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 this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 , including under the section entitled "Risk Factors" in each such report. 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. 16
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Our business activities are affected by many factors, including, without limitation, redemptions by mutual fund shareholders, taxes, general economic and financial conditions, including those relating to the COVID-19 pandemic, 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. 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. 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.
Our Response to the COVID-19 Pandemic
In recent months, we have joined the rest of the world in witnessing and
experiencing the profound effect of the COVID-19 pandemic on public health, the
global economy, and the everyday lives of people around the world. We hope you
and your loved ones are safe and healthy, and our hearts and our support go out
to the healthcare workers and first responders in every community who are on the
frontline fighting the virus.
In response to the COVID-19 crisis, we invoked our business continuity plan in
mid-March to ensure a smooth transition to remote work for all of our employees.
We have continued to effectively operate the Company and remain committed to
providing the same high level of services to the 16 Hennessy Funds and their
shareholders. Further, we have undertaken various initiatives to ensure our
continuing success in the new work-from-home environment, including the
following:
• Regularly engaging with key vendors and service providers to garnerassurance regarding their ability to continue to provide high-quality
services to us and to shareholders of the Hennessy Funds;
• Keeping open lines of communication with our employees as they work fromhome to ensure seamless operations and early identification of issues;
and
• Maintaining effective governance and internal controls in a remote work
setting.
We continue to actively address the COVID-19 crisis and its effects, and, as the situation evolves, we may revise our approach to these initiatives and take additional actions to meet the
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needs of our employees, our vendors, and the Hennessy Funds and their shareholders. While we cannot reasonably estimate the duration and severity of the pandemic or its ultimate impact on the global economy and our business and revenues, we believe we are in the best position we can be in to emerge from this crisis well positioned for long-term growth.
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, including making on-site visits as feasible. 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. The past six months have been marked by extremes. During the quarter endedDecember 31, 2019 , investors appeared focused on record-low unemployment, which was then 3.5%, and strong economic growth. Then, during the most recent quarter, equity prices hit an all-time high in mid-February before dropping precipitously in a matter of weeks as the COVID-19 pandemic began affecting the world economy. After the first cases were reported inChina inDecember 2019 , the virus quickly spread to more than 210 countries and territories in subsequent months. Shelter-in-place orders have limited business activity worldwide, with initial unemployment claims inthe United States hitting their highest number in history, and global travel has come to a near-complete halt. On a total return basis, the Dow Jones Industrial Average was down 17.6% for the six months endedMarch 31, 2020 (a sharp retreat from its 6.7% growth during the three months endedDecember 31, 2019 ), and down 22.7% for the three months endedMarch 31, 2020 , more than cancelling the positive returns achieved over the previous 12 months. Small-cap and mid-cap stocks generally fared worse than large-cap stocks, and the Financial sector was particularly hard hit as theFederal Reserve aggressively cut the Federal Funds rate in an effort to stabilize the economy. The Energy sector was decimated by both the sudden loss of demand due to the effects of COVID-19 and the oversupply caused by the surprise market-share battle betweenRussia andSaudi Arabia , and the sector ended the quarter down approximately 50%.
Long-term
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global economic recession became a more realistic possibility. WhileFederal Reserve actions in recent weeks have injected unprecedented amounts of liquidity into the financial system and fiscal policy announcements may help people over the short term, these actions may not stimulate the economy over the long term. A potentially sharp increase in unemployment and what may be pronounced weakness in the global economy could keep inflation muted and interest rates at low levels in the coming months. The Japanese equity market has also been negatively impacted by the COVID-19 pandemic. As measured by the Tokyo Stock Price Index, it was down 10.2% for the six months endedMarch 31, 2020 (after seeing 7.8% growth inU.S. dollar terms for the three months endedDecember 31, 2019 ), and down 16.7% inU.S. dollar terms for the three months endedMarch 31, 2020 .Japan was one of the first countries to deal directly with the effects of the COVID-19 pandemic by virtue of its geographic proximity toChina and, by many accounts, has been able to manage the outbreak effectively to date. Nevertheless, Japanese equities have declined as global economic activity is expected to remain weak over the coming months. Against this backdrop, all of the Hennessy Funds posted negative returns for the most recent quarter and one-year period endingMarch 31, 2020 . Over the five-year period endingMarch 31, 2020 , 11 of the Funds posted positive returns, while five Funds, all of which were in the particularly hard-hit categories and sectors discussed above, posted negative returns. The 14 of the 16 Hennessy Funds that have at least a 10-year operating history achieved positive returns over both their 10-year and since inception periods endingMarch 31, 2020 . As always, we are committed to employing a consistent and disciplined approach to investing based on a buy-and-hold philosophy that rejects the idea of market timing and to providing superior service to investors. Our goal is to provide products that investors can have confidence in, knowing their money is invested as promised and with their best interests in mind. Accordingly, we continually seek new and improved ways to support investors in the Hennessy Funds, including by providing thought leadership and other resources to help them navigate through this unprecedented market disruption. We operate a very robust and leading-edge marketing automation and customer relationship management (CRM) system, with a database of over 100,000 financial advisors in addition to retail investors. We utilize this technology both to retain assets and to drive new purchases into the Hennessy Funds. We employ a comprehensive marketing and sales program consisting of content, digital, and traditional marketing initiatives and proactive meetings. In addition, our consistent annual public relations campaign 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 200,000 mutual fund accounts nationwide, which includes shareholders who employ financial advisors to assist them with investing and retail shareholders who invest directly with us. We serve approximately 17,750 financial advisors who utilize the Hennessy Funds on behalf of their clients, including over 400 advisors who have purchased one of our Funds for the first time during the recent quarter. Approximately one in five advisors owns two or more Hennessy Funds, and over 500 advisors hold a position of over$500,000 , demonstrating strong brand loyalty. Total assets under management as ofMarch 31, 2020 , was$3.3 billion , a decrease of$1.8 billion , or 35.4%, compared toMarch 31, 2019 . The decrease in total assets during the 19
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12-month period was attributable to net outflows, but it was further impacted by significant market depreciation in the most recent quarter that primarily resulted from the COVID-19 pandemic.
The following table illustrates the changes quarter by quarter in our assets
under management since
3/31/2020 12/31/2019 9/30/2019 6/30/2019 3/31/2019
(In thousands)
Beginning assets under management $ 4,978,502 $ 4,873,839 $ 5,013,075 $ 5,135,937 $ 4,887,547
Acquisition inflows - - - - -
Organic inflows 161,368 187,057 130,352 142,155 242,566
Redemptions (685,621 ) (334,103 ) (351,303 ) (458,197 ) (516,592 )
Market appreciation (depreciation) (1,134,317 ) 251,709 81,715 193,180 522,416
Ending assets under management
4,873,839
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 ofMarch 31, 2020 , this asset had a net balance of$80.6 million , unchanged sinceSeptember 30, 2019 . The principal liability on our balance sheet has historically been bank debt. However, onMarch 26, 2020 , we prepaid in full all principal, accrued interest, and costs and expenses outstanding under our term loan agreement. The aggregate prepayment amount was$15.4 million . As a result of this prepayment, as ofMarch 31, 2020 , the principal liability on our balance sheet is the deferred tax liability of$11.2 million generated due to the continued write-off of management contracts for tax purposes, which creates a book-to-tax difference. 20
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Results of Operations
The following tables set forth items in the statements of income as dollar amounts and as percentages of total revenue for the three and six months endedMarch 31, 2020 : Three Months Ended March 31, 2020 2019 Percent of Percent of Total Total Amounts Revenue Amounts Revenue (In thousands, except percentages) Revenue Investment advisory fees$ 8,201 92.4 %$ 9,631 92.1 % Shareholder service fees 678 7.6 825 7.9 Total revenue 8,879 100.0 10,456 100.0 Operating expenses Compensation and benefits 2,414 27.2 2,752 26.3 General and administrative 1,288 14.5 1,335 12.8 Mutual fund distribution 115 1.3 106 1.0 Sub-advisory fees 2,008 22.6 2,251 21.5 Depreciation 61 0.7 54 0.5 Total operating expenses 5,886 66.3 6,498 62.1 Net operating income 2,993 33.7 3,958 37.9 Interest expense 260 2.9 299 2.9 Other income (32 ) (0.3 ) (84 ) (0.8 ) Income before income tax expense 2,765 31.1 3,743 35.8 Income tax expense 795 8.9 843 8.1 Net income$ 1,970 22.2 %$ 2,900 27.7 % Six Months Ended March 31, 2020 2019 Percent of Percent of Total Total Amounts Revenue Amounts Revenue (In thousands, except percentages) Revenue Investment advisory fees$ 17,650 92.3 %$ 20,369 92.2 % Shareholder service fees 1,473 7.7 1,731 7.8 Total revenue 19,123 100.0 22,100 100.0 Operating expenses Compensation and benefits 4,927 25.8 5,652 25.6 General and administrative 2,780 14.5 2,852 12.9 Mutual fund distribution 254 1.3 229 1.0 Sub-advisory fees 4,324 22.6 4,695 21.2 Depreciation 114 0.6 109 0.6 Total operating expenses 12,399 64.8 13,537 61.3 Net operating income 6,724 35.2 8,563 38.7 Interest expense 447 2.3 609 2.8 Other income (88 ) (0.4 ) (162 ) (0.8 ) Income before income tax expense 6,365 33.3 8,116 36.7 Income tax expense 1,767 9.3 2,149 9.7 Net income$ 4,598 24.0 %$ 5,967 27.0 % 21
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Revenue - Investment Advisory Fees and Shareholder Service Fees
Total revenue comprises investment advisory fees and shareholder service fees. Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , total revenue decreased by 15.1%, from$10.5 million to$8.9 million , investment advisory fees decreased by 14.8%, from$9.6 million to$8.2 million , and shareholder service fees decreased by 17.8%, from$0.8 million to$0.7 million . Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , total revenue decreased by 13.5%, from$22.1 million to$19.1 million , investment advisory fees decreased by 13.3%, from$20.4 million to$17.7 million , and shareholder service fees decreased by 14.9%, from$1.7 million to$1.5 million . In both periods, the decrease in investment advisory fees was due to decreased average daily net assets of the Hennessy Funds. The majority of the decrease in average daily net assets was attributable to net outflows, though net assets were further impacted by the market depreciation resulting from the COVID-19 pandemic. Although market depreciation had a significant impact on total assets under management during the most recent quarter, it occurred in the later part of the recent quarter and did not reduce our average assets under management (upon which investment advisory fees are calculated) as much as it would have had it occurred earlier in the quarter. The significant decline in total assets under management will put downward pressure on our average assets under management, and thus our revenues, in future quarters. The decrease in shareholder service fees in both periods 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. 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 endedMarch 31, 2020 , was$4.4 billion , which represents a decrease of$763 million , or 14.8%, compared to the three months endedMarch 31, 2019 , and average daily net assets for the six months endedMarch 31, 2020 , was$4.7 billion , which represents a decrease of$701 million , or 13.1%, compared to the six months endedMarch 31, 2019 .The Hennessy Fund with the largest average daily net assets for the three and six months endedMarch 31, 2020 , was theHennessy Focus Fund , with$1.6 billion and$1.7 billion , respectively. 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 and six months endedMarch 31, 2020 , was theHennessy Gas Utility Fund , with$0.8 billion in each period. We collect an investment advisory fee from theHennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets. 22
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The Hennessy Funds with net inflows for the three and six months ended
Three Months Ended March 31, 2020 Six
Months Ended
Fund Name Amount Fund Name Amount
Hennessy BP Midstream Fund Hennessy Large Cap
$4 million Financial Fund$0.5 million Hennessy Large Cap Financial Fund$2 million
The Hennessy Funds with the three largest amounts of net outflows for the three
and six months ended
Three Months Ended March 31, 2020 Six MonthsEndedMarch 31, 2020 Fund Name Amount Fund Name Amount Hennessy Focus Fund$(306) million Hennessy Focus Fund$(295) million Hennessy Gas Utility Fund$(75) million Hennessy Gas Utility Fund$(120) million Hennessy Japan Fund$(34) million Hennessy Mid Cap 30
Fund
Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , redemptions as a percentage of assets under management increased from an average of 3.4% per month to an average of 4.9% per month. Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , redemptions as a percentage of assets under management decreased from an average of 4.7% per month to an average of 3.6% per month.
Operating Expenses
Comparing the three months ended
Comparing the six months ended
In both periods, the dollar value decrease in operating expenses was due to decreases in all expense categories other than mutual fund distribution expense and depreciation expense, which moderately increased. Although the dollar value decreased in both periods, operating expenses increased as a percentage of total revenue due to our fixed costs, which did not decrease with decreasing revenue and thereby became a larger percentage of total operating expenses. Compensation and Benefits Expense: Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , compensation and benefits expense decreased by 12.3%, from$2.8 million to$2.4 million . As a percentage of total revenue, compensation and benefits expense increased 0.9 percentage points to 27.2%. Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , compensation and benefits expense decreased by 12.8%, from$5.7 million to$4.9 million . As a percentage of total revenue, compensation and benefits expense increased 0.2 percentage points to 25.8%. 23
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In both periods, the dollar value decrease in compensation and benefits expense was due primarily to a decrease in incentive-based compensation. Although the dollar value decreased in both periods, compensation and benefits expense increased as a percentage of total revenue due to our fixed salary and benefits costs, which did not decrease with decreasing revenue and thereby became a larger percentage of total expenses. General and Administrative Expense: Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , general and administrative expense decreased by 3.5% from$1.34 million to$1.29 million . As a percentage of total revenue, general and administrative expense increased 1.7 percentage points to 14.5%. The dollar value decrease was due mainly to decreased restricted stock expense for non-management directors. Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , general and administrative expense decreased by 2.5% from$2.85 million to$2.78 million . As a percentage of total revenue, general and administrative expense increased 1.6 percentage points to 14.5%. The dollar value decrease was due mainly to decreased variable sales-related costs. Although the dollar value decreased in both periods, general and administrative expense increased as a percentage of total revenue due to our fixed costs, such as professional services, which did not decrease with decreasing revenue and thereby became a larger percentage of total expenses. 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 ended
Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , mutual fund distribution expense increased by 10.9%, from$0.23 million to$0.25 million . As a percentage of total revenue, mutual fund distribution expense increased 0.3 percentage points to 1.3%. In both periods, the increase in mutual fund distribution expense was due to higher average daily net assets held by financial institutions, particularly assets held in Institutional Class shares of the Hennessy Funds. Institutional Class shares of the Hennessy Funds are not subject to 12b-1 fees, which are fees that can be used by the Hennessy Funds to pay mutual fund distribution expenses that we would otherwise pay. 24
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Sub-Advisory Fees Expense: Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , sub-advisory fees expense decreased by 10.8%, from$2.3 million to$2.0 million . As a percentage of total revenue, sub-advisory fees expense increased 1.1 percentage points to 22.6%.
Comparing the six months ended
In both periods, the dollar value decrease in sub-advisory fees expense was due to decreased average daily net assets held in the sub-advised Hennessy Funds. Although the dollar value decreased, sub-advisory fees expense increased as a percentage of total revenue due to a larger decreases in average daily net assets held by the Hennessy Funds that we internally manage than in average daily net assets of the sub-advised Hennessy Funds. Depreciation Expense: Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , depreciation expense increased by 13.0%, from$0.05 million to$0.06 million . As a percentage of total revenue, depreciation expense increased 0.2 percentage points to 0.7%. Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , depreciation expense increased by 4.6%, from$0.114 million to$0.109 million . As a percentage of total revenue, depreciation expense remained the same at 0.6%.
In both periods, the increase in depreciation expense was a result of a higher fixed asset purchase base.
Interest Expense Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , interest expense decreased by 13.0% from$0.30 million to$0.26 million . Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , interest expense decreased by 26.6% from$0.61 million to$0.45 million .
In both periods, the decrease in interest expense was due primarily to the
decrease in the Company's principal loan balance, which the Company repaid in
full on
Income Tax Expense Comparing the three months endedMarch 31, 2019 , to the three months endedMarch 31, 2020 , income tax expense decreased by 5.7%, from$0.84 million to$0.80 million . Comparing the six months endedMarch 31, 2019 , to the six months endedMarch 31, 2020 , income tax expense decreased by 17.8%, from$2.1 million to$1.8 million .
In both periods, the decrease in income tax expense was due primarily to lower net operating income in the current period, partially offset by a higher effective income tax rate due to changes in state apportionment factors.
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Net Income
Comparing the three months ended
In both periods, the decrease in net income was due to lower net operating income in the current period, partially offset by the higher 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 ofMarch 31, 2020 , 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 borrow funds or access the capital markets. There can be no assurance that we will be able to raise additional capital. Our total assets under management as ofMarch 31, 2020 , was$3.3 billion , a decrease of$1.8 billion or 35.4%, compared toMarch 31, 2019 . 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 six months endedMarch 31, 2020 , was$4.7 billion . As ofMarch 31, 2020 , we had cash and cash equivalents of$7.0 million and no debt. 26
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The following table summarizes key financial data relating to our liquidity and
use of cash:
For the Six Months
Ended March 31,
2020 2019
(In thousands)
Net cash provided by operating activities
Net cash used in investing activities (779 ) (1,858 )
Net cash used in financing activities (22,200 ) (3,929 )
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$18.3 million was due to the prepayment of the remaining outstanding balance payable under our term loan agreement withU.S. Bank , shares repurchased, and an increased dividend rate.
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