fees $ 2,482,829 $ 2,324,616 $ 7,379,279 $ 6,234,999
Shareholder service fees 290,647 269,980 867,387 749,888
Other 32,609 7,139 71,357 19,099
--------------- --------------- --------------- ---------------
Total revenue 2,806,085 2,601,735 8,318,023 7,003,986
Operating expenses
Compensation and benefits 608,408 579,462 1,773,727 1,604,259
General and administrative 201,937 194,450 671,264 645,645
Mutual fund distribution 514,480 471,590 1,505,216 1,395,232
Amortization and depreciation 9,917 9,891 32,932 22,905
--------------- --------------- --------------- ---------------
Total operating expenses 1,334,742 1,255,393 3,983,139 3,668,041
--------------- --------------- --------------- ---------------
Operating income 1,471,343 1,346,342 4,334,884 3,335,945
Interest expense 98,779 77,982 283,018 92,353
--------------- --------------- --------------- ---------------
Income before income tax expense 1,372,564 1,268,360 4,051,866 3,243,592
Income tax expense 571,669 491,016 1,643,922 1,265,969
--------------- --------------- --------------- ---------------
Net income $ 800,895 $ 777,344 $ 2,407,944 $ 1,977,623
=============== =============== =============== ===============
Earnings per share:
Basic $ 0.33 $ 0.32 $ 0.98 $ 0.81
=============== =============== =============== ===============
Diluted $ 0.31 $ 0.31 $ 0.93 $ 0.78
=============== =============== =============== ===============
Weighted average shares outstanding:
Basic 2,458,100 2,443,260 2,455,119 2,440,557
=============== =============== =============== ===============
Diluted 2,596,361 2,517,993 2,592,422 2,542,568
=============== =============== =============== ===============
See accompanying notes to condensed financial statements
4
Hennessy Advisors, Inc.
Statements of Changes in Stockholders' Equity
Nine Months Ended June 30, 2005
(Unaudited)
Additional Total
Common Common Paid-in Retained Stockholders'
Shares Stock Capital Earnings Equity
------ ----- ------- -------- ------
Balances as of September 30, 2004 2,452,713 $ 6,881,205 $ 37,098 $ 3,789,411 $ 10,707,714
Net income for the nine months
ended June 30, 2005 - - - 2,407,944 2,407,944
Dividends paid - - - (245,675) (245,675)
Employee stock options exercised 6,500 53,845 - - 53,845
Tax benefit of employee stock sales - - 8,040 - 8,040
---------------------------------------------------------------------
Balances as of June 30, 2005 2,459,213 $ 6,935,050 $ 45,138 $ 5,951,680 $ 12,931,868
=====================================================================
See accompanying notes to condensed financial statements
5
Hennessy Advisors, Inc.
Statements of Cash Flows
Nine Months Ended June 30, 2005 and 2004
(Unaudited)
2005 2004
-------------- ---------------
Cash flows from operating activities:
Net income $ 2,407,944 $ 1,977,623
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 420 22,905
Deferred income taxes 280,938 162,671
Tax benefit from exercise of employee stock options 8,040 -
Unrealized gains on marketable securities (52) (224)
(Increase) decrease in operating assets:
Investment fee income receivable (101,993) (286,881)
Prepaid expenses (16,702) (2,101)
Other current assets 736 (30,434)
Other assets (117,193) -
Increase (decrease) in operating liabilities:
Accrued liabilities and accounts payable (293,345) 437,175
Income taxes payable 11,058 38,377
---------- -----------
Net cash provided by operating activities 2,179,851 2,319,111
---------- -----------
Cash flows provided by (used) in investing activities:
Purchases of property and equipment (26,606) (53,645)
Disposal of fully depreciated assets 32,512 -
Purchases of investments (50) (66)
Payments related to acquisition of management contracts - (8,504,577)
---------- -----------
Net cash provided by (used) in investing activities 5,856 (8,558,288)
---------- -----------
Cash flows provided by (used) in financing activities:
Deferred offering costs (9,871) -
Proceeds from long-term debt - 7,861,544
Principal payments on long-term debt (846,541) (282,180)
Payment of loan acquisition costs - (21,548)
Proceeds from exercise of employee stock options 53,845 73,000
Dividend payment (245,675) -
---------- -----------
Net cash provided by (used) in financing activities (1,048,242) 7,630,816
---------- -----------
Net increase in cash and cash equivalents 1,137,465 1,391,639
Cash and cash equivalents at the beginning of the period 4,568,323 2,802,117
---------- -----------
Cash and cash equivalents at the end of the period $ 5,705,788 $ 4,193,756
========== ===========
Supplemental disclosures of cash flow information:
Cash paid for:
Income taxes $ 1,277,938 $ 1,057,207
========== ===========
Interest $ 280,106 $ 75,436
========== ===========
Non-cash investing and financing disclosures:
Loan acquisition costs withheld from long-term debt proceeds $ - $ 39,505
========== ===========
See accompanying notes to condensed financial statements
6
Hennessy Advisors, Inc.
Notes to Condensed Financial Statements
(1) Basis of Financial Statement Presentation
The accompanying condensed financial statements of Hennessy Advisors,
Inc. (the "Company") are unaudited, but in the opinion of management, such
financial statements have been presented on the same basis as the audited
financial statements and include all adjustments consisting of only normal
recurring adjustments necessary for a fair presentation of the financial
position, results of operations and cash flows for the periods presented. The
condensed financial statements were prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. Operating results for the three and nine months ended June
30, 2005, are not necessarily indicative of results which may be expected for
the fiscal year ending September 30, 2005. For additional information, refer to
the financial statements for the fiscal year ended September 30, 2004, which are
included in the Company's annual report on Form 10-KSB, filed with the
Securities and Exchange Commission on December 14, 2004.
The operating activities of the Company consist primarily of providing
investment management services to six open-end mutual funds (the "Hennessy
Funds"). The Company serves as investment advisor of the Hennessy Cornerstone
Growth Fund, Hennessy Cornerstone Growth Fund-Series II, Hennessy Cornerstone
Value Fund, Hennessy Balanced Fund, Hennessy Total Return Fund and Hennessy
Focus 30 Fund.
(2) Management Contracts
As of June 30, 2005, Hennessy Advisors, Inc. had contractual management
agreements with Hennessy Funds, Inc. for the Hennessy Balanced Fund and the
Hennessy Total Return Fund and with Hennessy Mutual Funds, Inc. for the Hennessy
Cornerstone Growth Fund, the Hennessy Cornerstone Value Fund and the Hennessy
Focus 30 Fund.
The management agreements were renewed by the Board of Directors of
Hennessy Funds, Inc. and Hennessy Mutual Funds, Inc., at their meeting on March
8, 2005 for a period of one year. The agreements may be renewed from year to
year, as long as continuance is specifically approved at least annually in
accordance with the requirements of the 1940 Act. Each management agreement will
terminate in the event of its assignment, or it may be terminated by Hennessy
Funds, Inc. or Hennessy Mutual Funds, Inc. (either by the Board of Directors or
by vote of a majority of the outstanding voting securities of each Fund) or by
Hennessy Advisors, upon 60 days' prior written notice.
Under the terms of the management agreements, each Fund bears all
expenses incurred in its operation that are not specifically assumed by Hennessy
Advisors, the administrator or the distributor. Hennessy Advisors bears the
expense of providing office space, shareholder servicing, fullfilment, clerical
and bookkeeping services and maintaining books and records of the Funds.
Hennessy Advisors, as deemed necessary or by contract, may be required to waive
its management fee or subsidize other expenses for the Funds it manages.
Hennessy Advisors has agreed to cap the expense ratio of the Hennessy
Cornerstone Growth Fund, Hennessy Cornerstone Value Fund, Hennessy Total Return
Fund and Hennessy Balanced Fund through June 2005 (these contractual expense
caps were instituted under the terms of the proxy statement and prospectus dated
December 8, 2003 for the reorganization of certain Lindner funds into certain
Hennessy Funds)and to subsidize certain expenses. The expense ratios for each of
7
the funds are well below the contractual cap and subsidy is not currently
required.
(3) Long-term Debt
On March 11, 2004, Hennessy Advisors, Inc. secured financing from US
Bank National Association to acquire the management contracts for certain
Lindner funds. The loan agreement requires fifty-nine (59) monthly payments in
the amount of $94,060 plus interest at the bank's prime rate, which may change
from time to time (6.25% at June 30, 2005), and is secured by the Company's
assets. The final installment of the then outstanding principal and interest is
due March 10, 2009. In connection with securing the financing, Hennessy
Advisors, Inc. incurred loan costs in the amount of $61,052. These costs are
included in other assets and are being amortized on a straight-line basis over
60 months.
On July 1, 2005, we completed the previously announced acquisition of
mutual fund assets related to the management contract for The Henlopen Fund. We
paid $6.7 million, which equaled 2.25% of the $299 million in assets under
management at the close of business on June 30, 2005. The transaction was
financed by U.S. Bank National Association and terms of the loan are included
in Exhibit 10.1.
(4) Investment Advisor and Shareholder Service Fee Revenue
Investment Advisory and Shareholder Service fees, which are the primary
sources of revenue, are recorded when earned. The Company receives investment
advisory fees monthly at an annual rate of 0.74% of the average daily net assets
of the Hennessy Cornerstone Growth Fund and the Hennessy Cornerstone Value Fund.
The annual advisory fee for the Hennessy Focus 30 Fund is 1.0%. The annual
advisory fee for the Hennessy Balanced Fund and Hennessy Total Return Fund is
0.60%.
Fees for shareholder support services provided to the Hennessy
Cornerstone Growth Fund and Hennessy Cornerstone Value Fund, are charged at an
annual rate of 0.1% of average daily net assets.
Effective July 1, 2005, concurrent with our acquisition of The Henlopen
Fund, advisor fees for the Focus 30 Fund will be reduced to an annual rate of
0.74% and shareholder service fees will be charged at an annual rate of 0.1%.
(5) Income Taxes
Income taxes are accounted for under the asset and liability method, in
accordance with the provisions of FASB Statement No. 109 "Accounting For Income
Taxes".
Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those differences are expected to be recovered or settled. Deferred tax
assets and liabilities are adjusted for the effects of changes in tax laws and
rates on the date of enactment.
A valuation allowance is then established to reduce that deferred tax
asset to the level at which it is "more likely than not" that the tax benefits
will be realized. Realization of tax benefits of deductible temporary
differences and operating losses or credit carryforwards depends on having
sufficient taxable income of an appropriate character within the carryforward
8
periods. Sources of taxable income that may allow for the realization of tax
benefits include income that will result from future operations.
The Company's effective tax rates for three and nine months ended June
30, 2005, were 41.6% and 40.6% respectively, and differ from the federal
statutory rate of 34% primarily due to the effects of state income taxes.
(6) Reclassification of Prior Period's Statements
Certain items previously reported have been reclassified to conform
with the current period's presentation.
(7) Earnings per Share
Basic earnings per share is determined by dividing net earnings by the
weighted average number of shares of common stock outstanding, while diluted
earnings per share is determined by dividing the weighted average number of
shares of common stock outstanding adjusted for the dilutive effect of common
stock equivalents.
On January 27, 2005, our Board of Directors declared a three-for-two
stock split which was implemented on March 8, 2005 for shareholders of record as
of February 15, 2005. The following table presents the pre-split and post-split
computations of weighted average shares outstanding and earnings per share
calculations:
Three Months Ended Nine Months Ended
June 30, June 30,
-------------------------------------------------------------
2005 2004 2005 2004
-------------------------------------------------------------
(Amounts in dollars)
Net earnings: $ 800,895 $ 777,344 $ 2,407,944 $ 1,977,623
=============================================================================================================================
Pre-Split Basis
----------------------------------------------
Basic earnings per share: $ 0.49 $ 0.48 $ 1.47 $ 1.22
=============================================================
Weighted average shares outstanding for
basic earnings per share calculation 1,638,733 1,628,840 1,636,746 1,627,038
=============================================================
Diluted earnings per share: $ 0.46 $ 0.46 $ 1.39 $ 1.17
=============================================================
Weighted average shares outstanding for
diluted earnings per share calculation 1,730,907 1,678,662 1,728,281 1,695,045
=============================================================
Adjusted for the effect of three-for-two stock
----------------------------------------------
split and as reported herein, June 30, 2005
----------------------------------------------
Basic earnings per share: $ 0.33 $ 0.32 $ 0.98 $ 0.81
=============================================================
Weighted average shares outstanding for
basic earnings per share calculation 2,458,100 2,443,260 2,455,119 2,440,557
=============================================================
Diluted earnings per share: $ 0.31 $ 0.31 $ 0.93 $ 0.78
=============================================================
Weighted average shares outstanding for
diluted earnings per share calculation 2,596,361 2,517,993 2,592,422 2,542,568
=============================================================
9
8) Stock-Based Compensation
On May 2, 2001, the Company established an incentive plan (the Plan)
providing for the issuance of options, stock appreciation rights, restricted
stock, performance awards, and stock loans for the purpose of attracting and
retaining executive officers and key employees. The maximum number of shares
which may be issued under the Plan is 25% of the outstanding common stock of the
Company, subject to adjustment by the compensation committee of the Board of
Directors. The 25% limitation shall not invalidate any awards made prior to a
decrease in the number of outstanding shares, even though such awards have
resulted or may result in shares constituting more than 25% of the outstanding
shares being available for issuance under the Plan. Shares available under the
Plan which are not awarded in one particular year may be awarded in subsequent
years. The compensation committee of the Board of Directors has the authority to
determine the awards granted under the Plan, including among other things, the
individuals who receive the awards, the times when they receive them, vesting
schedules, performance goals, whether an option is an incentive or nonqualified
option and the number of shares to be subject to each award. However, no
participant may receive options or stock appreciation rights under the Plan for
an aggregate of more than 75,000 shares in any calendar year. The exercise price
and term of each option or stock appreciation right will be fixed by the
compensation committee except that the exercise price for each stock option
which is intended to qualify as an incentive stock option must be at least equal
to the fair market value of the stock on the date of grant and the term of the
option cannot exceed 10 years. In the case of an incentive stock option granted
to a 10% shareholder, the exercise price must be at least 110% of the fair
market value on the date of grant and cannot exceed five years. Incentive stock
options may be granted only within ten years from the date of adoption of the
Plan. The aggregate fair market value (determined at the time the option is
granted) of shares with respect to which incentive stock options may be granted
to any one individual, which stock options are exercisable for the first time
during any calendar year, may not exceed $100,000. An optionee may, with the
consent of the compensation committee, elect to pay for the shares to be
received upon exercise of their options in cash or shares of common stock or any
combination thereof.
As the exercise price of all options granted under the Plan were equal
to the market price of the underlying common stock on the grant date, no
stock-based employee compensation cost was recognized in net income. There were
3,500 options granted during the three months ended June 30, 2005, and 3,000
options were granted during the quarter ended June 30, 2004. During the nine
months ended June 30, 2005, 119,000 options were granted and 21,750 options were
granted during the nine months ended June 30, 2004. The following tables
illustrate the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation", as amended, to options granted under
the stock option plan. Because the estimated value is determined as of the date
of grant, the actual value ultimately realized by the employee may be
significantly different.
As required under FASB Statement No. 123 and FASB Statement No. 148,
"Accounting for Stock-based Compensation - Transition and Disclosure", the
proforma effects of stock-based compensation on net income and earnings per
common share have been estimated at the date of grant using the Black-Scholes
option pricing model.
The value of options granted during the three months ended June 30,
2005, was determined at the date of grant by using an options pricing model with
an assumed risk-free interest rate of 4.24%, an expected life of 5 years, 0.41%
dividends and a volatility factor of 24.09%:
10
Basic Diluted
Net Income EPS EPS
-------------------- ------------ -------------
For the three months ended June 30, 2005
----------------------------------------
Net income $ 800,895 $ 0.33 $ 0.31
Fair value of stock options - net of tax 14,553 0.01 0.01
-------------------- ------------ -------------
Proforma net income $ 786,342 $ 0.32 $ 0.30
==================== ============ ============
The value of options granted during the three months ended June 30,
2004, was determined at the date of grant by using an options pricing model with
an assumed risk-free interest rate of 2.84%, an expected life of 5 years, zero
dividends and a volatility factor of 36.50%:
Basic Diluted
Net Income EPS EPS
-------------------- ------------ -------------
For the three months ended June 30, 2004
Net income $ 777,344 $ 0.32 $ 0.31
Fair value of stock options - net of tax 10,992 0.01 -
--------------------- ------------- ------------
Proforma net income $ 766,352 $ 0.31 $ 0.31
===================== ============= ============
The value of options granted during the nine months ended June 30,
2005, was determined at the date of grant by using an options pricing model with
an assumed risk-free interest rate of 3.44%, an expected life of 5 years, 0.96%
dividends and a volatility factor of 24.09%:
Basic Diluted
Net Income EPS EPS
-------------------- ------------ -------------
For the nine months ended June 30, 2005
Net income $ 2,407,944 $ 0.98 $ 0.93
Fair value of stock options - net of tax 508,368 0.21 0.20
-------------------- ------------ -------------
Proforma net income $ 1,899,576 $ 0.77 $ 0.73
==================== ============ =============
The value of options granted during the nine months ended June 30,
2004, was determined at the date of grant by using an options pricing model with
an assumed risk-free interest rate of 2.84%, an expected life of 5 years, zero
dividends and a volatility factor of 36.50%:
Basic Diluted
Net Income EPS EPS
-------------------- ------------ -------------
For the nine months ended June 30, 2004
Net income $ 1,977,623 $ 0.81 $ 0.78
Fair value of stock options - net of tax 23,817 0.01 0.01
--------------------- ------------- ------------
Proforma net income $ 1,953,806 $ 0.80 $ 0.77
===================== ============= ============
The Company will continue to account for its stock option plan under
the intrinsic value recognition and measurement principles of APB Opinion No. 25
and related interpretations through fiscal year end, September 30, 2005.
11
9) New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB)issued
FASB Statement No. 123R "Share-Based Payment", which amended the provisions of
FASB Statement No. 123 "Accounting for Stock-Based Compensation." FASB Statement
No. 123R requires public companies to recognize as an expense the fair value of
stock-based payment arrangements at the date of grant, including stock options
and employee stock purchase plans. The statement eliminates proforma accounting
for share-based payments using the intrinsic value method previously allowed
under the provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees". The are two possible methods of reporting
share-based payment expenses: the "Modified Prospective" method and the
"Modified Retrospective" method. We are currently evaluating the provisions of
each method and have not determined the potential impact that adoption of FASB
Statement No. 123R will have on our financial condition and results of
operations. The effective date for implementation by small business issuers is
the first interim or annual reporting period that begins after December 15,
2005.
On March 29,2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107, which contains the Staff's views and guidance
regarding valuation of share-based payment arrangements by public companies, and
appropriate disclosures in Management's Discussion and Analysis reporting
subsequent to adoption of FASB Statement No. 123R.
In accordance with the provisions of FASB Statement No. 123R,
and Staff Accounting Bulletin No. 107, we will begin reporting compensation
expense for all stock option grants in our first quarterly report for fiscal
year 2006 (quarter ending December 31, 2005). We will use the Black-Scholes
option pricing model to determine share-based compensation expense at the date
of grant at fair value.
During the first fiscal year that stock options were granted (year
ended September 30, 2002) and through the nine months ended June 30, 2005, we
have not recorded any compensation expense for stock option grants, as allowed
by the intrinsic value recognition and measurement principles of APB Opinion No.
25. Proforma effects on net income and earnings per common share have been
estimated and reported using the Black-Scholes option pricing model, as
displayed in note #8 above.
(10) Subsequent Events
On July 1, 2005, we completed the previously announced acquisition of
mutual fund assets related to the management contract for The Henlopen Fund. We
paid $6.7 million, which equaled 2.25% of the $299 million in assets under
management at the close of business on June 30, 2005. The transaction was
financed by U.S. Bank National Association, and terms of the loan are included
in Exhibit 10.1. Following completion of the acquisition, we changed the name
of The Henlopen Fund to the Hennessy Cornerstone Growth Fund, Series II (symbol
HENLX), and began to implement our investment strategy for Series II.
On July 26, 2005, we filed a Form S-1 Registration Statement with the
Securities and Exchange Commission (File No. 333-126896), for a public offering
of common stock (symbol HNNA). We also intend to apply to have our stock listed
on the NASDAQ National stock exchange.
12
Item 2. Management's Discussion and Analysis
Overview
We are a publicly traded investment management firm. Our principal
business activity is managing, servicing and marketing our six open-end mutual
funds. All of our mutual funds are no-load, meaning investors do not pay any
upfront or deferred sales charges. We use quantitative stock selection
strategies to manage each of the Hennessy Funds. The net assets of the mutual
funds we manage have increased by 856% from $194 million on September 30, 2001
to $1.67 billion as of July 1, 2005, including approximately $299 million in net
assets added on July 1, 2005 in connection with the acquisition of the
management agreement for The Henlopen Fund, which we renamed the Hennessy
Cornerstone Growth Fund, Series II. During this same period, the total number of
shareholders in our mutual funds has increased by 845% from 10,629 shareholders
on September 30, 2001 to 100,398 shareholders on July 1, 2005.
Neil J. Hennessy has served as chairman of the board, president and
chief executive officer of Hennessy since 1989 and as director, president and
portfolio manager of our mutual funds since 1996.
Each of the Hennessy Funds pay fees to us for our management services.
Management services include investment research, supervision of investments,
conducting investment programs, including evaluation, sale and reinvestment of
assets, the placement of orders for purchase and sale of securities,
solicitation of brokers to execute transactions and the preparation and
distribution of reports and statistical information. Some of our mutual funds
also pay fees to us for shareholder servicing. Shareholder servicing consists
primarily of providing a call center to respond to shareholder inquiries,
including inquiries regarding specific mutual fund account and investment
information. The fees that we receive for management services and shareholder
servicing are based on a percentage of the average daily net asset value of our
mutual funds and vary from fund to fund. The 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, our completed acquisitions of
management agreements, market conditions and the success of our marketing
efforts. Total assets under management were $1.67 billion as of July 1, 2005.
The assets we manage have grown rapidly as a result of acquisitions of
management agreements, fund inflows and market appreciation. The following
tables illustrate the growth in assets under management since June 30, 2003
through June 30, 2005:
13
Assets Under Management
At Each Quarter End, June 30,2004 through June 30, 2005
------------------------------------------------------------------------------------------
6/30/2004 9/30/2004 12/30/2004 3/31/2005 6/30/2005
--------- --------- ---------- --------- ---------
Beginning assets under
management................ $ 1,314,064 $ 1,284,720 $ 1,222,073 $ 1,376,303 $ 1,347,881
Acquisition flows.......... - - - - -
Organic inflows............ 48,096 33,306 64,390 107,136 72,672
Redemptions................ (94,936) (65,253) (91,804) (108,114) (87,886)
Market appreciation
(depreciation)............ 17,496 (30,700) 181,644 (27,444) 40,499
Ending assets under ----------------- ----------------- ----------------- ----------------- -----------------
management................ $ 1,284,720 $ 1,222,073 $ 1,376,303 $ 1,347,881 $ 1,373,166(1)
================= ================= ================= ================= =================
------------------------
(1) Does not include $299 million in assets under management added
in connection with the acquisition of The Henlopen Fund (now
known as the Hennessy Cornerstone Growth Fund, Series II),
which was completed on July 1, 2005.
Assets Under Management
At Each Quarter End, June 30,2003 through June 30, 2004
------------------------------------------------------------------------------------------
6/30/2003 9/30/2003 12/30/2003 3/31/2004 6/30/2004
--------- --------- ---------- --------- ---------
Beginning assets under
management................ $ 497,962 $ 663,243 $ 835,139 $ 1,012,903 $ 1,314,064
Acquisition flows.......... - 34,928 - 301,214 -
Organic inflows............ 110,767 79,619 117,651 116,299 48,096
Redemptions................ (35,147) (29,155) (40,318) (100,389) (94,936)
Market appreciation
(depreciation)............ 89,661 86,504 100,431 (15,963) 17,496
Ending assets under ----------------- ----------------- ----------------- ----------------- -----------------
management................ $ 663,243 $ 835,139 $ 1,012,903 $ 1,314,064 $ 1,284,720
================= ================= ================= ================= =================
Historically, we have received operating revenues from providing Mr.
Hennessy's services as an expert witness and mediator in securities cases. Also,
until June 2005, we provided management services to high net worth investors.
However, our business strategy has evolved and we no longer generate any
operating revenues from these services.
14
A significant portion of our expenses, including employee compensation,
are fixed and have historically demonstrated minimal variation. To implement our
business strategy, we intend to expand and upgrade our facilities and anticipate
increasing our staffing. As a result, we expect our fixed expenses to increase.
Due to the increases in fixed expenses and dilution of the shareholder
base expected in connection with our proposed public offering, our earnings per
share may decrease in the short-term.
The principal asset on our balance sheet, management contracts - net of
accumulated amortization, represents the capitalized costs incurred in
connection with the acquisition of management agreements. As of June 30, 2005,
this asset had a net balance of $14,142,520.
The principal liability on our balance sheet is the long-term bank debt
incurred in connection with the acquisition of the management agreements for the
Lindner Funds. As of June 30, 2005, this liability, including the current
portion of long-term debt, had a balance of $6.4 million. On July 1, 2005, we
incurred an additional $6.7 million of long-term debt to finance our acquisition
of the management agreement for The Henlopen Fund (now known as the Hennessy
Cornerstone Growth Fund, Series II). We intend to repay in full this bank debt
out of the net proceeds of our proposed public offering.
Results of Operations
The following table displays items in the statements of income as dollar
amounts and as percentages of total revenue for the three months ended June 30,
2005 and 2004:
Three Months Ended June 30,
---------------------------------------------------------------
2005 2004
----------------------------------------------------------------
Percent Percent
of Total of Total
Amounts Revenue Amounts Revenue
----------------------------------------------------------------
Revenue:
Investment advisory fees $ 2,482,829 88.5% $ 2,324,616 89.3%
Shareholder service fees 290,647 10.4 269,980 10.4
Other 32,609 1.1 7,139 0.3
----------------------------------------------------------------
Total revenue 2,806,085 100.0 2,601,735 100.0
----------------------------------------------------------------
Operating expenses:
Compensation and benefits 608,408 21.7 579,462 22.3
General and administrative 201,937 7.2 194,450 7.5
Mutual fund distribution 514,480 18.3 471,590 18.1
Amortization and depreciation 9,917 0.4 9,891 0.4
----------------------------------------------------------------
Total operating expenses 1,334,742 47.6 1,255,393 48.3
----------------------------------------------------------------
Operating income 1,471,343 52.4 1,346,342 51.7
Interest expense 98,779 3.5 77,982 3.0
----------------------------------------------------------------
Income before income tax expense 1,372,564 48.9 1,268,360 48.7
Income tax expense 571,669 20.4 491,016 18.8
----------------------------------------------------------------
Net income $ 800,895 28.5% $ 777,344 29.9%
================================================================
Revenues: Total revenue increased by $204,350, or 7.9%, in the three
months ended June 30, 2005, from $2,601,735 in the prior comparable period,
primarily due to fees earned from increased assets under management. Investment
management fees increased by $158,213, or 6.8%, in the three months ended June
30, 2005, from $2,324,616 in the prior comparable period, and shareholder
15
service fees increased by $20,667, or 7.7%, in the three months ended June 30,
2005, from $269,980 in the prior comparable period. These increases resulted
from increases in the average daily net assets of our mutual funds, which can
differ considerably from net assets of our mutual funds at the end of an
accounting period. Net assets in our mutual funds increased by $88.4 million, or
6.9%, as of June 30, 2005, from $1.285 billion as of the end of the prior
comparable period. This increase in the net assets of our mutual funds resulted
from cash inflows of $277.5 million, redemptions of $353.1 million and market
appreciation of $164.0 million. In comparison, from June 30, 2003 to June 30,
2004, cash inflows of our mutual funds were $697.8 million, which included
$336.1 million of cash inflows from acquisitions, redemptions were $264.8
million and market appreciation was $188.5 million. Although the amount of
redemptions increased by $23.0 million for the one year period ending June 30,
2005 as compared to the one year period ending June 30, 2004, redemptions as a
percentage of assets under management increased only marginally from an average
of 2.1% per month to 2.3% per month during the same period.
Operating Expenses: Total operating expenses increased by $79,349, or
6.3%, in the three months ended June 30, 2005, from $1,255,393 in the prior
comparable period. The increase resulted from higher compensation expense,
increases in several components of general and administrative expense and mutual
fund distribution costs. As a percentage of total revenue, total operating
expenses decreased by 0.7% to 47.6% in the three months ended June 30, 2005, as
compared to 48.3% in the prior comparable period.
Employee Compensation and Benefits: Compensation and benefits increased
by $28,946, or 5.0%, in the three months ended June 30, 2005, from $579,462 in
the prior comparable period. The increase resulted from the addition of a chief
compliance officer, the addition of a portfolio management specialist and salary
increases for officers and staff. As a percentage of total revenue, compensation
and benefits decreased by 0.6% to 21.7% for the three months ended June 30,
2005, compared to 22.3% in the prior comparable period.
General and Administrative Expenses: General and administrative expense
increased by $7,487, or 3.9%, in the three months ended June 30, 2005, from
$194,450 in the prior comparable period, primarily due to increases in
professional fees, board of directors fees and expenses and business insurance.
Partially offsetting these increases were reductions in marketing and promotion
expenses. As a percentage of total revenue, general and administrative expense
decreased by 0.3% to 7.2% in the three months ended June 30, 2005, from 7.5% in
the prior comparable period.
Mutual Fund Distribution Expenses: Distribution expenses increased by
$42,890, or 9.1%, in the three months ended June 30, 2005, from $471,590 in the
prior comparable period. As a percentage of total revenue, distribution expenses
increased by 0.2% to 18.3% for the three months ended June 30, 2005, compared to
18.1% in the prior comparable period. This slight increase is due to increased
assets through mutual fund supermarkets such as Charles Schwab, Fidelity and TD
Waterhouse.
Amortization and Depreciation Expense: Amortization and depreciation
expense remained essentially unchanged in the three months ended June 30, 2005,
from the prior comparable period.
Interest Expense: We incurred interest expense of $98,779 during the
three months ended June 30, 2005 as a result of the $7.9 million loan that we
entered into with U.S. Bank National Association to acquire the management
agreements for the Lindner Funds. Interest increased $20,797 from the prior
comparable period due to increases in interest rates. Interest accrues at the
prime rate in effect from time to time, which was 6.25% on June 30, 2005 and
4.0% on June 30, 2004.
16
Income Taxes: The provision for income taxes increased by $80,653, or
16.4%, in the three months ended June 30, 2005, from $491,016 in the prior
comparable period.
Net Income: Net income increased by $23,551, or 3.0%, in the three
months ended June 30, 2005, compared to $777,344 in the prior comparable period,
as a result of the factors discussed above.
The following table displays items in the statements of income as
dollar amounts and as percentages of total revenue for the nine months ended
June 30, 2005 and 2004:
Nine Months Ended June 30,
---------------------------------------------------------------
2005 2004
----------------------------------------------------------------
Percent Percent
of Total of Total
Amounts Revenue Amounts Revenue
----------------------------------------------------------------
Revenue:
Investment advisory fees $ 7,379,279 88.7% $ 6,234,999 89.0%
Shareholder service fees 867,387 10.4 749,888 10.7
Other 71,357 0.9 19,099 0.3
----------------------------------------------------------------
Total revenue 8,318,023 100.0 7,003,986 100.0
----------------------------------------------------------------
Operating expenses:
Compensation and benefits 1,773,727 21.3 1,604,259 23.0
General and administrative 671,264 8.1 645,645 9.2
Mutual fund distribution 1,505,216 18.1 1,395,232 19.9
Amortization and depreciation 32,932 0.4 22,905 0.3
----------------------------------------------------------------
Total operating expenses 3,983,139 47.9 3,668,041 52.4
----------------------------------------------------------------
Operating income 4,334,884 52.1 3,335,945 47.6
Interest expense 283,018 3.4 92,353 1.3
----------------------------------------------------------------
Income before income tax expense 4,051,866 48.7 3,243,592 46.3
Income tax expense 1,643,922 19.8 1,265,969 18.1
----------------------------------------------------------------
Net income $ 2,407,944 28.9% $ 1,977,623 28.2%
================================================================
Revenues: Total revenue increased by $1,314,037, or 18.8%, in the nine
months ended June 30, 2005, from $7,003,986 in the prior comparable period,
primarily due to fees earned from increased assets under management. Investment
management fees increased by $1,144,280, or 18.4%, in the nine months ended June
30, 2005, from $6,234,999 in the prior comparable period, and shareholder
service fees increased by $117,499, or 15.7%, in the nine months ended June 30,
2005, from $749,888 in the prior comparable period. These increases resulted
from increases in the average daily net assets of our mutual funds, which can
differ considerably from net assets of our mutual funds at the end of an
accounting period. Net assets in our mutual funds increased by $88.4 million, or
6.9%, as of June 30, 2005, from $1.285 billion as of the end of the prior
comparable period. This increase in the net assets of our mutual funds resulted
from cash inflows of $277.5 million, redemptions of $353.1 million and market
appreciation of $164.0 million. In comparison, from June 30, 2003 to June 30,
2004, cash inflows of our mutual funds were $697.8 million, which included
$336.1 million of cash inflows from acquisitions, redemptions were $264.8
17
million and market appreciation was $188.5 million. Although the amount of
redemptions increased by $23.0 million for the one year period ending June 30,
2005 as compared to the one year period ending June 30, 2004, redemptions as a
percentage of assets under management increased only marginally from an average
of 2.1% per month to 2.3% per month during the same period.
Operating Expenses: Total operating expenses increased by $315,098, or
8.6%, in the nine months ended June 30, 2005, from $3,668,041 in the prior
comparable period. The increase resulted from higher compensation expense,
increases in several components of general and administrative expense and mutual
fund distribution costs. As a percentage of total revenue, total operating
expenses decreased by 4.5% to 47.9% in the nine months ended June 30, 2005, as
compared to 52.4% in the prior comparable period.
Employee Compensation and Benefits: Compensation and benefits increased
by $169,468, or 10.6%, in the nine months ended June 30, 2005, from $1,604,259
in the prior comparable period. The increase primarily resulted from the
addition of a chief compliance officer, the addition of a portfolio management
specialist, salary increases for officers and staff and increased medical
insurance premiums. As a percentage of total revenue, compensation and benefits
decreased by 1.7% to 21.3% for the nine months ended June 30, 2005, compared to
23.0% in the prior comparable period.
General and Administrative Expenses: General and administrative expense
increased by $25,619, or 4.0%, in the nine months ended June 30, 2005, from
$645,645 in the prior comparable period, primarily due to increases in board of
directors fees and expenses, professional fees, business insurance, and computer
support services. Partially offsetting these increases were reductions in
marketing and promotion expenses. As a percentage of total revenue, general and
administrative expense decreased by 1.1% to 8.1% in the nine months ended June
30, 2005, from 9.2% in the prior comparable period.
Mutual Fund Distribution Expenses: Distribution expenses increased by
$109,984, or 7.9%, in the nine months ended June 30, 2005, from $1,395,232 in
the prior comparable period. As a percentage of total revenue, distribution
expenses decreased by 1.8% to 18.1% for the nine months ended June 30, 2005,
compared to 19.9% in the prior comparable period. The proportion of assets held
through mutual fund supermarkets declined in relation to assets held at other
financial institutions primarily as a result of the acquisition of the
management agreements for the Lindner Funds in March 2004. Because most of the
net assets of the Lindner Funds were not held through mutual fund supermarkets
and we do not pay distribution expenses on assets that are not held through
mutual fund supermarkets, our distribution expense as a percentage of total
revenues declined following our acquisition of the management agreements for the
Lindner Funds.
Amortization and Depreciation Expense: Amortization and depreciation
expense increased $10,027 in the nine months ended June 30, 2005, from $22,905
in the prior comparable period resulting from loan amortization costs and
purchases of furniture and equipment.
Interest Expense: We incurred interest expense of $283,018 during the
nine months ended June 30, 2005 as a result of the $7.9 million loan that we
entered into with U.S. Bank National Association to acquire the management
agreements for the Lindner Funds. Interest increased $190,665 from the prior
comparable period due to increases in interest rates. Interest accrues at the
prime rate in effect from time to time, which was 6.25% on June 30, 2005 and
4.0% on June 30, 2004.
18
Income Taxes: The provision for income taxes increased by $377,953, or
29.9%, in the nine months ended June 30, 2005, from $1,265,969 in the prior
comparable period.
Net Income: Net income increased by $430,321, or 21.8%, in the nine
months ended June 30, 2005, compared to $1,977,623 in the prior comparable
period, as a result of the factors discussed above.
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 June 30, 2005 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, 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 as of June 30, 2005 were $21,290,143, which was an
increase of $1,376,264, or 6.9%, from September 30, 2004. Property and equipment
and management agreements acquired totaled $14,233,444 as of June 30, 2005. Our
remaining assets are very liquid, consisting primarily of cash and receivables
derived from mutual fund asset management activities. As of June 30, 2005, we
had cash and cash equivalents of $5,705,788.
Dividend Payments: On March 8, 2005, we paid a cash dividend of $0.10
per common share. The total payment from cash on hand was $245,675. Upon the
successful completion of our proposed public offering announced July 26, 2005,
we intend to begin paying dividends on a quarterly basis.
Our Bank Loan: We have an outstanding bank loan with U.S. Bank National
Association. We incurred $7.9 million of indebtedness in connection with
acquiring the management agreements for the Lindner Funds and an additional $6.7
million of indebtedness in connection with acquiring the management agreement
for The Henlopen Fund (now known as the Hennessy Cornerstone Growth Fund, Series
II). The indebtedness we incurred to acquire the management agreement of The
Henlopen Fund was rolled into a single loan with the indebtedness we incurred to
acquire the management agreements of the Lindner Funds. We currently have $13.1
million of principal outstanding under our bank loan, which bears interest at
U.S. Bank National Association's prime rate as set by U.S. Bank National
Association from time to time (6.25% as of July 1, 2005). The loan agreement
requires us to make 64 monthly payments in the approximate amount of $0.2
million, plus interest, with the final installment of the then outstanding
principal and interest due on September 30, 2010. We intend to retire this loan
in full with a portion of the proceeds of our proposed public offering.
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
19
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
redemptions by mutual fund shareholders, general economic and financial
conditions, movement of interest rates, competitive conditions, industry
regulation, and others, many of which are beyond the control of our management.
Statements regarding the following subjects are forward-looking by their nature:
o our business strategy, including our ability to identify and
complete future acquisitions;
o market trends and risks;
o our estimates for future performance, including, among other
things, revenues we expect to receive from our new management
agreement covering Hennessy Cornerstone Growth Fund, Series II;
o our ability to maintain and grow our distribution channels on
which we depend;
o our estimates regarding anticipated revenues and operating
expenses;
o the costs we may incur in complying with increased securities
industry regulation;
o our ability to retain the mutual fund assets we currently
manage; and
o the effect international conflicts and the ongoing threat of
terrorism may have on the general economy, financial and capital
markets and our business.
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. Risk factors are described in more detail in the "Risk Factors" section
of the Company's Annual Report, filed on Form 10-KSB with the U.S. Securities
and Exchange Commission on December 14, 2004.
Item 3. Controls and Procedures
Under the supervision and with the participation of the Company's
management, including the Company's principal executive officer and principal
financial officer, the Company conducted an evaluation of its disclosure
controls and procedures, as such term is defined under Rule 13a-15(e)
promulgated under the Securities Exchange Act of 1934, as amended, as of the end
of the period covered by this report. Based on such evaluation, the Company's
principal executive officer and principal financial officer have concluded that
the Company's disclosure controls and procedures are effective.
There has been no significant change in our internal controls over
financial reporting identified in connection with the foregoing evaluation that
occurred during the last quarter and that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting.
20
Part II. OTHER INFORMATION
There were no reportable events for items 1 through 5.
Item 6. Exhibits
10.1* Amended and Restated Loan Agreement, dated July 1, 2005,
between Hennessy Advisors, Inc. and U.S. Bank National
Association
31.1 Rule 13a - 14a Certification of the Chief Executive
Officer
31.2 Rule 13a - 14a Certification of the Chief Financial
Officer
32.1 Written Statement of the Chief Executive Officer,
Pursuant to 18 U.S.C. ss. 1350
32.2 Written Statement of the Chief Financial Officer,
Pursuant to 18 U.S.C. ss. 1350
* Incorporated by reference from the Company's Form S-1 Registration Statement
(SEC File No. 333-126896).
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized:
HENNESSY ADVISORS, INC.
Date: August 2, 2005 By: /s/ Teresa M. Nilsen
--------------------
Teresa M. Nilsen, Executive Vice
President, Chief Financial Officer
and Secretary
21
EXHIBIT INDEX
-------------
10.1* Amended and Restated Loan Agreement, dated July 1, 2005,
between Hennessy Advisors, Inc. and U.S. Bank National
Association
31.1 Rule 13a - 14a Certification of the Chief Executive
Officer
31.2 Rule 13a - 14a Certification of the Chief Financial
Officer
32.1 Written Statement of the Chief Executive Officer,
Pursuant to 18 U.S.C. ss. 1350
32.2 Written Statement of the Chief Financial Officer,
Pursuant to 18 U.S.C. ss. 1350
* Incorporated by reference from the Company's Form S-1 Registration Statement
(SEC File No. 333-126896).
22