Hennessy Advisors (HNNA) 10-Q2023 Q3 Quarterly report

PART I:         FINANCIAL INFORMATION

Item 1:          Unaudited Condensed Financial Statements

Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements

Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements

Statements of Changes in Stockholders' Equity

(In thousands, except share data)

(Unaudited)

Statements of Changes in Stockholders' Equity

(In thousands, except share data)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements

Statements of Cash Flows

(In thousands)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements

HENNESSY ADVISORS, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

The accompanying condensed balance sheet as of September 30, 2022, which has been derived from audited financial statements, and the unaudited interim condensed financial statements as of and for the three and nine months ended June 30, 2023, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of Hennessy Advisors, Inc. (the “Company,” “we,” “us,” or “our”). Certain information and footnote disclosures in these unaudited interim condensed financial statements, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission for Quarterly Reports on Form 10-Q. In the opinion of management, the unaudited interim condensed financial statements reflect all adjustments necessary for a fair statement of the Company’s financial position at June 30, 2023, the Company’s operating results for the three and nine months ended June 30, 2023 and 2022, and the Company’s cash flows for the nine months ended June 30, 2023 and 2022. These unaudited interim condensed financial statements and notes should be read in conjunction with the Company’s audited financial statements and notes thereto for fiscal year 2022, which are included in the Company’s Annual Report on Form 10‑K for the fiscal year ended September 30, 2022.

The preparation of financial statements requires management to make estimates and assumptions. Making estimates requires management to exercise significant judgment. Accordingly, the actual results could differ substantially from those estimates.

The Company’s operating activities consist primarily of providing investment advisory services to 16 open-end mutual funds and one exchange‑traded fund (“ETF”) branded as the Hennessy Funds. The Company serves as the investment advisor to all classes of the Hennessy Cornerstone Growth Fund, the Hennessy Focus Fund, the Hennessy Cornerstone Mid Cap 30 Fund, the Hennessy Cornerstone Large Growth Fund, the Hennessy Cornerstone Value Fund, the Hennessy Total Return Fund, the Hennessy Equity and Income Fund, the Hennessy Balanced Fund, the Hennessy Energy Transition Fund, the Hennessy Midstream Fund, the Hennessy Gas Utility Fund, the Hennessy Japan Fund, the Hennessy Japan Small Cap Fund, the Hennessy Large Cap Financial Fund, the Hennessy Small Cap Financial Fund, and the Hennessy Technology Fund (collectively, the “Hennessy Mutual Funds”), as well as to the Hennessy Stance ESG ETF. The Company also provides shareholder services to investors in the Hennessy Mutual Funds.

          The employee retention credit (“ERC”), as originally enacted on March 27, 2020, by the CARES Act, was a refundable tax credit against certain employment taxes equal to 50% of the qualified wages an eligible employer paid to employees and allowed claims through December 31, 2021, by eligible employers who retained employees during the Covid-19 pandemic. The Company filed Form 941-X to request an ERC from the Internal Revenue Service. In May 2023, the Company received an ERC of approximately $0.3 million plus accrued interest. For-profit entities do not have specific guidance to apply under accounting principles generally accepted in the United States to account for ERCs and therefore follow guidance in accordance with Accounting for Government Grants and Disclosure of Government Assistance (IAS 20). In accordance with IAS 20, the Company is netting the credit against related payroll expense in the current period.

The Company’s operating revenues consist of contractual investment advisory and shareholder service fees paid to it by the Hennessy Funds. The Company earns investment advisory fees from each Hennessy Fund by, among other things:

The Company earns shareholder service fees from Investor Class shares of the Hennessy Mutual Funds by, among other things, maintaining a toll‑free number that the current investors in the Hennessy Funds may call to ask questions about their accounts or the funds and actively participating as a liaison between investors in the Hennessy Funds and U.S. Bank Global Fund Services. These fee revenues are earned and calculated daily by the Hennessy Funds’ accountants at U.S. Bank Global Fund Services and are subsequently reviewed by management. The fees are computed and billed monthly, at which time they are recognized in accordance with Accounting Standards Codification 606 — Revenue from Contracts with Customers.

The Company waives a portion of its fees with respect to the Hennessy Midstream Fund, the Hennessy Technology Fund, and the Hennessy Stance ESG ETF to comply with contractual expense ratio limitations. The fee waivers are calculated daily by the Hennessy Funds’ accountants at U.S. Bank Global Fund Services, reviewed by management, and then charged to expense monthly as offsets to the Company’s revenues. Each waived fee is then deducted from investment advisory fee income and reduces the aggregate amount of advisory fees the Company receives from such fund in the subsequent month. To date, the Company has only waived fees based on contractual obligations, but the Company has the ability to waive fees at its discretion. Any decision to waive fees would apply only on a going‑forward basis.

The Company’s contractual agreements for investment advisory and shareholder services prove that a contract exists with fixed and determinable fees, and the services are rendered daily. The collectability is deemed probable because the fees are received from the Hennessy Funds in the month subsequent to the month in which the services are provided.

Throughout its history, the Company has completed 11 purchases of the assets related to the management of 31 investment funds, some of which were reorganized into already existing Hennessy Funds. In accordance with Financial Accounting Standards Board (“FASB”) guidance, the Company periodically reviews the carrying value of its management contracts asset to determine if any impairment has occurred. The fair value of the management contracts asset was estimated as of September 30, 2022, by applying the income approach and is based on management estimates and assumptions, including third‑party valuations that utilize appropriate valuation techniques. It was determined there was no impairment as of such date. As of June 30, 2023, management performed a qualitative analysis and determined it was more likely than not that there continued to be no impairment.

Under Accounting Standards Codification 350 — Intangibles – Goodwill and Other, intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment. The Company reviews the useful life of the management contracts each reporting period to determine if they continue to have an indefinite useful life.

The Company completed its most recent asset purchase on December 22, 2022, when it purchased certain assets related to the management of the Stance Equity ESG Large Cap Core ETF (the “Stance ETF”). This asset purchase added approximately $43 million to the Company’s assets under management at the time of closing. The purchase was consummated in accordance with the terms and conditions of the Transaction Agreement, dated as of August 29, 2022, among the Company, Stance Capital, LLC, and Red Gate Advisers, LLC, among others. Upon completion of the transaction, the assets related to the management of the Stance ETF were reorganized into a newly formed series of Hennessy Funds Trust named the Hennessy Stance ESG ETF. In connection with the transaction, Stance Capital, LLC and Vident Investment Advisory, LLC became sub-advisors to the Hennessy Stance ESG ETF.

On April 26, 2023, the Company announced that it has signed a definitive agreement with Community Capital Management, LLC (“CCM”) related to the management of the CCM Core Impact Equity Fund and the CCM Small/Mid-Cap Impact Value Fund (the “CCM Equity Funds”). The definitive agreement includes customary representations, warranties, and covenants of the parties to the agreement. It provides for payment by the Company to be made upon closing equal to 1.25% of the aggregate current net asset value of the CCM Equity Funds measured as of the close of business two trading days prior to the closing date of the transaction. The Company expects to complete the transaction during calendar 2023.

In the current period, the Company capitalized $0.1 million in legal costs related to the transaction. Upon completion of the transaction, the CCM Equity Funds will be reorganized into the Hennessy Stance ESG ETF. The transaction is subject to customary closing conditions, including the approval of the CCM Equity Funds’ shareholders.

The Company has investment advisory agreements with Hennessy Funds Trust under which it provides investment advisory services to all classes of the 16 Hennessy Mutual Funds and the Hennessy Stance ESG ETF.

The investment advisory agreements must be renewed annually (except in limited circumstances) by (a) the Funds’ Board of Trustees or the vote of a majority of the outstanding shares of the applicable Hennessy Fund and (b) the vote of a majority of the trustees of Hennessy Funds Trust who are not interested persons of the Hennessy Funds. If an investment advisory agreement is not renewed, it terminates automatically. There are two additional circumstances in which an investment advisory agreement terminates. First, an investment advisory agreement automatically terminates if the Company assigns them to another advisor (assignment includes “indirect assignment,” which is the transfer of the Company’s common stock in sufficient quantities deemed to constitute a controlling block). Second, an investment advisory agreement may be terminated prior to its expiration upon 60 days’ written notice by either the applicable Hennessy Fund or the Company.

As provided in each investment advisory agreement, the Company receives investment advisory fees monthly based on a percentage of the applicable fund’s average daily net asset value.

The Company has entered into sub-advisory agreements for the Hennessy Focus Fund, the Hennessy Equity and Income Fund, the Hennessy Japan Fund, the Hennessy Japan Small Cap Fund, and the Hennessy Stance ESG ETF. Under each of these sub-advisory agreements, the sub‑advisor is responsible for the investment and reinvestments of the assets of the applicable Hennessy Fund in accordance with the terms of such agreement and the applicable Hennessy Fund’s Prospectus and Statement of Additional Information. The sub‑advisors are subject to the direction, supervision, and control of the Company and the Funds’ Board of Trustees. The sub‑advisory agreements must be renewed annually (except in limited circumstances) in the same manner as, and are subject to the same termination provisions as, the investment advisory agreements.

In exchange for the sub-advisory services, the Company (not the Hennessy Funds) pays sub-advisory fees to the sub-advisors out of its own assets. Sub‑advisory fees are calculated as a percentage of the applicable sub‑advised fund’s average daily net asset value.

The Company applies Accounting Standards Codification 820 — Fair Value Measurement for all financial assets and liabilities, which establishes a framework for measuring fair value and expands disclosures about fair value measurements. The standard defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” It also establishes a fair value hierarchy consisting of the following three levels that prioritize the inputs to the valuation techniques used to measure fair value:

Based on the definitions, the following tables represent the Company’s assets categorized in the Level 1 to Level 3 hierarchies:

There were no transfers between levels during the three months ended June 30, 2023, or the year ended September 30, 2022.

The fair values of receivables, payables, and accrued liabilities approximate their book values given the short-term nature of those instruments.

The fair value of the 2026 Notes (see Note 7) was approximately $36.93 million as of June 30, 2023, based on the last trading price of the notes on that date (Level 1).

The Company determines if an arrangement is an operating lease at inception. Operating leases are included in operating lease right‑of‑use assets and current and long‑term operating lease liabilities on the Company’s balance sheet. During the quarter ended March 31, 2021, the Company renewed the lease for its office in Novato, California for an additional three years, which created a long‑term operating lease as of such date. Upon renewal of the lease, the Company recorded a right‑of‑use asset of $1.1 million on its balance sheet. The renewed lease expires on July 31, 2024. There were no other long‑term operating leases as of June 30, 2023, and September 30, 2022.

Right‑of‑use assets represent the Company’s right to use an underlying asset for the lease term and operating lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease right‑of‑use assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. In determining the present value of lease payments, the Company uses its incremental borrowing rate based on the information available at the lease commencement date. The Company’s lease terms may include options to extend the lease when it is reasonably certain that it will exercise any such options. For its leases, the Company concluded that it is not reasonably certain that any renewal options would be exercised, and, therefore, the amounts are not recognized as part of operating lease right‑of‑use assets or operating lease liabilities. Leases with initial terms of 12 months or less, and certain office equipment leases that are deemed insignificant, are not recorded on the balance sheet and are expensed as incurred and included within rent expense under general and administrative expense. Lease expense related to operating leases is recognized on a straight-line basis over the expected lease terms.

The Company’s most significant leases are real estate leases of office facilities. The Company leases office space under non-cancelable operating leases. Its principal executive office is located in Novato, California, and it has additional offices in Austin, Texas, Dallas, Texas, Boston, Massachusetts, and Chapel Hill, North Carolina. Only the office lease in Novato, California has been capitalized because the other operating leases have terms of 12 months or less, including leases that are month‑to‑month in nature. The classification of the Company’s operating lease right-of-use assets and operating lease liabilities and other supplemental information related to the Company’s operating leases are as follows:

For the nine months ended June 30, 2023, rent expense for all offices, which is recorded under general and administrative expense in the statements of income, totaled $0.4 million.

The undiscounted cash flows for future maturities of the Company’s operating lease liabilities and the reconciliation to the balance of operating lease liabilities reflected on the Company’s balance sheet are as follows:

Details relating to accrued liabilities and accounts payable reflected on the Company’s balance sheet are as follows:

On October 20, 2021, the Company completed a public offering of 4.875% notes due 2026 in the aggregate principal amount of $40,250,000 (the “2026 Notes”), which included the full exercise of the underwriters’ overallotment option. The initial net proceeds received were approximately $38,607,000 after considering the impact of issuance costs and underwriter discounts. 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 mature on December 31, 2026.

The 2026 Notes are direct unsecured obligations, rank equally in right of payment with any of the Company’s future unsecured unsubordinated indebtedness, senior to any of the Company’s future indebtedness that expressly provides that it is subordinate to the 2026 Notes, effectively subordinate to all of the Company’s existing and future secured indebtedness, and structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s future subsidiaries.

The Company’s effective income tax rates for the nine months ended June 30, 2023 and 2022, were 26.2% and 23.0%, respectively. For the nine months ended June 30, 2022, the effective income tax rate was lower than the federal statutory rate due to the recognition of a tax benefit related to a California tax refund of $0.2 million.

The Company is subject to income tax in the U.S. federal jurisdiction and various state jurisdictions. As of June 30, 2023, the Company has identified 22 state tax jurisdictions in which it is subject to income tax.

In addition to the operating leases discussed in Note 5, the Company has contractual expense ratio limitations in place with respect to the Hennessy Midstream Fund, the Hennessy Technology Fund, and the Hennessy Stance ESG ETF. The contractual expense ratio limitations with respect to the Hennessy Midstream Fund and the Hennessy Technology Fund expire February 28, 2024. The contractual expense ratio limitation with respect to the Hennessy Stance ESG ETF expires December 31, 2024. Total fees waived during the nine months ended June 30, 2023 and June 30, 2022, were $0.11 million and $0.08 million, respectively. To date, the Company has only waived fees based on contractual obligations but has the ability to waive fees at its discretion. Any decision to waive fees would apply only on a going forward basis.

The Company has no other commitments and no significant contingencies with original terms in excess of one year.

Amended and Restated 2013 Omnibus Incentive Plan

The Company has adopted, and the Company’s shareholders have approved, the Amended and Restated 2013 Omnibus Incentive Plan (the “Omnibus Plan”). Under the Omnibus Plan, participants may be granted restricted stock units (“RSUs”), each of which represents an unfunded, unsecured right to receive a share of the Company’s common stock on the date specified in the recipient’s award. The Company issues new shares of its common stock when it is required to deliver shares to an RSU recipient. The RSUs granted under the Omnibus Plan vest over four years at a rate of 25% per year. The Company recognizes stock‑based compensation expense on a straight‑line basis over the four-year vesting term of each award.

A summary of RSU activity is as follows:

Additional information related to RSUs is as follows:

Dividend Reinvestment and Stock Purchase Plan

In January 2021, the Company adopted a Dividend Reinvestment and Stock Purchase Plan (the “DRSPP”), replacing the previous Dividend Reinvestment and Stock Purchase Plan that had been in place since 2018. The DRSPP provides shareholders and new investors with a convenient and economical means of purchasing shares of the Company’s common stock and reinvesting cash dividends paid on the Company’s common stock. Under the DRSPP, the Company issued 6,691 and 6,002 shares of common stock during the nine months ended June 30, 2023 and 2022, respectively. The maximum number of shares that may be issued under the DRSPP is 1,470,000, of which 1,446,154 shares remained available for issuance as of June 30, 2023.

Stock Buyback Program

In August 2010, the Company’s Board of Directors adopted a stock buyback program pursuant to which the Company was authorized to repurchase up to 1,500,000 shares of its common stock in the open market, in privately negotiated transactions, or otherwise. The program has no expiration date. In August 2022, the Board of Directors increased the number of shares that may be repurchased under the program to 2,000,000 shares. As a result, a total of 1,096,368 shares remains available for repurchase under the stock buyback program. The Company did not repurchase any shares of its common stock pursuant to the stock buyback program during the nine months ended June 30, 2023.

Basic earnings per share is determined by dividing net earnings by the weighted average number of shares of common stock outstanding, while diluted earnings per share is determined by dividing net earnings by the weighted average number of shares of common stock outstanding adjusted for the dilutive effect of common stock equivalents, which consist of RSUs.

For the nine months ended June 30, 2023 and 2022, the Company excluded 99,869 and 241 common stock equivalents, respectively, from the diluted earnings per share calculations because they were not dilutive. In each case, the excluded common stock equivalents consisted of non‑vested RSUs.

The Company paid a quarterly cash dividend of $0.1375 per share on June 5, 2023, to shareholders of record as of May 23, 2023.

The Company has reviewed accounting pronouncements issued between the filing date of its most recent Form 10-K, which was December 7, 2022, and the filing date of this Form 10-Q and has determined that no accounting pronouncements issued would have a material impact on the Company’s financial position, results of operations, or disclosures.

On July 14, 2023, one of the sub‑advisors to the Hennessy Stance ESG ETF, Vident Investment Advisory, LLC (“VIA”), completed an acquisition transaction that resulted in a change of control of VIA and an automatic termination of our sub‑advisory agreement with VIA. As a result of the transaction, VIA ceased to exist and Vident Advisory, LLC (“Vident Advisory”) is now the sole Vident enterprise carrying out Vident’s business and operations. On the same date, the Company entered into a new sub‑advisory agreement with Vident Advisory pursuant to which Vident Advisory now provides sub‑advisory services to the Hennessy Stance ESG ETF. The new sub‑advisory agreement has been approved by the Funds’ Board of Trustees and the shareholders of the Hennessy Stance ESG ETF.

In addition, at the same special meeting of shareholders of the Hennessy Stance ESG ETF at which the new sub��advisory agreement with Vident Advisory was approved, the shareholders of the Hennessy Stance ESG ETF approved the implementation of a manager of managers structure for the Fund. In the absence of a manager of managers structure, a sub‑advisory agreement automatically terminates if it is assigned. Assignment is generally defined under the Investment Company Act of 1940 (the “1940 Act”) and the Investment Advisers Act of 1940 (the “Advisers Act”) to include direct assignments as well as assignments that are deemed to occur due to the change in control of the investment advisor, which includes the Company or one of the sub‑advisors that the Company has engaged on behalf of certain of the Hennessy Funds. However, a transaction is not an assignment under the 1940 Act or the Advisers Act if it does not result in a change of actual control or management of the Company or, in the context of a sub-advisor, a change of actual control or management of the sub-advisor.

Upon the occurrence of an assignment due to a change of control of a sub-advisor, but not a change of control of the Company, the Company can continue acting as an advisor to the impacted Hennessy Fund, but the shareholders of such Fund would have to approve a new sub‑advisory agreement for the sub‑advisor. Because obtaining shareholder approval for a new sub‑advisor can be costly, both in terms of expense and time, the Company recently sought and received an exemptive order from the SEC to operate under a manager of managers structure. The manager of managers structure permits the Company to appoint and replace unaffiliated sub-advisors and to enter into and make material amendments to the related sub-advisory contracts on behalf of the Hennessy Funds without shareholder approval, but subject in each case to the approval of the Funds’ Board of Trustees. Under the manager of managers structure, the Company has ultimate responsibility, subject to oversight by the Funds’ Board of Trustees, for overseeing the Hennessy Funds’ unaffiliated sub-advisors and recommending their hiring, termination, or replacement. The manager of managers structure cannot be implemented on behalf of a particular Hennessy Fund until the shareholders of such Fund approve its implementation. As stated above, the shareholders of the Hennessy Stance ESG ETF recently approved this arrangement. The Company is evaluating the timing and process for implementing a manager of managers structure for the Hennessy Funds that have sub-advisors other than the Hennessy Stance ESG ETF.

Item 2.            Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 ended September 30, 2022, 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.

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 (a) the identification, completion, and integration of future acquisitions and (b) 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 this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022. 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 of the 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 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 21.73% for the nine months ended June 30, 2023. During the most recent quarter, equity prices advanced as investors appeared to continue to focus on a resilient, albeit slowing economy. While inflation continues to moderate in the United States, in other countries it remains stubbornly high. The consensus expectation that the Federal Reserve would start to lower the Federal Funds Rate in the fall has been put on hold as Federal Reserve officials continue to insist that they are not likely done with raising rates. The market’s strong advance this year, especially in technology-related shares, continues to defy expectations that higher interest rates would depress equity valuations.

Long-term U.S. bond yields increased during the three months ended June 30, 2023, as inflation remained above the Federal Reserve’s target of 2%. Although inflation has moderated, the Fed continues to be vigilant in signaling that more rate hikes could come in the back half of 2023. With the labor market continuing to show signs of strength, there is a belief that consumer demand could keep upward pressure on prices. According to estimates compiled by Bloomberg, the consumer price index is expected to rise 4.1% in 2023, with an expectation that it will moderate to 2.6% in 2024. We believe that investors will continue to monitor expectations for economic growth to get a gauge on how many more rate hikes could be forthcoming.

The Japanese equity market was up 26.87% in U.S. dollar terms over the nine months ended June 30, 2023, as measured by the Tokyo Stock Price Index. During the period, Japanese equities traded higher as robust domestic consumer demand coupled with increased foreign demand for Japanese equities propelled shares higher.

For the nine months ended June 30, 2023, 15 out of 17 Hennessy Funds generated positive returns. For the three‑year period ended June 30, 2023, 15 of the Hennessy Funds with at least three years of operating history posted positive annualized returns, with the exception of the Hennessy Japan Fund. Over the longer term, all Hennessy Funds with at least 10 years of operating history posted positive returns in each of the five-year and ten-year periods ended June 30, 2022.

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 138,500 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 11,500 financial advisors who utilize the Hennessy Funds on behalf of their clients, including approximately 210 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 June 30, 2023, was $3.0 billion, a decrease of $0.2 billion, or 6.1%, compared to June 30, 2022. The decrease in total assets was attributable to net outflows of the Hennessy Funds, partly offset by market appreciation.

The following table illustrates the quarter‑by‑quarter changes in our assets under management since June 30, 2022:

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, 2022:

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 investment funds. As of June 30, 2023, this asset had a net balance of $81.2 million, compared to $80.9 million as of September 30, 2022. The increase was due to the purchase of assets related to the management of the Stance ETF and the ongoing acquisition of the CCM Equity 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 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 $39.1 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:

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, 2022, to the three months ended June 30, 2023, total revenue decreased by 17.5%, from $6.9 million to $5.7 million, investment advisory fees decreased by 17.9%, from $6.4 million to $5.2 million, and shareholder service fees decreased by 12.9%, from $0.53 million to $0.47 million. Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, total revenue decreased by 23.4%, from $23.2 million to $17.8 million, investment advisory fees decreased by 24.1%, from $21.5 million to $16.3 million, and shareholder service fees decreased by 14.9%, from $1.7 million to $1.4 million.

In both periods, the decrease in investment advisory fees was due mainly to decreased average daily net assets of the Hennessy Funds, and 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. In each case, the decrease in average daily net assets was attributable primarily to net outflows.

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, 2023, was $2.9 billion, which represents a decrease of $0.6 billion, or 17.1%, compared to the three months ended June 30, 2022, and average daily net assets for the nine months ended June 30, 2023, was $3.0 billion, which represents a decrease of $0.8 billion, or 21.9%, compared to the nine months ended June 30, 2022. The Hennessy Fund with the largest average daily net assets for the three and nine months ended June 30, 2023, was the Hennessy Focus Fund, with $0.7 billion in each period. 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. The Hennessy Fund with the second largest average daily assets for the three and nine months ended June 30, 2023, was the Hennessy Gas Utility Fund, with $0.5 billion in each period. We collect an investment advisory fee from the Hennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets.

Total assets under management as of June 30, 2023, was $3.0 billion, a decrease of $0.2 billion, or 6.1%, compared to June 30, 2022. The decrease in total assets was attributable to net outflows of the Hennessy Funds, partly offset by market appreciation.

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 3.2% per month during the three months ended June 30, 2022, to an average of 2.1% per month during the three months ended June 30, 2023. Redemptions as a percentage of assets under management increased from an average of 2.7% per month during the nine months ended June 30, 2022, to an average of 2.8% per month during the nine months ended June 30, 2023.

Operating Expenses

Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, total operating expenses decreased by 5.7%, from $4.6 million to $4.3 million. As a percentage of total revenue, total operating expenses increased 9.5 percentage points to 75.8%.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, total operating expenses decreased by 14.4%, from $15.4 million to $13.2 million. As a percentage of total revenue, total operating expenses increased 7.8 percentage points to 74.2%.

In both periods, the dollar value decrease in operating expenses was due to decreases in all expense categories other than general and administrative expense and depreciation expense, which moderately increased.

Compensation and Benefits Expense: Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, compensation and benefits expense decreased by 2.3%, from $2.0 million to $1.9 million. As a percentage of total revenue, compensation and benefits expense increased 5.3 percentage points to 34.1%.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, compensation and benefits expense decreased by 9.9%, from $6.4 million to $5.7 million. As a percentage of total revenue, compensation and benefits expense increased 4.9 percentage points to 32.3%.

In both periods, the dollar value decrease in compensation and benefits expense was primarily due to the receipt of the Employee Retention Tax Credit from the Federal government in June 2023, which is recognized as a reduction to payroll expense.

General and Administrative Expense: Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, general and administrative expense increased by 6.3%, from $1.2 million to $1.3 million. As a percentage of total revenue, general and administrative expense increased 5.2 percentage points to 22.9%.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, general and administrative expense increased by 9.5%, from $3.8 million to $4.1 million. As a percentage of total revenue, general and administrative expense increased 7.0 percentage points to 23.4%.

In both periods, 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 third‑party 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 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:

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, 2022, to the three months ended June 30, 2023, fund distribution and other expense decreased by 0.9%, from $0.117 million to $0.116 million. As a percentage of total revenue, fund distribution and other expense increased 0.3 percentage points to 2.0%.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, fund distribution and other expense decreased by 23.8%, from $0.5 million to $0.3 million. As a percentage of total revenue, fund distribution and other expense remained the same at 1.9%.

In both periods, the dollar value decrease in fund distribution and other expense was primarily due to decreased average daily net assets of the Hennessy Funds.

Sub-Advisory Fees Expense: Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, sub-advisory fees expense decreased by 24.9%, from $1.2 million to $0.9 million. As a percentage of total revenue, sub-advisory expense decreased 1.5 percentage points to 15.8%. The decrease in sub-advisory 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 ETF that began in December 2022.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, sub-advisory fees expense decreased by 39.7%, from $4.6 million to $2.8 million. As a percentage of total revenue, sub-advisory expense decreased 4.3 percentage points to 15.7%. The decrease in sub-advisory expense was due to decreased average daily net assets of the sub‑advised Hennessy Funds, with an additional decrease as a result of us no longer paying sub‑advisory fees with respect to the Hennessy Energy Transition Fund and the Hennessy Midstream Fund after January 31, 2022.  The decrease was partly offset by the expense associated with new sub-advisory relationships relating to the Hennessy Stance ETF that began in December 2022.

Depreciation Expense: Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, depreciation expense increased by 13.5%, from $0.05 million to $0.06 million. As a percentage of total revenue, depreciation expense increased 0.2 percentage points to 1.0%.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, depreciation expense increased by 5.8%, from $0.155 million to $0.164 million. As a percentage of total revenue, depreciation expense increased 0.2 percentage points to 0.9%.

In both periods, 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 June 30, 2022, to the three months ended June 30, 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.

Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, interest expense increased from $1.6 million to $1.7 million. The increase in interest expense was due to a full period of 2026 Notes interest expense in the current period. The 2026 Notes were issued on October 20, 2021, and therefore incurred a partial period of interest expense in the prior comparable period.

Interest Income

Interest income consists of interest earned on cash and cash equivalents. Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, interest income increased from $0.02 million to $0.71 million. Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, interest income increased from $0.02 million to $1.76 million. In both periods, the increase in interest income was due to rising interest rates.

Income Tax Expense

Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, income tax expense decreased by 15.1%, from $0.5 million to $0.4 million. Comparing the nine months ended June 30, 2022, to the nine months ended June 30, 2023, income tax expense decreased by 15.2%, from $1.4 million to $1.2 million.

In both periods, the decrease in income tax expense was due primarily to lower net operating income in the current period, partly offset by a lower effective income tax rate in the prior period as previously discussed in the notes to the financial statements.

Net Income

Comparing the three months ended June 30, 2022, to the three months ended June 30, 2023, net income decreased by 14.2%, from $1.3 million to $1.1 million. Comparing the nine months ended June 30, 2023, to the nine months ended June 30, 2022, net income decreased by 28.8%, from $4.8 million to $3.4 million.

In both periods, the decrease in net income was primarily due to decreased assets under management, which resulted in lower revenues and net operating income.

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, 2022.

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, 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 June 30, 2023, was $3.0 billion, a decrease of $0.2 billion, or 6.1%, compared to June 30, 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 the three months ended June 30, 2023, was $2.9 billion, a decrease of $0.6 billion, or 17.1%, compared to the three months ended June 30, 2022. As of June 30, 2023, we had cash and cash equivalents of $59.4 million.

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

The decrease in cash provided by operating activities of $1.6 million was mainly due to decreased net income in the current period.

The increase in cash used in investing activities of $0.5 million was due to the purchase of assets related to the management of the Stance ETF and the ongoing CCM Equity Funds transaction in the current period.

The decrease in cash from financing activities of $38.6 million was due to the issuance of the 2026 Notes in the prior comparable period.

Item 4.            Controls and Procedures

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, 2023, and that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II:  OTHER INFORMATION

Item 1A.            Risk Factors

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, 2022, other than disclosed below.

The risk factor disclosure in our Annual Report on Form 10-K for the year ended September 30, 2022, set forth under the heading “We utilize unaffiliated sub-advisors to manage the portfolio composition of certain of the Hennessy Funds, and any matters that have an adverse impact on their businesses or any change in our relationships with our sub-advisors could lead to a reduction in assets under management, which would adversely affect our revenues.” is replaced in its entirety with the following risk factor:

We utilize unaffiliated sub-advisors to manage the portfolio composition of certain of the Hennessy Funds, and any matters that have an adverse impact on their businesses or any change in our relationships with our sub-advisors could lead to a reduction in assets under management, which would adversely affect our revenues.

We utilize unaffiliated sub‑advisors to manage the portfolio composition of some of the Hennessy Funds. Although we perform due diligence on our sub‑advisors, we do not manage their day‑to‑day business activities. Our financial condition and profitability may be adversely affected by situations that are specific to such sub‑advisors, such as disruption of their operations, their exposure to disciplinary action, or reputational harm to them.

We periodically negotiate the terms and conditions of these sub‑advisory relationships, and there can be no assurance that such terms will remain acceptable to us or our sub‑advisors. These relationships may also be terminated by us or the applicable sub‑advisor without penalty on 60 days’ notice. In addition, each sub‑advisory agreement must be renewed annually by the Funds’ Board of Trustees (or by the vote of a majority of the outstanding shares of the applicable Hennessy Fund), including a majority of the disinterested trustees. Furthermore, a sub‑advisory agreement automatically terminates if it is assigned. Assignment is generally defined under the 1940 Act and the Advisers Act to include direct assignments as well as assignments that are deemed to occur due to the change in control of the investment advisor, which includes us or one of the sub‑advisors that we have engaged on behalf of certain of the Hennessy Funds. However, a transaction is not an assignment under the 1940 Act or the Advisers Act if it does not result in a change of actual control or management of us or, in the context of a sub-advisor, a change of actual control or management of the sub-advisor.

            Upon the occurrence of an assignment due to a change of control of a sub-advisor, but not a change of control of us, we can continue acting as an advisor to the impacted Hennessy Fund, but the shareholders of such Fund would have to approve a new sub‑advisory agreement for the sub‑advisor. Because obtaining shareholder approval for a new sub‑advisor can be costly, both in terms of expense and time, we recently sought and received an exemptive order from the SEC to operate under a manager of managers structure. The manager of managers structure permits us to appoint and replace unaffiliated sub-advisors and to enter into and make material amendments to the related sub-advisory contracts on behalf of the Hennessy Funds without shareholder approval, but subject in each case to the approval of the Funds’ Board of Trustees. Under the manager of managers structure, we have ultimate responsibility, subject to oversight by the Funds’ Board of Trustees, for overseeing the Hennessy Funds’ unaffiliated sub-advisors and recommending their hiring, termination, or replacement. The manager of managers structure cannot be implemented on behalf of a particular Hennessy Fund until the shareholders of such Fund approve its implementation.

            As an example, our sub‑advisory agreement with VIA, a sub‑advisor for the Hennessy Stance ESG ETF, terminated automatically on July 14, 2023, in connection with an acquisition transaction that resulted in a change of control of VIA. As a result of the transaction, VIA ceased to exist and Vident Advisory became the sole Vident enterprise carrying out Vident’s business and operations. On the same date, we entered into a new sub‑advisory agreement with Vident Advisory pursuant to which Vident Advisory now provides sub‑advisory services to the Hennessy Stance ESG ETF. The new sub‑advisory agreement was approved by the Funds’ Board of Trustees and by vote of the shareholders of the Hennessy Stance ESG ETF. At the same special meeting of shareholders of the Hennessy Stance ESG ETF at which the new sub‑advisory agreement with Vident Advisory was approved, the shareholders of the Hennessy Stance ESG ETF also approved the implementation of the manager of managers structure for the Fund. If the manager of managers structure had already been in place for the Hennessy Stance ESG ETF prior to the change of control of VIA, we could have avoided the expense of a special meeting of shareholders. We are evaluating the timing and process for implementing a manager of managers structure for the remaining Hennessy Funds that have sub-advisors.

           Any interruption or termination of our sub‑advisory relationships, whether due to a change of control or any other circumstance, could affect our ability to market our sub‑advised funds and result in a reduction in assets under management, which would adversely affect our revenues.

Item 6.            Exhibits

Set forth below is a list of all exhibits to this Quarterly Report on Form 10-Q.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized: