UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended December 31, 2019

For the Transition Period From                      to                     

Commission File Number 001-36423

HENNESSY ADVISORS, INC.

(Exact name of registrant as specified in its charter)

(415) 899-1555

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act:

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  ☒

As of February 7, 2020, there were 7,379,341 shares of common stock issued and outstanding.

HENNESSY ADVISORS, INC.

TABLE OF CONTENTS

i

PART I:    FINANCIAL INFORMATION

Balance Sheets

(In thousands, except share and per share amounts)

See Notes to Unaudited Condensed Financial Statements.

1

Statements of Income

(In thousands, except share and per share amounts)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements.

2

Statements of Changes in Stockholders’ Equity

(In thousands, except share data)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements.

3

Statements of Cash Flows

(In thousands)

(Unaudited)

See Notes to Unaudited Condensed Financial Statements.

4

HENNESSY ADVISORS, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

The accompanying condensed balance sheet as of September 30, 2019, which has been derived from audited financial statements, and the unaudited interim condensed financial statements as of and for the three months ended December 31, 2019, 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 December 31, 2019, the Company’s operating results for the three months ended December 31, 2019 and 2018, and the Company’s cash flows for the three months ended December 31, 2019 and 2018. 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 2019, which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

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 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 BP Energy Fund, the Hennessy BP 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. The Company also provides shareholder services to shareholders of the Hennessy Funds.

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:

5

6

The Company earns shareholder service fees from Investor Class shares of the Hennessy Funds by, among other things, maintaining a toll-free number that the current investors in the Hennessy Funds may call to ask questions about the funds or their accounts, or to get help with processing exchange and redemption requests or changing account options. 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 Recognition.

The Company waives a portion of its fees with respect to the Hennessy Cornerstone Large Growth Fund (through expiration of the expense limitation agreement on November 30, 2019), the Hennessy BP Midstream Fund, and the Hennessy Technology Fund 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 revenue. The waived fees are deducted from investment advisory fee income and reduce the aggregate amount of advisory fees received by the Company 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 10 purchases of the assets related to the management of 30 different mutual 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 purchased management contracts to determine if any impairment has occurred. The fair value of management contracts is based on management estimates and assumptions, including third-party valuations that utilize appropriate valuation techniques. The fair value of the management contracts was estimated by applying the income approach. It is the opinion of the Company’s management that there was no impairment as of December 31, 2019, or September 30, 2019.

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 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 October 26, 2018, when it purchased the assets related to the management of the BP Capital TwinLine Energy Fund and the BP Capital TwinLine MLP Fund (together, the “BP Funds”). This asset purchase added nearly $200 million to the Company’s assets under management. The purchase was consummated in accordance with the terms and conditions of the Transaction Agreement, dated as of July 10, 2018, between the Company and BP Capital Fund Advisors, LLC (“BP Capital”). Upon completion of the transaction, the assets related to the management of the BP Funds were reorganized into two new series of Hennessy Funds Trust called the Hennessy BP Energy Fund and the Hennessy BP Midstream Fund, respectively. In connection with the transaction, BP Capital became the sub-advisor to the Hennessy BP Energy Fund and the Hennessy BP Midstream Fund.

7

In accordance with the Transaction Agreement, the purchase price comprised two payments. The initial payment of $1.6 million was funded with available cash in connection with the closing and was based on the aggregate current net asset value of the BP Funds measured as of the close of business on October 25, 2018, the trading day immediately preceding the closing date of the transaction, plus $100,000. The second payment of $0.7 million was funded with available cash promptly following the one-year anniversary of the closing and was based on the aggregate current net asset value of the BP Funds measured as of the close of business on October 25, 2019, the trading day immediately preceding the one-year anniversary of the closing date. The Company included the amount of the liability for the second payment in its fiscal year 2019 financial statements because it was measurable prior to the filing date of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

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

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 the investment advisory agreements are not renewed annually as described above, they terminate automatically. There are two additional circumstances in which the investment advisory agreements terminate. First, the investment advisory agreements automatically terminate 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, each investment advisory agreement may be terminated prior to its expiration upon 60 days’ notice by either the Company or the applicable Hennessy Fund.

As provided in the investment advisory agreements with the 16 Hennessy Funds, the Company receives investment advisory fees monthly based on a percentage of each fund’s average daily net assets.

The Company has entered into sub-advisory agreements for the Hennessy Focus Fund, the Hennessy Equity and Income Fund, the Hennessy BP Energy Fund, the Hennessy BP Midstream Fund, the Hennessy Japan Fund, and the Hennessy Japan Small Cap Fund. Under each of these sub-advisory agreements, the sub-advisor is responsible for the investment 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.

8

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 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. 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, 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 three months ended December 31, 2019, the Company’s lease payments related to its operating lease right-of-use assets totaled $109,138 and rent expense, which is recorded under general and administrative expense in the statements of income, totaled $95,360.

9

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 as of December 31, 2019:

The Company has an outstanding term loan agreement with U.S. Bank National Association (“U.S. Bank”). The term loan agreement requires monthly payments of $364,583 plus interest calculated based on one of the following, at the Company’s option:

(1) the sum of (a) a margin that ranges from 2.25% to 2.75%, depending on the Company’s ratio of consolidated debt to consolidated earnings before interest, taxes, depreciation, and amortization (excluding, among other things, certain non-cash gains and losses) (“EBITDA”), plus (b) the LIBOR rate; or

(2) the sum of (a) a margin that ranges from 0.25% to 0.75%, depending on the Company’s ratio of consolidated debt to consolidated EBITDA, plus (b) the highest rate out of the following three rates: (i) the prime rate set by U.S. Bank from time to time; (ii) the Federal Funds Rate plus 0.50%; or (iii) the one-month LIBOR rate plus 1.00%.

The Company currently uses a one-month LIBOR rate contract, which must be renewed monthly. As of December 31, 2019, the effective rate under the term loan agreement was 3.947%, which comprised the one-month LIBOR rate of 1.697% as of December 2, 2019, plus a margin of 2.25% based on the Company’s ratio of consolidated debt to consolidated EBITDA as of September 30, 2019. The Company intends to renew the LIBOR rate contract on a monthly basis as long as it remains the most favorable option. The Company has amended the term loan agreement to address possible LIBOR changes as discussed in the section entitled “Risk Factors” in its Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

All borrowings under the term loan agreement are secured by substantially all of the Company’s assets. The final installment of the then-outstanding principal plus accrued interest is due May 9, 2022. As of December 31, 2019, the principal amount outstanding under the term loan agreement was $16.4 million ($16.3 million net of debt issuance costs).

The term loan agreement includes certain reporting requirements and loan covenants requiring the maintenance of certain financial ratios. The Company was in compliance with its loan covenants for the periods ended December 31, 2019 and 2018.

In connection with securing the term loan agreement, the Company incurred $0.49 million in loan costs ($0.38 million of which has been expensed in previous periods). The balance of $0.11 million is being amortized on a straight-line basis, which approximates the effective interest basis, over the 36 months beginning May 2019. Amortization expense during the three months ended December 31, 2019 and 2018, was $0.01 million and $0.04 million, respectively. The unamortized balance of the loan fees was $0.11 million as of December 31, 2019.

10

In accordance with Accounting Standards Update (“ASU”) 2015-03, the amortization expense of the debt issuance cost is included in interest expense.

The Company’s effective income tax rates for the three months ended December 31, 2019 and 2018, were 27.0% and 29.9%, respectively. The effective income tax rate was lower for the three months ended December 31, 2019, due to changes in state apportionment factors.

The Company is subject to income tax in the U.S. federal jurisdiction and multiple state jurisdictions. Following is a list of jurisdictions that the Company has identified as its major tax jurisdictions with the tax years that remain open and subject to examination by the appropriate governmental agencies marked:

For state tax jurisdictions with unfiled tax returns, the statutes of limitations will remain open indefinitely.

11

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 restricted stock units (“RSUs”).

For the three months ended December 31, 2019, the Company excluded 184,871 common stock equivalents from the diluted earnings per share calculations because they were not dilutive. For the three months ended December 31, 2018, the Company excluded 328,607 common stock equivalents from the diluted earnings per share calculation 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 December 3, 2019, to shareholders of record as of November 12, 2019.

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 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:

12

Additional information related to RSUs is as follows:

Dividend Reinvestment and Stock Purchase Plan

In January 2018, the Company adopted an updated Dividend Reinvestment and Stock Purchase Plan (the “DRSPP”), replacing the previous Dividend Reinvestment and Stock Purchase Plan established in March 2015, to provide 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 and its predecessor, the Company issued 3,298 and 1,503 shares of common stock during the three months ended December 31, 2019 and 2018, respectively. The maximum number of shares that may be issued under the current DRSPP is 1,550,000, of which 1,536,046 shares remain available for issuance.

Although the Company may issue up to 1,550,000 shares of its common stock under the DRSPP, the Company intends to limit the issuances to less than 20% of the number of outstanding shares of the Company’s common stock. As of December 31, 2019, the Company had 7,465,551 shares outstanding. Therefore, the Company will not issue more than 1,493,110 shares of its common stock under the DRSPP without seeking shareholder approval as required by the listing requirements of The NASDAQ Capital Market.

Stock Buyback Program

In August 2010, the Company adopted a stock buyback program. The program provides that the Company may repurchase up to 1,500,000 shares of its common stock and has no expiration date. Share repurchases may be made in the open market, in privately negotiated transactions, or otherwise. The Company repurchased 64,787 shares of its common stock pursuant to the stock buyback program during the three months ended December 31, 2019. A total of 802,477 shares remains available for repurchase under the stock buyback program.

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, Boston, Massachusetts, and Chapel Hill, North Carolina. Certain leases provide for renewal options.

Total rent expense for the three months ended December 31, 2019, was $0.1 million. As of December 31, 2019, there were no material changes in the leasing arrangements that would have a significant effect on the future minimum lease payments reported in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019. See Note 4 for additional disclosure regarding the Company’s leases.

13

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:

14

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

There were no transfers between levels during the three months ended December 31, 2019, or the year ended September 30, 2019.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” as amended, which requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model that requires a lessee to recognize a right-of-use asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. All of the Company’s leases are operating leases.

The Company adopted the new standard on October 1, 2019, using the modified retrospective method and the transition relief guidance provided by the FASB in ASU 2018-11, “Leases (Topic 842): Targeted Improvements.” As a result, the Company did not update financial information or provide disclosures required under the new standard for dates and periods prior to October 1, 2019. In addition, the Company adopted the FASB’s lessee practical expedient option to combine lease and non-lease components for all asset classes and elected, as an accounting policy, not to recognize right-of-use assets and lease liabilities for leases with terms of 12 months or less. Non-lease components are fixed costs, such as electricity or common area maintenance, that can be included in rent payments but are not a part of the underlying asset being capitalized. There were no such fixed costs associated with our capitalized right-of-use asset, so this election did not impact our financial statements.

15

As a result of adopting the new standard, the Company recorded operating lease right-of-use assets and operating lease liabilities of $652,686 and $768,899, respectively, as of October 1, 2019. The operating lease right-of-use assets were net of $116,213 in deferred rent adjustments that the Company previously recorded in deferred rent on the consolidated balance sheet as of September 30, 2019. Adopting the new standard did not result in any cumulative-effect adjustments to retained earnings or impact the Company’s statements of income or statement of cash flows for the three months ended December 31, 2019.

See Note 4 for additional disclosure regarding the Company’s leases.

The Company has evaluated subsequent events through the date these financial statements were issued and has concluded that no material subsequent events occurred during this period that would require recognition or disclosure.

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 the section entitled “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019. 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 mutual fund shareholders, taxes, general economic and financial conditions, movement of interest rates, competitive conditions, industry regulation, and fluctuations in the stock market, many of which are beyond the control of our management. Further, the business and regulatory environments in which we operate remain complex, uncertain, and subject to change. We expect that regulatory requirements and developments will cause us to incur additional administrative and compliance costs. In addition, while current domestic economic conditions are relatively favorable, changes in short-term interest rates, policy changes by the administration in Washington, D.C., and developments in international financial markets could influence economic and financial conditions significantly. 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.

16

Our business strategy centers on (a) the identification, completion, and integration of future acquisitions and (b) organic growth, through both the retention of the mutual fund assets we currently manage and the generation of inflows into the mutual funds we manage. The success of our business strategy may be influenced by the factors discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019. All statements regarding our business strategy, as well as statements regarding market trends and risks and assumptions about changes in the marketplace, are forward-looking by their nature.

Overview

Our primary business activity is providing investment advisory services to a family of open-end mutual funds branded as the Hennessy Funds. We manage 10 of the 16 Hennessy Funds internally. For the remaining six funds, we have delegated the day-to-day portfolio management responsibilities to sub-advisors, subject to our oversight. We oversee the selection and continued employment of each sub-advisor, review each sub-advisor’s investment performance, and monitor each sub-advisor’s adherence to each applicable fund’s investment objectives, policies, and restrictions. In addition, we conduct ongoing reviews of the compliance programs of sub-advisors and make on-site visits to sub-advisors. Our secondary business activity is providing shareholder services to shareholders of each Hennessy Fund.

We derive our operating revenues from investment advisory fees and shareholder service fees paid to us by the Hennessy Funds. These fees are calculated as a percentage of the average daily net assets in each Hennessy Fund. The percentage amount of the investment advisory fees varies from fund to fund. The percentage amount of the shareholder service fees is consistent across all funds, but shareholder service fees are charged on Investor Class shares only. The dollar amount of the fees we receive fluctuates with changes in the average net asset value of 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 6.7% for the three months ended December 31, 2019. During the most recent quarter, equity prices rose as continuing growth in employment and strong levels of consumer confidence buoyed investor spirits. In addition, strong holiday spending coupled with the announcement of the completion of Phase One trade negotiations with China further emboldened investors as the prospect of a trade war faded. While we believe investors are no longer pricing in a Federal Reserve interest rate cut, they do appear focused on record low unemployment, which currently stands at 3.5%, and strong economic growth. One result of these trends can be found in the U.S. housing market. Currently, housing is in its second longest expansion on record as a result of continued low interest rates, favorable demographic trends, and low unemployment.

17

Long-term U.S. bond yields increased during the three months ended December 31, 2019, as the economic outlook improved. While trends in inflation remained muted, the prospects of a Federal Reserve rate adjustment have diminished with the market not expecting any change until late in 2020.

The Japanese equity market rallied 7.8% in U.S. dollar terms over the three months ended December 31, 2019, as measured by the Tokyo Stock Price Index. The resolution over Phase One trade negotiations between the United States and China removed much of the uncertainty that had weighed on Japanese equities. A record budget expected for next fiscal year should help the Japanese economy to grow despite weaker growth in exports.

We strive to provide positive returns for investors in the Hennessy Funds over market cycles. Fourteen of the Hennessy Funds posted positive annualized returns in each of the three-year, five-year, 10-year, and since inception periods ended December 31, 2019. In the one-year period ended December 31, 2019, all 16 Hennessy Funds generated positive returns.

To help drive inflows into the Hennessy Funds, we maintain a marketing database of over 100,000 financial advisors in addition to retail investors. We employ robust marketing and sales efforts consisting of content, digital, and traditional marketing initiatives and proactive phone and in-person meetings. In addition, we maintain an active annual public relations campaign that 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 230,000 mutual fund accounts nationwide, which comprise shareholders who employ financial advisors to assist them with investing and retail shareholders who invest directly with us. We serve approximately 18,100 financial advisors who utilize the Hennessy Funds on behalf of their clients. Approximately one in five of those advisors owns two or more Hennessy Funds, demonstrating strong brand loyalty.

Total assets under management as of December 31, 2019, was $5.0 billion, an increase of $91 million, or 1.9%, compared to December 31, 2018. The increase in total assets was attributable to market appreciation, partially offset by net outflows from the Hennessy Funds.

The following table illustrates the changes quarter by quarter in our assets under management since December 31, 2018:

The principal asset on our balance sheet, management contracts, represents the capitalized costs incurred in connection with the purchase of the assets related to the management of mutual funds. As of December 31, 2019, this asset had a net balance of $80.6 million, unchanged since September 30, 2019.

18

The principal liability on our balance sheet is the bank debt incurred in connection with the purchase of the assets related to the management of mutual funds and the repurchase of 1,500,000 shares of our common stock pursuant to the completion of our self-tender offer in September 2015. As of December 31, 2019, this liability had a balance of $16.4 million ($16.3 million net of debt issuance costs of $0.11 million), compared to $17.5 million ($17.4 million net of debt issuance costs of $0.12 million) as of September 30, 2019. The decrease was the result of making monthly loan payments on our bank debt.

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 December 31, 2018, to the three months ended December 31, 2019, total revenue decreased by 12.0%, from $11.6 million to $10.2 million, investment advisory fees also decreased by 12.0%, from $10.7 million to $9.4 million, and shareholder service fees decreased by 12.3%, from $0.9 million to $0.8 million.

The decrease in investment advisory fees was due mainly to decreased average daily net assets of the Hennessy Funds. 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 Funds. Assets held in Investor Class shares of the Hennessy Funds are subject to a shareholder service fee, whereas assets held in Institutional Class shares of the Hennessy Funds are not subject to a shareholder service fee.

19

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 December 31, 2019, was $4.9 billion, which represents a decrease of $637 million, or 11.4%, compared to the three months ended December 31, 2018. The Hennessy Fund with the largest average daily net assets for the three months ended December 31, 2019, was the Hennessy Focus Fund, with $1.8 billion. We collect an investment advisory fee from the Hennessy Focus Fund at an annual rate of 0.90% of average daily net assets. However, we pay a sub-advisory fee at an annual rate of 0.29% to the fund’s sub-advisor, which reduces the net operating profit contribution of the fund to our financial operations. The Hennessy Fund with the second largest average daily assets for the three months ended December 31, 2019, was the Hennessy Gas Utility Fund, with $0.9 billion. We collect an investment advisory fee from the Hennessy Gas Utility Fund at an annual rate of 0.40% of average daily net assets.

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:

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, redemptions as a percentage of assets under management decreased from an average of 6.0% per month to an average of 2.2% per month.

Operating Expenses

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, total operating expenses decreased by 7.5%, from $7.0 million to $6.5 million. Although the dollar value of total operating expenses decreased, as a percentage of total revenue, total operating expenses increased 3.1 percentage points to 63.6%. The dollar value decrease was due to decreases in all expense categories other than mutual fund distribution expense, which moderately increased.

Compensation and Benefits Expense: Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, compensation and benefits expense decreased by 13.3%, from $2.9 million to $2.5 million. As a percentage of total revenue, compensation and benefits expense decreased 0.4 percentage points to 24.5%. The decrease was due primarily to a decrease in incentive-based compensation.

20

General and Administrative Expense: Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, general and administrative expense remained the same at $1.5 million. Although the dollar value of general and administrative expense remained the same, as a percentage of total revenue, general and administrative expense increased 1.6 percentage points to 14.6%.

Mutual Fund Distribution Expense: Mutual fund distribution expense consists of fees paid to various financial institutions that offer the Hennessy Funds as potential investments to their clients. When the Hennessy Funds are purchased through one of these financial institutions, the institution typically charges an asset-based fee, which is recorded in “mutual fund distribution expense” in our statement of operations to the extent paid by us. When the Hennessy Funds are purchased directly, we do not incur any such expense. These fees generally increase or decrease in line with the net assets of the Hennessy Funds held through these financial institutions, which are affected by inflows, outflows, and fund performance.

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, mutual fund distribution expense increased by 13.0%, from $0.12 million to $0.14 million. As a percentage of total revenue, mutual fund distribution expense increased 0.3 percentage points to 1.4%. The dollar value increase was due to higher average daily net assets held by financial institutions.

Sub-Advisory Fees Expense: Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, sub-advisory fees expense decreased by 5.2%, from $2.4 million to $2.3 million. Although the dollar value of sub-advisory fees expense decreased, as a percentage of total revenue, sub-advisory fees expense increased 1.6 percentage points to 22.6%. The dollar value decrease resulted from decreased average daily net assets of the sub-advised Hennessy Funds, partially offset by the new sub-advisory relationship with BP Capital for the BP Funds that became effective October 26, 2018.

Depreciation Expense: Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, depreciation expense decreased by 3.6%, from $0.06 million to $0.05 million. As a percentage of total revenue, depreciation expense remained the same at 0.5%. The dollar value decrease was a result of lower fixed asset purchases.

Interest Expense

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, interest expense decreased by 39.7% from $0.3 million to $0.2 million. The decrease is due primarily to a decrease in the Company’s principal loan balance along with a decrease in the interest rate charged to the loan. As a percentage of total revenue, interest expense decreased 0.9 percentage points to 1.8%.

21

Income Tax Expense

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, income tax expense decreased by 25.6%, from $1.3 million to $1.0 million. The decrease was due primarily to lower net operating income for the current period, and secondarily to a lower effective income tax rate due to changes in state apportionment factors.

Net Income

Comparing the three months ended December 31, 2018, to the three months ended December 31, 2019, net income decreased by 14.3%, from $3.1 million to $2.6 million. The decrease was due to lower net operating income for the current period, partially offset by the benefit of the lower effective income tax rate discussed above.

Critical Accounting Policies

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 of the possibility that future events affecting them may differ markedly from management’s current judgment. For a discussion of the accounting policies that we believe are most critical to understanding our results of operations and financial position, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

Liquidity and Capital Resources

We continually review our capital requirements to ensure that we have funding available to support our business model. Management anticipates that cash and other liquid assets on hand as of December 31, 2019, will be sufficient to meet our capital requirements for at least one year from the issuance date of this report. To the extent that liquid resources and cash provided by operations are not adequate to meet long-term capital requirements, management plans to raise additional capital by either, or both, seeking to increase our borrowing capacity or accessing the capital markets. There can be no assurance that we will be able to raise additional capital.

Our total assets under management as of December 31, 2019, was $5.0 billion, an increase of $91 million or 1.9%, compared to December 31, 2018. 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 December 31, 2019, was $4.9 billion. As of December 31, 2019, we had cash and cash equivalents of $22.5 million.

22

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

The decrease in cash provided by operating activities of $0.5 million was due mainly to decreased operating income.

The decrease in cash used in investing activities of $1.1 million was due to the first payment for the purchase of the assets related to the management of the BP Funds in the prior period, which was larger than the second payment for such assets in the current period.

The increase in cash used in financing activities of $0.8 million was due to shares repurchased and an increased dividend rate.

We have an outstanding term loan agreement with U.S. Bank. The term loan agreement requires monthly payments of $364,583 plus interest calculated based on one of the following, at our option:

(1) the sum of (a) a margin that ranges from 2.25% to 2.75%, depending on our ratio of consolidated debt to consolidated EBITDA, plus (b) the LIBOR rate; or

(2) the sum of (a) a margin that ranges from 0.25% to 0.75%, depending on our ratio of consolidated debt to consolidated EBITDA, plus (b) the highest rate out of the following three rates: (i) the prime rate set by U.S. Bank from time to time; (ii) the Federal Funds Rate plus 0.50%; or (iii) the one-month LIBOR rate plus 1.00%.

We currently use a one-month LIBOR rate contract, which must be renewed monthly. As of December 31, 2019, the effective rate under the term loan agreement was 3.947%, which comprised the one-month LIBOR rate of 1.697% as of December 2, 2019, plus a margin of 2.25% based on our ratio of consolidated debt to consolidated EBITDA as of September 30, 2019. We intend to renew the LIBOR rate contract on a monthly basis as long as it remains the most favorable option. We have amended the term loan agreement to address possible LIBOR changes as discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019.

All borrowings under the term loan agreement are secured by substantially all of our assets. The final installment of the then-outstanding principal plus accrued interest is due May 9, 2022. As of December 31, 2019, the principal amount outstanding under the term loan agreement was $16.4 million ($16.3 million net of debt issuance costs).

23

The term loan agreement includes certain reporting requirements and loan covenants requiring the maintenance of certain financial ratios. We were in compliance with our loan covenants for the periods ended December 31, 2019 and 2018.

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 Controls over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

24

PART II:    OTHER INFORMATION

We purchased shares of our common stock pursuant to our stock buyback program. These purchases are presented in the following table:

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

25

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:

26