HENNESSY ADVISORS INC - Quarter Report: 2012 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended March 31, 2012

For the Transition Period From              to             

Commission File Number 000-49872

HENNESSY ADVISORS, INC.

(Exact name of registrant as specified in its charter)

(415) 899-1555

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of April 4, 2012 there were 5,759,857 shares of common stock issued and outstanding.

HENNESSY ADVISORS, INC.

INDEX

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Hennessy Advisors, Inc.

Balance Sheets

(In thousands, except share and per share amounts)

See accompanying notes to unaudited condensed financial statements

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Hennessy Advisors, Inc.

Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

See accompanying notes to unaudited condensed financial statements

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Hennessy Advisors, Inc.

Statements of Changes in Stockholders’ Equity

Six Months Ended March 31, 2012

(In thousands, except share data)

(Unaudited)

See accompanying notes to unaudited condensed financial statements

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Hennessy Advisors, Inc.

Statements of Cash Flows

(Unaudited)

See accompanying notes to unaudited condensed financial statements

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Hennessy Advisors, Inc.

Notes to Unaudited Condensed Financial Statements

(1) Basis of Financial Statement Presentation

The accompanying condensed balance sheet as of September 30, 2011, which has been derived from audited financial statements, and the unaudited interim condensed financial statements as of March 31, 2012 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”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at March 31, 2012, the operating results for the three and six months ended March 31, 2012 and March 31, 2011, and the cash flows for the six months ended March 31, 2012 and March 31, 2011. These financial statements and notes should be read in conjunction with the Company’s audited financial statements and notes thereto for the year ended September 30, 2011, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

The operating activities of the Company consist of providing investment advisory and shareholder services to nine open-end mutual funds (collectively the “Hennessy Funds”), six of which also have institutional share classes; and investment advisory services to one non-registered private pooled investment fund, the Hennessy Micro Cap Growth Fund, LLC. The Company serves as investment advisor for all classes of the Hennessy Cornerstone Growth Fund, the Hennessy Focus 30 Fund, the Hennessy Cornerstone Large Growth Fund, the Hennessy Cornerstone Value Fund, the Hennessy Select Large Value Fund, the Hennessy Select SPARX Japan Fund, the Hennessy Select SPARX Japan Smaller Companies Fund, the Hennessy Total Return Fund, the Hennessy Balanced Fund, and the Hennessy Micro Cap Growth Fund, LLC.

(2) Management Contracts

As of March 31, 2012, Hennessy Advisors had contractual management agreements with Hennessy Funds, Inc. for the Hennessy Balanced Fund and the Hennessy Total Return Fund; with Hennessy Mutual Funds, Inc. for all classes of the Hennessy Cornerstone Growth Fund, the Hennessy Cornerstone Value Fund, and the Hennessy Focus 30 Fund; with Hennessy Funds Trust for all classes of the Hennessy Cornerstone Large Growth Fund and the Hennessy Select Large Value Fund; and with Hennessy SPARX Funds Trust for all classes of the Hennessy Select SPARX Japan Fund and the Hennessy Select SPARX Japan Smaller Companies Fund.

The management agreements for the Hennessy Funds are renewed annually by (1) the board of directors or trustees of the applicable investment company or by a majority vote of the outstanding shares of the applicable fund and (2) by the vote of a majority of the directors or trustees of the applicable investment company who are not parties to the management agreement and are disinterested directors or trustees. These management agreements were renewed by the Board of Directors of Hennessy Funds, Inc. and Hennessy Mutual Funds, Inc. and by the Board of Trustees of Hennessy Funds Trust and Hennessy SPARX Funds Trust on March 7, 2012 for a period of one year.

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Other than non-renewal, two other circumstances might lead to termination of the management agreements: (1) the assignment of a management agreement to another advisor automatically terminates the agreement (assignment includes an “indirect assignment” by transferring a controlling block of our common stock); and (2) the termination of the agreement by the Company or by one of the Hennessy Funds’ investment companies upon 60 days’ prior written notice.

Under the terms of the management agreements, each fund bears all expenses incurred in its operation that are not specifically assumed by Hennessy Advisors, the administrator or the distributor. Hennessy Advisors bears the expense of providing office space, shareholder servicing, fulfillment, clerical and bookkeeping services and maintaining books and records of the Hennessy Funds.

The Company waives its investment advisory fees to comply with contractual expense ratio limitations for the Hennessy Funds’ institutional class shares. The fee waivers are calculated daily by the funds’ accountants at US Bancorp Fund Services, LLC and are charged to expense monthly by the Company as an offset to revenue. The fees are deducted from the management fee income, and are deducted from the funds received from the funds’ accountants in the subsequent month.

In the past, fees have only been waived based on contractual obligations. However, the Company regularly analyzes the fees and has the right to waive fees at its discretion to compete with other mutual funds with lower expense ratios. Any decision to waive fees would not apply to previous periods, but would apply on a going forward basis. As of March 31, 2012, the Company has never voluntarily waived fees, and has no current intention to voluntarily waive fees.

Hennessy Advisors is also the Managing Member of the Hennessy Micro Cap Growth Fund, LLC (the “Micro Cap Fund”). Hennessy Advisors will serve as the Managing Member until its resignation or removal. The Managing Member may voluntarily resign with 30 days’ prior written notice to the other members or 60 days’ prior written notice if there is not then a remaining Managing Member. At any time, the Managing Member may designate an additional Managing Member or designate a successor Managing Member with no further consent or approval required from the other members. The Managing Member may be removed at any time, with or without cause, by the vote of the other members owning a majority-in-interest of the capital accounts of the “Disinterested Members,” defined as members other than members who are the Managing Member or affiliates of the Managing Member.

Under the terms of the management agreement for the Micro Cap Fund, the Managing Member bears all organizational expenses (defined as expenses incurred in connection with and directly related to the formation, qualification and funding of the Micro Cap Fund), but the Micro Cap Fund bears all of its operating, investment and other expenses. However, the Managing Member is responsible for the ordinary and extraordinary costs of administering the Micro Cap Fund, including any placement fees incurred in connection with the offering of interests in the Micro Cap Fund.

Hennessy Advisors, as the Managing Member of the Micro Cap Fund, has the right to reduce or waive the management fee or incentive allocation (as defined in Note 5) chargeable to any member’s account without the consent of or notice to any other member.

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As of March 31, 2012, no triggering events or changes in circumstances occurred that indicated potential impairment of the management contracts.

(3) Investment in the Hennessy Micro Cap Growth Fund, LLC

On October 30, 2007, Hennessy Advisors invested $0.5 million in the Micro Cap Fund. The investment currently represents approximately 28.8% of the total subscriptions in the Micro Cap Fund. The Micro Cap Fund is a limited liability company for which Hennessy Advisors is the Managing Member.

The investment is classified as an available-for-sale security, is included on the balance sheet at fair market value and is accounted for using the equity method. The fair market value of the investment at March 31, 2012 was $0.4 million.

The accounting method the Company uses for its equity investments is generally dependent upon the influence the Company has over the investee. If there are investments where the Company can exert control over the financial and operating policies of the investee, which generally exists if there is a 50% or greater voting interest (the Company’s ownership in the Micro Cap Fund is approximately 28.8%), the investee will be consolidated into the Company’s financial statements. Further, as managing member of an investee, the Company is generally presumed to control the investee (and should consolidate the investee into the Company’s financial statements) unless this presumption is overcome because members of the investee other than the Company and its affiliates have the substantive ability to dissolve the investee or otherwise remove the Company as the managing member without cause. After considering the above with respect to the investment in the Micro Cap Fund and the Financial Accounting Standards Board’s (FASB) guidance on investment in equity and variable interests, the Company determined that the Micro Cap Fund should not be consolidated because the Company’s investment is less than 50% of the total investment, the Company can be removed from its position as Managing Member at any time, with or without cause, by the vote of the other members owning a majority-in-interest of the capital accounts of the “Disinterested Members,” and the Company does not have a controlling financial interest in the Micro Cap Fund as the Company has no obligation to absorb gains or losses.

(4) Bank Loan

On March 11, 2004, Hennessy Advisors secured financing from US Bank National Association to acquire the management contracts for certain Lindner Funds. The loan has been amended several times, most recently on September 27, 2010. As of March 31, 2012, the outstanding balance of $2.2 million requires 42 monthly payments in the amount of $52,083 plus interest at the bank’s prime rate (currently 3.25%, in effect since December 17, 2008) less one percent (effective interest rate of 2.25%) and is secured by the Company’s assets. The final installment of the then outstanding principal and its interest are due September 30, 2015. The loan agreement includes certain reporting requirements and loan covenants requiring the maintenance of certain financial ratios. The Company is in compliance as of March 31, 2012.

In connection with securing the financing discussed above, Hennessy Advisors incurred loan costs in the amount of $31,250, which are being amortized on a straight-line basis over 60 months. These costs are included in other assets on the balance sheet, net of accumulated amortization.

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(5) Investment Advisory and Shareholder Service Fee Revenue

Investment advisory and shareholder services, which are the Company’s primary sources of revenue, are recorded when earned. The Company receives investment advisory fees monthly at an annual rate of 0.74% of the average daily net assets of the Hennessy Cornerstone Growth Fund, the Hennessy Focus 30 Fund, the Hennessy Cornerstone Large Growth Fund, and the Hennessy Cornerstone Value Fund; at an annual rate of 0.85% of the average daily net assets of the Hennessy Select Large Value Fund; at an annual rate of 1.00% of the Hennessy Select SPARX Japan Fund; and at an annual rate of 1.20% of the Hennessy Select SPARX Japan Smaller Companies Fund. The annual advisory fee for the Hennessy Balanced Fund and the Hennessy Total Return Fund is 0.60%, and the annual advisory fee for the Micro Cap Fund is 2.0% of the aggregate capital accounts of the members, but no management fee is charged to the capital account of the Company.

The Company has delegated the day-to-day portfolio management of the Hennessy Select Large Value Fund, the Hennessy Select SPARX Japan Fund and the Hennessy Select SPARX Japan Smaller Companies Fund (the “Select Funds”) to sub-advisors. Hennessy Advisors pays RBC Global Asset Management (U.S.) Inc. at an annual rate of 0.35% of the average daily net assets of the Hennessy Select Large Value Fund; and Hennessy Advisors pays SPARX Asset Management Co., Ltd. at an annual rate of 0.35% of the average daily net assets of the Hennessy Select SPARX Japan Fund and of 0.20% of the average daily net assets of the Hennessy Select SPARX Japan Smaller Companies Fund.

Fees are earned for shareholder support services provided for each of the original class shares of the nine Hennessy Funds. The shareholder service fees are charged at an annual rate of 0.1% of average daily net assets.

In the Micro Cap Fund, an additional “incentive allocation” can potentially be earned on any member’s balance, other than the Company’s balance. The allocation is determined at the end of each calendar quarter as 20% of the amount by which net profits (defined as the amount by which the net asset value on the last day of a period exceeds the net asset value on the commencement of the same period), if any, exceed the positive balance, if any, of a member’s loss carryforward (defined as a memorandum account kept for each member having an initial balance of zero that is increased by the net loss, if any, allocated to each member for each calendar period). The incentive fee is calculated and earned on the last day of the quarter, at which point it would be recognized in accordance with FASB guidance on revenue recognition, which specifies that the following criteria must be met for revenue recognition: persuasive evidence of an arrangement exists, delivery has occurred or the service has been rendered, the fee is fixed and determinable, and collectability is probable. The incentive income is not subject to any clawback provisions that would require us to return fees to investors. There was no incentive fee earned in the six months ended March 31, 2012 and 2011.

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(6) Income Taxes

The following is our tax position at March 31, 2012 and 2011:

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of March 31, 2012 and September 30, 2011 are presented below:

The Company files U.S. federal and state tax returns and has determined that its major tax jurisdictions are the United States and California. The tax years ended in 2007 through 2010 remain open and subject to examination by the appropriate governmental agencies in the U.S., and the 2004 through 2010 tax years remain open in California.

The Company’s effective tax rates for the six months ended March 31, 2012 and 2011, were 46.6% and 41.6%, respectively, and differ from the federal statutory rate of 34% primarily due to the effects of state income taxes. The effective tax rate for the current period ended March 31, 2012 is abnormally high due to a non-recurring revaluation of the Company’s state deferred tax liabilities to reflect a higher blended state tax rate.

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(7) Earnings per Share and Dividends per Share

Basic earnings per share are determined by dividing net earnings by the weighted average number of shares of common stock outstanding, while diluted earnings per share are 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.

There were 439,738 common stock equivalents, consisting of unexercised options, excluded from the per share calculation for the six months ended March 31, 2012 because they were anti-dilutive. There were 653,175 common stock equivalents, consisting of unexercised options and unvested Restricted Stock Units (“RSUs”), excluded from the per share calculation for the six months ended March 31, 2011 because they were anti-dilutive.

Quarterly cash dividends of $0.025 and $0.03125 per share, respectively, were paid on December 8, 2011 to shareholders of record as of November 15, 2011; and on March 1, 2012 to shareholders of record as of February 7, 2012.

(8) Stock-Based Compensation

On May 2, 2001, the Company established an omnibus incentive plan (the Plan) providing for the issuance of options, stock appreciation rights, restricted stock, performance awards, and stock loans for the purpose of attracting and retaining executive officers and key employees. The maximum number of shares which may be issued under the Plan is 25% of the outstanding common stock of the Company, subject to adjustment by the compensation committee of the Board of Directors. The 25% limitation does not invalidate any awards made prior to a decrease in the number of outstanding shares, even though such awards have resulted or may result in shares constituting more than 25% of the outstanding shares being available for issuance under the Plan. Shares available under the Plan which are not awarded in one particular year may be awarded in subsequent years. The compensation committee of the Board of Directors has the authority to determine the awards granted under the Plan, including among other things, the individuals who receive the awards, the times when they receive them, vesting schedules, performance goals, whether an option is an incentive or nonqualified option and the number of shares to be subject to each award. However, no participant may receive options or stock appreciation rights under the Plan for an aggregate of more than 75,000 shares in any calendar year. The exercise price and term of each option or stock appreciation right is fixed by the compensation committee except that the exercise price for each stock option which is intended to qualify as an incentive stock option must be at least equal to the fair market value of the stock on the date of grant and the term of the option cannot exceed 10 years. In the case of an incentive stock option granted to a 10% shareholder, the exercise price must be at least 110% of the fair market value on the date of grant and cannot exceed five years. Incentive stock options may be granted only within ten years from the date of adoption of the Plan. The aggregate fair market value (determined at the time the option is granted) of shares with respect to which incentive stock options may be granted to any one individual, which stock options are exercisable for the first time during any calendar year, may not exceed $100,000. An optionee may, with the consent of the compensation committee, elect to pay for the shares to be received upon exercise of their options in cash or shares of common stock or any combination thereof.

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The exercise price of all options granted under the Plan was equal to the market price of the underlying common stock on the grant date and all options were granted and fully vested on the grant date. There were no options granted during the six months ended March 31, 2012 and 2011.

Under the Plan, participants may be granted RSUs, representing an unfunded, unsecured right to receive a Company common share on the date specified in the recipient’s award. The Company issues new shares for shares delivered for RSU recipients. The RSUs granted under the Plan vest over four years, at a rate of 25 percent per year. The Company recognizes compensation expense on a straight-line basis over the four-year vesting term of each award. There were no RSUs granted during the six months ended March 31, 2012 and 2011. RSU activity for the six months ended March 31, 2012 was as follows:

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As of March 31, 2012, there was $0.02 million of total RSU compensation expense related to non-vested awards not yet recognized, which is expected to be recognized over a weighted-average vesting period of 7 months.

(9) Commitments and Contingencies

The Company’s headquarters is located in leased office space under a single non-cancelable operating lease at 7250 Redwood Blvd., Suite 200, in Novato, California. There were no other commitments or contingencies as of March 31, 2012.

On March 1, 2012, the Company signed an amended lease agreement for the Novato office space extending the lease term through March 31, 2014 with an option for an additional two years thereafter. The amendment includes $0.11 million of free rent at the beginning of the new term, and subsequently a cost of $1.95 per square foot, which is a decrease from $2.05 per square foot prior to the lease amendment. Effective April 1, 2013, there is a rent increase to $2.05 per square foot. The straight-line rent expense through March 31, 2014, the end of the lease amendment, is $1.67 per square foot, or $0.02 million per month.

(10) Fair Value Measurements

In September, 2006, the FASB issued new standard “Fair Value Measurements,” which was effective for our fiscal year 2009. In February, 2008, the FASB issued a new standard which delayed the effective date for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, to the fiscal year beginning after November 15, 2008 (our fiscal year 2010). The Company adopted the fair value measurement for all financial and non-financial assets and liabilities as of October 1, 2009. Based on the scope of the new accounting guidance, all of the non-financial assets and non-financial liabilities on the Company’s balance sheet are excluded from the new accounting guidance. 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:

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Based on the definitions, the following table represents the Company’s assets categorized in the level 1 to 3 hierarchies as of March 31, 2012:

(11) New Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) No. 2011-12. The amendments in this Update supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income,” to effectively defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The guidance provided by this update becomes effective for annual periods beginning on or after December 15, 2011 (the Company’s fiscal year 2013). The adoption of this standard is not expected to have a material impact on the Company’s financial position and results of operations.

In February 2012, the Financial Accounting Standards Board (“FASB”) issued amendments to Accounting Standards Update (ASU) No. 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRS.” The amendments change the wording used to describe the requirements in US GAAP for measuring fair value and for disclosing information about fair value requirements and are a result of the joint efforts by the FASB and the IASB to develop a single, converged fair value framework on how to measure fair value

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and what disclosures to provide about fair value measurements. The guidance provided by this update becomes effective for interim and annual periods beginning on or after December 15, 2011 (the Company’s current fiscal quarter). The adoption of this standard did not impact the Company’s financial position and results of operations.

There have been no other significant changes in the Company’s critical accounting policies and estimates during the six months ended March 31, 2012 as compared to what was previously disclosed in the Company’s Annual Report on Form 10-K for the year ended September 30, 2011 as filed with the SEC on December 9, 2011.

(12) Comprehensive Income

Comprehensive income includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that, under GAAP, are included in comprehensive income, but excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity. The Company’s other comprehensive income is composed of unrealized gains on its investment in the Micro Cap Fund. The components of comprehensive income consisted of the following (in thousands):

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

Forward Looking Statements

Certain statements in this report are forward-looking within the meaning of the federal securities laws. Although management believes that the expectations reflected in the forward-looking statements are reasonable, future levels of activity, performance or achievements cannot be guaranteed. Additionally, management does not assume responsibility for the accuracy or completeness of these statements. There is no regulation requiring an update of any of the forward-looking statements after the date of this report to conform these statements to actual results or to changes in our expectations.

Our business activities are affected by many factors, including, without limitation, redemptions by mutual fund shareholders, general economic and financial conditions, movement of interest rates, competitive conditions, industry regulation, fluctuation in the stock market, and others, many of which are beyond the control of our management.

Statements regarding the following subjects are forward-looking by their nature:

Although we seek to maintain cost controls, a significant portion of our expenses are fixed and do not vary greatly. As a result, substantial fluctuations in our revenue can directly impact our net income from period to period.

Overview

We derive our operating revenue from investment advisory fees and shareholder service fees paid to us by the Hennessy Funds. These fees are calculated as a percentage of the average daily net assets in our mutual funds and vary from fund to fund. The fees we receive fluctuate with changes in the total net asset value of the assets in our mutual funds, which are affected by our investment performance, redemptions, completed acquisitions

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of management agreements, market conditions and the success of our marketing efforts. Average assets under management were $793.2 million and $909.8 million for the six months ended March 31, 2012 and 2011, respectively.

Total assets under management were $814.9 million as of March 31, 2012. Our total assets under management have decreased since March 31, 2011, due to net outflows. The following table illustrates the changes in assets under management from March 31, 2011 through March 31, 2012:

The principal asset on our balance sheet, management contracts – net of accumulated amortization, represents the capitalized costs incurred in connection with the acquisition of management agreements. As of March 31, 2012, this asset had a net balance of $22.3 million.

The principal liability on our balance sheet is the bank debt incurred in connection with the acquisition of management contracts. As of March 31, 2012, this liability had a balance of $2.2 million.

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Results of Operations

The following table displays items in the statements of operations as dollar amounts and as percentages of total revenue for the three months ended March 31, 2012 and 2011:

Revenues: Total revenue decreased 12.6% to $1.7 million in the three months ended March 31, 2012, due to decreased average assets under management. Investment advisory fees decreased 12.7% to $1.5 million in the three months ended March 31, 2012, and shareholder service fees decreased 12.4% to $0.2 million in the three months ended March 31, 2012. The decrease in investment advisory and shareholder service fees is due to decreased average daily net assets in our mutual funds.

Average daily net assets in our mutual funds for the three months ended March 31, 2012 decreased by $113.9 million, or 12.3%, to $809.5 million from $923.4 million in the prior comparable period. The decrease is mainly attributable to net outflows. The largest net outflows were from the Hennessy Cornerstone Growth Fund ($31.4 million) and the Hennessy Cornerstone Value Fund ($25.2 million).

About 23.9% of the total average daily net assets ($193.2 million) for the period are concentrated in the Hennessy Cornerstone Growth Fund. All of the largest funds generate revenue at a rate of 0.84% of daily average assets, except for the Hennessy Select Large Value Fund, which generates revenue at a rate of 0.95% of daily average assets. However, the Company pays a sub-advisor fee of 0.35% of daily average assets of the Hennessy Select Large Value Fund, which reduces the net income generated by the fund for the Company.

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Total net assets in our mutual funds decreased by $100.9 million, or 11.0%, as of March 31, 2012, from $915.8 million as of the end of the prior comparable period. The $100.9 million decrease in net mutual fund assets is attributable to net outflows of $114.4 million, partly offset by market appreciation of $13.5 million. Redemptions as a percentage of assets under management decreased from an average of 3.9% per month to 3.1% per month during the same period due to decreased outflows.

The net outflows are due to investors remaining apprehensive of the equity markets. Despite investor fear, there has been very little market depreciation since the prior period.

Redemptions from the funds were due, among other factors, to the following:

We are confident that the overall economic environment is beginning to see signs of improvement, but investors have yet to return to investing in domestic equity funds. Corporate earnings before tax were at an all-time high last year, and while many corporations may not see record growth in the coming year, we believe that corporate profits in the U.S. will remain strong.

Domestic unemployment continues to register at about 8 percent or higher as more than 15 million Americans look for work. Companies will continue to spend money on internal infrastructure, initiate and pay dividends, buy back their stock, hoard cash, and make acquisitions, and all of these practices are good for the stock market, but until we see companies hire, overall economic growth will be slow.

Due to the continued slow growth in our overall economy, the turmoil globally, and the lack of clarity from the U.S. Government on several important issues (taxes, healthcare, and regulation), investors are not quite ready to jump back in and invest in mutual funds, and many continue to redeem their mutual fund investments.

In the past, the Company has been obligated to waive fees to comply with contractual expense ratio limitations for all classes of shares, but now only has contractual expense ratio limitations for institutional class shares. The Company does not normally waive fees (other than for institutional class shares), nor does it anticipate waiving fees, on a voluntary basis.

Although the Company may earn incentive income on the Micro Cap Fund, the Company did not earn incentive income for the three months ended March 31, 2012 and 2011.

Operating Expenses: Total operating expenses decreased 7.8% to $1.3 million in the three months ended March 31, 2012, from $1.4 million in the prior comparable period. The decrease is due to decreases in all expense categories. As a percentage of total revenue, total operating expenses increased by 4.0% to 74.6% in the three months ended March 31, 2012, as compared to 70.6% in the prior comparable period.

Compensation and Benefits: Compensation and benefits decreased 2.7% to $0.59 million in the three months ended March 31, 2012, from $0.60 million in

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the prior comparable period. The decrease resulted primarily from decreased RSU compensation expense as new awards have not been granted and previous awards have been fully vested. As a percentage of total revenue, compensation and benefits increased by 3.5% to 33.9% for the three months ended March 31, 2012, compared to 30.4% in the prior comparable period.

General and Administrative Expenses: General and administrative expense decreased 8.9% to $0.39 million in the three months ended March 31, 2012, from $0.43 million in the prior comparable period. The decrease resulted primarily from a decrease in office rent due to the transition of our trading headquarters from Stamford, Connecticut to our main headquarters in Novato, California. As a percentage of total revenue, general and administrative expense increased by 0.9% to 22.4% in the three months ended March 31, 2012, from 21.5% in the prior comparable period.

Mutual Fund Distribution Expenses: Distribution expense decreased 11.3% to $0.15 million in the three months ended March 31, 2012, from $0.17 million in the prior comparable period. As a percentage of total revenue, distribution expense increased by 0.1% to 8.6% for the three months ended March 31, 2012, compared to 8.5% in the prior comparable period.

The mutual fund distribution expense consists of fees paid for our mutual funds to be offered on various financial “platforms.” The platforms allow consumers to purchase shares from numerous mutual fund companies through a single location, which provides those customers with a single statement of investments and a single source for mutual fund information and customer service. When our funds are purchased through one of these platforms, such as Charles Schwab, Fidelity, TD Ameritrade or Morgan Stanley Smith Barney, the platform typically charges us an asset based fee which is recorded in “mutual fund distribution expense” in our statement of operations. The fees increase or decrease in line with the value of the funds held on the platforms, which can be affected by inflows, outflows and market impact.

The decreased costs in the current period are due to a decrease in the value of average assets held through mutual fund platforms such as Charles Schwab, Fidelity and TD Ameritrade. For the three months ended March 31, 2012, the value of the mutual funds held on Charles Schwab (the platform to which we pay over half of our total mutual fund distribution fees) decreased by 11% from the prior comparable period.

The incremental assets purchased through the mutual fund platforms are not as profitable as those purchased in direct shareholder accounts due to the participation fees paid on assets held in the various mutual fund platforms. All of our funds are impacted by activity on the financial platforms as they are all available on several platforms.

Sub-advisor Fee Expense: Sub-advisor fee expense decreased 19.8% to $0.14 million in the three months ended March 31, 2012, from $0.18 million in the prior comparable period. The decrease is a result of a decrease in sub-advised assets in the current period, mainly due to net outflows. As a percentage of total revenue, sub-advisor fee expense decreased by 0.7% to 8.2% for the three months ended March 31, 2012, compared to 8.9% in the prior comparable period.

Amortization and Depreciation Expense: Amortization and depreciation decreased 3.8% to $0.025 million in the three months ended March 31, 2012, from $0.026 million in the prior comparable period. As a percentage of total

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revenue, amortization and depreciation expense increased by 0.2% to 1.5% for the three months ended March 31, 2012, compared to 1.3% in the prior comparable period.

Interest Expense: Interest expense decreased by 23.5% from the prior comparable period due to payments of $0.6 million on the principal loan balance since the prior comparable period. As a percentage of total revenue, interest expense decreased by 0.2% to 0.7% for the three months ended March 31, 2012, compared to 0.9% in the prior comparable period.

Income Taxes: The provision for income taxes decreased 22.3% to $0.18 million in the three months ended March 31, 2012, from $0.23 million in the prior comparable period. The change is due to decreased income before tax in the current period.

Net Income: Net income decreased by 25.9% to $0.25 million in the three months ended March 31, 2012, from $0.33 million in the prior comparable period, as a result of the factors discussed above.

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The following table displays items in the statements of operations as dollar amounts and as percentages of total revenue for the six months ended March 31, 2012 and 2011: