HENNESSY ADVISORS, INC. Forward-Looking Statements
This report contains "forward-looking statements" within the meaning of the securities laws, for which we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by terminology such as "expect," "anticipate," "intend," "may," "plan," "will," "should," "could," "would," "assume," "believe," "estimate," "predict," "potential," "project," "continue," "seek," and similar expressions, as well as statements in the future tense. We have based these forward-looking statements on our current expectations and projections about future events, based on information currently available to us. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at which, or means by which, such performance or results will be achieved. Forward-looking statements are subject to risks, uncertainties, and assumptions, including those described in the section entitled "Risk Factors" and elsewhere in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 . Unforeseen developments could cause actual performance or results to differ substantially from those expressed in or suggested by the forward-looking statements. Management does not assume responsibility for the accuracy or completeness of these forward-looking 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, taxes, general economic and financial conditions, movement of interest rates, competitive conditions, industry regulation, and fluctuations in the stock market, many of which are beyond the control of our management. Further, the business and regulatory environments in which we operate remain complex, uncertain, and subject to change. We expect that regulatory requirements and developments will cause us to incur additional administrative and compliance costs. In addition, while current domestic economic conditions are relatively favorable, changes in short-term interest rates, policy changes by the administration inWashington, D.C. , and developments in international financial markets could influence economic and financial conditions significantly. Notwithstanding the variability in our economic and regulatory environments, we remain focused on the investment performance of the Hennessy Funds and on providing high-quality customer service to investors. 16
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Our business strategy centers on (a) the identification, completion, and integration of future acquisitions and (b) organic growth, through both the retention of the mutual fund assets we currently manage and the generation of inflows into the mutual funds we manage. The success of our business strategy may be influenced by the factors discussed in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 . All statements regarding our business strategy, as well as statements regarding market trends and risks and assumptions about changes in the marketplace, are forward-looking by their nature.
Overview
Our primary business activity is providing investment advisory services to a family of open-end mutual funds branded as the Hennessy Funds. We manage 10 of the 16 Hennessy Funds internally. For the remaining six funds, we have delegated the day-to-day portfolio management responsibilities to sub-advisors, subject to our oversight. We oversee the selection and continued employment of each sub-advisor, review each sub-advisor's investment performance, and monitor each sub-advisor's adherence to each applicable fund's investment objectives, policies, and restrictions. In addition, we conduct ongoing reviews of the compliance programs of sub-advisors and make on-site visits to sub-advisors. Our secondary business activity is providing shareholder services to shareholders of eachHennessy Fund . We derive our operating revenues from investment advisory fees and shareholder service fees paid to us by the Hennessy Funds. These fees are calculated as a percentage of the average daily net assets in eachHennessy Fund . The percentage amount of the investment advisory fees varies from fund to fund. The percentage amount of the shareholder service fees is consistent across all funds, but shareholder service fees are charged on Investor Class shares only. The dollar amount of the fees we receive fluctuates with changes in the average net asset value of eachHennessy Fund , which is affected by each fund's investment performance, purchases and redemptions of shares, general market conditions, and the success of our marketing, sales, and public relations efforts. On a total return basis, the Dow Jones Industrial Average was up 6.7% for the three months endedDecember 31, 2019 . During the most recent quarter, equity prices rose as continuing growth in employment and strong levels of consumer confidence buoyed investor spirits. In addition, strong holiday spending coupled with the announcement of the completion of Phase One trade negotiations withChina further emboldened investors as the prospect of a trade war faded. While we believe investors are no longer pricing in aFederal Reserve interest rate cut, they do appear focused on record low unemployment, which currently stands at 3.5%, and strong economic growth. One result of these trends can be found in theU.S. housing market. Currently, housing is in its second longest expansion on record as a result of continued low interest rates, favorable demographic trends, and low unemployment. 17
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Long-termU.S. bond yields increased during the three months endedDecember 31, 2019 , as the economic outlook improved. While trends in inflation remained muted, the prospects of aFederal Reserve rate adjustment have diminished with the market not expecting any change until late in 2020. The Japanese equity market rallied 7.8% inU.S. dollar terms over the three months endedDecember 31, 2019 , as measured by the Tokyo Stock Price Index. The resolution over Phase One trade negotiations betweenthe United States andChina removed much of the uncertainty that had weighed on Japanese equities. A record budget expected for next fiscal year should help the Japanese economy to grow despite weaker growth in exports. We strive to provide positive returns for investors in the Hennessy Funds over market cycles. Fourteen of the Hennessy Funds posted positive annualized returns in each of the three-year, five-year, 10-year, and since inception periods endedDecember 31, 2019 . In the one-year period endedDecember 31, 2019 , all 16 Hennessy Funds generated positive returns. To help drive inflows into the Hennessy Funds, we maintain a marketing database of over 100,000 financial advisors in addition to retail investors. We employ robust marketing and sales efforts consisting of content, digital, and traditional marketing initiatives and proactive phone and in-person meetings. In addition, we maintain an active annual public relations campaign that has resulted in the Hennessy brand name appearing on TV, radio, print, or online media on average once every two to three days. We provide service to over 230,000 mutual fund accounts nationwide, which comprise shareholders who employ financial advisors to assist them with investing and retail shareholders who invest directly with us. We serve approximately 18,100 financial advisors who utilize the Hennessy Funds on behalf of their clients. Approximately one in five of those advisors owns two or more Hennessy Funds, demonstrating strong brand loyalty. Total assets under management as ofDecember 31, 2019 , was$5.0 billion , an increase of$91 million , or 1.9%, compared toDecember 31, 2018 . The increase in total assets was attributable to market appreciation, partially offset by net outflows from the Hennessy Funds.
The following table illustrates the changes quarter by quarter in our assets
under management since
12/31/2019 9/30/2019 6/30/2019 3/31/2019 12/31/2018
(In thousands)
Beginning assets under management $ 4,873,839 $ 5,013,075 $ 5,135,937 $ 4,887,547 $ 6,197,617
Acquisition inflows - - - - 194,948
Organic inflows 187,057 130,352 142,155 242,566 310,468
Redemptions (334,103 ) (351,303 ) (458,197 ) (516,592 ) (1,048,642 )
Market appreciation (depreciation) 251,709 81,715 193,180 522,416 (766,844 )
Ending assets under management
The principal asset on our balance sheet, management contracts, represents the capitalized costs incurred in connection with the purchase of the assets related to the management of mutual funds. As ofDecember 31, 2019 , this asset had a net balance of$80.6 million , unchanged sinceSeptember 30, 2019 . 18
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The principal liability on our balance sheet is the bank debt incurred in connection with the purchase of the assets related to the management of mutual funds and the repurchase of 1,500,000 shares of our common stock pursuant to the completion of our self-tender offer inSeptember 2015 . As ofDecember 31, 2019 , this liability had a balance of$16.4 million ($16.3 million net of debt issuance costs of$0.11 million ), compared to$17.5 million ($17.4 million net of debt issuance costs of$0.12 million ) as ofSeptember 30, 2019 . The decrease was the result of making monthly loan payments on our bank debt.
Results of Operations
The following table sets forth items in the statements of income as dollar amounts and as percentages of total revenue:
Three Months Ended December 31,
2019 2018
Percent of Percent of
Amounts Total Revenue Amounts Total Revenue
(In thousands, except percentages)
Revenue
Investment advisory fees $ 9,449 92.2 % $ 10,738 92.2 %
Shareholder service fees 795 7.8 906 7.8
Total revenue 10,244 100.0 11,644 100.0
Operating expenses
Compensation and benefits 2,513 24.5 2,900 24.9
General and administrative 1,492 14.6 1,517 13.0
Mutual fund distribution 139 1.4 123 1.1
Sub-advisory fees 2,316 22.6 2,444 21.0
Depreciation 53 0.5 55 0.5
Total operating expenses 6,513 63.6 7,039 60.5
Net operating income 3,731 36.4 4,605 39.5
Interest expense 187 1.8 310 2.7
Other income (56 ) (0.6 ) (78 ) (0.7 )
Income before income tax expense 3,600 35.2 4,373 37.5
Income tax expense 972 9.5 1,306 11.2
Net income $ 2,628 25.7 % $ 3,067 26.3 %
Revenue - Investment Advisory Fees and Shareholder Service Fees
Total revenue comprises investment advisory fees and shareholder service fees. Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , total revenue decreased by 12.0%, from$11.6 million to$10.2 million , investment advisory fees also decreased by 12.0%, from$10.7 million to$9.4 million , and shareholder service fees decreased by 12.3%, from$0.9 million to$0.8 million . The decrease in investment advisory fees was due mainly to decreased average daily net assets of the Hennessy Funds. The decrease in shareholder service fees was due to a decrease in the average daily net assets held in Investor Class shares of the Hennessy Funds. Assets held in Investor Class shares of the Hennessy Funds are subject to a shareholder service fee, whereas assets held in Institutional Class shares of the Hennessy Funds are not subject to a shareholder service fee. 19
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We collect investment advisory fees from each of the Hennessy Funds at differing annual rates. These annual rates range between 0.40% and 1.25% of average daily net assets. Average daily net assets of the Hennessy Funds for the three months endedDecember 31, 2019 , was$4.9 billion , which represents a decrease of$637 million , or 11.4%, compared to the three months endedDecember 31, 2018 .The Hennessy Fund with the largest average daily net assets for the three months endedDecember 31, 2019 , was theHennessy Focus Fund , with$1.8 billion . We collect an investment advisory fee from theHennessy Focus Fund at an annual rate of 0.90% of average daily net assets. However, we pay a sub-advisory fee at an annual rate of 0.29% to the fund's sub-advisor, which reduces the net operating profit contribution of the fund to our financial operations.The Hennessy Fund with the second largest average daily assets for the three months endedDecember 31, 2019 , was theHennessy Gas Utility Fund , with$0.9 billion . We collect an investment advisory fee from theHennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets. The Hennessy Funds with the three largest amounts of net inflows were as follows: Three Months Ended December 31, 2019 Fund Name Amount Hennessy Japan Fund$ 17 million Hennessy Focus Fund$ 11 million Hennessy Technology Fund$ 0.09 million The Hennessy Funds with the three largest amounts of net outflows were as follows: Three Months Ended December 31, 2019 Fund Name Amount Hennessy Gas Utility Fund$ (45) million Hennessy Mid Cap 30 Fund$ (39) million Hennessy Equity and Income Fund$ (29) million
Comparing the three months ended
Operating Expenses
Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , total operating expenses decreased by 7.5%, from$7.0 million to$6.5 million . Although the dollar value of total operating expenses decreased, as a percentage of total revenue, total operating expenses increased 3.1 percentage points to 63.6%. The dollar value decrease was due to decreases in all expense categories other than mutual fund distribution expense, which moderately increased. Compensation and Benefits Expense: Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , compensation and benefits expense decreased by 13.3%, from$2.9 million to$2.5 million . As a percentage of total revenue, compensation and benefits expense decreased 0.4 percentage points to 24.5%. The decrease was due primarily to a decrease in incentive-based compensation. 20
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General and Administrative Expense: Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , general and administrative expense remained the same at$1.5 million . Although the dollar value of general and administrative expense remained the same, as a percentage of total revenue, general and administrative expense increased 1.6 percentage points to 14.6%. Mutual Fund Distribution Expense: Mutual fund distribution expense consists of fees paid to various financial institutions that offer the Hennessy Funds as potential investments to their clients. When the Hennessy Funds are purchased through one of these financial institutions, the institution typically charges an asset-based fee, which is recorded in "mutual fund distribution expense" in our statement of operations to the extent paid by us. When the Hennessy Funds are purchased directly, we do not incur any such expense. These fees generally increase or decrease in line with the net assets of the Hennessy Funds held through these financial institutions, which are affected by inflows, outflows, and fund performance. Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , mutual fund distribution expense increased by 13.0%, from$0.12 million to$0.14 million . As a percentage of total revenue, mutual fund distribution expense increased 0.3 percentage points to 1.4%. The dollar value increase was due to higher average daily net assets held by financial institutions. Sub-Advisory Fees Expense: Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , sub-advisory fees expense decreased by 5.2%, from$2.4 million to$2.3 million . Although the dollar value of sub-advisory fees expense decreased, as a percentage of total revenue, sub-advisory fees expense increased 1.6 percentage points to 22.6%. The dollar value decrease resulted from decreased average daily net assets of the sub-advised Hennessy Funds, partially offset by the new sub-advisory relationship withBP Capital for the BP Funds that became effectiveOctober 26, 2018 . Depreciation Expense: Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , depreciation expense decreased by 3.6%, from$0.06 million to$0.05 million . As a percentage of total revenue, depreciation expense remained the same at 0.5%. The dollar value decrease was a result of lower fixed asset purchases.
Interest Expense
Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , interest expense decreased by 39.7% from$0.3 million to$0.2 million . The decrease is due primarily to a decrease in the Company's principal loan balance along with a decrease in the interest rate charged to the loan. As a percentage of total revenue, interest expense decreased 0.9 percentage points to 1.8%. 21
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Income Tax Expense
Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , income tax expense decreased by 25.6%, from$1.3 million to$1.0 million . The decrease was due primarily to lower net operating income for the current period, and secondarily to a lower effective income tax rate due to changes in state apportionment factors.
Net Income
Comparing the three months endedDecember 31, 2018 , to the three months endedDecember 31, 2019 , net income decreased by 14.3%, from$3.1 million to$2.6 million . The decrease was due to lower net operating income for the current period, partially offset by the benefit of the lower effective income tax rate discussed above. Critical Accounting Policies Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted inthe United States , which require the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. These accounting policies, methods, and estimates are an integral part of the financial statements prepared by management and are based upon management's 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 management's current judgment. For a discussion of the accounting policies that we believe are most critical to understanding our results of operations and financial position, see the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 .
Liquidity and Capital Resources
We continually review our capital requirements to ensure that we have funding available to support our business model. Management anticipates that cash and other liquid assets on hand as ofDecember 31, 2019 , will be sufficient to meet our capital requirements for at least one year from the issuance date of this report. 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 by either, or both, seeking to increase our borrowing capacity or accessing the capital markets. There can be no assurance that we will be able to raise additional capital. Our total assets under management as ofDecember 31, 2019 , was$5.0 billion , an increase of$91 million or 1.9%, compared toDecember 31, 2018 . The primary sources of our revenue, liquidity, and cash flow are our investment advisory fees and shareholder service fees, which are based on and generated by our average assets under management. Our average assets under management for the three months endedDecember 31, 2019 , was$4.9 billion . As ofDecember 31, 2019 , we had cash and cash equivalents of$22.5 million . 22
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The following table summarizes key financial data relating to our liquidity and
use of cash:
For the Three Months
Ended December 31,
2019 2018
(In thousands)
Net cash provided by operating activities
Net cash used in investing activities (744 ) (1,797 )
Net cash used in financing activities (2,773 ) (1,984 )
Net decrease in cash and cash equivalents
The decrease in cash provided by operating activities of
The decrease in cash used in investing activities of$1.1 million was due to the first payment for the purchase of the assets related to the management of theBP Funds in the prior period, which was larger than the second payment for such assets in the current period.
The increase in cash used in financing activities of
We have an outstanding term loan agreement with
(1) the sum of (a) a margin that ranges from 2.25% to 2.75%, depending on our ratio of consolidated debt to consolidated EBITDA, plus (b) the LIBOR rate; or
(2) the sum of(a) a margin that ranges from 0.25% to 0.75%, depending on our ratio of consolidated debt to consolidated EBITDA, plus (b) the highest rate out of the following three rates: (i) the prime rate set byU.S. Bank from time to time; (ii) the Federal Funds Rate plus 0.50%; or (iii) the one-month LIBOR rate plus 1.00%. We currently use a one-month LIBOR rate contract, which must be renewed monthly. As ofDecember 31, 2019 , the effective rate under the term loan agreement was 3.947%, which comprised the one-month LIBOR rate of 1.697% as ofDecember 2, 2019 , plus a margin of 2.25% based on our ratio of consolidated debt to consolidated EBITDA as ofSeptember 30, 2019 . We intend to renew the LIBOR rate contract on a monthly basis as long as it remains the most favorable option. We have amended the term loan agreement to address possible LIBOR changes as discussed in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 . All borrowings under the term loan agreement are secured by substantially all of our assets. The final installment of the then-outstanding principal plus accrued interest is dueMay 9, 2022 . As ofDecember 31, 2019 , the principal amount outstanding under the term loan agreement was$16.4 million ($16.3 million net of debt issuance costs). 23
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The term loan agreement includes certain reporting requirements and loan
covenants requiring the maintenance of certain financial ratios. We were in
compliance with our loan covenants for the periods ended
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