**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                                                                                                                                                             | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                        |
| **For the Quarterly Period Ended March 31, 2009**                                                                                                                                            |
|                                                                                                                                                                                              |
| **or**                                                                                                                                                                                            |
|                                                                                                                                                                                              |
| **o**                                                                                                                                                                                             | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
| ** **                                                                                                                                                                                        |
| **For the transition period from              to             ** |

 

**Commission file number 001-33761**

 

**PZENAINVESTMENT MANAGEMENT, INC.**

(Exact Name of Registrant asSpecified in its Charter)

 

| **Delaware**                              | ** ** | **20-8999751**      |
|-------------------------------------------|------------|---------------------|
| (State or Other  Jurisdiction of          | ** ** | (I.R.S. Employer    |
| Incorporation or  Organization)           | ** ** | Identification No.) |
|                                      | ** ** |                |
| **120 West  45th Street**            |
| **New York,  New York 10036**             |
| (Address of Principal  Executive Offices) |

 

Registrant’s telephonenumber, including area code: **(212) 355-1600**

 

**NotApplicable**

(Former name, former address, and formerfiscal year if changed since last report)

 

Indicate by check mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate web site, if any, every Interactive Date File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o    No o

 

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

 
| Large Accelerated Filer o                                                   | Accelerated Filer x         |
|----------------------------------------------------------------------------------|----------------------------------|
|                                                                             |                             |
| Non-accelerated filer o  (Do not check if a smaller reporting company) | Smaller reporting company o |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes o  No x

 

As of May 8, 2009, therewere 8,633,041 outstanding shares of the registrant’s Class A commonstock, par value $0.01 per share.

 

As of May 8 2009, therewere 55,559,751 outstanding shares of the registrant’s Class B commonstock, par value $0.000001 per share.

 

 

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| ** **    | ** **                                                                                                                                                   | **Page**   |
|---------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **    | **PART I — FINANCIAL INFORMATION**                                                                                                                 |       |
| Item 1.  | Consolidated Statements of  Financial Condition of Pzena Investment Management, Inc. as of  March 31, 2009 (unaudited) and December 31, 2008  | 1          |
|          | Consolidated Statements of  Operations (unaudited) of Pzena Investment Management, Inc. for the  Three Months Ended March 31, 2009 and 2008        | 2          |
|          | Consolidated Statements of  Cash Flows (unaudited) of Pzena Investment Management, Inc. for the  Three Months Ended March 31, 2009 and 2008        | 3          |
|          | Consolidated Statements of  Changes in Equity (unaudited) of Pzena Investment Management, Inc. for  the Three Months Ended March 31, 2009 and 2008 | 4          |
|          | Notes to the Consolidated  Financial Statements (unaudited)                                                                                                  | 5          |
| Item 2.  | Management’s Discussion  and Analysis of Financial Condition and Results of Operations                                                                  | 23         |
| Item 3.  | Quantitative and  Qualitative Disclosures About Market Risk                                                                                                  | 35         |
| Item 4.  | Controls and Procedures                                                                                                                                      | 35         |
| ** **    | ** **                                                                                                                                                   | ** ** |
|          | **PART II  — OTHER INFORMATION**                                                                                                                   |       |
| Item 1.  | Legal Proceedings                                                                                                                                            | 36         |
| Item 1A. | Risk Factors                                                                                                                                                 | 36         |
| Item 2.  | Unregistered Sales of  Equity Securities and Use of Proceeds                                                                                                 | 36         |
| Item 3.  | Defaults Upon Senior  Securities                                                                                                                             | 36         |
| Item 4.  | Submission of Matters to a  Vote of Security Holders                                                                                                         | 36         |
| Item 5.  | Other Information                                                                                                                                            | 36         |
| Item 6.  | Exhibits                                                                                                                                                     | 36         |

 

i

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**CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report on Form 10-Qcontains forward-looking statements. Forward-looking statements provide our current expectations, orforecasts, of future events. Forward-looking statements include statements about our expectations,beliefs, plans, objectives, intentions, assumptions and other statements thatare not historical facts.  Words orphrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,” “expect,”“intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words orphrases, or the negatives of those words or phrases, may identifyforward-looking statements, but the absence of these words does not necessarilymean that a statement is not forward-looking.

 

Forward-looking statementsare subject to known and unknown risks and uncertainties and are based onpotentially inaccurate assumptions that could cause actual results to differmaterially from those expected or implied by the forward-lookingstatements.  Our actual results coulddiffer materially from those anticipated in forward-looking statements for manyreasons, including the factors described in Item 1A, “Risk Factors” in Part Iof our Annual Report on Form 10-K for our fiscal year ended December 31,2008.  Accordingly, you should not undulyrely on these forward-looking statements, which speak only as of the date ofthis Quarterly Report on Form 10-Q. We undertake no obligation to publicly revise any forward-lookingstatements to reflect circumstances or events after the date of this QuarterlyReport on Form 10-Q, or to reflect the occurrence of unanticipatedevents.  You should, however, review thefactors and risks we describe in the reports we will file from time to timewith the Securities and Exchange Commission, or SEC, after the date of this QuarterlyReport on Form 10-Q.

 

Forward-looking statementsinclude, but are not limited to, statements about:

 

·                  our anticipatedfuture results of operations and operating cash flows;

 

·                  our businessstrategies and investment policies;

 

·                  our financingplans and the availability of short- or long-term borrowing, or equityfinancing;

 

·                  our competitiveposition and the effects of competition on our business;

 

·                  potentialgrowth opportunities available to us;

 

·                  the recruitmentand retention of our employees;

 

·                  our expectedlevels of compensation for our employees;

 

·                  our potentialoperating performance, achievements, efficiency and cost reduction efforts;

 

·                  our expectedtax rate;

 

·                  changes ininterest rates;

 

·                  our expectationwith respect to the economy, capital markets, the market for asset managementservices and other industry trends; and

 

·                  the impact offuture legislation and regulation, and changes in existing legislation andregulation, on our business.

 

The reports that we filewith the SEC, accessible on the SEC’s website at *www.sec.gov*, identify additional factors that can affectforward-looking statements.

 

ii

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**PART I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**PZENA INVESTMENT MANAGEMENT, INC.**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(in thousands, except share and per-share amounts)**

 
| ** **                                                                                                                                                               | ** ** | **As of**           | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                               | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**          | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                               |       |                     |       |   |   |
| **ASSETS**                                                                                                                                                               |       |                     |       |   |   |
| Cash and Cash Equivalents                                                                                                                                                |       | $                        | 26,705     |   | $ | 27,421 |   |
| Due from Broker                                                                                                                                                          |       | 37                       |       | 41 |   |
| Advisory Fees Receivable                                                                                                                                                 |       | 10,316                   |       | 13,606 |   |
| Investments in Marketable Securities, at Fair Value                                                                                                                      |       | 11,369                   |       | 14,045 |   |
| Receivable from Related Parties                                                                                                                                          |       | 189                      |       | 191 |   |
| Other Receivables                                                                                                                                                        |       | 89                       |       | 74 |   |
| Prepaid Expenses and Other Assets                                                                                                                                        |       | 801                      |       | 949 |   |
| Deferred Tax Assets                                                                                                                                                      |       | 4,208                    |       | 3,444 |   |
| Property and Equipment, Net of Accumulated Depreciation of $2,034 and  $1,913, respectively                                                                              |       | 2,627                    |       | 2,748 |   |
| TOTAL ASSETS                                                                                                                                                             |       | $                        | 56,341     |   | $ | 62,519 |   |
| ** **                                                                                                                                                               |       |                     |       |   |   |
| **LIABILITIES AND EQUITY**                                                                                                                                               |       |                     |       |   |   |
| Liabilities:                                                                                                                                                             |       |                     |       |   |   |
| Accounts Payable and Accrued Expenses                                                                                                                                    |       | $                        | 5,149      |   | $ | 4,338 |   |
| Due to Broker                                                                                                                                                            |       | 41                       |       | 47 |   |
| Term Loan                                                                                                                                                                |       | 14,000                   |       | 22,000 |   |
| Senior Subordinated Debt to Related Parties                                                                                                                              |       | 16,000                   |       | 16,000 |   |
| Liability to Selling and Converting Shareholders                                                                                                                         |       | 2,519                    |       | 1,787 |   |
| Other Liabilities                                                                                                                                                        |       | 1,939                    |       | 2,007 |   |
| TOTAL LIABILITIES                                                                                                                                                        |       | 39,648                   |       | 46,179 |   |
|                                                                                                                                                                     |       |                     |       |   |   |
| Equity:                                                                                                                                                                  |       |                     |       |   |   |
| Preferred Stock (Par Value $0.01; 200,000,000 Shares Authorized; None  Outstanding)                                                                                      |       | —                   |       | — |   |
| Class A Common Stock (Par Value $0.01; 750,000,000 Shares  Authorized; 8,633,041 and 6,111,118 Shares Issued and Outstanding in 2009 and  2008, respectively)       |       | 86                       |       | 61 |   |
| Class B Common Stock (Par Value $0.000001; 750,000,000 Shares  Authorized; 55,529,751 and 57,975,724 Shares Issued and Outstanding in 2009  and 2008, respectively) |       | —                   |       | — |   |
| Additional Paid-In Capital                                                                                                                                               |       | 9,866                    |       | 9,749 |   |
| Accumulated Deficit                                                                                                                                                      |       | (4,807                   | )          | (5,289 | ) |
| Total Pzena Investment Management, Inc.’s Equity                                                                                                               |       | 5,145                    |       | 4,521 |   |
| Non-Controlling Interests                                                                                                                                                |       | 11,548                   |       | 11,819 |   |
| TOTAL EQUITY                                                                                                                                                             |       | 16,693                   |       | 16,340 |   |
| TOTAL LIABILITIES AND EQUITY                                                                                                                                             |       | $                        | 56,341     |   | $ | 62,519 |   |

 

Seeaccompanying notes to consolidated financial statements

 

1

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except share and per-share amounts)**

 
| ** **                                                                                                          | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                                                                                                          |       |                                                               |       |   |   |   |   |
| **REVENUE**                                                                                                         |       | $                                                                  | 13,671     |   | $ | 30,012 |   |
| ** **                                                                                                          |       |                                                               |       |   |   |
| **EXPENSES**                                                                                                        |       |                                                               |       |   |   |
| Compensation and Benefits Expense                                                                                   |       | 6,040                                                              |       | 8,951 |   |
| General and Administrative Expenses                                                                                 |       | 2,453                                                              |       | 3,043 |   |
| TOTAL OPERATING EXPENSES                                                                                            |       | 8,493                                                              |       | 11,994 |   |
| Operating Income                                                                                                    |       | 5,178                                                              |       | 18,018 |   |
| ** **                                                                                                          |       |                                                               |       |   |   |
| **OTHER INCOME/(EXPENSE)**                                                                                          |       |                                                               |       |   |   |
| Interest and Dividend Income                                                                                        |       | 120                                                                |       | 478 |   |
| Interest Expense                                                                                                    |       | (450                                                               | )          | (963 | ) |
| Realized and Unrealized Loss, Net on Marketable Securities                                                          |       | (1,820                                                             | )          | (3,580 | ) |
| Other Expense                                                                                                       |       | (580                                                               | )          | (14 | ) |
| Total Other Expense                                                                                                 |       | (2,730                                                             | )          | (4,079 | ) |
| Income Before Income Taxes                                                                                          |       | 2,448                                                              |       | 13,939 |   |
| Provision/(Benefit) for Income Taxes                                                                                |       | (274                                                               | )          | 1,542 |   |
| Consolidated Net Income                                                                                             |       | 2,722                                                              |       | 12,397 |   |
| Less: Net Income Attributable to Non-Controlling Interests                                                          |       | 2,240                                                              |       | 11,577 |   |
| Net Income Attributable to Pzena Investment Management, Inc.                                                   |       | $                                                                  | 482        |   | $ | 820 |   |
|                                                                                                                |       |                                                               |       |   |   |
| Earnings Per Share — Basic and Diluted Attributable to Pzena  Investment Management, Inc. Common Stockholders: |       |                                                               |       |   |   |
|                                                                                                                |       |                                                               |       |   |   |
| Net Income for Basic Earnings per Share                                                                             |       | $                                                                  | 482        |   | $ | 820 |   |
| Basic Earnings per Share                                                                                            |       | $                                                                  | 0.07       |   | $ | 0.13 |   |
| Basic Weighted Average Shares Outstanding                                                                           |       | 6,948,037                                                          |       | 6,119,686 |   |
|                                                                                                                |       |                                                               |       |   |   |
| Net Income for Diluted Earnings per Share                                                                           |       | $                                                                  | 2,776      |   | $ | 8,597 |   |
| Diluted Earnings per Share                                                                                          |       | $                                                                  | 0.04       |   | $ | 0.13 |   |
| Diluted Weighted Average Shares Outstanding                                                                         |       | 64,192,792                                                         |       | 64,070,596 |   |

 

See accompanying notes toconsolidated financial statements

 

2

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                     | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                                                                     |       |                                                               |       |   |   |
| **OPERATING ACTIVITIES**                                                       |       |                                                               |       |   |   |
| Consolidated Net Income                                                        |       | $                                                                  | 2,722      |   | $ | 12,397 |   |
| Adjustments to Reconcile Net Income to Cash Provided by Operating  Activities: |       |                                                               |       |   |   |
| Depreciation                                                                   |       | 121                                                                |       | 115 |   |
| Non-Cash Compensation                                                          |       | 251                                                                |       | 344 |   |
| Director Share Grant                                                           |       | 280                                                                |       | 140 |   |
| Realized and Unrealized Loss, Net on Marketable Securities                     |       | 1,820                                                              |       | 3,580 |   |
| Increase in Liability to Selling and Converting Shareholders                   |       | 602                                                                |       | — |   |
| Deferred Income Taxes                                                          |       | (667                                                               | )          | 547 |   |
| Changes in Operating Assets and Liabilities:                                   |       |                                                               |       |   |   |
| Advisory Fees Receivable                                                       |       | 3,290                                                              |       | 4,436 |   |
| Due from Broker                                                                |       | 4                                                                  |       | 191 |   |
| Prepaid Expenses and Other Assets                                              |       | (147                                                               | )          | 1,111 |   |
| Due to Broker                                                                  |       | (6                                                                 | )          | (3,795 | ) |
| Accounts Payable, Accrued Expenses and Other Liabilities                       |       | 727                                                                |       | 1,508 |   |
| Purchases of Marketable Securities                                             |       | (2,572                                                             | )          | (16,836 | ) |
| Proceeds from Sale of Marketable Securities                                    |       | 3,431                                                              |       | 6,667 |   |
| **Net Cash Provided by Operating Activities**                                  | ** ** | **9,856**                                                          | ** ** | **10,225** | ** ** |
| ** **                                                                     |       |                                                               |       |   |   |
| **INVESTING ACTIVITIES**                                                       |       |                                                               |       |   |   |
| Receivable from Related Parties                                                |       | 2                                                                  |       | (67 | ) |
| Purchases of Property and Equipment                                            |       | —                                                             |       | (50 | ) |
| **Net Cash Provided by/(Used in) Investing Activities**                        | ** ** | **2**                                                              | ** ** | **(117** | **)** |
| ** **                                                                     |       |                                                               |       |   |   |
| **FINANCING ACTIVITIES**                                                       |       |                                                               |       |   |   |
| Contributions from Non-Controlling Interests                                   |       | —                                                             |       | 6,833 |   |
| Distributions to Non-Controlling Interests                                     |       | —                                                             |       | (1,080 | ) |
| Capital Distribution                                                           |       | (9                                                                 | )          | — |   |
| Debt Repayment                                                                 |       | (8,000                                                             | )          | — |   |
| Dividends                                                                      |       | —                                                             |       | (672 | ) |
| Distributions to Members                                                       |       | (2,565                                                             | )          | (6,373 | ) |
| **Net Cash Used in Financing Activities**                                      | ** ** | **(10,574**                                                        | **)**      | **(1,292** | **)** |
| **NET CHANGE IN CASH**                                                         | ** ** | **$**                                                              | **(716**   | **)** | **$** | **8,816** | ** ** |
| ** **                                                                     |       |                                                               |       |   |   |
| **CASH AND CASH EQUIVALENTS—Beginning of Period**                         |       | $                                                                  | 27,421     |   | $ | 27,184 |   |
| Net Change in Cash                                                             |       | (716                                                               | )          | 8,816 |   |
| **CASH AND CASH EQUIVALENTS—End of Period**                               |       | $                                                                  | 26,705     |   | $ | 36,000 |   |
|                                                                           |       |                                                               |       |   |   |
| Supplementary Cash Flow Information:                                           |       |                                                               |       |   |   |
| Interest Paid                                                                  |       | $                                                                  | 467        |   | $ | 982 |   |
| Income Taxes Paid                                                              |       | $                                                                  | 619        |   | $ | — |   |

 

See accompanying notes toconsolidated financial statements

 

3

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY**

**(inthousands, except share and per-share amounts)**

 
| ** **                                                                       | ** ** | **Shares of  Class A  Common  Stock** | ** ** | **Shares of  Class B  Common  Stock** | ** ** | **Class A  Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other****Comprehensive****Income** | ** ** | **Retained  Earnings/  (Accumulated  Deficit)** | ** ** | **Non-  Controlling  Interests** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                                                       | ** ** | ** **                                      | ** ** | ** **                                      | ** ** | ** **                      | ** ** | ** **                       | ** ** | ** **                                        | ** ** | ** **                                      | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance at December 31, 2008**                                            | ** ** | **6,187,068**                                   | ** ** | **57,975,724**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **9,749**                                         | ** ** | **$**                                           | **—** | ** **                       | **$**      | **(5,289** | **)**      | **$** | **11,819** | ** ** | **$** | **16,340** | ** ** |
| Unit Conversion                                                                  |       | 2,445,973                                       |       | (2,445,973                                      | )          | 25                              |       | 107                              |       | —                                            |       | —                                          |       | (108                             | **)**      | **24**     | ** ** |
| Amortization of Non-Cash Compensation                                            |       | —                                          |       | —                                          |       | —                          |       | 19                               |       | —                                            |       | —                                          |       | 162                              | ** ** | **181**    | ** ** |
| Net Income                                                                       |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                            |       | 482                                             |       | 2,240                            | ** ** | **2,722**  | ** ** |
| Capital Distribution                                                             |       | —                                          |       | —                                          |       | —                          |       | (9                               | )          | —                                            |       | —                                          |       | (2,565                           | **)**      | **(2,574** | **)**      |
| **Balance at March 31, 2009**                                               | ** ** | **8,633,041**                                   | ** ** | **55,529,751**                                  | ** ** | **$**                           | **86**     | ** **                       | **$**      | **9,866**                                         | ** ** | **$**                                           | **—** | ** **                       | **$**      | **(4,807** | **)**      | **$** | **11,548** | ** ** | **$** | **16,693** | ** ** |
| ** **                                                                       | ** ** | ** **                                      | ** ** | ** **                                      | ** ** | ** **                      | ** ** | ** **                       | ** ** | ** **                                        | ** ** | ** **                                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| **Balance at December 31, 2007**                                            | ** ** | **6,111,118**                                   | ** ** | **57,937,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **(2,043**                                        | **)**      | **$**                                           | **—** | ** **                       | **$**      | **61**     | ** ** | **$** | **16,355** | ** ** | **$** | **14,434** | ** ** |
| Issuance of Class A Common Stock                                            |       | 12,376                                          |       | —                                          |       | —                          |       | 11                               | ** ** | **—**                                        |       | —                                          |       | 118                              | ** ** | **129**    | ** ** |
| Issuance of Class B Common Stock and Amortization of Non-Cash  Compensation |       | —                                          |       | 13,000                                          |       | —                          |       | 16                               |       | —                                            |       | —                                          |       | 131                              | ** ** | **147**    | ** ** |
| Net Income                                                                       |       | —                                          |       | —                                          |       | —                          |       | —                           | ** ** | **—**                                        |       | 820                                             |       | 11,577                           | ** ** | **12,397** | ** ** |
| Accumulated Other Comprehensive Income                                           |       | —                                          |       | —                                          |       | —                          |       | —                           |       | (46                                               | )          | —                                          |       | (430                             | **)**      | **(476**   | **)**      |
| Equity Effect of Operating Company Net Deficit on Non-Controlling  Interests     |       | —                                          |       | —                                          |       | —                          |       | 6,923                            |       | —                                            |       | —                                          |       | (6,923                           | **)**      | **—** | ** ** |
| Class A Cash Dividends Declared ($0.11 per share)                           |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                            |       | (674                                            | )          | (620                             | **)**      | **(1,294** | **)**      |
| **Balance at March 31, 2008**                                               | ** ** | **6,123,494**                                   | ** ** | **57,950,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **4,907**                                         | ** ** | **$**                                           | **(46**    | **)**                            | **$**      | **207**    | ** ** | **$** | **20,208** | ** ** | **$** | **25,337** | ** ** |

 

See accompanying notes to consolidated financial statements

 

4

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**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements**

 

**Note 1—Organization**

 

Pzena Investment Management, Inc. (the “Company”) functions as theholding company through which the business of its operating company, Pzena InvestmentManagement, LLC, is conducted. The Company was incorporated in the Stateof Delaware on May 8, 2007. Concurrently with the consummation of the Company’s initial publicoffering, on October 30, 2007, the Operating Agreement of Pzena InvestmentManagement, LLC (the “Operating Agreement”) was amended and restated suchthat, among other things, the Company became the sole managing member of PzenaInvestment Management, LLC.  Theacquisition of the operating company’s membership interests by the Company wastreated as a reorganization of entities under common control pursuant to theguidance set forth in Financial Accounting Standards Board Technical Bulletin No. 85-5,*Issues Relating to Accounting for BusinessCombinations* (“FTB 85-5”).  Asa result of these transactions, as of and subsequent to October 30, 2007, (i) theCompany has consolidated the financial results of Pzena InvestmentManagement, LLC with its own and reflected the membership interest in itthat it does not own as a non-controlling interest in its consolidatedfinancial statements, and (ii) the Company recognizes income generatedfrom its economic interest in Pzena Investment Management, LLC’s netincome.

 

Pzena InvestmentManagement, LLC is an investment adviser which is registered under theInvestment Advisers Act of 1940 and is headquartered in New York, NewYork.  As of March 31, 2009, theCompany managed assets in a variety of value-oriented investment strategiesacross a wide range of market capitalizations in both U.S. and internationalcapital markets.

 

The Company, through itsinvestment in its operating company, has consolidated the results of operationsand financial condition of the following private investment partnerships as of March 31,2009:

 
| **Entity**                                   | ** ** | **Type of Entity (Date of Formation)** | ** ** | **Ownership at  March 31,  2009** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------|------------|
|                                         |       |                                                            |       |                                        |       |
| Pzena Large Cap Value Fund                   |       | Massachusetts Trust  (11/1/2002)                                |       | 99.6%                                       |       |
| Pzena International Value Service            |       | Delaware Limited Liability  Company (12/22/2003)                |       | 17.5%                                       |       |
| Pzena Global Value Service                   |       | Delaware Limited Liability  Company (12/22/2003)                |       | 0.6%                                        |       |
| Pzena Emerging Markets Country Value Service |       | Delaware Limited Liability  Company (12/28/2007)                |       | 99.9%                                       |       |
| Pzena Emerging Markets Focused Value Service |       | Delaware Limited Liability  Company (12/28/2007)                |       | 99.9%                                       |       |
|                                              |            |                                                                 |            |                                             |            |  |

 

Pursuant to its OperatingAgreement, the operating company will continue until December 31, 2026,unless a terminating event, as defined in the Operating Agreement, occurs priorto this date. Operating company members are not liable for repayment,satisfaction or discharge of any debts, liabilities or obligations of theoperating company, except to the extent of their capital accounts.

 

**Note 2—Significant Accounting Policies**

 

***Basis of Presentation:***

 

The consolidated financialstatements are prepared in conformity with U.S. generally accepted accountingprinciples and related Securities and Exchange Commission rules andregulations.  The Company’s policy is toconsolidate all majority-owned subsidiaries in which it has a controllingfinancial interest and variable interest entities where the Company is deemedto be the primary beneficiary (“Consolidated Subsidiaries”).  Pursuant to the guidance of Emerging IssuesTask Force Issue No. 04-5, *DeterminingWhether a General Partner, or the General Partners as a Group, Controls aLimited Partnership or Similar Entity When the Limited Partners Have CertainRights* (“EITF 04-5”), the Company also consolidatesnon-variable-interest entities in which it acts as the general partner ormanaging member.  All of these entitiesrepresent private investment partnerships over which the Company exercises orexercised control.  Non-controllinginterests recorded on the consolidated financial statements of the Companyinclude the non-controlling interests of the outside investors in each of theseentities, as well as those of the operating company.  All significant inter-company transactionsand balances have been eliminated.

 

The Pzena InternationalValue Service and the Pzena Global Value Service are limited liabilitycompanies whose managing members are or were members of the executive committeeof the operating company or the operating company itself.  Neither of these entities are consideredvariable-interest entities, as the managing members have substantive interestsin the partnerships.  Each of theselimited liability companies are considered entities “similar” to limitedpartnerships and thus subject to the guidance of EITF 04-5.  Under each of their respective operatingagreements, none of these entities’ non-managing members have the ability toremove the managing member under any circumstance, nor do they have anyparticipating rights.  As a result,nothing substantive exists to overcome the presumption of control by themanaging member

 

5

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies (continued)**

 

laid out by EITF 04-5.  As the managing members of these entitiesare, or were, either the operating company or one of the controlling persons ofthe operating company, their results of operations and financial position havebeen consolidated.

 

During 2008, the decisionwas made to close the Pzena Large Cap Value Fund II, the Pzena Emerging MarketsValue Service, the Pzena Mega Cap Value Fund and Pzena Value Partners.  The results of operations and financialposition of each of these entities were consolidated until the dates of theirrespective liquidations.

 

All of the consolidatedinvestment partnerships are, or were, investment companies under the AmericanInstitute of Certified Public Accountants Audit and Accounting Guide forInvestment Companies (the “AICPA Guide”). The Company has retained the specialized accounting for these partnershipspursuant to Emerging Issues Task Force Issue No. 85-12, *Retention of Specialized Accounting for Investmentsin Consolidation* (“EITF 85-12”).  Thus, the Company reports the investmentpartnerships’ investments in marketable securities at fair value, with netrealized and unrealized gains and losses reported in earnings in theconsolidated statements of operations.

 

The Company records in itsown equity its pro rata share of transactions that impact the operating company’snet equity, including equity and option issuances and adjustments toaccumulated other comprehensive income. The operating company’s pro rata share of such transactions are recordedas adjustments to additional paid-in capital or non-controlling interests, asapplicable, on the consolidated statements of financial position.  As discussed further in Note 13, the Companydid not initially record a non-controlling interest associated with theacquisition of its operating company, as the post offering net equity of theoperating company was less than zero. Pursuant to the guidance in Emerging Issues Task Force Issue No. 95-7,*Implementation Issues Related to theTreatment of Minority Interest in Certain Real Estate Trusts* (“EITF 95-7”),an operating company non-controlling interest was recorded after the initialdeficit that existed at acquisition was extinguished in 2008.

 

The Company acts as theinvestment manager for four trusts and one offshore investment company, each ofwhich are considered variable-interest entities.  All of these entities are vehicles throughwhich the Company offers its Global Value and/or International Valuestrategies.  The Company is notconsidered the primary beneficiary of any of these entities.  Correspondingly, their results of operationsand financial condition are not consolidated by the Company.  The total net assets of thesevariable-interest entities were approximately $351.1 million and$446.0 million at March 31, 2009 and December 31, 2008,respectively.  The Company is not exposedto losses as a result of its involvement with these entities because it has nodirect investment in them.

 

***Management’s Use of Estimates:***

 

The preparation of financialstatements in conformity with U. S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses for the period. Actual results could differ from those estimates.

 

***Fair Values of FinancialInstruments:***

 

The carrying amount of allfinancial instruments in the consolidated statements of financial condition,including investments in marketable securities, approximates their fair values.

 

***Revenue Recognition:***

 

Revenue, comprised ofadvisory fee income, is recognized over the period in which investmentmanagement services are provided. Advisory fee income includes management fees that are calculated basedon percentages of assets under management, generally billed quarterly, eitherin arrears or advance, depending on their contractual terms.  Advisory fee income also includes incentivefees that may be earned by the Company depending on the investment return ofthe assets under management.  Incentivefee arrangements generally entitle the Company to participate, on afixed-percentage basis, in any returns generated in excess of an agreed-uponbenchmark.  The Company’s participationpercentage in such return differentials is then multiplied by assets undermanagement to determine the incentive fees earned.  Returns are calculated on an annualized basisover the contract’s measurement period, which may extend up to threeyears.  Incentive fees are generallypayable annually.  Pursuant to the preferredaccounting method under Emerging Issues Task Force Issue D-96, *Accounting*

 

6

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies(continued)**

 

* for Management Fees Based on a Formula* (“EITF D-96”),such incentive fee income is recorded at the conclusion of the contractualperformance period, when all contingencies are resolved.  The Company recognized no such incentive feesfor the three months ended March 31, 2009 and 2008.

 

***Earnings per Share:***

 

Basic earnings per share iscomputed by dividing the Company’s net income or loss attributable to theCompany’s common stockholders by the weighted-average number of shares outstandingduring the reporting period.  Dilutedearnings per share adjusts this calculation to reflect the impact of alloutstanding operating company membership units, as well as outstandingoperating company options and phantom units, to the extent that they would havea dilutive effect on net income per share for the reporting period.  Net income for diluted earnings per sharegenerally assumes all operating company membership units are converted intoCompany stock at the beginning of the reporting period and the resulting changeto Company net income associated with its increased interest in the operatingcompany is taxed at the Company’s effective tax rate.  For the three months ended March 31,2009, 3,153,122 options to purchase operating company units and 153,829 phantomoperating company units were excluded from the calculation of diluted netincome per share, as their inclusion would have had an antidilutive effect forthe period.  For the three months ended March 31,2008, 954,310 options to purchase operating company units and 89,826 phantomunits were excluded from the calculation of diluted net income per share, astheir inclusion would have had an antidilutive effect.

 

For the three months ended March 31,2009 and 2008, the Company’s basic and diluted earnings per share attributableto the Company’s common stockholders were determined as follows (in thousands,except for share and per-share amounts):

 
| ** **                                  | ** ** | **For the Three  Months Ended  March 31, 2009** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------|------------|
|                                        |       |                                                                     |       |   |
| Net Income for Basic Earnings per Share     |       | $                                                                        | 482        |   |
| Basic Weighted Average Shares Outstanding   |       | 6,948,037                                                                |       |
| Basic Earnings per Share                    |       | $                                                                        | 0.07       |   |
|                                        |       |                                                                     |       |
| Net Income for Diluted Earnings per Share   |       | $                                                                        | 2,776      |   |
| Dilutive Effect of Operating Company Units  |       | 57,244,755                                                               |       |
| Diluted Weighted Average Shares Outstanding |       | 64,192,792                                                               |       |
| Diluted Earnings per Share                  |       | $                                                                        | 0.04       |   |

 
| ** **                                  | ** ** | **For the Three  Months Ended  March 31, 2008** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------|------------|
|                                        |       |                                                                     |       |   |
| Net Income for Basic Earnings per Share     |       | $                                                                        | 820        |   |
| Basic Weighted Average Shares Outstanding   |       | 6,119,686                                                                |       |
| Basic Earnings per Share                    |       | $                                                                        | 0.13       |   |
|                                        |       |                                                                     |       |
| Net Income for Diluted Earnings per Share   |       | $                                                                        | 8,597      |   |
| Dilutive Effect of Operating Company Units  |       | 57,950,910                                                               |       |
| Diluted Weighted Average Shares Outstanding |       | 64,070,596                                                               |       |
| Diluted Earnings per Share                  |       | $                                                                        | 0.13       |   |

 

7

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies(continued)**

 

***Cash and Cash Equivalents:***

 

The Company considers allhighly-liquid debt instruments with an original maturity of three months orless at the time of purchase to be cash equivalents.  The Company maintains its cash in bankdeposits and other accounts, the majority of which are held at two financialinstitutions.  These balances, at times,exceed federally insured limits.

 

Interest on cash and cashequivalents is recorded as interest income on an accrual basis on theconsolidated statements of operations.

 

***Due to/from Broker:***

 

Due to/from broker consistsprimarily of cash balances and amounts receivable/payable for unsettledsecurities transactions held/initiated at the clearing brokers of the Company’sconsolidated investment partnerships.

 

***Investments in Securities:***

 

Investments in marketablesecurities represent primarily the securities held by the Company’sconsolidated investment partnerships. All such securities are recorded at fair value, with net realized andunrealized gains and losses reported in earnings in the consolidated statementsof operations.

 

The Company adopted theprovisions of Statement of Financial Accounting Standard No.157, *Fair Value Measurements* (“FAS 157”),on January 1, 2008.  FAS 157defines fair value as the price that would be received to sell an asset, orpaid to transfer a liability, in an orderly transaction between marketparticipants at the measurement date. FAS 157 also establishes a framework for measuring fair value and avaluation hierarchy based upon the transparency of inputs used in the valuationof an asset or liability.  Classificationwithin the hierarchy is based upon the lowest level of input that issignificant to the fair value measurement. The valuation hierarchy contains three levels: (i) valuation inputsare unadjusted quoted market prices for identical assets or liabilities inactive markets (Level 1); (ii) valuation inputs are quoted prices foridentical assets or liabilities in markets that are not active, quoted marketprices for similar assets and liabilities in active markets and otherobservable inputs directly or indirectly related to the asset or liabilitybeing measured (Level 2); and (iii) valuation inputs are unobservableand significant to the fair value measurement (Level 3).

 

The Company’s fair valuemeasurements relate to its interest rate swap, as well as its investments inmarketable securities, which are primarily exchange-traded securities withquoted prices in active markets.  Thefair value measurement of the interest rate swap has been determined primarilybased upon the market prices for interest rate swaps with similar provisionsand the use of forward interest rate curves. The interest rate swap has been classified as Level 2 and recordedin other liabilities on the consolidated statement of financial condition.  The fair value measurements of the securitieshave been classified as Level 1.

 

The following table presentsthese instruments’ fair value at March 31, 2009 (in thousands):

 
| ** **            | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|-----------------------|------------|------------------|------------|------------------|------------|------------------|------------|
|                  |       |             |       |             |       |             |       |
| Assets:               |       |             |       |             |       |             |       |
| Marketable Securities |       | $                | 11,369     |             | $          | —           |       | $ | — |   |
| Liabilities:          |       |             |       |             |       |             |       |
| Interest Rate Swap    |       | —           |       | (372             | )          | —           |       |
| Total Fair Value      |       | $                | 11,369     |             | $          | (372             | )          | $ | — |   |

 

8

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies(continued)**

 

The following table presentsthese instruments’ fair value at December 31, 2008 (in thousands):

 
| ** **            | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|-----------------------|------------|------------------|------------|------------------|------------|------------------|------------|
|                  |       |             |       |             |       |             |       |
| Assets:               |       |             |       |             |       |             |       |
| Marketable Securities |       | $                | 14,045     |             | $          | —           |       | $ | — |   |
| Liabilities:          |       |             |       |             |       |             |       |
| Interest Rate Swap    |       | —           |       | (628             | )          | —           |       |
| Total Fair Value      |       | $                | 14,045     |             | $          | (628             | )          | $ | — |   |

 

***Securities Valuation:***

 

Investments in marketableequity securities which are traded on a national securities exchange arecarried at fair value based on the last reported sales price on the valuationdate.  If no reported sales occurred onthe valuation date, investments in securities are valued at the bid price.  Securities transactions are recorded on thetrade date.

 

The net realized gain orloss on sales of securities is determined on a specific identification basisand is included in realized and unrealized loss, net on marketable securitiesin the consolidated statements of operations.

 

***Concentrations of Credit Risk:***

 

Financial instruments thatpotentially subject the Company to concentrations of credit risk consistprincipally of cash and cash equivalents, amounts due from brokers and advisoryfees receivable.  The Company maintainsits cash and temporary cash investments in bank deposits and other accountswhose balances, at times, exceed federally insured limits.

 

The concentration of creditrisk with respect to advisory fees receivable is generally limited due to theshort payment terms extended to clients by the Company.  On a periodic basis, the Company evaluatesits advisory fees receivable and establishes an allowance for doubtfulaccounts, if necessary, based on a history of past write-offs and collectionsand current credit conditions.  For thethree months ended March 31, 2009 and 2008, approximately 12.2% and 15.7%,respectively, of the Company’s advisory fees were generated from an advisoryagreement with one client.  At March 31,2009 and December 31, 2008, no allowance for doubtful accounts has beendeemed necessary.

 

***Financial Instruments:***

 

On February 28, 2008,the operating company entered into an interest rate swap agreement to manageits exposure to changes in interest rates associated with the credit agreement(the “Credit Agreement”) discussed in Note 9.  The counterparty to this agreement is a majorfinancial institution.  The Companydesignated the interest rate swap agreement as a cash flow hedge of the CreditAgreement effective February 28, 2008. Pursuant to Statement of Financial Accounting Standards No. 133, *Accounting for Derivative Instruments and Certain HedgingActivities* (“FAS 133”), the Company recorded the cash flowhedge at fair value on the consolidated statement of financial condition.  Additionally, the Company’s pro rata share ofthe changes in the fair value of this agreement were recorded as a component ofaccumulated other comprehensive income.

 

During the quarter ended September 30,2008, the Company changed the designation of its swap agreement from a cashflow hedge to a trading derivative, as a significant portion of the cash flowsassociated with the original forecasted transaction were probable to not occurdue to amortization payments required be made pursuant to the terms of itsamended Credit Agreement.  Accordingly,the Company reclassified the cumulative changes in fair value related to thisswap from accumulated other comprehensive income to other expense.  The Company records all subsequent changes tothe swap’s fair value as a component of other expense.  For the three months ended March 31,2009, the Company recognized less than $0.1 million in other incomerelated to such changes.  For the threemonths ended March 31, 2008, the Company recognized approximately $0.0million in other accumulated comprehensive loss associated with the change infair value of  this swap agreement.

 

9

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies(continued)**

 

At March 31, 2009 and December 31,2008, the approximate fair value of the liability associated with the swapagreement was $0.4 million and $0.6 million, respectively, and has beenincluded in other liabilities on the statements of financial condition.

 

The following tablesummarizes the impact of the Company’s derivative financial instruments on itsresults of operations for the three months ended March 31, 2009 and 2008(in thousands):

 
| **Derivatives Not Accounted For As Hedging** | ** ** | **Statement of**       | ** ** | **Amount of Gain Recognized  In Income on Derivative** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **Instruments Under FAS 133**                          | ** ** | **Operations Account** | ** ** | **2009**                                                                             | ** ** | **2008** | ** ** |
|                                                                  |       |                        |       |                                                                                 |       |   |   |   |   |
| Interest Rate Contracts                                               |       | Other Income/(Expense)      |       | $                                                                                    | 25         |   | $ | — |   |
| Total                                                                 |       |                        |       | $                                                                                    | 25         |   | $ | — |   |

 

The following tablesummarizes the impact of the Company’s derivative financial instruments on itsfinancial position as of March 31, 2009 (in thousands):

 
| **Derivatives Not Accounted**                                | ** ** | **Asset Derivatives**                     | ** ** | **Liability Derivatives** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| **For As Hedging Instruments  Under FAS 133** | ** ** | **Statement of  Financial Condition  Account** | ** ** | **Fair Value**            | ** ** | **Statement of  Financial Condition  Account** | ** ** | **Fair Value** | ** ** |
|                                                                   |       |                                           |       |                           |       |   |   |   |   |   |   |
| Interest Rate Contracts                                                |       | —                                         |       | $                              | —     |   | Other  Liabilities |   | $ | 372 |   |
| Total                                                                  |       |                                           |       | $                              | —     |   |   |   | $ | 372 |   |

 

The following tablesummarizes the impact of the Company’s derivative financial instruments on itsfinancial position as of December 31, 2008 (in thousands):

 
| **Derivatives Not Accounted**                                |       | **Asset Derivatives**                     |       | **Liability Derivatives** |       |
|------------------------------------------------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|
| **For As Hedging Instruments  Under FAS 133** | ** ** | **Statement of  Financial Condition  Account** | ** ** | **Fair Value**            | ** ** | **Statement of  Financial Condition  Account** | ** ** | **Fair Value** | ** ** |
|                                                                   |       |                                           |       |                           |       |   |   |   |   |   |   |
| Interest Rate Contracts                                                |       | —                                         |       | $                              | —     |   | Other  Liabilities |   | $ | 628 |   |
| Total                                                                  |       |                                           |       | $                              | —     |   |   |   | $ | 628 |   |

 

***Property and Equipment:***

 

Property and equipment iscarried at cost, less accumulated depreciation and amortization.  Depreciation is provided on a straight-linebasis over the estimated useful lives of the respective assets, which rangefrom three to seven years.  Leaseholdimprovements are amortized on a straight-line basis over the shorter of theuseful life of the improvements or the remaining lease term.

 

***Business Segments:***

 

The Company views itsoperations as comprising one operating segment.

 

***Income Taxes:***

 

The Company is a “C”corporation under the Internal Revenue Code, and thus liable for federal, stateand local taxes on the income derived from its economic interest in itsoperating company.  The operating companyis a limited liability company that has elected to be treated as a partnershipfor tax purposes.  It has not made aprovision for federal or state income taxes because it is the responsibility ofeach of the operating company’s members (including the Company) to separatelyreport their proportionate share of the operating company’s taxable income orloss.  Similarly, the income of theCompany’s consolidated investment partnerships is not subject to income taxes,as it is allocated to each partnership’s

 

10

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies (continued)**

 

individual partners.  The operating company has made a provisionfor New York City Unincorporated Business Tax, (“UBT”).

 

The Company and itsconsolidated subsidiaries account for all state, local and federal taxationpursuant to the asset and liability method, which requires deferred income taxassets and liabilities to be recorded for temporary differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or deductible amounts in the future, based on enacted tax laws andrates applicable to the periods in which the temporary differences are expectedto affect taxable income.  Valuationallowances are established, when necessary, to reduce deferred tax assets tothe amount more likely than not to be realized. At March 31, 2009 and December 31, 2008, the Company had a$64.3 million and a $62.7 million valuation allowance, respectively,against the deferred tax asset recorded as part of the Company’s acquisition ofoperating company membership units in conjunction with the offering and the March 3,2009 unit conversions.  These valuationallowances represent approximately 94% and 95% of the total value of suchdeferred tax assets as of March 31, 2009 and December 31, 2008,respectively.  The income tax provision,or credit, is the tax payable or refundable for the period, plus or minus thechange during the period in deferred tax assets and liabilities.  The Company records its deferred taxliabilities as a component of other liabilities on the consolidated statementsof financial condition.

 

***Foreign Currency:***

 

Investment securities andother assets and liabilities denominated in foreign currencies are remeasuredinto U. S. dollar amounts at the date of valuation.  Purchases and sales of investment securities andincome and expense items denominated in foreign currencies are remeasured intoU. S. dollar amounts on the respective dates of such transactions.

 

The Company does not isolatethat portion of the results of its operations resulting from changes in foreignexchange rates on investments from the fluctuations arising from changes inmarket prices of securities held.  Suchfluctuations are included in the net realized and unrealized loss, net onmarketable securities in the consolidated statements of operations.

 

Reported net realizedforeign exchange gains or losses arise from sales of foreign currencies,currency gains or losses realized between the trade and settlement dates onsecurities transactions, and the difference between the amounts of dividends, interest,and foreign withholding taxes recorded on the Company’s books and the U.S.dollar equivalent of the amounts actually received or paid.  Net realized foreign exchange gains andlosses arise from changes in the fair values of assets and liabilitiesresulting from changes in exchange rates.

 

***New Accounting Pronouncements:***

 

In December 2007, theFASB issued Statement of Financial Accounting Standards No. 160, *Noncontrolling Interests in Consolidated FinancialStatements—an amendment of ARB No. 51* (“FAS 160”).  FAS 160 amends ARB No. 51 andestablishes accounting and reporting standards that require non-controllinginterests (previously referred to as minority interest) to be reported as acomponent of equity, changes in a parent’s ownership interest while the parentretains its controlling interest be accounted for as equity transactions, andupon a loss of control, retained ownership interest will be remeasured at fairvalue, with any gain or loss recognized in earnings.  FAS 160 was adopted by the Company on January 1,2009.  The adoption of FAS 160 onlyimpacted the Company’s presentation of its consolidated financial statements.

 

In March 2008, the FASBissued Statement of Financial Accounting Standards No. 161, *Disclosures about Derivative Instruments and HedgingActivities* (“FAS 161”). FAS 161 is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance, and cash flows. It is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008.  As FAS 161 only affects financialstatement disclosure, the impact of adoption and January 1, 2009 waslimited to additional financial statement disclosure.

 

In June 2008, the FASBissued EITF 03-6-1, *Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities* (“EITF 03-6-1”). The EITF release states that unvested share-based payment awards thatcontain nonforfeitable rights to dividends or dividend equivalents (whetherpaid or unpaid) are participating securities and shall be included in thecomputation of earnings per share pursuant to the two-class method.  EITF 03-6-1 is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those

 

11

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies(continued)**

 

years. The adoption of EITF 03-6-1 on January 1, 2009 did not have amaterial impact on the Company’s consolidated financial statements.

 

On January 1, 2009, theCompany adopted the remaining provisions of Statement of Financial Accounting Standards No. 157, *Fair Value Measurements* (“FAS No. 157”),as permitted by the FASB Staff Position 157-2, *“EffectiveDate of FASB Statement No. 157”* (“FSP 157-2”), which delayed theeffective date of SFAS No. 157 for nonfinancial assets and nonfinancialliabilities, except those that are recognized or disclosed at fair value in thefinancial statements on a recurring basis (at least annually). These nonfinancialitems include, for example, reporting units required to be measured at fairvalue for annual goodwill impairment testing purposes and nonfinancial assetsacquired and liabilities assumed in a business combination. The Company did nothave any impairments or business combinations during the first quarter of 2009,therefore the adoption of FAS 157 for nonfinancial assets did not impact theCompany’s consolidated financial statements.

 

**Note 3—Property and Equipment**

 

Property and equipment, net,is comprised of the following:

 
| ** **                                      | ** ** | **As of**           | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|
| ** **                                      | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                      | ** ** | **(in thousands)**  | ** ** |
|                                            |       |                     |       |   |   |   |   |
| Computer Hardware                               |       | $                        | 921        |   | $ | 921 |   |
| Computer Software                               |       | 191                      |       | 191 |   |
| Furniture and Fixtures                          |       | 1,161                    |       | 1,161 |   |
| Office Equipment                                |       | 243                      |       | 243 |   |
| Leasehold Improvements                          |       | 2,145                    |       | 2,145 |   |
| Total                                           |       | 4,661                    |       | 4,661 |   |
| Less: Accumulated Depreciation and Amortization |       | (2,034                   | )          | (1,913 | ) |
| Total                                           |       | $                        | 2,627      |   | $ | 2,748 |   |

 

Depreciation is included ingeneral and administrative expenses and totaled $0.1 million for each ofthe three months ended March 31, 2009 and 2008.

 

**Note 4—Related Party Transactions**

 

For the three months ended March 31,2009 and 2008, the Company earned $0.9 million and $1.8 million,respectively, in investment advisory fees from unconsolidated entities forwhich it acts as the investment manager.

 

At March 31, 2009 and December 31,2008, the Company had advanced $0.1 million and $0.1 million,respectively, to an international investment company for organization andstart-up costs, which are included in receivable from related parties on theconsolidated statements of financial condition. The Company is the sponsor and investment manager of this entity.

 

At March 31, 2009 and December 31,2008, receivable from related parties included $0.1 million and$0.1 million of loans to employees. These loans are in the form of forgivable promissory notes which areamortized through compensation expense pursuant to their terms.

 

Employees of the Company whoare considered accredited investors have the ability to open separately-managedaccounts, or invest in certain of the Company’s consolidated investmentpartnerships, without being assessed advisory fees.  Investments by employees inseparately-managed accounts are permitted only at the discretion of theExecutive Committee of the Company, but are generally not subject to the sameminimum investment levels that are required of outside investors.  Some of the investment advisory fees that arewaived on separately managed accounts for employees are for strategies thattypically have account fee minimums, which vary by strategy, but typicallyaverage approximately $50,000 per account per year.

 

During the quarter ended June 30,2008, an unaffiliated shareholder who held more than 10% of the Company’soutstanding shares sold shares in transactions deemed to be short-swingsales.  Under Section 16(b) ofthe Securities Exchange Act of 1934, the shareholder was required to disgorgeto the Company the $0.2 million in profits realized from these stocksales.  The Company recognized these proceedsas a capital contribution from a shareholder and reflected a correspondingincrease to additional paid-in capital in its consolidated statements ofchanges in equity.  Proceeds from thesetransactions did not affect the Company’s consolidated statements ofoperations.

 

As discussed in Note 9,on October 28, 2008, the operating company issued an aggregate of$16.0 million principal amount of Senior Subordinated Notes to entitiesestablished by Richard S. Pzena, the Company’s Chief Executive Officer,for the benefit of certain of his family members, an entity controlled by aCompany Director, and a former employee.

 

12

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 5—Commitments and Contingencies**

 

In the normal course ofbusiness, the Company enters into agreements that include indemnities in favorof third parties, such as engagement letters with advisors andconsultants.  In certain cases, theCompany may have recourse against third parties with respect to theseindemnities.  The Company maintainsinsurance policies that may provide coverage against certain claims under theseindemnities.  FASB issued Interpretation No.  45,*Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers* (“FIN 45”), providing accounting and disclosurerequirements for certain guarantees.  TheCompany has had no claims or payments pursuant to these agreements, and itbelieves the likelihood of a claim being made is remote.  Utilizing the methodology in FIN 45, theCompany’s estimate of the value of such guarantees is de minimis, and,therefore, an accrual has not been made in the consolidated financial statements.

 

The Company may be subjectto various legal and administrative proceedings in the normal course ofbusiness.  On November 21, 2007 and January 16,2008, substantively identical putative class action lawsuits were commenced inthe United States District Court for the Southern District of New York againstthe Company and Richard S. Pzena, the Company’s chief executive officer,seeking remedies under Section 11 of the Securities Act of 1933, asamended.  The Court consolidated thelawsuits and appointed co-lead plaintiffs, who filed a consolidated amendedcomplaint.  The consolidated amendedcomplaint named as defendants the Company, Richard S. Pzena, and two of theunderwriters of the Company’s initial public offering, Goldman Sachs & Co, Inc.and UBS Securities LLC.  Plaintiffssought to represent a class of all persons who purchased or otherwise acquired Class Acommon stock issued pursuant or traceable to the Company’s initial publicoffering.  The consolidated amendedcomplaint alleged that the registration statement and prospectus relating tothe initial public offering of the Company’s Class A common stockcontained material misstatements and omissions and wrongfully failed todisclose net redemptions in the John Hancock Classic Value Fund, for which theCompany acts as sub-investment advisor. The consolidated amended complaint sought damages in an unspecifiedamount including rescission or rescissory damages.  The Court granted Company’s motion to dismissthe consolidated amended complaint and, on September 4, 2008, the Courtentered a judgment in favor of the Company. Plaintiffs have filed a Notice of Appeal of the Court’s judgment to theUnited States Court of Appeals for the Second Circuit.  The Company believes that the allegations andclaims are without merit and will continue to contest these claims vigorously.

 

The Company leases officespace under two non-cancelable operating lease agreements which expire on October 31,2015.  The Company reflects lease expenseon a straight-line basis over the lease term. Lease expenses totaled $0.6 million for each of the three months ended March 31,2009 and 2008.

 

**Note 6—Retirement Plan**

 

The Company maintains adefined contribution pension plan which covers substantially all members andemployees.  The Company may makecontributions to the plan at the discretion of management.  Under the terms of the plan, all suchcontributions vest immediately.  TheCompany recognized $0.5 million in expense associated with this plan for thethree months ended March 31, 2008. These expenses are included in compensation and benefits expense in theconsolidated statements of operations. No such expenses were incurred during the three months ended March 31,2009

 

**Note 7—Compensation andBenefits**

 

Compensation and benefitsexpense to employees and members is comprised of the following:

 
| ** **                              | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                            | ** ** |
|                                    |       |                                                               |       |   |   |   |   |
| Cash Compensation and Other Benefits    |       | $                                                                  | 5,789      |   | $ | 8,607 |   |
| Other Non-Cash Compensation             |       | 251                                                                |       | 344 |   |
| Total Compensation and Benefits Expense |       | $                                                                  | 6,040      |   | $ | 8,951 |   |

 

13

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 7—Compensation andBenefits (continued)**

 

For the three months ended March 31,2008, the operating company granted 446,000 options to purchase units pursuantto the Pzena Investment Management, LLC 2006 Equity Incentive Plan.  For the three months ended March 31,2009, the operating company granted no options to purchase such units.  The options had varying vesting schedules andwere issued at strike prices equal to the assessed fair market value per unitat the time of award issuance.  TheCompany determined that the total grant-date fair value of the options awardedduring the three months ended March 31, 2008 was approximately $1.2million.  For the three months ended March 31,2009 and 2008, the Company recognized approximately $0.1 million and $0.1million, respectively, in compensation and benefits expense associated with theamortization of these awards.

 

For the three months ended March 31,2009 and 2008, the Company granted 30,000 and 13,000 restricted Class B units to certain memberspursuant to the Pzena Investment Management, LLC 2006 Equity IncentivePlan.  These unit grants each vestratably over a four-year period commencing January 1, 2009 and 2008,respectively.  The amortization of theseawards was not material for the three months ended March 31, 2009 and2008.

 

Pursuant to the operatingcompany’s bonus plan, which became effective January 1, 2007, eligibleemployees whose cash compensation is in excess of certain thresholds have aportion of that excess mandatorily deferred. Amounts deferred may be credited to an investment account or take theform of phantom Class B units, at the employee’s discretion, and vestratably over four years.  At March 31,2009 and December 31, 2008, no such compensation was deferred.  At March 31, 2009 and December 31,2008, the liability associated with such investment accounts was approximately$0.1 million and $0.3 million, respectively, and has been included as acomponent of other liabilities on the consolidated statements of financialcondition.  For the three months ended March 31,2009 and 2008, the Company recognized approximately $0.2 million and $0.3million, respectively, in compensation and benefits expense associated with theamortization of all deferred compensation awards.

 

**Note 8—Short Term Borrowings**

 

Simultaneously with the CreditAgreement described below, on July 23, 2007, the operating companyobtained a $20.0 million revolving credit facility, expiring on July 23,2010, in order to finance its short term working capital needs.  This facility carries a commitment fee of0.2% on any unused amounts, and the Company’s approximately $1.8 millionletter of credit reduces the amounts otherwise available to be used.  On February 11, 2008, the operatingcompany entered into Amendment No. 1 to its Credit Agreement.  The amendment changed a number of CreditAgreement provisions, including reducing the capacity of the revolving creditfacility from $20.0 million to $5.0 million.  On September 19, 2008, the operatingcompany entered into Amendment No. 2 to its Credit Agreement.  The amendment reduced the capacity of therevolving credit facility from $5.0 million to $3.0 million andextended its maturity to July 23, 2011. On October 28, 2008, the operating company entered into Amendment No. 3to its Credit Agreement, which reduced the capacity of the revolving creditfacility to the value of its letter of credit, approximately$1.8 million.  As of and for theperiods ended March 31, 2009 and December 31, 2008, no balance wasoutstanding against the facility.

 

**Note 9—Debt**

 

On July 23, 2007, theoperating company entered into a $60.0 million, three-year CreditAgreement, the proceeds of which were used to finance a one-time distributionto its members.  The principal amountborrowed bore interest at a variable rate based, at the Company’s option, on (i) theone, two, three, nine or twelve-month LIBOR rate plus 1.00%, or (ii) thehigher of the lender’s prime rate and the Federal Funds Rate.  The principal amount was payable in full atthe end of the three-year term, with no penalty for prepayment.  Approximately $0.1 million in debtissuance costs were incurred in association with this loan.  Such costs have been recorded in prepaidexpenses and other assets on the consolidated statements of financial conditionand are being amortized over the term of the loan.

 

On February 11, 2008,the operating company entered into Amendment No. 1 to the CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$15.0 billion and generate consolidated earnings before interest, taxes,depreciation and amortization (“EBITDA”), as defined, of at least$40.0 million in any consecutive four fiscal quarterly periods.  Pursuant to the terms of the amendedagreement, term loan amortization was required beginning in any period whenassets under management were less than $20.0 billion and ending whenassets under management was greater than $21.5 billion.  Further, a 50% excess cash flow sweep wasrequired if assets

 

14

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 9—Debt (continued)**

 

under management were below$17.5 billion.  Additionally, theLIBOR interest rate option was increased to LIBOR plus 1.50%.  For the period from February 11, 2008through July 23, 2008, the interest rate in effect was 6.91%, which wasequal to the twelve-month LIBOR rate in effect at the time of the closing ofthe agreement of 5.41%, plus 1.50%. During the quarter ended June 30, 2008, the Company’s assets undermanagement fell below $20 billion. On June 30, 2008, the Company made a required amortization paymentof $3.0 million.

 

On September 19, 2008,the operating company entered into Amendment No. 2 to its CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$12.0 billion and to make minimum quarterly amortization payments of$2.0 million until maturity, which was extended to July 23,2011.  Additionally, the LIBOR interestrate option was increased to LIBOR plus 1.75% and the EBITDA financial covenantstipulated in Amendment No. 1 was eliminated.  The excess cash flow sweep was also increasedto 75% of excess cash flow.  On September 22,2008, the Company made a required amortization payment of $5.0 million asa condition precedent to the effectiveness of this amendment.  On September 30, 2008, the Company madea quarterly amortization payment of $5.0 million.

 

On October 28, 2008,the operating company entered into Amendment No. 3 to its CreditAgreement.  This amendment provided forthe following changes to the Credit Agreement, among others:

 
| (i)    | the minimum assets under management financial covenant was  eliminated;                                                                                                               |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                  |
| (ii)   | the excess cash flow mandatory repayment was eliminated;                                                                                                                              |
|   |                                                                                                                                                                                  |
| (iii)  | the commitments under the revolving credit facility were reduced from  $3. 0 million to approximately $1.8 million;                                                         |
|   |                                                                                                                                                                                  |
| (iv)   | with respect to loans borrowed at base rate, the margin added to base  rate was increased from 0.00% to 0.75%; with respect to loans borrowed at  LIBOR, the margin was not modified; |
|   |                                                                                                                                                                                  |
| (v)    | certain additional restrictions were placed on the operating  company’s ability to make Restricted Payments (as defined in the Credit  Agreement), including dividends; and      |
|   |                                                                                                                                                                                  |
| (vi)   | amendments to certain covenants in order to permit the incurrence of  subordinated debt by the operating company.                                                                     |

 

Conditions precedent to theexecution of Amendment No. 3 included, among others, (i) therepayment by the operating company of $25.0 million of the$47.0 million principal amount outstanding under the Credit Agreement asof October 28, 2008, and (ii) the grant by the operating company andone of its subsidiaries of a security interest in their accounts receivable.

 

In order to fund the$25.0 million repayment by the operating company, the Company used$9.0 million in cash reserves and the proceeds from the issuance by theoperating company of an aggregate of $16.0 million principal amount ofSenior Subordinated Notes (collectively, the “Notes”) to entities establishedby Richard S. Pzena, the Company’s Chief Executive Officer, for thebenefit of certain of his family members, an entity controlled by a Companydirector, and a former employee.  Theissuance of these Notes was approved by the three independent members of theCompany’s Board of Directors.

 

The Notes were issued on October 28,2008.  Each of these Notes is unsecured,has a ten-year maturity and bears interest at 6.30% per annum.  The provisions of the Notes include a restrictedpayments covenant (including dividends), a prohibition on incurringindebtedness which is not subordinated to the Notes, and events of defaultbased on failure to make payments, bankruptcy, change of control andacceleration of material indebtedness. In addition, the Notes are subordinated to the repayment in full of theloans under the Credit Agreement.

 

As discussed above,subsequent to Amendment No. 2 and Amendment No. 3 to the Company’sCredit Agreement in 2008, the minimum EBITDA and minimum AUM covenants wereeliminated.  The Company was incompliance with these covenants as of and for all 2008 periods in which theywere in effect.

 

15

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 9—Debt (continued)**

 

Pursuant to the CreditAgreement and the Senior Subordinated Notes, the operating company would be indefault if it ever failed to pay required interest and amortization payments ina timely fashion.  Further, the CreditAgreement stipulates that the operating company would be in default thereunderif it defaults on its Senior Subordinated Notes.  Such events of default would permit thelender under the applicable debt agreement to accelerate the debtthereunder.  No such occurrence ofacceleration occurred during the three months ended March 31, 2009 and2008.

 

On January 23, 2009,the Company repaid $8.0 million of the principal amount outstanding underthe Credit Agreement.

 

**Note 10—Interest Rate Swap**

 

The Company manages itsexposure to changes in market rates of interest.  The Company’s use of derivative instrumentsis limited to an interest rate swap used to manage the interest rate exposurerelated to its Credit Agreement.  The Companymonitors its position and the credit rating of the counterparty and does notanticipate non-performance by such counterparty.

 

On February 28, 2008,the operating company entered into a $60.0 million notional amountinterest rate swap agreement that commenced on July 23, 2008.  The swap, which expires July 23, 2010,obligates the operating company to pay a 2.825% fixed rate of interest on thenotional amount and requires the counterparty to pay the operating company afloating interest rate based on the monthly LIBOR interest rate.  The spread on the Credit Agreement is inaddition to these amounts.  As discussedin Note 9, on September 19, 2008, the maturity of amounts outstandingunder the Company’s Credit Agreement was extended to July 23, 2011.  The Company has not entered into anyagreements to manage its exposure to fluctuations in interest rates from July 23,2010 through July 23, 2011.

 

During the quarter ended September 30,2008, the Company changed the designation of its swap agreement from a cashflow hedge to a trading derivative, as a significant portion of the cash flowsassociated with the original forecasted transaction were probable to not occurdue to the amortization payments required to be made pursuant to the terms ofits amended agreement.  Accordingly, theCompany reclassified the cumulative changes in fair value related to this swapfrom accumulated other comprehensive income to other expense.  The Company records all changes to the swap’sfair value as a component of other expense. For the three months ended March 31, 2009, the Company recognizedapproximately $0.1 million in other expense related to such changes.  For the three months ended March 31,2008, the Company recognized approximately $0.5 million in other accumulatedcomprehensive loss associated with the change in fair value of  this swap agreement.

 

Concurrently with thereductions in principal outstanding under the Credit Agreement in 2008, theCompany reduced the notional amount of its interest rate swap to$22.0 million.  The amounts paid tothe counterparty in exchange for these 2008 reductions were approximately$0.1 million.  During the threemonths ended March 31, 2009, the Company reduced the notional amount ofits interest rate swap to $14.0 million. The amounts paid to the counterparty in exchange for this reduction wasapproximately $0.2 million.

 

**Note 11—Income Taxes**

 

The operating company is alimited liability company that has elected to be treated as a partnership fortax purposes.  Neither it nor the Company’sother consolidated subsidiaries has made a provision for federal or stateincome taxes because it is the personal responsibility of each of theseentities’ members (including the Company) to separately report theirproportionate share of the respective entity’s taxable income or loss.  The operating company has made a provisionfor New York City UBT.  Subsequent to theoffering and reorganization on October 30, 2007, the Company, as a “C”corporation under the Internal Revenue Code, is liable for federal, state andlocal taxes on the income derived from its economic interest in its operatingcompany, which is net of UBT. Correspondingly, in its consolidated financial statements, the Companyreports both the operating company’s provision for UBT as well as its provisionfor federal, state and local corporate taxes.

 

16

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes (continued)**

 

For the three months ended March 31,2009 and 2008, the Company’s taxable income was determined as follows:

 
| ** **                           | ** ** | **For the Three Months** | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                           | ** ** | **Ended March 31,**           | ** ** |
| ** **                           | ** ** | **2009**                                | ** ** | **2008** | ** ** |
| ** **                           | ** ** | **(in thousands)**                 | ** ** |
|                                 |       |                                    |       |   |   |   |   |
| Income Before Taxes                  |       | $                                       | 2,448      |   | $ | 13,939 |   |
| Unincorporated Business Taxes        |       | (338                                    | )          | (940 | ) |
| Non-Controlling Interests            |       | (2,240                                  | )          | (11,577 | ) |
| Income Before Corporate Income Taxes |       | $                                       | (130       | ) | $ | 1,422 |   |

 

In September 2006, theFinancial Accounting Standards Board issued Interpretation No.48, *Accounting for Uncertainty in Income Taxes*(“FIN 48”).  FIN 48 establishesthe minimum threshold for recognizing, and a system for measuring, the benefitsof tax return positions in financial statements.  It is the Company’s policy to recognizeaccrued interest and penalties associated with uncertain tax positions as partof the tax provision.  For the threemonths ended March 31, 2009 and 2008, no such expenses wererecognized.  As of March 31, 2009and December 31, 2008, no accruals were recorded.

 

The Company and theoperating company are generally no longer subject to U. S federal, or state andlocal income tax examinations by tax authorities for any year prior to2005.  All tax years subsequent to thisdate are considered open and subject to examination by tax authorities.

 

The components of theprovision for income taxes are as follows (in thousands):

 
| ** **                                       | ** ** | **For the Three Months** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **Ended March 31,**           | ** ** |
| ** **                                       | ** ** | **2009**                                | ** ** | **2008** | ** ** |
|                                             |       |                                    |       |   |   |
| Current Provision:                               |       |                                    |       |   |   |
| Unincorporated Business Taxes                    |       | $                                       | 393        |   | $ | 995 |   |
| Local Corporate Tax                              |       | —                                  |       | — |   |
| State Corporate Tax                              |       | —                                  |       | — |   |
| Federal Corporate Tax                            |       | —                                  |       | — |   |
| Total Current Provision                          |       | $                                       | 393        |   | $ | 995 |   |
| Deferred Provision:                              |       |                                    |       |   |   |
| Unincorporated Business Taxes                    |       | $                                       | (55        | ) | $ | (55 | ) |
| Local Corporate Tax                              |       | 21                                      |       | 64 |   |
| State Corporate Tax                              |       | 41                                      |       | 115 |   |
| Federal Corporate Tax                            |       | 140                                     |       | 423 |   |
| Total Deferred Provision                         |       | $                                       | 147        |   | $ | 547 |   |
| Change in Deferred Tax Asset Valuation Allowance |       | (814                                    | )          | — |   |
| Total Provision for Income Taxes                 |       | $                                       | (274       | ) | $ | 1,542 |   |

 

Prior to October 30,2007, the operating company was a cash basis taxpayer.  As the result of the Company’s acquisition ofmembership units in conjunction with the offering, the operating company wasrequired to become an accrual basis taxpayer. Pursuant to Section 481 of the Internal Revenue Code, thecumulative difference between the two methods of taxpaying are amortizable overfour years.  These differences generatedapproximately $0.4 million and $0.4 million in deferred taxliabilities as of March 31, 2009 and December 31, 2008,respectively.  Such amounts are recordedin other liabilities in the consolidated statements of financial condition.

 

The acquisition of theoperating company membership units noted above has allowed the Company to makean election under Section 754 of the Internal Revenue Code (“Section 754”)to step up its tax basis in the net assets acquired.  

 

17

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes (continued)**

 

This step up is deductible for tax purposesover a 15-year period.  Based on the netproceeds of the offering and tax basis of the operating company as of October 30,2007, this election gave rise to a deferred tax asset of approximately$68.7 million.

 

Pursuant to a Tax ReceivableAgreement signed between the members of the operating company and the Company,85% of the cash savings generated by this election will be distributed to theselling shareholders upon this benefit’s realization.

 

In September 2008, theCompany evaluated the asset associated with this election after the decline inits AUM brought, for the first time, revenue projections below the point atwhich the Company would generate sufficient full-year taxable income to fullyutilize this deferred tax asset.  Other negativeevidence it reviewed included (i) the general uncertain economicenvironment, which has been reflected in declining stock markets and had acorresponding impact on AUM and revenue levels; (ii) the acceleratingnegative trends affecting the asset management industry in particular; and (iii) thedifficulty of projecting AUM in the current volatile environment.  These factors were moderated by (i) theCompany’s ability to control its compensation costs, which is its singlelargest expense; (ii) management’s experience in the asset managementindustry and minimal turnover of key personnel; and (iii) the ability ofthe Company to utilize tax losses generated by this asset over a longer timehorizon.  In conducting its analysis, theCompany believed that the inherent difficulty in projecting future income wasexacerbated by the economic environment. It correspondingly limited its projections to three years.  Over this time period, the Company projectedtaxable income assuming no AUM growth and modest reductions in its coststructure.

 

The Company determined that, after weighingboth the positive and negative evidence discussed above, a portion of benefitsassociated with this deferred tax asset were more likely than not to gounrealized due to estimates of future taxable income.  As a result, the Company established a$62.7 million valuation allowance to reduce the net deferred tax asset toan amount more likely than not to be realized on September 30, 2008.  This deferred tax asset remains available tothe Company and can be used to reduce taxable income in future years.  The Company similarly reduced the associatedliability to selling and converting shareholders to reflect this change in theestimated realization of the asset.  TheCompany recorded an approximate $53.3 million increase to other incomeassociated with this reduction in the liability to selling and convertingshareholders on September 30, 2008.

 

In October 2008, theselling unitholders agreed to waive any payments that the Company is or will berequired to make to them for the 2008 and 2009 tax years pursuant to the TaxReceivable Agreement.  During the quarterended December 31, 2008, the Company recognized approximately$2.9 million in other income associated with this waiver.

 

As discussed further in Note15 below, on March 3, 2009 certain of the operating company’s membersexchanged an aggregate of 2,445,973 of their Class B units for anequivalent number of shares of Company Class A common stock.   The Company elected to step up its tax basisin the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair value of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $2.5 million deferred tax asset and a corresponding $2.2million liability to selling and converting shareholders under the TaxReceivable Agreement.  Using themethodology described above, the Company assessed the realizability of thedeferred tax asset associated with this exchange and determined that a portionof its benefits would go unutilized. Consequently, the Company established a $2.4 million valuation allowanceto reduce the incremental deferred tax asset to an amount more likely than notto be realized.  This deferred tax assetremains available to the Company and can be used to reduce taxable income infuture years.  The Company similarlyreduced the associated liability to selling and converting shareholders toreflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging IssuesTask Force Issue No. 94-10, *Accounting by a Companyfor the Income Tax Effects of Transactions among or with Its Shareholders underFASB Statement No.109* (“EITF 94-10”), the Company recorded theeffects of these transactions in equity.

 

During the first quarter of2009, the Company reduced its valuation allowance by approximately $0.8 milliondue to revised estimates of future taxable income, primarily related to lowerexpense projections.   The Companycorrespondingly increased its liability to selling and converting shareholdersby $0.6 million to reflect this change in the estimated realization of theasset.  The effects of these changes tothe deferred tax asset and liability to selling and converting shareholderswere recorded as a component of the provision for income taxes and otherexpense, respectively, on the consolidated statements of operations.  As of March 31, 2009 and December 31,2008, the net value of all deferred tax assets was approximately$4.2 million and $3.4 million, respectively.  As of March 31, 2009 and December 31,2008, the liability to selling and converting shareholders was approximately$2.5 million and $1.8 million, respectively.

 

18

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes (continued)**

 

The change in the Company’snet deferred tax assets for the three months ended March 31, 2009 issummarized as follows (in thousands):

 
| ** **                        | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Valuation  Allowance** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|----------------------|------------|------------|------------|--------------------------|------------|------------|------------|
| ** **                        | ** ** | ** **           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** |
| Balance at December 31, 2008 |       | $                    | 65,368     |       | $          | 785                      |       | $          | (62,709    | ) | $ | 3,444 |   |
| Deferred Tax Expense              |       | (714                 | )          | 512        |       | —                   |       | (202       | )          |
| Unit Conversion                   |       | 2,532                |       | —     |       | (2,380                   | )          | 152        |       |
| Change in Valuation Allowance     |       | —               |       | —     |       | 814                      |       | 814        |       |
| Balance at March 31, 2009    |       | $                    | 67,186     |       | $          | 1,297                    |       | $          | (64,275    | ) | $ | 4,208 |   |

 

**Note 12—Investments in Marketable Securities**

 

Investments in marketablesecurities consisted of the following at March 31, 2009:

 

| ** ** | ** ** | **Cost**                | ** ** | **Unrealized  Gain/(Loss)** | ** ** | **Fair Value** | ** ** |
|------------|------------|-------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** ** | ** ** | **(in thousands)** | ** ** |
|       |       |                    |       |                        |       |                |       |   |   |   |
| Equities   |       | $                       | 20,978     |                        | $          | (9,609              | )          | $ | 11,369 |   |

 

Investments in marketablesecurities consisted of the following at December 31, 2008:

 

| ** ** | ** ** | **Cost**                | ** ** | **Unrealized  Gain/(Loss)** | ** ** | **Fair Value** | ** ** |
|------------|------------|-------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** ** | ** ** | **(in thousands)** | ** ** |
|       |       |                    |       |                        |       |                |       |   |   |   |
| Equities   |       | $                       | 24,097     |                        | $          | (10,052             | )          | $ | 14,045 |   |

 

**Note 13—Non-Controlling Interests**

 

The Company did notinitially record a non-controlling interest associated with the acquisition ofits operating company, as the post-offering net equity of the operating companywas less than zero.  Pursuant to theguidance of EITF 95-7, no operating company non-controlling interest wasrecorded until the deficit attributable to non-controlling interest,approximately $10.8 million as of the date of the initial public offering,was extinguished.  As of December 31,2008, this deficit was extinguished.

 

Non-controlling interests inthe operations of the Company’s operating company and consolidated subsidiariesare comprised of the following:

 
| ** **                                                   | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                                            | ** ** |
|                                                         |       |                                                               |       |   |   |   |   |
| Non-Controlling Interest of Pzena Investment Management, LLC |       | $                                                                  | 3,566      |   | $ | 13,477 |   |
| Non-Controlling Interest in Consolidated Subsidiaries        |       | (1,326                                                             | )          | (1,900 | ) |
| Non-Controlling Interests                                    |       | $                                                                  | 2,240      |   | $ | 11,577 |   |

 

19

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 13—Non-Controlling Interests (continued)**

 

Non-controlling interests inthe equity of the Company’s operating company and consolidated subsidiaries aresummarized as follows:

 
| ** **                                                   | ** ** | **As of**           | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                   | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**  | ** ** |
|                                                         |       |                     |       |   |   |   |   |
| Non-Controlling Interest of Pzena Investment Management, LLC |       | $                        | 4,453      |   | $ | 3,397 |   |
| Non-Controlling Interest in Consolidated Subsidiaries        |       | 7,095                    |       | 8,422 |   |
| Non-Controlling Interests                                    |       | $                        | 11,548     |   | $ | 11,819 |   |

 

**Note 14—Members’ Equity Interests of Operating Company**

 

For the three months ended March 31,2008, the operating company granted 446,000 options to purchase units pursuantto the Pzena Investment Management, LLC 2006 Equity Incentive Plan.  The Company granted no such options for thethree months ended March 31, 2009. The options had varying vesting schedules and were issued at strikeprices equal to the assessed fair market value per unit at the time of awardissuance.  The Company determined thatthe total grant-date fair value of the options awarded was $1.2 million,using the Black-Scholes option pricing model. The weighted-average grant date fair value of options issued for thethree months ended March 31, 2008 was $2.64.

 

On January 1, 2009 and 2008, theoperating company granted 30,000 and 13,000, respectively, restricted Class Bunits to certain members pursuant to the Pzena Investment Management, LLC2006 Equity Incentive Plan.  On January 1,2008, the operating company also issued 86,458 phantom Class B units aspart of its Bonus Plan.  In December,2008, participants in the Company’s deferred compensation program converted aportion of their holdings in investment accounts into an aggregate of 89,826phantom Class B units.  No suchphantom units were granted for the three months ended March 31, 2009.  All outstanding phantom units vest ratablyover a four-year period that commenced January 1, 2008.

 

Except as otherwise providedby law, the liability of a member of the operating company is limited to theamount of its capital account.  A membermay transfer or assign all, or any part of, its membership interest to anyother party (a “Transferee”).  ATransferee of such membership interest shall not become a member unless itsmembership in the operating company is unanimously approved by the thenexisting member(s) in writing.  AnyTransferee admitted as a member shall succeed to the capital account or portionthereof transferred or assigned, as if no such transfer or assignment hadoccurred.

 

**Note 15—Shareholders’ Equity**

 

The Company was incorporatedin the State of Delaware on May 8, 2007. On May 10, 2007, the Company issued 100 shares of its common stock,par value $0.01 per share (the “Old Common Stock”), for $100 to Richard S.Pzena, the sole director of the Company as of that date.  On October 5, 2007, the Company effecteda 100-for-6 reverse stock split of all shares of its Old Common Stock thenoutstanding.  All share amounts have beenadjusted to reflect this split.  As ofthe effectiveness of the amendment and restatement of the Company’s certificateof incorporation on October 30, 2007, each share of the Old Common Stockoutstanding immediately prior to effectiveness was reclassified as one share ofthe Company’s Class A common stock, par value $0.01 per share.

 

On October 30, 2007,the Company consummated an initial public offering of 6,100,000 shares of its Class Acommon stock, par value $0.01 per share, for net proceeds of approximately$98.9 million, after payment of underwriting discounts and estimatedoffering expenses.  These net proceedswere used to purchase 6,100,000 membership units of the operating company,representing 9.5% of its then outstanding membership units, from its twooutside investors and one former employee. Concurrently with the consummation of the Company’s initial publicoffering, the Operating Agreement of the operating company was amended andrestated such that, among other things, (i) the Company became the solemanaging member of the operating company, (ii) the 6,100,000 membershipunits of the operating company that the Company acquired were reclassified as Class Aunits of the operating company, (iii) an additional 11,118 Class Aunits were issued to the Company in respect of its issuance of 11,112 shares ofClass A common stock to certain directors of the Company on October 30,2007, and contribution of the $100 initial investment the Company received in exchangefor issuance of six shares of Class A common stock on May 10, 2007,and (iv) the holders of the remaining 90. 5% of the

 

20

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**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 15—Shareholders’Equity (continued)**

 

outstanding membership units of the operatingcompany were reclassified as Class B units of the operating company.  Class A and Class B units of theoperating company have the same economic rights per unit.  Accordingly, immediately following theconsummation of the offering and reorganization, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 9.5% and 90.5%, respectively, of theeconomic interests in the operations of the business.  As of March 31, 2009, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 13.4% and 86.6%, respectively, of theeconomic interests in the operations of the business.

 

For each membership unit of the operatingcompany that was reclassified as a Class B unit in the reorganization, theCompany issued the holder one share of its Class B common stock, par value$0.000001 per share, in exchange for the payment of this par value.  Each share of the Company’s Class Bcommon stock entitles its holder to five votes, until the first time that thenumber of shares of Class B common stock outstanding constitutes less than20% of the number of all shares of our common stock outstanding.  From this time and thereafter, each share ofthe Company’s Class B common stock entitles its holder to one vote.  When a Class B unit is exchanged for ashare of the Company’s Class A common stock or forfeited, a correspondingshare of the Company’s Class B common stock will automatically be redeemedand cancelled.  Conversely, to the extentthat the Company causes Pzena Investment Management, LLC to issueadditional Class B units to employees pursuant to its equity incentiveplan, these additional holders of Class B units would be entitled toreceive a corresponding number of shares of the Company’s Class B commonstock (including if the Class B units awarded are subject to vesting).

 

Simultaneously with theconsummation of the offering and reorganization, all holders of the Company’s Class Bcommon stock entered into a stockholders’ agreement, pursuant to which theyagreed to vote all shares of Class B common stock then held by them, andacquired in the future, together on all matters submitted to a vote of thecommon stockholders.

 

The outstanding shares ofthe Company’s Class A common stock represent 100% of the rights of theholders of all classes of the Company’s capital stock to receive distributions,except that holders of Class B common stock will have the right to receivethe class’s par value upon the Company’s liquidation, dissolution or windingup.

 

Pursuant to the amended andrestated Operating Agreement of the operating company, each vested Class Bunit is exchangeable for a share of the Company’s Class A common stock,subject to certain exchange timing and volume limitations.

 

The acquisition of theoperating company’s membership interests by the Company has been treated as areorganization of entities under common control pursuant to the guidance setforth in FTB 85-5.  Accordingly, thenet assets assumed by the Company through the offering have been reported atthe operating company’s historical cost basis. As a result of these transactions, as of and subsequent to October 30,2007, (i) the Company has consolidated the financial results of theoperating company with its own and reflected the membership interest in it thatit does not own as a non-controlling interest in its consolidated financialstatements, and (ii) the Company’s income will be generated by itseconomic interest in the operating company’s net income.

 

This acquisition ofmembership units in the operating company has allowed the Company to make an electionto step up its tax basis in the net assets acquired.  This step up is deductible for tax purposesover a 15-year period.  Pursuant to a taxreceivable agreement between the Company and the operating company, 85% of thebenefits of this election, less amounts waived, will be returned to the sellingunitholders of the operating company as they are realized.

 

On February 17, 2009,the Company’s form S-3 registration statement, filed in order to registerthe Company’s issuance to Class B unitholders the total number of sharesof Class A common stock issuable upon exchange of all Class B unitsoutstanding immediately after the consummation of the operating company’sreorganization, was declared effective.

 

On March 3, 2009certain of the operating company’s members exchanged an aggregate of 2,445,973of their Class B units for an equivalent number of shares of Company Class Acommon stock.  The incrementalacquisition of additional operating company membership interests was similarlytreated as a reorganization of entities under common control pursuant to theguidance set forth in FTB 85-5. Subsequent to the exchange, the holders of Class A common stock(through the Company) and the holders of Class B units of the operatingcompany held approximately 13.4% and 86.6%, respectively, of the economicinterest in the operations of the business.

 

21

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**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements (Continued)**

 

**Note 15—Shareholders’Equity (continued)**

 

The Company elected to stepup its tax basis in the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair value of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $2.5 million deferred tax asset and a corresponding$2.3 million liability to selling and converting shareholders under the TaxReceivable Agreement.  Consequently, theCompany established a $2.4 million valuation allowance to reduce theincremental deferred tax asset to an amount more likely than not to berealized.  This deferred tax assetremains available to the Company and can be used to reduce taxable income infuture years.  The Company similarlyreduced the associated liability to selling and converting shareholders toreflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging IssuesTask Force Issue No. 94-10, *Accounting by a Companyfor the Income Tax Effects of Transactions among or with Its Shareholders underFASB Statement No.109* (“EITF 94-10”), the Company recorded theeffects of these transactions in equity.

 

The incremental assets andliabilities assumed in the exchange were recorded on March 3, 2009 asfollows:

 
| ** **                                             | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
|                                                   |       |                    |       |   |
| Pzena Investment Management, LLC Members’ Capital |       | $                       | 33,788     |   |
| Pzena Investment Management, LLC Retained Deficit      |       | (33,679                 | )          |
| Realizable Deferred Tax Asset                          |       | 152                     |       |
| Net Tax Receivable Liability to Converting Unitholders |       | (129                    | )          |
| Total                                                  |       | $                       | 132        |   |
|                                                   |       |                    |       |
| Common Stock, at Par                                   |       | $                       | 25         |   |
| Additional Paid-in Capital                             |       | 107                     |       |
| Total                                                  |       | $                       | 132        |   |

 

**Note 16—SubsequentEvents**

 

On April 23, 2009, theCompany repaid $2.0 million of the principal amount outstanding under theCredit Agreement.

 

On April 30, 2009, theCompany’s assets under management were approximately $10.1 billion.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

**Overview**

 

We are an investmentmanagement firm that utilizes a classic value investment approach in each ofour investment strategies.  We currentlymanage assets in a variety of value-oriented investment strategies across awide range of market capitalizations in both U. S. and international capitalmarkets.  At March 31, 2009, ourassets under management, or AUM, were $8.6 billion.  We manage separate accounts on behalf ofinstitutions and high net worth individuals and act as sub-investment adviserfor a variety of SEC-registered mutual funds and offshore funds.

 

We function as the holdingcompany through which the business of our operating company, Pzena InvestmentManagement, LLC, is conducted. Following our initial public offering and reorganization on October 30,2007, we became the sole managing member of Pzena InvestmentManagement, LLC.  As such, we nowcontrol its business and affairs and, therefore, consolidate its financialresults with ours.  In light of ouremployees’ and other investors’ collective membership interest in our operatingcompany, we reflect their ownership as a non-controlling interest in ourconsolidated financial statements.  As aresult, subsequent to October 30, 2007, our income is generated by oureconomic interest in our operating company’s net income.  As of March 31, 2009, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 13.4% and 86.6%, respectively, of theeconomic interests in the operations of the business.

 

**Revenue**

 

We generate revenue frommanagement fees and incentive fees, which we collectively refer to as ouradvisory fees, by managing assets on behalf of separate accounts and acting asa sub-investment adviser for mutual funds and certain other investment funds.  Our advisory fee income is recognized overthe period in which investment management services are provided.  Pursuant to the preferred accounting methodunder Emerging Issues Task Force Issue D-96, *Accountingfor Management Fees Based on a Formula* (“EITF D-96”), income fromincentive fees is recorded at the conclusion of the contractual performanceperiod, when all contingencies are resolved.

 

Our advisory fees areprimarily driven by the level of our AUM. Our AUM increases or decreases with the net inflows or outflows of fundsinto our various investment strategies and with the investment performancethereof.  In order to increase our AUMand expand our business, we must develop and market investment strategies thatsuit the investment needs of our target clients and provide attractive returnsover the long term.  The value andcomposition of our AUM, and our ability to continue to attract clients, willdepend on a variety of factors including, among other things:

 
| · | our ability to educate our target clients about our classic value  investment strategies and provide them with exceptional client service; |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                       |
| · | the relative investment performance of our investment strategies, as  compared to competing products and market indices;                   |
|   |                                                                                                                                       |
| · | competitive conditions in the investment management and broader  financial services sectors;                                               |
|   |                                                                                                                                       |
| · | general economic conditions;                                                                                                               |
|   |                                                                                                                                       |
| · | investor sentiment and confidence; and                                                                                                     |
|   |                                                                                                                                       |
| · | our decision to close strategies when we deem it to be in the best  interests of our clients.                                              |

 

For our separately-managedaccounts, we are paid fees according to a schedule, which varies by investmentstrategy.  The substantial majority ofthese accounts pay us management fees pursuant to a schedule in which the ratewe earn on the AUM declines as the amount of AUM increases, subject to aminimum fee to manage each account. Certain of these clients pay us fees according to the performance oftheir accounts relative to certain agreed-upon benchmarks, which results in aslightly lower base fee, but allow us to earn higher fees if the relevantinvestment strategy outperforms the agreed-upon benchmark.

 

Pursuant to oursub-investment advisory agreements, we are generally paid a management feeaccording to a schedule, in which the rate we earn on the AUM declines as theamount of AUM increases.  Certain ofthese funds pay us fixed rate management fees. Due to the substantially larger account size of certain of theseaccounts, the average advisory fees we earn on them, as a percentage of AUM,are lower than the advisory fees we earn on our separately-managed accounts.

 

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The majority of advisoryfees we earn on separately-managed accounts are based on the value of AUM at aspecific date on a quarterly basis, either in arrears or advance.  Advisory fees on certain of ourseparately-managed accounts, and with respect to most of the mutual funds thatwe sub-advise, are calculated based on the average of the monthly or dailymarket value.  Advisory fees are alsoadjusted for any cash flows into or out of a portfolio, where the cash flowrepresents greater than 10% of the value of the portfolio.  While a specific group of accounts may usethe same fee rate, the method used to calculate the fee according to the feerate schedule may differ as described above.

 

Our advisory fees mayfluctuate based on a number of factors, including the following:

 

·                  changes in AUMdue to appreciation or depreciation of our investment portfolios, and thelevels of the contribution and withdrawal of assets by new and existingclients;

 

·                  distribution ofAUM among our investment strategies, which have different fee schedules;

 

·                  distribution ofAUM between separately-managed accounts and sub-advised funds, for which wegenerally earn lower overall advisory fees; and

 

·                  the level ofour performance with respect to accounts on which we are paid incentive fees.

 

**Expenses**

 

Our expenses consistprimarily of compensation and benefits expenses, as well as general andadministrative expenses.  These expensesmay fluctuate due to a number of factors, including the following:

 

·                  variations inthe level of total compensation expense due to, among other things, bonuses,awards of equity to our employees and members of our operating company, changesin our employee count and mix, and competitive factors; and

 

·                  expenses, suchas rent, professional service fees and data-related costs, incurred, asnecessary, to run our business.

 

**Compensation and Benefits Expense**

 

Our largest expense iscompensation and benefits, which includes the salaries, bonuses, equity-basedcompensation and related benefits and payroll costs attributable to our membersand employees.  Compensation and benefitspackages are benchmarked against relevant industry and geographic peer groupsin order to attract and retain qualified personnel.  Cash compensation has also declined due tolower revenue-based variable compensation costs and a decline inheadcount.  The table included in thesection below describes the components of our compensation expense for thethree months ended March 31, 2009 and 2008:

 
| ** **                              | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                            | ** ** |
|                                    |       |                                                               |       |   |   |   |   |
| Cash Compensation and Other Benefits    |       | $                                                                  | 5,789      |   | $ | 8,607 |   |
| Other Non-Cash Compensation             |       | 251                                                                |       | 344 |   |
| Total Compensation and Benefits Expense |       | $                                                                  | 6,040      |   | $ | 8,951 |   |

 

On January 1, 2007, weadopted the PIM LLC 2006 Equity Incentive Plan, pursuant to which we haveissued restricted units, and options to acquire units, in our operatingcompany, both of which vest ratably over a four-year period.  We used a fair-value method in recording thecompensation expense associated with the granting of these restricted units,and options to acquire units, to new and existing members under thePIM LLC 2006 Equity Incentive Plan. Under this method, compensation expense is measured at the grant datebased on the estimated fair value of the award and is recognized over the award’svesting period.  The fair value of theunits is to be determined by reference to the market price of our Class Acommon stock on the date of grant, since these units are exchangeable forshares of our Class A common stock on a one-for-one basis.  The fair value of the options to acquireunits will be determined by using an appropriate option pricing model on thegrant date.

 

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On January 1, 2007, weinstituted a deferred compensation plan, in which employees who earn in excessof $600,000 per year are required to defer a portion of their compensation inexcess of this amount.  These deferredamounts may be invested, at the employee’s discretion, in certain of ourinvestment strategies, restricted phantom units of our operating company, ormoney market funds.  Amounts deferred inany period reduce that period’s cash compensation expense and vest ratably overa four-year period beginning on January 1 of the next year.  Therefore, the amortization of a ratableportion of 2007 deferred amounts has been reflected in our expenses for thethree months ended March 31, 2009 and 2008.  At March 31, 2009 and December 31,2008, no such compensation was deferred. Should additional amounts be deferred in future periods, we would expectthe non-cash portion of our compensation expense to increase as the existingand subsequently deferred amounts are amortized through income.

 

As of March 31, 2009,we had approximately $1.9 million in unrecorded compensation expenserelated to phantom operating company units issued pursuant to our deferredcompensation plan and operating company unit and option grants issued under ourPIM LLC 2006 Equity Incentive Plan.  Weexpect that the amortization of these amounts will be approximately$0.7 million for each of the next three years, with a negligible amountamortized thereafter.

 

**General and Administrative Expenses**

 

General and administrativeexpenses include professional and outside services fees, office expenses, depreciationand the costs associated with operating and maintaining our research, tradingand portfolio accounting systems.  Ouroccupancy-related costs and professional services expenses, in particular,generally increase or decrease in relative proportion to the overall size andscale of our business operations.

 

As a result of our offeringon October 30, 2007, we have incurred and expect to incur, additionalexpenses associated with being a public company for, among other things,director and officer insurance, director fees, SEC reporting and compliance(including Sarbanes-Oxley compliance), transfer agent fees, professional feesand other similar expenses.  Theseadditional expenses have and will reduce our net income.

 

**Other Income/(Expense)**

 

Other income/(expense) isderived primarily from interest income generated on our excess cash balances,investment income or loss arising from our investments in various privateinvestment vehicles that we employ to incubate new strategies, interest expenseon our amended credit agreement and senior subordinated notes, andmark-to-market movements on our swap agreement. Other income/(expense) is also affected by changes in our estimates ofthe liability due to our selling and converting shareholders associated with paymentsowed to them under the tax receivable agreement which was implementedsubsequent to our reorganization and offering on October 30, 2007.  As discussed further below, this liabilityrepresents 85% of the amount of cash savings, if any, in U.S. federal, stateand local income tax that we realize as a result of the amortization of theincreases in tax basis generated from company’s acquisition of operatingcompany units from its selling shareholders. Amounts waived by our selling shareholders reduce this liability.  We expect the interest and investmentcomponents of other income, in the aggregate, to fluctuate based on marketconditions and the performance of our investment strategies.

 

**Non-Controlling Interests**

 

Our operating company hashistorically consolidated the results of operations of the private investmentpartnerships over which we exercise a controlling influence.  After our reorganization, we became the solemanaging member of our operating company and now control its business andaffairs and, therefore, consolidate its financial results with ours.  In light of our employees’ and outsideinvestors’ interest in our operating company, we have reflected theirmembership interests as a non-controlling interest in our consolidatedfinancial statements.  As a result,subsequent to October 30, 2007, our income is generated by our economicinterest in our operating company’s net income. As of March 31, 2009, the holders of Class A common stock(through the Company) and the holders of Class B units of the operatingcompany held approximately 13.4% and 86.6%, respectively, of the economicinterests in the operations of the business.

 

**Provision/(Benefit) for Income Tax**

 

While our operating companyhas historically not been subject to U.S. federal and certain state incometaxes, it has been subject to New York City Unincorporated Business Tax.  As a result of our reorganization, we are nowsubject to taxes applicable to C-corporations. As such, our effective tax rate has increased as a result of ourreorganization.  Valuation allowances areestablished, when necessary, to reduce deferred tax assets to the amountexpected to be realized.  As of March 31,2009 and December 31, 2008, the Company recorded a $64.3 million and a$62.7 million valuation allowance, respectively, against the deferred tax assetassociated with our acquisition of operating company units in conjunction withthe offering and unit conversion.

 

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**Operating Results**

 

***General***

 

Our earningsand cash flows are heavily dependent upon prevailing financial marketconditions.  Significant increases ordecreases in the various securities markets, particularly the equities markets,can have a material impact on our results of operations, financial condition,and cash flows.

 

Beginning inthe second half of 2007 and continuing through the quarter ended March 31,2009, performance of our investment strategies was negatively impacted bysignificant volatility in the equity markets. Performance prior to 2009 was influenced by our overweight investmentexposure to the financial services sector in particular.  As a result, our assets under managementdeclined by $11.8 billion, or 57.8% from $20.4 billion at March 31,2008 to $8.6 billion at March 31, 2009, due to negative performanceof $9.5 billion and net outflows of $2.3 billion.

 

During thethree months ended March 31, 2009, we experienced gross outflows of$1.2 billion, which were partially offset by gross inflows of$0.8 billion.  Our sub-advisedaccounts experienced gross outflows of $0.7 billion, which were offset by$0.3 billion in gross inflows.  The$0.4 billion in net outflows were mainly attributable to the weakerperformance of our sub-advised funds compared to that of their peers.  Our separately-managed accounts experienced$0.5 billion in gross outflows, offset entirely by $0.5 billion in grossinflows.

 

During thethree months ended March 31, 2008, we experienced gross outflows of$2.3 billion, which were offset by gross inflows of$1.3 billion.  Our sub-advisedaccounts experienced $1.3 billion in gross outflows of AUM, which wereoffset by $0.5 billion in gross inflows. As noted above, the $0.8 billion in net outflows were mainlyattributable to the weaker performance of our sub-advised funds compared tothat of their peers.  Ourseparately-managed accounts experienced $1.0 billion in gross outflows and$0.8 billion in gross inflows.

 

Our averageAUM fluctuates based on changes in the market value of accounts advised andsub-advised by us and on fund flows. Accordingly, our revenues during 2009 are expected to decline from thecomparable 2008 periods to the extent that the markets continue to beunfavorable to our value investment strategy. A decrease in revenue results in lower operating income and net income.

 

We expect thatwe will experience continued pressure on our operating margins in the future ifAUM continues to decline.  We expect ouroperating expenses to decline modestly in 2009 from the comparable 2008periods, as we identify and implement potential cost savings opportunities.

 

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***Assets Under Management and Flows***

 

The change inAUM in our separately-managed accounts and our sub-advised accounts for thethree months ended March 31, 2009 and 2008 is described below:

 
| ** **                            | ** ** | **Three Months Ended  March, 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------|------------|
| **Assets Under Management** | ** ** | **2009**                                          | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(in billions)**                            | ** ** |
|                                  |       |                                              |       |   |   |
| Separately-Managed Accounts           |       |                                              |       |   |   |
| Beginning of Period Assets            |       | $                                                 | 6.4        |   | $ | 14.0 |   |
| *Inflows*                             | * *   | *0.5*                                             | * *   | *0.8* | * * |
| *Outflows*                            | * *   | *(0.5*                                            | *)*        | *(1.0* | *)* |
| Net Flows                             |       | —                                            |       | (0.2 | ) |
| Performance                           |       | (1.1                                              | )          | (1.3 | ) |
| End of Period Assets                  |       | $                                                 | 5.3        |   | $ | 12.5 |   |
|                                  |       |                                              |       |   |   |
| Sub-Advised Accounts                  |       |                                              |       |   |   |
| Beginning of Period Assets            |       | $                                                 | 4.3        |   | $ | 9.6 |   |
| *Inflows*                             | * *   | *0.3*                                             | * *   | *0.5* | * * |
| *Outflows*                            | * *   | *(0.7*                                            | *)*        | *(1.3* | *)* |
| Net Flows                             |       | (0.4                                              | )          | (0.8 | ) |
| Performance                           |       | (0.6                                              | )          | (0.9 | ) |
| End of Period Assets                  |       | $                                                 | 3.3        |   | $ | 7.9 |   |
|                                  |       |                                              |       |   |   |
| Total                                 |       |                                              |       |   |   |
| Beginning of Period Assets            |       | $                                                 | 10.7       |   | $ | 23.6 |   |
| *Inflows*                             | * *   | *0.8*                                             | * *   | *1.3* | * * |
| *Outflows*                            | * *   | *(1.2*                                            | *)*        | *(2.3* | *)* |
| Net Flows                             |       | (0.4                                              | )          | (1.0 | ) |
| Performance                           |       | (1.7                                              | )          | (2.2 | ) |
| End of Period Assets                  |       | $                                                 | 8.6        |   | $ | 20.4 |   |

 

At March 31,2009, our $8.6 billion of AUM were invested in twelve value-orientedinvestment strategies which represent distinct capitalization segments of theU.S and international markets.  Thefollowing table describes the allocation of our AUM as of March 31, 2009among our seven largest investment strategies and the aggregate of our otherinvestment strategies:

 
| **Investment Strategy** | ** ** | **AUM at  March 31, 2009** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| ** **                   | ** ** | **(in billions)**                    | ** ** |
|                         |       |                                      |       |   |
| Large Cap Value              |       | $                                         | 4.4        |   |
| Value Service                |       | 1.4                                       |       |
| Global Value                 |       | 1.5                                       |       |
| Small Cap Value              |       | 0.4                                       |       |
| International Value          |       | 0.2                                       |       |
| Mid Cap Value                |       | 0.2                                       |       |
| Other Strategies(1)          |       | 0.5                                       |       |
| Total                        |       | $                                         | 8.6        |   |

 

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(1)                             Oursix other investment strategies are: All Cap Value, Financial OpportunitiesService, Diversified Value, European Value, Mega Cap Value, and InternationalDiversified Value.

 

*Three Months Ended March 31, 2009 versus March 31, 2008*

 

At March 31, 2009, theCompany managed $8.6 billion in total assets, a decrease of $11.8 billion,or 57.8%, from $20.4 billion at March 31, 2008.  The decrease year-over-year in AUM was dueprimarily to $9.5 billion in market depreciation, and, to a lesser extent,net outflows of $2.3 billion. Generally negative economic conditions and our 2008 overweightinvestment exposure to the financial services sector in particular contributedto the performance-related decline in our AUM. Our sub-advised accounts experienced net outflows of $0.4 billionfor the three months ended March 31, 2009. These net outflows were driven in part by our investment strategies’underperformance relative to their respective benchmarks and client assetre-balancing in response to the volatile economic environment.

 

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The Companymanaged $5.3 billion in separately-managed accounts and $3.3 billionin sub-advised accounts, for a total of $8.6 billion in assets at March 31,2009.  Assets in separately-managedaccounts decreased by $1.1 billion, or 17.2%, during the three monthsended March 31, 2009, due to $1.1 billion in marketdepreciation.  Assets in sub-advisedfunds decreased by $1.0 billion, or 23.3%, during the three months ended March 31,2009, as a result of $0.6 billion in market depreciation and$0.7 billion in gross outflows, offset by $0.3 billion in grossinflows.

 

The Companymanaged $12.5 billion in separately-managed accounts and $7.9 billionin sub-advised accounts, for a total of $20.4 billion in assets at March 31,2008.  Assets in separately-managedaccounts decreased by $1.5 billion, or 10.7%, during the three monthsended March 31, 2008, due to $1.3 billion in market depreciation and$1.0 billion in gross outflows, offset by $0.8 billion in grossinflows.  Assets in sub-advised fundsdecreased by $1.7 billion, or 17.7%, during the three months ended March 31,2008, as a result of $0.9 billion in market depreciation and$1.3 billion in gross outflows, offset by $0.5 billion in grossinflows.

 

At March 31,2009, separately-managed accounts represented 61.6% of our total AUM, ascompared to 61.3% at March 31, 2008. AUM in our International Value and Global Value strategies decreased bya total of $1.3 billion, or 43.3%, to $1.7 billion, at March 31,2009 from $3.0 billion at March 31, 2008.  At March 31, 2009, our InternationalValue and Global Value investment strategies accounted for 19.8% of our AUM, ascompared to 14.7% at March 31, 2008.

 

***Revenues***

 

Our revenuesfrom advisory fees earned on our separately-managed accounts and oursub-advised accounts for the three months ended March 31, 2009 and 2008 isdescribed below:

 
| ** **                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| **Revenue**                 | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in millions)**                           | ** ** |
|                        |       |                                             |       |   |   |   |   |
| Separately-Managed Accounts |       | $                                                | 10.0       |   | $ | 21.6 |   |
| Sub-Advised Accounts        |       | 3.7                                              |       | 8.4 |   |
| Total                       |       | $                                                | 13.7       |   | $ | 30.0 |   |

 

*Three Months Ended March 31, 2009 versusMarch 31, 2008*

 

Our totalrevenue decreased $16.3 million, or 54.3%, to $13.7 million for thethree months ended March 31, 2009, from $30.0 million for the threemonths ended March 31, 2008.  Thischange was driven primarily by a reduction in weighted-average AUM, whichdecreased $12.8 billion, or 58.2%, to $9.2 billion for the threemonths ended March 31, 2009 from $22.0 billion for the three monthsended March 31, 2008.

 

Our weightedaverage fees were 0.594% and 0.545% for the three months ended March 31,2009 and 2008, respectively.  Theincrease in weighted average fees was primarily due to a higher mix of assetsin our International Value and Global Value strategies, which generally carryhigher fees than our domestic strategies. Weighted-average assets in separately-managed accounts decreased$7.8 billion, or 58.2%, to $5.6 billion, for the three months ended March 31,2009 from $13.4 billion at March 31, 2008, and had weighted averagefees of 0.715% and 0.646% for the three months ended March 31, 2009 and2008, respectively.  Weighted-averageassets in sub-advised accounts decreased $5.0 billion, or 58.1%, to$3.6 billion for the three months ended March 31, 2009 from$8.6 billion for the three months ended March 31, 2008, and hadweighted average fees of 0.406% and 0.389% for the three months ended March 31,2008, respectively.  This increase inweighted average fees were generated by the timing of asset flows in oursub-advised accounts.

 

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***Expenses***

 

Our operatingexpenses are driven primarily by our compensation costs.  The table below describes the components ofour compensation expense for the three months ended March 31, 2009 and2008.

 
| ** **                              | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                                           | ** ** | **2008** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                            | ** ** |
|                                    |       |                                                               |       |   |   |   |   |
| Cash Compensation and Other Benefits    |       | $                                                                  | 5,789      |   | $ | 8,607 |   |
| Other Non-Cash Compensation             |       | 251                                                                |       | 344 |   |
| Total Compensation and Benefits Expense |       | $                                                                  | 6,040      |   | $ | 8,951 |   |

 

*Three Months Ended March 31, 2009 versusMarch 31, 2008*

 

Totaloperating expenses decreased by $3.5 million, or 29.2%, to $8.5 million for thethree months ended March 31, 2009, from $12.0 million for the three monthsended March 31, 2008.  This declinewas primarily the result of overall reductions in bonus-related and variablecompensation costs as well as decreases in professional services and datasystems expenses.

 

Compensationand benefits expense decreased by $3.0 million, or 33.3%, to$6.0 million for the three months ended March 31, 2009 from$9.0 million for the three months ended March 31, 2008.  This decline was primarily the result oflower cash compensation arising from reduced staffing levels and firmwidedecreases in bonus-related and AUM-based variable compensation expense.  Our employee count decreased from 78 at March 31,2008 to 67 at March 31, 2009.  Theyear-over-year decrease in headcount was primarily the result of staffreductions in back office operations undertaken in the fourth quarter of 2008,as well as natural attrition throughout the year.

 

General andadministrative expenses decreased by $0.5 million, or 20.0%, to$2.5 million for the three months ended March 31, 2009 from$3.0 million for the three months ended March 31, 2008.  This decrease was mainly attributable todecreases in professional services fees and data systems costs arising fromongoing efforts to contain costs.

 

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***Other Expense***

 

*Three Months Ended March 31, 2009 versusMarch 31, 2008*

 

Other expensewas $2.7 million for the three months ended March 31, 2009, and consistedprimarily of $1.8 million in charges related to the negative performance of theCompany’s investments in its own products and $0.6 million in other expenseassociated with an increase in the Company’s liability to its selling andconverting shareholders associated with changes in the realizability of itsrelated deferred tax asset.  Theremaining $0.3 million consisted of interest expense of $0.5 million, offsetpartially by dividends, interest income, and other income.  Other expense was $4.1 million for the threemonths ended March 31, 2008, and consisted of $3.6 million in chargesrelated to the negative performance of the Company’s investments in its ownproducts and $1.0 million in interest expense, partially offset by $0.5 millionin interest and dividend income.  The$1.4 million annual decline in first quarter 2009 other expense arose primarilyas a result of smaller losses incurred by the Company’s investments in its ownproducts and reduced interest expense, partially offset by the adjustments tothe Company’s liability to its selling and converting shareholders.

 

***Provision /(Benefit) for Income Taxes***

 

*Three Months Ended March 31, 2009 versusMarch 31, 2008*

 

The provisionfor income taxes was a benefit of $0.3 million for the three months ended March 31,2009, compared to an expense of $1.5 million for the three months ended March 31,2008.  The $1.8 million decline wasmainly attributable to a decline in taxable income and an approximately $0.8million benefit recorded in 2009 related to adjustments to the valuationallowance recorded in 2008 against the deferred tax asset associated with thetax receivable agreement.  A comparisonof the effective tax rate for the three months ended March 31, 2009 to theeffective tax rate for the three months ended March 31, 2008 is notmeaningful due to the valuation allowance adjustments recorded in 2009.

 

***Non-ControllingInterests***

 

*Three Months Ended March 31, 2009 versusMarch 31, 2008*

 

Non-controllinginterests were $2.2 million for the three months ended March 31, 2009and consisted of $3.5 million associated with our employees’ and outsideinvestors’ interest in the income of the operating company, offset by the$1.3 million effect of the absorption, by our consolidated subsidiaries,of their share of the losses of our consolidated investment partnerships.  For the three months ended March 31,2008, non-controlling interests were $11.6 million and consisted of $13.5million associated with our employees’ and outside investors’ interest in theincome of the operating company, offset by the $1.9 million effect of theabsorption, by our consolidated subsidiaries, of their share of the losses ofour consolidated investment partnerships. The change in non-controlling interests reflects primarily the declinein our weighted-average AUM, which had a corresponding negative impact onrevenues and income.

 

**Liquidity and Capital Resources**

 

Historically,the working capital needs of our business have primarily been met through cashgenerated by our operations. Distributions to members of our operating company and loan amortizationpayments have been our largest use of cash from financing activities.  Investing activities have historically been investmentsin our own investment strategies and, to a lesser extent, capital expenditures.

 

At March 31,2009, our cash and cash equivalents were $26.7 million, inclusive of$0.3 million in cash held by our consolidated investmentpartnerships.  Advisory fees receivablewere $10.3 million.  We also hadapproximately $3.7 million in marketable equity securities, net of$6.9 million in non-controlling interests, and exclusive of approximately$0.8 million in investments set aside to satisfy our obligations under ourdeferred compensation program.

 

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We expect to fund the liquidity needs of our business in the nexttwelve months, and over the long term, primarily through cash generated fromoperations.  As an investment managementfirm, our business has been materially affected by conditions in the globalfinancial markets and economic conditions throughout the world.  Our liquidity is highly dependent on therevenue and income from our operations, which is directly related to our levelsof AUM.  As of, and for, the three monthsended March 31, 2009, our AUM and revenues declined by 57.8% and 54.3%,respectively, compared to the three months ended March 31, 2008.  These reductions contributed to a 2.9%decline in our cash provided by operating activities during the comparableperiods.  To the extent that our AUMcontinues to decline, the cash provided by operating activities may benegatively impacted.

 

In determiningthe sufficiency of liquidity and capital resources to fund our business, weregularly monitor our liquidity position, including, among other things, cash,working capital, investments, long-term liabilities, lease commitments, debtobligations (including required amortization payments), and operating companydistributions.  Further, we considercompensation, one of our largest expenses, as sufficiently variable such thatit can be adjusted to mitigate the decline in revenue we have experienced, andmay continue to experience in the next twelve months.  We continuously evaluate our staffingrequirements and compensation levels with reference to our own liquidityposition and external peer benchmarking data. The result of this review directly influences management’srecommendations to our board of directors with respect to such staffing andcompensation levels.

 

We anticipatethat tax allocations to the members of our operating company, which consistedof 36 of our employees as of March 31, 2009, two outside investors, oneformer employee and us, will continue to be a material financing activity.  Under the terms and conditions of our amendedcredit agreement and senior subordinated notes, we have suspended our dividendpayment to shareholders.  Cashdistributions to operating company members for partnership tax allocations areexpected to decline if the taxable income of the operating company decreases.

 

As discussedfurther below, on October 28, 2008, our operating company entered into athird amendment to its credit agreement and issued $16.0 million in SeniorSubordinated Notes to entities established by Richard S. Pzena, theCompany’s CEO, for the benefit of certain of his family members, an entitycontrolled by a company director and a former employee.  The proceeds of the notes and$9.0 million of cash reserves were used to reduce the principal amountsoutstanding under the credit agreement. The amendment to the credit agreement, among other things, eliminatedall financial covenants and the excess cash flow sweep, and reducedavailability under the revolving credit facility from $3.0 million to$1.8 million.  It also requires usto make mandatory quarterly principal repayments of $2.0 million andprecludes us from paying dividends to shareholders.  As of March 31, 2009, we had$14.0 million and $16.0 million outstanding under the creditagreement and the Senior Subordinated Notes, respectively.  Although we are comfortable with our currentcapital structure, in the current economic environment, it is uncertain whetheradditional or alternative sources of debt or equity financing would beavailable on acceptable terms.  We havenever drawn on our current revolving credit facility for liquidity needs and donot anticipate needing to draw on such a facility in the future.

 

We do notanticipate meaningful outlays for internal investment or capital expendituresover the next nine months.

 

We believethat the amendment of our credit agreement, elimination of the dividend,reductions in headcount and ability to vary cash compensation levels haveprovided us with an appropriate degree of flexibility in providing for ourliquidity needs.

 

**Dividend Policy**

 

We are aholding company and have no material assets other than our ownership ofmembership interests in our operating company. As a result, we depend upon distributions from our operating company topay any dividends that our board of directors may declare to be paid to our Class Acommon stockhoders, if any.  When and ifour board of directors declares any such dividends, we then cause our operatingcompany to make distributions to us in an amount sufficient to cover the amountof the dividends declared.  We may notpay dividends to our Class A common stockholders in amounts that have beenpaid to them in the past, or at all, if, among other things, we do not have thecash necessary to pay our intended dividends or any of our financing facilitiesor other agreements restrict us from doing so. Pursuant to restrictions set forth in our amended credit agreement andthe Senior Subordinated Notes as of October 28, 2008, we have suspendedprevious quarterly cash dividend payments to our Class A commonstockholders.  In the future, our boardof directors may, in its discretion and subject to the Company’s operatingresults, debt agreements and applicable law, reinstate the dividend at anamount to be determined by it.  To theextent we do not have cash on hand sufficient to pay dividends in the future,we may decide not to pay dividends.  Bypaying cash dividends rather than investing that cash in our future growth, werisk slowing the pace of our growth, or not having a sufficient amount of cashto fund our operations or unanticipated capital expenditures, should the needarise.

 

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**Credit Agreement**

 

On July 23,2007, our operating company borrowed $60.0 million pursuant to athree-year term loan facility, the proceeds of which were used to finance aspecial one-time distribution to the members of our operating company as ofthat date.  Concurrently, our operatingcompany also obtained a $20.0 million revolving Credit facility to financeour short-term working capital needs.  Werefer to the term loan and revolving loan facilities as our Credit Agreement.  On February 11, 2008, our operatingcompany entered into the first amendment to the Credit Agreement.  The amendment changed a number of CreditAgreement provisions, including: (i) the minimum AUM financial covenantwas reduced from $20.0 billion to $15.0 billion; (ii) theminimum Earnings Before Interest, Taxes, Depreciation and Amortization, orEBITDA, financial covenant for each four quarter period was reduced from$60.0 million to $40.0 million; (iii) the capacity of therevolving credit facility was reduced from $20.0 million to$5.0 million; and (iv) the interest rate was increased from LIBORplus 1.0% to LIBOR plus 1.5%.  Inaddition, two mandatory prepayment provisions were added: (a) term loanamortization was required beginning in any period when AUM was less than$20 billion and ending when AUM was greater than $21.5 billion, and (b) a50% excess cash flow sweep was required if AUM was below $17.5 billion.During the three months ended June 30, 2008, our assets under managementfell below $20 billion.  Pursuant tothe provisions of the term loan, as amended, our operating company was requiredto make an amortization payment of $3.0 million on June 30, 2008.

 

On September 19,2008, our operating company entered into Amendment No. 2 to its CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$12.0 billion and to make minimum quarterly amortization payments of$2.0 million until maturity, which was extended to July 23, 2011.Additionally, the LIBOR interest rate option was increased to LIBOR plus 1.75%and the EBITDA financial covenant stipulated in Amendment No.1 waseliminated.  The excess cash flow sweepwas also increased to 75% of excess cash flow. On September 22, 2008, our operating company made a requiredamortization payment of $5.0 million as a condition precedent to theeffectiveness of this amendment.  On September 30,2008, our operating company made a quarterly amortization payment of$5.0 million.

 

On October 28,2008, our operating company entered into Amendment No. 3 to its Credit Agreement.  This amendment provided for the followingchanges to the Credit Agreement, among others:

 
| (i)    | the minimum assets under management  financial covenant was eliminated;                                                                                                               |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                  |
| (ii)   | the excess cash flow mandatory repayment  was eliminated;                                                                                                                             |
|   |                                                                                                                                                                                  |
| (iii)  | the commitments under the revolving credit  facility were reduced from $3.0 million to approximately  $1.8 million;                                                         |
|   |                                                                                                                                                                                  |
| (iv)   | with respect to loans borrowed at base  rate, the margin added to base rate was increased from 0.00% to 0.75%; with  respect to loans borrowed at LIBOR, the margin was not modified; |
|   |                                                                                                                                                                                  |
| (v)    | certain additional restrictions were placed  on the operating company’s ability to make Restricted Payments (as defined in  the Credit Agreement), including dividends; and      |
|   |                                                                                                                                                                                  |
| (vi)   | amendments to certain covenants in order to  permit the incurrence of subordinated debt by the operating company.                                                                     |

 

Conditionsprecedent to the execution of Amendment No.3 included, among others, (i) therepayment by the operating company of $25.0 million of the$47.0 million principal amount outstanding under the Credit Agreement asof October 28, 2008, and (ii) the grant by the operating company andone of its subsidiaries of a security interest in their accounts receivable.

 

In order tofund the $25.0 million repayment by our operating company, we used$9.0 million in cash reserves and the proceeds from the issuance on October 28,2008 of an aggregate of $16.0 million principal amount of SeniorSubordinated Notes (collectively, the “Notes”) to entities established byRichard Pzena, our Company’s Chief Executive Officer, for the benefit ofcertain of his family members, an entity controlled by a Company director, anda former employee of our operating company. Each of these Notes is unsecured, has a ten-year maturity and bearsinterest at 6.30% per annum.  Theprovisions of the Notes include a restricted payments covenant (includingdividend payments), a prohibition on incurring indebtedness which is notsubordinated to the Notes, and events of default based on failure to makepayments, bankruptcy, change of control and acceleration of materialindebtedness.  In addition, the Notes aresubordinated to the repayment in full of the loans under the Credit Agreement.

 

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On January 23,2008, the Company used cash generated from operations to repay $8.0 million ofthe principal amount outstanding under the Credit Agreement.

 

**Tax Receivable Agreement**

 

Our purchaseof membership units of our operating company concurrently with our initialpublic offering, and the future exchanges by holders of Class B units ofour operating company for shares of our Class A common stock (pursuant tothe exchange rights provided for in the Operating Company’s operatingagreement), has resulted in, and are expected to continue to result in,increases in our share of the tax basis of the tangible and intangible assetsof our operating company at the time of our acquisition and these futureexchanges, which will increase the tax depreciation and amortization deductionsthat otherwise would not have been available to us.  These increases in tax basis and taxdepreciation and amortization deductions have reduced and are expected tocontinue to reduce, the amount of tax that we would otherwise be required topay in the future.  We have entered intoa tax receivable agreement with the current members of our operating company,the one member of our operating company immediately prior to our initial publicoffering who sold all of its membership units to us in connection with ourinitial public offering, and any future holders of Class B units, thatrequires us to pay them 85% of the amount of cash savings, if any, in U.S.federal, state and local income tax that we actually realize (or are deemed torealize in the case of an early termination payment by us, or a change incontrol, as described in the tax receivable agreement) as a result of theincreases in tax basis described above and certain other tax benefits relatedto entering into the tax receivable agreement, including tax benefitsattributable to payments under the tax receivable agreement.

 

In October 2008,the selling unitholders agreed to waive any payments that we are or will berequired to make to them for the 2008 and 2009 tax years pursuant to the taxreceivable agreement.

 

**Cash Flows**

 

Operatingactivities provided $9.9 million and $10.2 million for the threemonths ended March 31, 2009 and 2008, respectively.  This decline in cash flows from operatingactivities was driven primarily by a decrease in average AUM from$22.0 billion for the three months ended March 31, 2008, to$9.2 billion for the three months ended March 31, 2009, which had acorresponding negative impact on total revenues.

 

Investingactivities consist primarily of investments in affiliates and other investmentpartnerships, as well as capital expenditures. Investing activities provided less than $0.1 million for the threemonths ended March 31, 2009 and used $0.1 million for the three monthsended March 31, 2008.

 

Financingactivities consist primarily of borrowing arrangements and contributions from,and distributions to, non-controlling interests.  Financing activities used $10.6 millionand $1.3 million for the three months ended March 31, 2009 and 2008,respectively.  The increase in cash usedin financing activities is due primarily to $8.0 million in repayments on ourterm debt and reductions in contributions from non-controlling interests anddistributions to members.

 

**Off-Balance Sheet Arrangements**

 

We did nothave any off-balance sheet arrangements as of March 31, 2009.

 

**Critical Accounting Policies and Estimates**

 

Thepreparation of our consolidated financial statements in accordance with U.S.generally accepted accounting principles requires management to make estimatesand judgments that affect our reported amounts of assets, liabilities, revenuesand expenses and related disclosure of contingent assets and liabilities.  We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder current circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily available from other sources.  Weevaluate our estimates on an ongoing basis. Actual results may differ from these estimates under differentassumptions or conditions.

 

Accountingpolicies are an integral part of our financial statements.  A thorough understanding of these accountingpolicies is essential when reviewing our reported results of operations and ourfinancial condition. Management believes that the critical accounting policiesdiscussed below involve additional management judgment due to the sensitivityof the methods and assumptions used.

 

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***Consolidation***

 

Our policy isto consolidate all majority-owned subsidiaries in which we have a controllingfinancial interest and variable-interest entities where we are deemed to be theprimary beneficiary.  We also consolidatenon-variable-interest entities which we control as the general partner ormanaging member. We assess our consolidation practices regularly, ascircumstances dictate.  All significantinter-company transactions and balances have been eliminated.

 

***Income Taxes***

 

We are a “C”corporation under the Internal Revenue Code, and thus liable for federal, stateand local taxes on the income derived from our economic interest in ouroperating company.  The operating companyis a limited liability company that has elected to be treated as a partnershipfor tax purposes.  Our operating companyhas not made a provision for federal or state income taxes because it is theresponsibility of each of the operating company’s members (including us) toseparately report their proportionate share of the operating company’s taxableincome or loss. Similarly, the income of our consolidated investmentpartnerships is not subject to income taxes, as such income is allocated toeach partnership’s individual partners. The operating company has made a provision for New York City UBT.

 

We recognizedeferred tax assets and liabilities for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases, net operatingloss carryforwards and tax credits.  Avaluation allowance is maintained for deferred tax assets that we estimate aremore likely than not to be unrealizable based on available evidence at the timethe estimate is made.  Determining thevaluation allowance requires significant management judgments andassumptions.  In determining thevaluation allowance, we use historical and forecasted future operating results,based upon approved business plans, including a review of the eligiblecarryforward periods, tax planning opportunities and other relevantconsiderations.  Each quarter, wereevaluate our estimate related to the valuation allowance, including ourassumptions about future profitability.

 

We believethat the accounting estimate related to the $64.3 million valuationallowance, assessed as of March 31, 2009 against the deferred tax assetassociated with our acquisitions of operating company membership units, is acritical accounting estimate because the underlying assumptions can change fromperiod to period.  For example, tax lawchanges or variances in future projected operating performance could result ina change in the valuation allowance.  Ifwe were not able to realize all or part of our net deferred tax assets in thefuture, an adjustment to our deferred tax assets valuation allowance would becharged to income tax expense in the period such determination was made.

 

Managementjudgment is required in determining our provision for income taxes, evaluatingour tax positions and establishing deferred tax assets and liabilities.  The calculation of our tax liabilitiesinvolves dealing with uncertainties in the application of complex taxregulations.  If our estimate of tax liabilitiesproves to be less than the ultimate assessment, a further charge to earningswould result.

 

**Recently Issued Accounting Pronouncements**

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 160, *Noncontrolling Interests in Consolidated FinancialStatements—an amendment of ARB No. 51* (“FAS 160”).  FAS 160 amends ARB No. 51 andestablishes accounting and reporting standards that require non-controllinginterests (previously referred to as minority interest) to be reported as acomponent of equity, changes in a parent’s ownership interest while the parentretains its controlling interest be accounted for as equity transactions, andupon a loss of control, retained ownership interest will be remeasured at fairvalue, with any gain or loss recognized in earnings.  FAS 160 was adopted by the Company on January 1,2009.  The adoption of FAS 160 onlyimpacted the Company’s presentation of its consolidated financial statements.

 

In March 2008,the FASB issued Statement of Financial Accounting Standards No. 161, *Disclosures about Derivative Instruments and HedgingActivities* (“FAS 161”). FAS 161 is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance, and cash flows. It is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008.  As FAS 161 only affects financialstatement disclosure, the impact of adoption on January 1, 2009 waslimited to additional financial statement disclosure.

 

In June 2008,the FASB issued EITF 03-6-1, *DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities* (“EITF 03-6-1”).  The EITF release states that unvestedshare-based payment awards that contain nonforfeitable rights to dividends ordividend equivalents (whether paid or unpaid) are participating securities andshall be included in the computation of earnings per share pursuant to thetwo-class method.  EITF 03-6-1 is 

 

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effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those years.  Theadoption of EITF 03-6-1 on January 1, 2009 did not have a materialimpact on our Company’s consolidated financial statements.

 

On January 1,2009, the Company adopted the remaining provisions of  Statement of Financial Accounting StandardsNo. 157, *Fair Value Measurements*(“FAS No. 157”), as permitted by the FASB Staff Position 157-2, *“Effective Date of FASB Statement No. 157”*(“FSP 157-2”), which delayed the effective date of SFAS No. 157 fornonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). These nonfinancial items include, forexample, reporting units required to be measured at fair value for annualgoodwill impairment testing purposes and nonfinancial assets acquired andliabilities assumed in a business combination. The Company did not have anyimpairments or business combinations during the first quarter of 2009,therefore the adoption of FAS 157 for nonfinancial assets did not impact theCompany’s consolidated financial statements.

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk.**

 

**Market Risk**

 

Our exposure to market risk is directly related to our role asinvestment adviser for the separate accounts we manage and the funds for whichwe act as a sub-investment adviser. Global markets have continued to experience unprecedented volatility,and a challenging business climate is forecast for the foreseeable future.  Market conditions have resulted in asignificant reduction in our assets under management, which directly impactsour revenues and net income.  A continuedeconomic downturn and volatility in the global financial markets could alsosignificantly affect the estimates, judgments, and assumptions used in thevaluation of our financial instruments.

 

All of our revenue for the three months ended months March 31,2009 and 2008 was derived from advisory fees, which are typically based on themarket value of AUM, which can be affected by adverse changes in interestrates, foreign currency exchange and equity prices.  Accordingly, a decline in the prices ofsecurities would cause our revenue and income to decline due to a decrease inthe value of the assets we manage.  In addition,such a decline could cause our clients to withdraw their funds in favor ofinvestments offering higher returns or lower risk, which would cause ourrevenue and income to decline further.

 

We are also subject to market risk due to a decline in the value of theholdings of our consolidated subsidiaries, which consist primarily ofmarketable securities.  At March 31,2009, the fair value of these assets was $11.4 million.  Assuming a 10% increase or decrease, the fairvalue would have increased or decreased by $1.1 million at March 31, 2009.

 

***Interest Rate Risk***

 

The amount that our operating company borrowed pursuant to the CreditAgreement, and any amounts our operating company borrows under the relatedrevolving credit facility, will accrue interest at variable rates.  The operating company entered into aninterest rate swap agreement that commenced on July 23, 2008.  The swap, which expires on July 23,2010, obligates us to pay a 2.825% fixed rate of interest on the notionalamount and requires the counterparty to pay us a floating interest rate basedon the monthly LIBOR interest rate.  Thespread on the Credit Agreement is in addition to these amounts.  Interest rate changes may, therefore, affectthe amount of our interest payments related to any potential differentialbetween the notional amount of the interest rate swap and amounts outstandingunder the Credit Agreement, as well as any amounts borrowed under the revolvingcredit facility.  Such changes wouldcorrespondingly affect our future earnings and cash flows.  In addition, we have not entered anyarrangement to hedge our exposure to interest rates from July 23, 2010 to July 23,2011.  For this one year period, interestrate changes would affect our future earnings and cash flows.  Based on the consolidated debt obligationsthat we have as of March 31, 2009, we believe that our hedge would beunaffected in the event that interest rates were to increase by one percentagepoint.

 

**Item4.   Controls and Procedures.**

 

During the course of their review of our consolidated financialstatements as of March 31, 2009, our management, including our ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofour disclosure controls and procedures pursuant to Rule 13a-15(b) underthe Exchange Act as of March 31, 2009. Based on that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that, as of March 31,2009, our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Exchange Act) were effective to ensure that information we are required todisclose in reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in SEC rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure.

 

There was no change in our internal control over financial reporting(as defined in Rule 13a-15(f) under the Exchange Act) that occurredduring the first quarter of 2009 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings.**

 

In the normalcourse of business, we may be subject to various legal and administrativeproceedings. On November 21, 2007 and January 16, 2008, substantivelyidentical putative class action lawsuits were commenced in the United StatesDistrict Court for the Southern District of New York against us and Richard S.Pzena, our chief executive officer, seeking remedies under Section 11 ofthe Securities Act of 1933, as amended (the “Securities Act”). The Courtconsolidated the lawsuits and appointed co-lead plaintiffs, who filed aconsolidated amended complaint. The consolidated amended complaint named asdefendants us, Richard S. Pzena, and two of the underwriters of our initialpublic offering, Goldman Sachs & Co., Inc. and UBSSecurities LLC. Plaintiffs sought to represent a class of all persons whopurchased or otherwise acquired Class A common stock issued pursuant ortraceable to our initial public offering. The consolidated amended complaintalleged that the registration statement and prospectus relating to the initialpublic offering of our Class A common stock contained materialmisstatements and omissions and wrongfully failed to disclose net redemptionsin the John Hancock Classic Value Fund, for which we act as sub-investmentadvisor. The consolidated amended complaint sought damages in an unspecifiedamount, including rescission or rescissory damages. The Court granteddefendants’ motion to dismiss the consolidated amended complaint and, on September 4,2008, the Court entered a judgment in favor of defendants. Plaintiffs haveappealed the Court’s judgment to the United States Court of Appeals for theSecond Circuit, and that appeal is pending. We believe that the allegations andclaims are without merit and we will continue to contest these claimsvigorously.

 

**Item 1A. Risk Factors.**

 

There are no material changes from the risk factors set forth in Part 1,Item 1A of the Company’s 2008 Form 10-K.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

None.

 

**Item 3. Defaults Upon Senior Securities.**

 

None.

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

 

None.

 

**Item 5. Other Information.**

 

None

 

**Item 6. Exhibits.**

 
| **Exhibit** | ** ** | **Description  of Exhibit**                                                                                                                                        |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 14.1        |       | Code of Business Conduct and Ethics  (effective as of October 25, 2007) (revised as of January 16, 2009)                                                 |
| 31.1        |       | Certification of Chief Executive Officer  pursuant to Exchange Act Rule 13a-14(a)/15(d)-14(a)                                                                 |
| 31.2        |       | Certification of Chief Financial Officer  pursuant to Exchange Act Rule 13a-14(a)/15(d)-14(a)                                                                 |
| 32.1        |       | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2        |       | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002      |

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

Dated: May 11, 2009

 
|   | PZENA INVESTMENT MANAGEMENT, INC. |
|--------|----------------------------------------|
|   |                                   |
|   | By:                                    | /s/ RICHARD S. PZENA |
|   |                                   |   |
|   |                                   | Name: Richard S. Pzena |
|   |                                   | Title: *Chief  Executive Officer* |
|   |                                   |   |
|   | By:                                    | /s/ GREGORY S. MARTIN |
|   |                                   |   |
|   |                                   | Name: Gregory S. Martin |
|   |                                   | Title: *Chief  Financial Officer* |

 

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