Hennessy Advisors Inc: Form 10-Q for the period ended Jun 30, 2024

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 applicable 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 18.51% for the nine months ended June 30, 2024. During the most recent quarter, equity prices declined modestly as investors adjusted to an increasing likelihood that the Federal Reserve may cut the Federal Funds rate perhaps only once during 2024, according to estimates from Bloomberg. Earlier this year, the market was pricing in no fewer than three to four cuts. While the labor market remains strong, there are anecdotal reports from retailers that consumers are starting to allocate their disposable income in a more cautious manner. With the release of corporate earnings in the first quarter of 2024, we saw a landscape where earnings growth outpaced revenue growth, which speaks to marginally higher profit margins. This news, in conjunction with the strong labor market, has reinforced the idea that the economy is no longer headed toward recessionary territory. According to Bloomberg, real GDP growth in 2024 is expected to come in around 2.3%, only modestly behind last year’s real GDP growth of 2.5%.

While long-term U.S. bond yields were essentially flat from the beginning of our fiscal year nine months ago, a strong labor market and economic resilience caused long-term yields to increase nicely since the beginning of 2024. The Federal Reserve’s 2% inflation goal continues to dominate its thinking as it ponders the course for interest rate changes. In May, the consumer price index advanced at a 3.3% rate, well above the 2% target. According to Federal Reserve Chairman Jerome Powell, inflation is not expected to reach its 2% target rate until late 2025 or even in 2026. Despite this prediction, the market continues to hold out hope that the Fed may be able to cut interest rates even with elevated levels of inflation.

The Japanese equity market was up 13.72% in U.S. dollar terms over the nine months ended June 30, 2024, as measured by the Tokyo Stock Price Index. During the period, Japanese equities traded higher as investors cheered stronger corporate earnings, a weaker yen, and more shareholder friendly corporate governance.

For the twelve months ended June 30, 2024, all 17 Hennessy Funds generated positive total returns. For the three‑year period ended June 30, 2024, nearly all of the 17 Hennessy Funds posted positive annualized total returns, with the exception of the Hennessy Focus Fund, the Hennessy Japan Small Cap Fund, the Hennessy Large Cap Financial Fund, and the Hennessy Small Cap Financial Fund. Over the longer term, all of the Hennessy Funds with at least five or ten years of operating history posted positive returns in each of the five- and ten-year periods ended June 30, 2024.

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 180,000 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 11,500 financial advisors who utilize the Hennessy Funds on behalf of their clients, including over 450 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 500 advisors hold a position of over $500,000. While numbers have declined in recent years, we continue to focus significant efforts on building and maintaining brand loyalty among our top tier of advisors.

Total assets under management as of June 30, 2024, was $4.0 billion, an increase of $1.1 billion, or 35.9%, compared to June 30, 2023. The increase in total assets was attributable to net inflows into the Hennessy Funds, market appreciation, and the purchase of the assets related to the CCM Funds.

The following table illustrates the quarter‑by‑quarter changes in our assets under management since June 30, 2023:

(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 June 30, 2023:

(In thousands)

The principal asset on our balance sheet, the management contracts asset, represents the capitalized costs incurred in connection with the purchase of the assets related to the management of investment funds. As of June 30, 2024, this asset had a net balance of $82.3 million, compared to $81.3 million as of September 30, 2023. The increase was due to the purchase of assets related to the management of the CCM Funds.

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 future secured indebtedness, and structurally subordinate to all future indebtedness and other obligations of any future subsidiaries of ours.

The 2026 Notes are the principal liability on our balance sheet at $39.4 million, net of issuance costs.

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 June 30, 2024, 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.

As discussed above, on October 20, 2021, we completed a public offering of our 2026 Notes in the aggregate principal amount of $40.25 million. 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.

Our total assets under management as of June 30, 2024, was $4.0 billion, an increase of $1.1 billion, or 35.9%, compared to June 30, 2023. 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 nine months ended June 30, 2024, was $3.5 billion, an increase of $0.5 billion, or 16.9%, compared to the nine months ended June 30, 2023. As of June 30, 2024, we had cash and cash equivalents of $62.0 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 $1.2 million was primarily due to increased net income in the current period.

The increase in cash used in investing activities of $0.5 million was primarily due to the costs associated with the purchase of assets related to the management of the CCM Funds in the current period.

The increase in cash used in financing activities of $0.03 million was due to 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.

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)

(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 June 30, 2023, to the three months ended June 30, 2024, total revenue increased by 36.5%, from $5.7 million to $7.8 million, investment advisory fees increased by 38.3%, from $5.2 million to $7.2 million, and shareholder service fees increased by 16.6%, from $0.47 million to $0.54 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, total revenue increased by 17.5% from $17.8 million to $20.9 million, investment advisory fees increased by 18.5%, from $16.3 million to $19.3 million, and shareholder service fees increased by 6.1%, from $1.4 million to $1.5 million.

In both periods, the increase in investment advisory fees was due mainly to increased average daily net assets of the Hennessy Funds, and the increase in shareholder service fees was due to an increase 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 the three months ended June 30, 2024, was $3.9 billion, which represents an increase of $1.0 billion, or 36.6%, compared to the three months ended June 30, 2023, and average daily net assets for the nine months ended June 30, 2024, was $3.5 billion, which represents an increase of $0.5 billion, or 16.9%, compared to the nine months ended June 30, 2023. The Hennessy Fund with the largest average daily net assets for the three and nine months ended June 30, 2024, was the Hennessy Cornerstone Mid Cap 30 Fund, with $1.1 billion and $0.9 billion, respectively. 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 and nine months ended June 30, 2024, was the Hennessy Focus Fund, with $0.64 billion and $0.63 billion, respectively. 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 June 30, 2024, was $4.0 billion, an increase of $1.1 billion, or 35.9%, compared to June 30, 2023. The increase in total assets was attributable to net inflows into the Hennessy Funds, market appreciation, and the purchase of the assets related to the CCM 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 increased from an average of 2.1% per month during the three months ended June 30, 2023, to an average of 2.2% per month during the three months ended June 30, 2024. Redemptions as a percentage of assets under management decreased from an average of 2.8% per month during the nine months ended June 30, 2023, to an average of 2.4% per month during the nine months ended June 30, 2024.

Operating Expenses

Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, total operating expenses increased by 20.4%, from $4.3 million to $5.2 million. As a percentage of total revenue, total operating expenses decreased 9.0 percentage points to 66.8%.

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, total operating expenses increased by 13.3%, from $13.2 million to $14.9 million. As a percentage of total revenue, total operating expenses decreased 2.6 percentage points to 71.6%.

In both periods, the dollar value increase in operating expense was due to increases in all expense categories.

Compensation and Benefits Expense: Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, compensation and benefits expense increased by 17.1%, from $1.9 million to $2.3 million. As a percentage of total revenue, compensation and benefits expense decreased 4.9 percentage points to 29.2%. The dollar value increase in compensation and benefit expense was due to the ERC received in the prior comparable period, as discussed in Note 1 to Item 1, "Unaudited Condensed Financial Statements."

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, compensation and benefits expense increased by 11.6%, from $5.7 million to $6.4 million. As a percentage of total revenue, compensation and benefits expense decreased 1.7 percentage points to 30.6%. The dollar value increase in compensation and benefit expense was due to an increase in incentive-based compensation in the current period and also due to the ERC received in the prior comparable period, as discussed in Note 1 to Item 1, "Unaudited Condensed Financial Statements."

General and Administrative Expense: Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, general and administrative expense increased by 19.4%, from $1.3 million to $1.6 million. As a percentage of total revenue, general and administrative expense decreased 2.9 percentage points to 20.0%.

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, general and administrative expense increased by 14.4%, from $4.1 million to $4.7 million. As a percentage of total revenue, general and administrative expense decreased 0.7 percentage points to 22.7%.

In both periods, the dollar value increase in general and administrative expense was primarily due to increased commission expense on sales of the Hennessy Funds.

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 June 30, 2023, to the three months ended June 30, 2024, fund distribution and other expense increased by 96.6%, from $0.1 million to $0.2 million. As a percentage of total revenue, fund distribution and other expense increased 0.9 percentage points to 2.9%. The increase in fund distribution and other expense was primarily due to increased average daily net assets across the Hennessy Funds. Additionally, there was an increase in operating expenses relating to the Hennessy Stance ESG ETF, which had greater average daily net assets in the current period resulting from the purchase of assets related to the management of the CCM Core Impact Fund and subsequent reorganization of such assets into the Hennessy Stance ESG ETF. Such reorganization, which was effective as of February 23, 2024, nearly doubled the average daily net assets of the Hennessy Stance ESG ETF.

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, fund distribution and other expense increased by 68.5%, from $0.3 million to $0.6 million. As a percentage of total revenue, fund distribution and other expense increased 0.9 percentage points to 2.8%. The increase in fund distribution and other expense was primarily due to the additional expenses relating to the Hennessy Stance ESG ETF resulting from the purchase of assets related to the management of the CCM Funds and subsequent reorganization of such assets into the Hennessy Stance ESG ETF in the current period, but was also due to increased average daily net assets across the Hennessy Funds. In addition, the increase was also partially attributable 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 June 30, 2023, to the three months ended June 30, 2024, sub-advisory fees expense increased by 20.4%, from $0.9 million to $1.1 million. As a percentage of total revenue, sub-advisory fees expense decreased 1.9 percentage points to 13.9%.

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, sub-advisory fees expense increased by 8.6%, from $2.8 million to $3.0 million. As a percentage of total revenue, sub-advisory fees expense decreased 1.1 percentage points to 14.6%.

In both periods, the dollar value increase in sub-advisory fees expense was due to increased average daily net assets of the sub‑advised Hennessy Funds, the expense associated with new sub-advisory relationships relating to the Hennessy Stance ESG ETF that became effective on December 22, 2022, and the increase in average daily net assets of the Hennessy Stance ESG ETF as a result of the purchase of assets related to the management of the CCM Funds and subsequent reorganization of such assets into the Hennessy Stance ESG ETF.

Depreciation Expense: Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, depreciation expense remained the same at $0.06 million. As a percentage of total revenue, depreciation expense decreased 0.2 percentage points to 0.8%.

Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, depreciation expense increased by 12.8%, from $0.16 million to $0.19 million. As a percentage of total revenue, depreciation expense remained the same at 0.9%. The dollar value increase in depreciation expense resulted from new fixed asset purchases, partially offset by the write-off of fully depreciated assets.

Interest Income

Interest income consists of interest earned on cash and cash equivalents. Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, interest income increased from $0.7 million to $0.8 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, interest income increased from $1.8 million to $2.3 million.

In both periods, the increase in interest income resulted from increased interest rates and increased principal balances.

Interest Expense

Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, interest expense increased from $0.565 million to $0.569 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, interest expense increased from $1.69 million to $1.70 million.

In both periods, the increase in interest expense was due to the manner in which interest expense is calculated under U.S. GAAP. 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.

Income Tax Expense

Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, income tax expense increased by 84.2%, from $0.4 million to $0.8 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, income tax expense increased by 46.7%, from $1.2 million to $1.8 million.

In both periods, the increase in income tax expense was due to increased net operating income, as well as a higher effective income tax rate in the current period due to a greater exposure to state income tax liability based on the location of investors in the Hennessy Funds.

Net Income

Comparing the three months ended June 30, 2023, to the three months ended June 30, 2024, net income increased by 81.8%, from $1.1 million to $2.0 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2024, net income increased by 39.0%, from $3.4 million to $4.8 million.

In both periods, the increase in net income was primarily due to increased revenue, and additionally 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 U.S. GAAP, 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. There has been no material change to our critical accounting estimates disclosed in such Annual Report.

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 June 30, 2024, 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.