Hennessy Advisors Inc: Form 10-Q for the period ended Dec 31, 2023

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 our Annual Report on Form 10‑K for the fiscal year ended September 30, 2023, including under the section entitled “Risk Factors” in 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.

Our business activities are affected by many factors, including, without limitation, redemptions by investors in the Hennessy Funds, taxes, general economic and business conditions, interest rate movements, inflation, the personal savings rate, 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 (i) the identification, completion, and integration of future acquisitions and (ii) organic growth, through both the retention of the fund assets we currently manage and the generation of inflows into the funds we manage. The success of our business strategy may be influenced by the factors discussed in the section titled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2023. 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 16 open-end mutual funds and one ETF branded as the Hennessy Funds. We manage 12 of the 17 Hennessy Funds internally. For the remaining five 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 fund’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 onsite visits to sub‑advisors, as feasible. Our secondary business activity is providing shareholder services to investors in the Hennessy Mutual Funds.

We derive our operating revenues from investment advisory fees paid to us by the Hennessy Funds and shareholder service fees paid to us by the Hennessy Mutual Funds. These fees are calculated as a percentage of the average daily net assets of each Hennessy Fund. The percentage amount of the investment advisory fees varies by fund. The percentage amount of the shareholder service fees is consistent across all Hennessy Mutual 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 each Hennessy Fund, which are 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 13.09% for the three months ended December 31, 2023. During the most recent quarter, equity prices advanced as investors reacted positively to encouraging signs that inflation is moderating. While the rate of inflation continues to be above the Federal Reserve’s stated 2% target, the market increasingly seems to believe that the potential for slowing economic growth could bring inflation close to the Federal Reserve's stated goal. Notwithstanding this past quarter’s anemic revenue and earnings growth for S&P 500 companies, earnings broadly came in higher than consensus estimates, which may speak to the idea that companies are reining in expenses, which may in turn bolster margins in 2024.

Long-term U.S. bond yields decreased meaningfully during the three months ended December 31, 2023, as encouraging inflation data pointed to the potential that the Federal Reserve could be done raising rates for the foreseeable future. While the Federal Reserve continues to indicate that it reserves the right to raise rates, the market believes that the Federal Reserve is more likely to cut rates in 2024 rather than raise them. According to Bloomberg, the market is pricing in six rates cuts in 2024. With the labor market continuing to show signs of strength, we expect investors to focus on any weakness as a signal that inflation could moderate further. Economic growth in 2024 is expected to be 1.3% versus an expectation of 2.4% in 2023, according to Bloomberg. Any unexpected strength in either the labor market or the economy at large could pose a risk to the market’s belief that lower rates are on the horizon.

The Japanese equity market was up 8.00% in U.S. dollar terms over the three months ended December 31, 2023, as measured by the Tokyo Stock Price Index. During the period, Japanese equities traded higher as an emphasis on increasing shareholder value has taken root in Japan. Investors have applauded an increasing focus on corporate governance, capital allocation, and shareholder returns.

For the twelve months ended December 31, 2023, all 17 Hennessy Funds generated positive returns. For the three‑year period ended December 31, 2023, 13 of the Hennessy Funds with at least three years of operating history posted positive annualized returns, with the exception of the Hennessy Japan Fund, the Hennessy Japan Small Cap Fund, and the Hennessy Large Cap Financial Fund. Over the longer term, all Hennessy Funds with at least ten years of operating history posted positive returns in each of the five-year and ten-year periods ended December 31, 2023.

As always, we are committed to providing superior service to investors and employing a consistent and disciplined approach to investing based on a buy‑and‑hold philosophy that rejects the idea of market timing. 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 market insights, sector highlights, and other resources to help them manage their fund investments with confidence. We operate a 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 help retain assets and drive new purchases into the Hennessy Funds. We employ a comprehensive marketing and sales program consisting of content, digital, social media, 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 147,500 fund accounts nationwide, including accounts held by investors who employ financial advisors to assist them with investing as well as accounts held by retail investors who invest directly with us. We serve approximately 11,400 financial advisors who utilize the Hennessy Funds on behalf of their clients, including approximately 300 who purchased one of our Funds for the first time during the most recent quarter. Approximately 17% of such advisors own two or more Hennessy Funds, and over 400 advisors hold a position of over $500,000. While numbers have declined in recent years, we continue to focus significant efforts on financial advisors who own two or more Hennessy Funds or hold a position of over $500,000 in an effort to build and maintain brand loyalty among our top tier of advisors.

Total assets under management as of December 31, 2023, was $3.3 billion, an increase of $0.3 billion, or 9.0%, compared to December 31, 2022. The increase in total assets was attributable to market appreciation and the purchase of the assets related to the CCM Small/Mid-Cap Impact Value Fund, partly offset by net outflows of the Hennessy Funds.

The following table illustrates the quarter‑by‑quarter changes in our assets under management since December 31, 2022:

(In thousands)

As stated above, the fees we receive for providing investment advisory and shareholder services are based on average assets under management. The following table shows average assets under management for each quarter since December 31, 2022:

(In thousands)

The principal asset on our balance sheet, the management contract asset, represents the capitalized costs incurred in connection with the purchase of the assets related to the management of investment funds. As of December 31, 2023, this asset had a net balance of $81.5 million, compared to $81.3 million as of September 30, 2023. The increase is related to costs associated with the CCM Transaction Agreement.

On October 20, 2021, we completed a public offering of the 2026 Notes in the aggregate principal amount of $40.25 million, which included the full exercise of the underwriters’ overallotment option. The 2026 Notes mature on December 31, 2026, and may be redeemed in whole or in part at any time or from time to time at our option on or after December 31, 2023. The 2026 Notes bear interest at 4.875% per annum, payable on the last day of each calendar quarter and at maturity, beginning December 31, 2021. The 2026 Notes are direct unsecured obligations, rank equally in right of payment with any of our future unsecured unsubordinated indebtedness, senior to any of our future indebtedness that expressly provides that it is subordinate to the 2026 Notes, effectively subordinate to all of our existing and future secured indebtedness, and structurally subordinated to all existing and future indebtedness and other obligations of any future subsidiaries of ours.

The 2026 Notes are the principal liability on our balance sheet at $39.2 million, net of issuance costs.

Results of Operations

The following table sets forth items in the statements of income as dollar amounts and as percentages of total revenue:

(In thousands, except percentages)

18

Revenue – Investment Advisory Fees and Shareholder Service Fees

Total revenue comprises investment advisory fees and shareholder service fees. Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, total revenue remained flat at $6.1 million, investment advisory fees remained flat at $5.7 million, and shareholder service fees decreased by 2.4%, from $0.49 million to $0.48 million.

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 Mutual Funds. Assets held in Investor Class shares of the Hennessy Mutual Funds are subject to a shareholder service fee, whereas assets held in Institutional Class shares of the Hennessy Mutual 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 both the three months ended December 31, 2023 and 2022, was unchanged at $3.0 billion. The Hennessy Fund with the largest average daily net assets for the three months ended December 31, 2023, was the Hennessy Cornerstone Mid Cap 30 Fund, with $0.64 billion. We collect an investment advisory fee from the Hennessy Cornerstone Mid Cap 30 Fund at an annual rate of 0.74% of average daily net assets. The Hennessy Fund with the second largest average daily assets for the three months ended December 31, 2023, was the Hennessy Focus Fund, with $0.61 billion. We collect an investment advisory fee from the Hennessy 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.

Total assets under management as of December 31, 2023, was $3.3 billion, an increase of $0.3 billion, or 9.0%, compared to December 31, 2022. The increase in total assets was attributable to market appreciation and the purchase of the assets related to the CCM Small/Mid Cap Impact Value Fund, partly offset by net outflows of the Hennessy Funds.

The Hennessy Funds with the three largest amounts of net inflows were as follows:

The Hennessy Funds with the three largest amounts of net outflows were as follows:

Redemptions as a percentage of assets under management decreased from an average of 3.4% per month during the three months ended December 31, 2022, to an average of 2.8% per month during the three months ended December 31, 2023.

Operating Expenses

Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, total operating expenses increased by 3.9%, from $4.5 million to $4.7 million. As a percentage of total revenue, total operating expenses increased 2.9 percentage points to 76.8%.

The increase in operating expenses was due to increases in all expense categories other than sub-advisory fees, which decreased, and compensation and benefits, which remained flat.

Compensation and Benefits Expense: Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, compensation and benefits expense remained flat at $1.9 million. As a percentage of total revenue, compensation and benefits expense increased 0.2 percentage points to 30.4%.

General and Administrative Expense: Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, general and administrative expense increased by 9.9%, from $1.6 million to $1.7 million. As a percentage of total revenue, general and administrative expense increased 2.6 percentage points to 28.1%.

The increase in general and administrative expense was primarily due to increased professional services expense.

Fund Distribution and Other Expense: Fund distribution and other expense consists primarily of financial institution fees incurred by us for distribution of the Hennessy Funds and also for the operations of the Hennessy Stance ESG ETF. Fund distribution and other expense does not include sub‑advisory fees, which are shown separately.

The distribution component of fund distribution and other 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 as a fund distribution expense on our statement of operations to the extent paid by us. The Hennessy Mutual Funds, but not the Hennessy Stance ESG ETF, may be purchased directly and when 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. In addition, some financial institutions charge a minimum fee if the average daily net assets of a Hennessy Fund held by such an institution are less than a threshold amount. In such cases, we pay the minimum fee.

The distribution component of fund distribution and other expenses is affected by many factors, including the following:

• average daily net assets held by financial institutions;
• the split of average daily net assets held by financial institutions in Institutional Class shares of the Hennessy Mutual Funds versus Investor Class shares of the Hennessy Mutual Funds; and
• fee minimums at various financial institutions.

The other component of fund distribution and other expense consists of fees incurred by us for the operations of the Hennessy Stance ESG ETF. We receive a unitary investment advisory fee from the Hennessy Stance ESG ETF and then pay all of its operating expenses (with limited exceptions), including fund administration, fund accounting, transfer agency, custody, licensing, audit, and tax services.

Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, fund distribution and other expense increased by 56.8%, from $0.10 million to $0.15 million. As a percentage of total revenue, fund distribution and other expense increased 0.9 percentage points to 2.4%.

The increase in fund distribution and other expense was primarily due to a full period of fees incurred by us for the operations of the Hennessy Stance ESG ETF in the current period. We began advising the Hennessy Stance ESG ETF on December 22, 2022, and therefore only a partial period of expenses related to its operations were incurred in the prior comparable period.

Sub-Advisory Fees Expense: Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, sub-advisory fees expense decreased by 6.0%, from $1.0 million to $0.9 million. As a percentage of total revenue, sub-advisory fees expense decreased 1.0 percentage point to 14.8%. The decrease in sub-advisory fees expense was due to decreased average daily net assets of the sub‑advised Hennessy Funds, partly offset by the expense associated with new sub-advisory relationships relating to the Hennessy Stance ESG ETF that became effective on December 22, 2022.

Depreciation Expense: Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, depreciation expense increased by 40.8%, from $0.05 million to $0.07 million. As a percentage of total revenue, depreciation expense increased 0.2 percentage points to 1.1%.

The increase in depreciation expense resulted from new fixed asset purchases, partially offset by the write-off of fully depreciated assets.

Interest Expense

Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, interest expense increased from $0.56 million to $0.57 million. The increase in interest expense was due to the manner in which interest expense is calculated under accounting principles generally accepted in the United States. The issuance costs related to the 2026 Notes that have been capitalized are amortized over time and therefore increase the carrying amount of the 2026 Notes. As the carrying amount of the 2026 Notes increases, the interest expense on the 2026 Notes for financial statement purposes also increases.

Interest Income

Interest income consists of interest earned on cash and cash equivalents. Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, interest income increased from $0.47 million to $0.79 million.

The increase in interest income resulted from increased interest rates, as well as an increased cash balance.

Income Tax Expense

Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, income tax expense remained flat at $0.4 million.

Net Income

Comparing the three months ended December 31, 2022, to the three months ended December 31, 2023, net income increased by 7.2%, from $1.1 million to $1.2 million.

The increase in net income was primarily due to increased interest income in the current period.

Critical Accounting Policies and Estimates

Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the 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 future events affecting them may differ markedly from management’s current judgment. For a discussion of the accounting policies and estimates that we believe are most critical to understanding our results of operations and financial position, see the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10‑K for the fiscal year ended September 30, 2023.

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 of December 31, 2023, will be sufficient to meet our capital requirements for one year from the issuance date of this report, as well as our longer-term capital requirements for periods beyond 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 bank financing or accessing the capital markets. There can be no assurance that we will be able to raise additional capital.

On October 20, 2021, we completed a public offering of our 2026 Notes in the aggregate principal amount of $40.25 million, which included the full exercise of the underwriters’ overallotment option. The 2026 Notes mature on December 31, 2026, and may be redeemed in whole or in part at any time or from time to time at our option on or after December 31, 2023. The 2026 Notes bear interest at 4.875% per annum, payable on the last day of each calendar quarter and at maturity, beginning December 31, 2021. The 2026 Notes are direct unsecured obligations, rank equally in right of payment with any of our future unsecured unsubordinated indebtedness, senior to any of our future indebtedness that expressly provides that it is subordinate to the 2026 Notes, effectively subordinate to all of our existing and future secured indebtedness, and structurally subordinated to all existing and future indebtedness and other obligations of any future subsidiaries of ours.

Our total assets under management as of December 31, 2023, was $3.3 billion, an increase of $0.3 billion, or 9.0%, compared to December 31, 2022. 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 both the three months ended December 31, 2023 and 2022, was unchanged at $3.0 billion. As of December 31, 2023, we had cash and cash equivalents of $59.6 million.

The following table summarizes key financial data relating to our liquidity and use of cash:

(In thousands)

The increase in cash provided by operating activities of $0.4 million was primarily due to timing of cash payments and also due to increased net income in the current period.

The decrease in cash used in investing activities of $0.1 million was due to the costs associated with the purchase of assets related to the management of an ETF that was reorganized into the Hennessy Stance ESG ETF in the prior comparable period.

The increase in cash used in financing activities of $0.01 million was due the increased dollar amount of dividends paid as a result of having more shares outstanding in the current period than in the prior comparable period.

Evaluation of Disclosure Controls and Procedures

Management performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, management, including the Company’s principal executive officer and principal financial officer, concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting as defined in Rules 13a-15(f) of the Exchange Act that occurred during the fiscal quarter ended December 31, 2023, and that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended September 30, 2023.