** **

**UNITEDSTATES**

**SECURITIES AND 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 June 30, 2010**

 

**Or**

** **
| **o** | **  Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|----------------------------------------------------------------------------------------------------------------|

** **

 

**For the transition periodfrom                to                **

 

**Commissionfile number 001-33761**

 

**PZENA INVESTMENT 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 West45th Street**

**New York, New York 10036**

(Address of PrincipalExecutive Offices) (Zip Code)

 

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

 

**Not Applicable**(Former name, former address, and former fiscal year if changed since lastreport)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateweb site, if any, every Interactive Date File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files). Yes o  No o

 

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

 

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

 

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

 

As of August 4, 2010, there were 9,367,659 outstanding shares ofthe registrant’s Class A common stock, par value $0.01 per share.

 

As of August 4, 2010, there were 54,960,918 outstanding shares ofthe registrant’s Class B common stock, par value $0.000001 per share.

 

 

 

----

 

**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 June 30, 2010 (unaudited)  and December 31, 2009                      | 1        |
|          | Consolidated Statements of Operations (unaudited)  of Pzena Investment Management, Inc. for the Three and Six Months  Ended June 30, 2010 and June 30, 2009 | 2        |
|          | Consolidated Statements of Cash Flows (unaudited)  of Pzena Investment Management, Inc. for the Three and Six Months  Ended June 30, 2010 and June 30, 2009 | 3        |
|          | Consolidated Statement of Changes in Equity  (unaudited) of Pzena Investment Management, Inc.  for the Six  Months Ended June 30, 2010                           | 4        |
|          | Notes to the Consolidated Financial Statements  (unaudited)                                                                                                                     | 5        |
| Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                     | 19       |
| Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                     | 31       |
| Item 4.  | Controls  and Procedures                                                                                                                                                        | 31       |
|          |                                                                                                                                                                            |     |
| ** **    | **PART II — OTHER INFORMATION**                                                                                                                                       |     |
| Item 1.  | Legal  Proceedings                                                                                                                                                              | 32       |
| Item 1A. | Risk  Factors                                                                                                                                                                   | 32       |
| Item 2.  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                    | 32       |
| Item 3.  | Defaults  Upon Senior Securities                                                                                                                                                | 32       |
| Item 4.  | (Removed  and Reserved)                                                                                                                                                         | 32       |
| Item 5.  | Other  Information                                                                                                                                                              | 32       |
| Item 6.  | Exhibits                                                                                                                                                                        | 32       |

 

i

----

 

**CAUTIONARYSTATEMENT REGARDING FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report on Form 10-Q contains forward-lookingstatements.  Forward-looking statementsprovide our current expectations, or forecasts, of future events.  Forward-looking statements include statementsabout our expectations, beliefs, plans, objectives, intentions, assumptions,and other statements that are not historical facts.  Words or phrases such as “anticipate,” “believe,”“continue,” “ongoing,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,”“predict,” “project,” or similar words or phrases, or the negatives of thosewords or phrases, may identify forward-looking statements, but the absence ofthese words does not necessarily mean that a statement is not forward-looking.

 

Forward-looking statements are subject to known and unknown risks anduncertainties and are based on potentially inaccurate assumptions that couldcause actual results to differ materially from those expected or implied by theforward-looking statements. Our actual results could differ materially fromthose anticipated in forward-looking statements for many reasons, including thefactors described in Item 1A, “Risk Factors” in Part I of our AnnualReport on Form 10-K for our fiscal year ended December 31, 2009.  Accordingly, you should not unduly rely onthese forward-looking statements, which speak only as of the date of thisQuarterly Report.  We undertake noobligation to publicly revise any forward-looking statements to reflectcircumstances or events after the date of this Quarterly Report, or to reflectthe occurrence of unanticipated events. You should, however, review the factors and risks we describe in thereports we will file from time to time with the Securities and ExchangeCommission, or SEC, after the date of this Quarterly Report on Form 10-Q.

 

Forward-looking statements include, but are not limited to, statementsabout:

 

·      ouranticipated future results of operations and operating cash flows;

 

·      ourbusiness strategies and investment policies;

 

·      ourfinancing plans and the availability of short- or long-term borrowing, orequity financing;

 

·      ourcompetitive position and the effects of competition on our business;

 

·      potentialgrowth opportunities available to us;

 

·      therecruitment and retention of our employees;

 

·      ourexpected levels of compensation for our employees;

 

·      ourpotential operating performance, achievements, efficiency, and cost reductionefforts;

 

·      ourexpected tax rate;

 

·      changesin interest rates;

 

·                  our expectation with respectto the economy, capital markets, the market for asset management services, andother industry trends; and

 

·      theimpact of future legislation and regulation, and changes in existinglegislation and regulation, on our business.

 

The reports that we file with the SEC, accessible on the SEC’s websiteat *www.sec.gov*, identifyadditional factors that can affect forward-looking statements.

 

ii

----

 

**PART I. FINANCIALINFORMATION**

 

**Item 1. FinancialStatements.**

** **

**PZENA INVESTMENT MANAGEMENT, INC.**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

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

 
| ** **                                                                                                                                                               | ** ** | **As of**         | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                               | ** ** | **2010**          | ** ** | **2009** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**   | ** ** | ** ** | ** ** |
|                                                                                                                                                                     |       |              |       |   |   |
| **ASSETS**                                                                                                                                                               |       |              |       |   |   |
| Cash  and Cash Equivalents                                                                                                                                               |       | $                 | 23,596     |   | $ | 15,908 |   |
| Restricted  Cash                                                                                                                                                         |       | 1,416             |       | 1,407 |   |
| Due  from Broker                                                                                                                                                         |       | 71                |       | 116 |   |
| Advisory  Fees Receivable                                                                                                                                                |       | 13,320            |       | 13,378 |   |
| Investments  in Equity Securities, at Fair Value                                                                                                                         |       | 4,080             |       | 7,951 |   |
| Receivable  from Related Parties                                                                                                                                         |       | 67                |       | 149 |   |
| Other  Receivables                                                                                                                                                       |       | 124               |       | 36 |   |
| Prepaid  Expenses and Other Assets                                                                                                                                       |       | 594               |       | 504 |   |
| Deferred  Tax Asset, Net of Valuation Allowance of $63,552 and $60,252, respectively                                                                                     |       | 5,933             |       | 6,754 |   |
| Property  and Equipment, Net of Accumulated Depreciation of $2,596 and $2,385,  respectively                                                                             |       | 2,110             |       | 2,315 |   |
| TOTAL  ASSETS                                                                                                                                                            |       | $                 | 51,311     |   | $ | 48,518 |   |
|                                                                                                                                                                     |       |              |       |   |   |
| **LIABILITIES AND EQUITY**                                                                                                                                               |       |              |       |   |   |
| Liabilities:                                                                                                                                                             |       |              |       |   |   |
| Accounts  Payable and Accrued Expenses                                                                                                                                   |       | $                 | 8,286      |   | $ | 3,644 |   |
| Due  to Broker                                                                                                                                                           |       | 95                |       | 731 |   |
| Senior  Subordinated Notes                                                                                                                                               |       | —            |       | 10,000 |   |
| Liability  to Selling and Converting Shareholders                                                                                                                        |       | 5,883             |       | 5,642 |   |
| Other  Liabilities                                                                                                                                                       |       | 1,112             |       | 1,143 |   |
| TOTAL  LIABILITIES                                                                                                                                                       |       | 15,376            |       | 21,160 |   |
|                                                                                                                                                                     |       |              |       |   |   |
| 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; 9,367,659 and  8,633,041 Shares Issued and Outstanding in 2010 and 2009, respectively)       |       | 93                |       | 86 |   |
| Class B  Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 54,931,418  and 55,659,236 Shares Issued and Outstanding in 2010 and 2009, respectively) |       | —            |       | — |   |
| Additional  Paid-In Capital                                                                                                                                              |       | 10,592            |       | 10,104 |   |
| Accumulated  Deficit                                                                                                                                                     |       | (744              | )          | (1,920 | ) |
| Total  Pzena Investment Mangement, Inc.’s Equity                                                                                                               |       | 9,941             |       | 8,270 |   |
| Non-Controlling  Interests                                                                                                                                               |       | 25,994            |       | 19,088 |   |
| TOTAL  EQUITY                                                                                                                                                            |       | 35,935            |       | 27,358 |   |
| TOTAL  LIABILITIES AND EQUITY                                                                                                                                            |       | $                 | 51,311     |   | $ | 48,518 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

1

----

 

**PZENAINVESTMENT MANAGEMENT, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                         | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|--------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                         | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                                                         | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                         | ** ** | ** **               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **REVENUE**                                                        |       | $                        | 19,388     |                    | $          | 14,232 |   | $ | 38,538 |   | $ | 27,904 |   |
|                                                               |       |                     |       |                    |       |   |   |   |   |
| **EXPENSES**                                                       |       |                     |       |                    |       |   |   |   |   |
| Compensation  and Benefits Expense                                 |       | 7,263                    |       | 5,983                   |       | 14,651 |   | 12,023 |   |
| General  and Administrative Expenses                               |       | 2,169                    |       | 1,973                   |       | 4,090 |   | 4,426 |   |
| TOTAL  OPERATING EXPENSES                                          |       | 9,432                    |       | 7,956                   |       | 18,741 |   | 16,449 |   |
| Operating  Income                                                  |       | 9,956                    |       | 6,276                   |       | 19,797 |   | 11,455 |   |
|                                                               |       |                     |       |                    |       |   |   |   |   |
| **OTHER INCOME/(EXPENSE)**                                         |       |                     |       |                    |       |   |   |   |   |
| Interest  and Dividend Income                                      |       | 112                      |       | 127                     |       | 185 |   | 247 |   |
| Interest  Expense                                                  |       | (77                      | )          | (405                    | )          | (232 | ) | (855 | ) |
| Realized  and Unrealized Gain/(Loss) on Equity Securities, Net     |       | (871                     | )          | 3,729                   |       | (407 | ) | 1,909 |   |
| Other  Income/(Expense)                                            |       | 1,208                    |       | (515                    | )          | 161 |   | (1,096 | ) |
| Total  Other Income/(Expense)                                      |       | 372                      |       | 2,936                   |       | (293 | ) | 205 |   |
| Income  Before Income Taxes                                        |       | 10,328                   |       | 9,212                   |       | 19,504 |   | 11,660 |   |
| Income  Tax Provision/(Benefit)                                    |       | 2,547                    |       | (64                     | )          | 2,448 |   | (338 | ) |
| Consolidated  Net Income                                           |       | 7,781                    |       | 9,276                   |       | 17,056 |   | 11,998 |   |
| Less:  Net Income Attributable to Non-Controlling Interests        |       | 7,308                    |       | 8,455                   |       | 15,599 |   | 10,695 |   |
| Net  Income Attributable to Pzena Investment Management, Inc. |       | $                        | 473        |                    | $          | 821 |   | $ | 1,457 |   | $ | 1,303 |   |
|                                                               |       |                     |       |                    |       |   |   |   |   |
| Net  Income for Basic Earnings per Share                           |       | $                        | 473        |                    | $          | 821 |   | $ | 1,457 |   | $ | 1,303 |   |
| Basic  Earnings per Share                                          |       | $                        | 0.05       |                    | $          | 0.10 |   | $ | 0.16 |   | $ | 0.17 |   |
| Basic  Weighted Average Shares Outstanding                         |       | 9,367,659                |       | 8,633,041               |       | 9,002,379 |   | 7,795,194 |   |
|                                                               |       |                     |       |                    |       |   |   |   |   |
| Net  Income for Diluted Earnings per Share                         |       | $                        | 473        |                    | $          | 4,330 |   | $ | 10,464 |   | $ | 6,860 |   |
| Diluted  Earnings per Share                                        |       | $                        | 0.05       |                    | $          | 0.07 |   | $ | 0.16 |   | $ | 0.11 |   |
| Diluted  Weighted Average Shares Outstanding                       |       | 9,367,659                |       | 64,778,860              |       | 65,012,960 |   | 64,566,604 |   |
|                                                               |       |                     |       |                    |       |   |   |   |   |
| Cash  Dividends per Share                                          |       | $                        | 0.03       |                    | $          | — |   | $ | 0.03 |   | $ | — |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

----

** **

**PZENA INVESTMENTMANAGEMENT, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                               | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                               | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                                                               | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                               | ** ** | ** **               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **OPERATING ACTIVITIES**                                                 |       |                     |       |                    |       |   |   |   |   |
| Consolidated  Net Income                                                 |       | $                        | 7,781      |                    | $          | 9,276 |   | $ | 17,056 |   | $ | 11,998 |   |
| Adjustments  to Reconcile Net Income:                                    |       |                     |       |                    |       |   |   |   |   |
| Depreciation                                                             |       | 104                      |       | 120                     |       | 211 |   | 241 |   |
| Non-Cash  Compensation                                                   |       | 822                      |       | 310                     |       | 1,664 |   | 561 |   |
| Director  Share Grant                                                    |       | 14                       |       | —                  |       | 27 |   | 280 |   |
| Realized  and Unrealized (Gain)/Loss on Equity Securities, Net           |       | 871                      |       | (3,729                  | )          | 407 |   | (1,909 | ) |
| Increase/(Decrease)  in Liability to Selling and Converting Shareholders |       | (1,118                   | )          | 602                     |       | (92 | ) | 1,204 |   |
| Deferred  Income Taxes                                                   |       | 1,869                    |       | (526                    | )          | 1,098 |   | (1,193 | ) |
|                                                                     |       |                     |       |                    |       |   |   |   |   |
| Changes  in Operating Assets and Liabilities:                            |       |                     |       |                    |       |   |   |   |   |
| Advisory  Fees Receivable                                                |       | 134                      |       | (296                    | )          | 58 |   | 2,994 |   |
| Due  from Broker                                                         |       | (55                      | )          | 2                       |       | 45 |   | 6 |   |
| Restricted  Cash                                                         |       | (5                       | )          | —                  |       | (9 | ) | — |   |
| Prepaid  Expenses and Other Assets                                       |       | (3                       | )          | 153                     |       | (136 | ) | 6 |   |
| Due  to Broker                                                           |       | 88                       |       | (10                     | )          | (636 | ) | (16 | ) |
| Due  to Principles                                                       |       | —                   |       | 57                      |       | — |   | 653 |   |
| Accounts  Payable, Accrued Expenses, and Other Liabilities               |       | 3,070                    |       | 2,194                   |       | 4,363 |   | 2,325 |   |
| Purchases  of Equity Securities                                          |       | (2,358                   | )          | (2,285                  | )          | (3,511 | ) | (4,857 | ) |
| Proceeds  from Sale of Equity Securities                                 |       | 3,284                    |       | 2,184                   |       | 4,151 |   | 5,615 |   |
| **Net Cash Provided by Operating Activities**                            | ** ** | **14,498**               | ** ** | **8,052**               | ** ** | **24,696** | ** ** | **17,908** | ** ** |
|                                                                     |       |                     |       |                    |       |   |   |   |   |
| **INVESTING ACTIVITIES**                                                 |       |                     |       |                    |       |   |   |   |   |
| Receivable  from Related Parties                                         |       | —                   |       | 47                      |       | 40 |   | 49 |   |
| Proceeds  from Sale of Investments                                       |       | 2,824                    |       | —                  |       | 2,824 |   | — |   |
| Disposals  of Property and Equipment                                     |       | (3                       | )          | —                  |       | (3 | ) | — |   |
| Purchases  of Property and Equipment                                     |       | 3                        |       | (6                      | )          | (4 | ) | (6 | ) |
| **Net Cash Provided by Investing Activities**                            | ** ** | **2,824**                | ** ** | **41**                  | ** ** | **2,857** | ** ** | **43** | ** ** |
|                                                                     |       |                     |       |                    |       |   |   |   |   |
| **FINANCING ACTIVITIES**                                                 |       |                     |       |                    |       |   |   |   |   |
| Distributions  to Non-Controlling Interests                              |       | (9,927                   | )          | (4,906                  | )          | (13,903 | ) | (7,480 | ) |
| Contributions  from Non-Controlling Interests                            |       | 4,321                    |       | —                  |       | 4,321 |   | — |   |
| Retirement  of B Units                                                   |       | —                   |       | —                  |       | (2 | ) | — |   |
| Term  Loan and Senior Subordinated Notes Repayment                       |       | (7,500                   | )          | (4,000                  | )          | (10,000 | ) | (12,000 | ) |
| Dividends                                                                |       | (281                     | )          | —                  |       | (281 | ) | — |   |
| **Net Cash Used in Financing Activities**                                | ** ** | **(13,387**              | **)**      | **(8,906**              | **)**      | **(19,865** | **)** | **(19,480** | **)** |
| ** **                                                               | ** ** | ** **               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **NET CHANGE IN CASH**                                                   | ** ** | **$**                    | **3,935**  | ** **              | **$**      | **(813** | **)** | **$** | **7,688** | ** ** | **$** | **(1,529** | **)** |
|                                                                     |       |                     |       |                    |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS - Beginning of Period**                      |       | $                        | 19,661     |                    | $          | 26,705 |   | $ | 15,908 |   | $ | 27,421 |   |
| Net  Change in Cash                                                      |       | 3,935                    |       | (813                    | )          | 7,688 |   | (1,529 | ) |
| **CASH AND CASH EQUIVALENTS - End of Period**                            |       | $                        | 23,596     |                    | $          | 25,892 |   | $ | 23,596 |   | $ | 25,892 |   |
|                                                                     |       |                     |       |                    |       |   |   |   |   |
| Supplementary  Cash Flow Information:                                    |       |                     |       |                    |       |   |   |   |   |
| Interest  Paid                                                           |       | $                        | 77         |                    | $          | 392 |   | $ | 232 |   | $ | 859 |   |
| Income  Taxes Paid                                                       |       | $                        | 1,131      |                    | $          | 753 |   | $ | 1,954 |   | $ | 1,372 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

----

** **

**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF CHANGES IN EQUITY**

**(in thousands, except share amounts)**

 
| ** **                                          | ** ** | **Shares of**    | ** ** | **Shares of**    | ** ** | ** **            | ** ** | ** **               | ** ** | ** **      | ** ** | ** **          | ** ** | ** **  | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|--------------------------|------------|-----------------|------------|---------------------|------------|-------------|------------|
| ** **                                          | ** ** | **Class A**      | ** ** | **Class B**      | ** ** | **Class A**      | ** ** | **Additional**           | ** ** | **Accumulated** | ** ** | **Non-Controlling** | ** ** | ** **  | ** ** |
| ** **                                          | ** ** | **Common Stock** | ** ** | **Common Stock** | ** ** | **Common Stock** | ** ** | **Paid-In Capital** | ** ** | **Deficit**     | ** ** | **Interests**       | ** ** | **Total**   | ** ** |
|                                                |       |                  |       |                  |       |                  |       |                     |       |            |       |                |       |        |       |
| **Balance at December 31, 2009**               | ** ** | **8,633,041**         | ** ** | **55,659,236**        | ** ** | **$**                 | **86**     | ** **               | **$**      | **10,104**      | ** ** | **$**               | **(1,920** | **)**       | **$**      | **19,088** | ** ** | **$** | **27,358** | ** ** |
| Unit  Conversion                                    |       | 734,618               |       | (734,618              | )          | 7                     |       | 368                      |       | —          |       | (318                | )          | **57**      | ** ** |
| Retirement  of Class B Units                   |       | —                |       | (700                  | )          | —                |       | —                   |       | —          |       | (2                  | )          | **(2**      | **)**      |
| Directors’  Shares                             |       | —                |       | —                |       | —                |       | 2                        |       | —          |       | 25                  | ** ** | **27**      | ** ** |
| Amortization  of Non-Cash Compensation              |       | —                |       | 7,500                 |       | —                |       | 181                      |       | —          |       | 1,121               | ** ** | **1,302**   | ** ** |
| Net  Income                                         |       | —                |       | —                |       | —                |       | —                   |       | 1,457           |       | 15,599              | ** ** | **17,056**  | ** ** |
| Contributions  from Non-Controlling Interests       |       | —                |       | —                |       | —                |       | —                   |       | —          |       | 4,321               | ** ** | **4,321**   | ** ** |
| Distributions  to Non-Controlling Interests         |       | —                |       | —                |       | —                |       | (63                      | )          | —          |       | (13,840             | )          | **(13,903** | **)**      |
| Class A  Cash Dividends Paid ($0.03 per share) |       | —                |       | —                |       | —                |       | —                   |       | (281            | )          | —              | ** ** | **(281**    | **)**      |
| **Balance at June 30, 2010**                   | ** ** | **9,367,659**         | ** ** | **54,931,418**        | ** ** | **$**                 | **93**     | ** **               | **$**      | **10,592**      | ** ** | **$**               | **(744**   | **)**       | **$**      | **25,994** | ** ** | **$** | **35,935** | ** ** |

 

See accompanying notes toconsolidated financial statements.

 

4

----

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements**

 

**Note 1—Organization**

 

Pzena Investment Management, Inc. (the “Company”)functions as the holding company through which the business of its operatingcompany, Pzena Investment Management, LLC, is conducted.  The Company was incorporated in the State ofDelaware on May 8, 2007.  OnOctober 30, 2007, the Company consummated an initial public offering.  Concurrently with the consummation of theCompany’s initial public offering, 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.  As a result of these transactions, as of andsubsequent to October 30, 2007, (i) the Company has consolidated thefinancial results of Pzena Investment Management, LLC with its own andreflected the membership interest in it that it does not own as anon-controlling interest in its consolidated financial statements, and(ii) the Company recognizes income generated from its economic interest inPzena Investment Management, LLC’s net income.

 

PzenaInvestment Management, LLC is an investment adviser which is registeredunder the Investment Advisers Act of 1940 and is headquartered in New York, NewYork.  As of June 30, 2010, theCompany managed assets in a variety of value-oriented investment strategiesacross a wide range of market capitalizations in both U.S. and non-U.S. capitalmarkets.

 

TheCompany, through its investment in its operating company, has consolidated theresults of operations and financial condition of the following privateinvestment partnerships as of June 30, 2010:

 
| ** **                                     | ** ** | ** **                                       | ** ** | **Company’s**     | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | ** **                                       | ** ** | **Ownership at**       | ** ** |
| **Entity**                                     | ** ** | **Type of Entity (Date of Formation)**           | ** ** | **June 30, 2010** | ** ** |
| Pzena  Large Cap Value Fund                    |       | Massachusetts Trust  (11/01/2002)                |       | 0.0                    | %          |
| Pzena  Emerging Market Countries Value Service |       | Delaware Limited Liability  Company (12/28/2007) |       | 0.0                    | %          |
| Pzena  Emerging Markets Focused Value Service  |       | Delaware Limited Liability  Company (12/28/2007) |       | 0.0                    | %          |

 

**Note 2—Significant Accounting Policies**

 

***Basis of Presentation:***

 

Theconsolidated financial statements are prepared in conformity with U.S.generally accepted accounting principles (“GAAP”) and related Securities andExchange Commission (“SEC”) rules and regulations.  The Company’s policy is to consolidate allmajority-owned subsidiaries in which it has a controlling financial interestand variable-interest entities (“VIEs”) where the Company is deemed to be theprimary beneficiary (“consolidated subsidiaries”).  As required by the *Consolidation Topic* of the Financial Accounting StandardsBoard Accounting Standards Codification (“FASB ASC”), the Company alsoconsolidates non-variable-interest entities in which it acts as the generalpartner or managing member.  All of theseentities represent private investment partnerships over which the Companyexercises or exercised control. Non-controlling interests recorded on the consolidated financialstatements of the Company include the non-controlling interests of the outsideinvestors in each of these entities, as well as those of the operatingcompany.  All significant inter-companytransactions and balances have been eliminated.

 

ThePzena Global Value Service and the Pzena Europe, Australasia, and Far East (“EAFE”)Value Service (formerly known as the International Value Service) are limitedliability companies whose managing members are or were members of the executivecommittee of the operating company, or the operating company itself.  Until December 31, 2009, neither ofthese entities were considered VIEs, as the members of the executive committeeof the operating company and/or the operating company were the majority holdersof the equity investments and had controlling financial interests in thepartnerships.  Each of these limitedliability companies were considered entities “similar” to limited partnerships,and are subject to the guidance of the *ConsolidationTopic* of the FASB ASC.  Undereach of their respective operating agreements, none of these entities’non-managing members had the ability to remove the managing member under anycircumstance, nor did they have any participating rights.  As a result, nothing substantive existed toovercome the presumption of control by the managing member, as required by the *Consolidation Topic* of the FASB ASC.  Since the managing members of these entitieswere either the operating company, or one of the controlling persons of theoperating company, their results of operations and financial position had beenconsolidated through December 30, 2009.

 

Effective December 31, 2009, substantially all of the Company’sinvestments in the Pzena Global Value Service and the Pzena EAFE Value Service,held to satisfy the Company’s obligations under its deferred compensationprogram, were reallocated to the Pzena Large Cap Value Fund.  Also effective December 31, 2009, theinvestments of the operating company’s executive committee members in the PzenaGlobal Value Service and the Pzena EAFE Value Service were transferred to aseparately-managed account.  Since theremaining holders of the equity investments in the partnerships subsequent tothese transactions lacked a controlling financial interest in thesepartnerships, as of December 31, 2009, these entities were deemedVIEs.  The Company is not considered theprimary beneficiary of these entities. Correspondingly, the Pzena Global Value Service and the Pzena EAFE ValueService were deconsolidated effective December 31, 2009.  The results of operations and financialposition of each of these entities were consolidated through December 30,2009.  The Pzena Global Value Service andthe Pzena EAFE Value Service, and other VIEs that are not consolidated,continue receiving investment management services from the Company, and arevehicles through which 

 

5

----

 

**Pzena InvestmentManagement, Inc.**

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

 

the Company offers its Global Value and/or its EAFE Valuestrategies.  The total net assets ofthese VIEs was approximately $466.9 million and $522.1 million at June 30,2010 and December 31, 2009, respectively. The Company is not exposed to losses as a result of its involvement withthese entities, since it has no direct investment in them.

 

Duringthe three months ended June 30, 2010, the Company redeemed its investmentsin the Pzena Large Cap Value Fund, the Pzena Emerging Market Countries ValueService, and the Pzena Emerging Markets Focused Value Service.  Since thecontrolling financial interest in these partnerships is held by the operatingcompany, and not by the holders of the equity investments in the partnerships,these entities are deemed VIEs.  Sincecertain members of the operating company’s executive committee are majority holdersof the equity investments in the partnerships, the Company is considered theprimary beneficiary of these entities. As such, the results of operations and financial position of theseentities continue to be consolidated by the Company in accordance with the *Consolidation Topic* of the FASB ASC.  The Company’s investments previously held inthe Pzena Large Cap Value Fund to satisfy the Company’s obligations under itsdeferred compensation program have been transferred to a third-party fund andare included in cash and cash equivalents at June 30, 2010.

 

Allof the consolidated investment partnerships are, or were, investment companiesunder the American Institute of Certified Public Accountants Audit andAccounting Guide for Investment Companies. The Company has retained the specialized accounting for thesepartnerships pursuant to the *ConsolidationTopic* of the FASB ASC.  Thus,the Company reports the investment partnerships’ investments in equitysecurities at fair value, with net realized and unrealized gains and lossesreported in earnings in the consolidated statements of operations.

 

TheCompany records in its own equity its pro-rata share of transactions thatimpact the operating company’s net equity, including equity and optionissuances and adjustments to accumulated other comprehensive income.  The operating company’s pro-rata share ofsuch transactions are recorded as adjustments to additional paid-in capital ornon-controlling interests, as applicable, on the consolidated statements offinancial position.

 

***Management’s Use of Estimates:***

 

Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities, disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expenses forthe period.  Actual results could differfrom those estimates.

 

***Fair Values of Financial Instruments:***

 

Thecarrying amounts of all financial instruments in the consolidated statements offinancial condition, including investments in equity securities, approximatetheir fair value.  

 

***Revenue Recognition:***

 

Revenue,comprised of advisory fee income, is recognized over the period in whichadvisory services are provided.  Advisoryfee income includes management fees that are calculated based on percentages ofassets under management (“AUM”), generally billed quarterly, either in arrearsor 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 AUM.  Incentive fee arrangementsgenerally entitle the Company to participate, on a fixed-percentage basis, inany returns generated in excess of an agreed-upon benchmark.  The Company’s participation percentage insuch return differentials is then multiplied by AUM to determine the incentivefees earned.  In general, returns arecalculated on an annualized basis over the contract’s measurement period, whichusually extends up to three years. Incentive fees are generally payable annually.  Following the preferred method identified inthe *Revenue Recognition Topic* ofthe FASB ASC, such incentive fee income is recorded at the conclusion of thecontractual performance period, when all contingencies are resolved.

 

***Earnings per Share:***

 

Basicearnings per share is computed by dividing the Company’s net income or lossattributable to the Company’s common stockholders by the weighted averagenumber of shares outstanding during the reporting period.  Diluted earnings per share adjusts thiscalculation to reflect the impact of all outstanding operating companyClass B units, outstanding operating company phantom Class B units,and outstanding options granted under the Pzena Investment Management, LLC 2006Equity Incentive Plan (the “2006 Plan”) and the Pzena InvestmentManagement, Inc. 2007 Equity Incentive Plan (the “2007 Plan”), to theextent they would have a dilutive effect on net income per share for thereporting period.  Net income for dilutedearnings per share generally assumes all operating 

 

6

----

 

**Pzena InvestmentManagement, Inc.**

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

 

companyClass B units are converted into Company stock at the beginning of thereporting period and the resulting change to Company net income associated withits increased interest in the operating company is taxed at the Company’seffective tax rate.

 

For the three and six monthsended June 30, 2010 and 2009, the Company’s diluted net income wasdetermined as follows: 

 
| ** **                                                     | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|----------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                                                     | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**       | ** ** |
| Non-Controlling  Interests of Pzena Investment Management, LLC |       | $                        | 7,470      |                    | $          | 6,119 |   | $ | 15,761 |   | $ | 9,685 |   |
| Less:  Assumed Corporate Income Taxes                          |       | 3,201                    |       | 2,610                   |       | 6,754 |   | 4,128 |   |
| Assumed  After-Tax Income of Pzena Investment Management, LLC  |       | $                        | 4,269      |                    | $          | 3,509 |   | $ | 9,007 |   | $ | 5,557 |   |
|                                                           |       |                     |       |                    |       |   |   |   |   |
| Assumed  After-Tax Income of Pzena Investment Management, LLC  |       | $                        | 4,269      |                    | $          | 3,509 |   | $ | 9,007 |   | $ | 5,557 |   |
| Net  Income of Pzena Investment Management, Inc.          |       | 473                      |       | 821                     |       | 1,457 |   | 1,303 |   |
| Diluted  Net Income(1)                                         |       | $                        | 4,742      |                    | $          | 4,330 |   | $ | 10,464 |   | $ | 6,860 |   |

 

----

(1)Since the assumed incremental income results in an increase in per share incomefor the three months ended June 30, 2010, the assumed effects of theconversion of operating company Class B units, options to purchaseoperating company units, options to purchase Class A common stock, andphantom operating company units are excluded from the calculation of dilutedincome per share.

 

Forthe three months ended June 30, 2010, 54,931,418 operating company units,3,618,872 options to purchase operating company units, 961,750 options topurchase Class A common stock, and 142,555 phantom operating company unitswere excluded from the calculation of diluted net income per share, as theirinclusion would have had an antidilutive effect for the period.  For the six months ended June 30, 2010,1,620,060 options to purchase operating company units, 961,750 options topurchase Class A common stock, and 84,916 phantom operating company unitswere excluded from the calculation of diluted net income per share, as theirinclusion would have had a similarly antidilutive effect for the period.  For the three and six months ended June 30,2009, 954,310 options to purchase operating company units and 67,371 phantomoperating company units were excluded from the calculation of diluted netincome per share, as their inclusion also would have had an antidilutiveeffect.

 

7

----

 

**Pzena InvestmentManagement, Inc.**

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

 

Forthe three and six months ended June 30, 2010 and 2009, the Company’s basicand diluted earnings per share were determined as follows:

 
| ** **                                                  | ** ** | **For the Three Months**                               | ** ** | **For the Six Months**  | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                  | ** ** | **Ended June 30,**                                | ** ** | **Ended June 30,** | ** ** |
| ** **                                                  | ** ** | **2010**                                               | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                  | ** ** | **(in thousands, except share and per-share amounts)** | ** ** |
|                                                        |       |                                                   |       |                    |       |   |   |   |   |
| Net  Income for Basic Earnings per Share                    |       | $                                                      | 473        |                    | $          | 821 |   | $ | 1,457 |   | $ | 1,303 |   |
| Basic  Weighted Average Shares Outstanding                  |       | 9,367,659                                              |       | 8,633,041               |       | 9,002,379 |   | 7,795,194 |   |
| Basic  Earnings per Share                                   |       | $                                                      | 0.05       |                    | $          | 0.10 |   | $ | 0.16 |   | $ | 0.17 |   |
|                                                        |       |                                                   |       |                    |       |   |   |   |   |
| Net  Income for Diluted Earnings per Share                  |       | $                                                      | 473        |                    | $          | 4,330 |   | $ | 10,464 |   | $ | 6,860 |   |
| Dilutive  Effect of Operating Company Class B Units(1) |       | —                                                 |       | 55,559,751              |       | 55,326,546 |   | 56,397,598 |   |
| Dilutive  Effect of Phantom Units(1)                        |       | —                                                 |       | 564,211                 |       | 19,057 |   | 363,224 |   |
| Dilutive  Effect of Options(1)                              |       | —                                                 |       | 21,857                  |       | 664,978 |   | 10,588 |   |
| Diluted  Weighted Average Shares Outstanding                |       | 9,367,659                                              |       | 64,778,860              |       | 65,012,960 |   | 64,566,604 |   |
| Diluted  Earnings per Share                                 |       | $                                                      | 0.05       |                    | $          | 0.07 |   | $ | 0.16 |   | $ | 0.11 |   |

 

----

(1)Since the assumed incremental income results in an increase in per share incomefor the three months ended June 30, 2010, the assumed effects of theconversion of operating company Class B units, options to purchaseoperating company units, options to purchase Class A common stock, andphantom operating company units are excluded from the calculation of dilutedincome per share.

 

***Cash and Cash Equivalents:***

 

AtJune 30, 2010, cash and cash equivalents was $23.6 million, inclusiveof $2.1 million set aside to satisfy our obligations under our deferredcompensation program and $0.1 million held by the Company’s consolidatedsubsidiaries.  The Company considers allmoney market funds and highly-liquid debt instruments with an original maturityof three months or less at the time of purchase to be cash equivalents.  The Company maintains its cash in bankdeposit and other accounts whose balances, at times, exceed federally insuredlimits.

 

Intereston cash and cash equivalents is recorded as interest income on an accrual basison the consolidated statements of operations.

 

***Restricted Cash:***

 

TheCompany maintains a compensating balance of $1.4 million at June 30,2010 as collateral for a letter of credit issued by a third party in lieu of acash security deposit, as required by the Company’s lease for its New Yorkoffice space.  Such amounts are recordedin restricted cash on the consolidated statements of financial condition.

 

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

 

Dueto/from broker consists primarily of cash balances and amountsreceivable/payable for unsettled securities transactions held/initiated at theclearing brokers of the Company’s consolidated investment partnerships.  At June 30, 2010, due from broker on theconsolidated statement of financial condition represents assets of consolidatedVIEs that can be used only to settle obligations of the consolidated VIEs anddue to broker represents liabilities of the consolidated VIEs for whichcreditors (or beneficial interest holders) do not have recourse to the generalcredit of the Company.

 

***Investments in Securities:***

 

Investmentsin equity securities represent the securities held by the Company and itsconsolidated 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.  At June 30, 2010, allsuch investments in equity securities represent assets of the Company’sconsolidated VIEs and can be used only to settle the obligations of thoseentities.

 

8

----

 

**Pzena InvestmentManagement, Inc.**

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

 

The*Fair Value Measurements and DisclosuresTopic* of the FASB ASC defines fair value as the price that would bereceived to sell an asset, or paid to transfer a liability, in an orderly transactionbetween market participants at the measurement date.  The *FairValue Measurements and Disclosures Topic* of the FASB ASC alsoestablishes a framework for measuring fair value and a valuation hierarchybased upon the transparency of inputs used in the valuation of an asset orliability.  Classification within thehierarchy is based upon the lowest level of input that is significant to thefair value measurement.  The valuationhierarchy contains three levels: (i) valuation inputs are unadjusted quotedmarket prices for identical assets or liabilities in active markets(Level 1); (ii) valuation inputs are quoted prices for identicalassets or liabilities in markets that are not active, quoted market prices forsimilar assets and liabilities in active markets, and other observable inputsdirectly or indirectly related to the asset or liability being measured(Level 2); and (iii) valuation inputs are unobservable andsignificant to the fair value measurement (Level 3).  Additionally, entities are required todisclose in interim and annual periods the inputs and valuation techniques usedto measure fair value and define assets and liabilities measured at fair valueby major class.

 

TheCompany’s fair value measurements relate to its consolidated investmentpartnerships’ investments in equity securities, which are exchange-tradedsecurities with quoted prices in active markets.  The fair value measurements of the securitieshave been classified as Level 1.

 

Thefollowing table presents these instruments’ fair value at June 30, 2010:

 
| ** **         | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|--------------------|------------|--------------------|------------|-------------|------------|-------------|------------|
| ** **         | ** ** | **(in thousands)** | ** ** |
| ** **         | ** ** | ** **         | ** ** | ** **  | ** ** | ** **  | ** ** |
| Assets:            |       |               |       |        |       |        |       |
| Equity  Securities |       | $                  | 4,080      |        | $          | —      |       | $ | — |   |
|               |       |               |       |        |       |        |       |
| Total  Fair Value  |       | $                  | 4,080      |        | $          | —      |       | $ | — |   |

 

Thefollowing table presents these instruments’ fair value at December 31,2009:

 
| ** **         | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|--------------------|------------|--------------------|------------|-------------|------------|-------------|------------|
| ** **         | ** ** | **(in thousands)** | ** ** |
| ** **         | ** ** | ** **         | ** ** | ** **  | ** ** | ** **  | ** ** |
| Assets:            |       |               |       |        |       |        |       |
| Equity  Securities |       | $                  | 7,951      |        | $          | —      |       | $ | — |   |
|               |       |               |       |        |       |        |       |
| Total  Fair Value  |       | $                  | 7,951      |        | $          | —      |       | $ | — |   |

 

***Securities Valuation:***

 

Investmentsin equity securities which are traded on a national securities exchange arecarried at fair value based on the last 

 

9

----

 

**Pzena InvestmentManagement, Inc.**

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

 

reportedsales price on the valuation date.  If noreported sales occurred on the valuation date, investments in securities arevalued at the bid price.  Securitiestransactions are recorded on the trade date.

 

Thenet realized gain or loss on sales of securities is determined on a specificidentification basis and is included in realized and unrealized gain/(loss),net on equity securities in the consolidated statements of operations.

 

***Concentrations of Credit Risk:***

 

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of cash and cash equivalents, amounts due frombrokers, and advisory fees receivable. The Company maintains its cash and temporary cash investments in bankdeposits and other accounts whose balances, at times, exceed federally insuredlimits.

 

Theconcentration of credit risk with respect to advisory fees receivable isgenerally limited due to the short payment terms extended to clients by theCompany.  On a periodic basis, theCompany evaluates its advisory fees receivable and establishes an allowance fordoubtful accounts, if necessary, based on a history of past write-offs andcollections and current credit conditions. For the three months ended June 30, 2010 and 2009, approximately10.5% and 11.2%, respectively, of the Company’s advisory fees were generatedfrom an advisory agreement with one client. For the six months ended June 30, 2010 and 2009, fees generatedfrom this agreement comprised 10.0% and 11.9%, respectively, of the Company’stotal advisory fees.  At June 30,2010 and December 31, 2009, no allowance for doubtful accounts has beendeemed necessary.

 

***Financial Instruments:***

 

OnFebruary 28, 2008, the operating company entered into an interest rateswap agreement, as discussed further in Note 9.  This interest rate swap was subsequentlyunwound in conjunction with the termination of the credit agreement inSeptember 2009.  The counterparty tothis agreement was a major financial institution.  The Company’s swap agreement was designatedas a trading derivative and the fair value was recorded in other liabilities,with changes to the swap’s fair value recognized as a component of otherincome/(expense).  For the three and sixmonths ended June 30, 2009, the Company recognized less than$0.1 million and $0.1 million, respectively, in other income related tosuch changes.

 

Pursuantto the guidance in the *Derivatives andHedging Topic* of the FASB ASC, it is a requirement to disclosebalance sheet and income statement amounts of derivatives, as well as theirlocations within the financial statements. The following table summarizes the impact of the Company’s derivativefinancial instruments on its results of operations for the three and six monthsended June 30, 2009:

 
| ** **                                    | ** ** | ** **             | ** ** | **Amount of Loss Recognized** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-------------------------------|------------|
| **Derivatives  Not Accounted For As Hedging** | ** ** | ** **             | ** ** | **in Income of Derivative**   | ** ** |
| **Instruments  Under the Derivatives and**    | ** ** | **Statement of**       | ** ** | **For the Three Months**      | ** ** | **For the Six Months** | ** ** |
| **Hedging  Topic of the FASB ASC**            | ** ** | **Operations Account** | ** ** | **Ended June 30, 2009**  | ** ** | **Ended June 30, 2009** | ** ** |
| ** **                                    | ** ** | ** **             | ** ** | **(in thousands)**            | ** ** |
|                                          |       |                   |       |                          |       |   |   |
| Interest  Rate Contracts                      |       | Other  Expense         |       | $                             | 43         |   | $ | 68 |   |
| Total                                         |       |                   |       | $                             | 43         |   | $ | 68 |   |

 

***Property and Equipment:***

 

Propertyand equipment is carried at cost, less accumulated depreciation andamortization.  Depreciation is providedon a straight-line basis over the estimated useful lives of the respectiveassets, which range from three to seven years. Leasehold improvements are amortized on a straight-line basis over theshorter of the useful life of the improvements or the remaining lease term.

 

***Business Segments:***

 

TheCompany views its operations as comprising one operating segment.

 

***Income Taxes:***

 

TheCompany is a “C” corporation under the Internal Revenue Code, and thus liablefor federal, state, and local taxes on the income derived from its economicinterest in its operating company.  Theoperating company is a limited liability company that has elected to be treatedas a partnership for tax purposes.  Ithas not made a provision for federal or state income taxes because it is theindividual responsibility of each of the operating company’s members (includingthe Company) to separately report their proportionate share of the operatingcompany’s taxable income or loss. Similarly, the income of the Company’s consolidated investment partnershipsis not subject to income taxes, since it is allocated to each partnership’sindividual partners.  The operatingcompany has made a provision for New York City Unincorporated Business Tax (“UBT”).

 

TheCompany and its consolidated subsidiaries account for all federal, state, andlocal taxation pursuant to the asset and liability method, which requiresdeferred income tax assets and liabilities to be recorded for temporarydifferences between the financial statement and tax bases of assets and liabilitiesthat will result in taxable or deductible amounts in the future, based on enacted

 

10

----

 

**Pzena InvestmentManagement, Inc.**

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

 

taxlaws and rates applicable to the periods in which the temporary differences areexpected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferredtax assets to the amount more likely than not to be realized.  At June 30, 2010, the Company had a$63.6 million valuation allowance against the deferred tax asset recorded aspart of the Company’s initial public offering and the subsequent exchanges ofClass B units for shares of its Class A common stock.  At December 31, 2009, the Company had a$60.3 million valuation allowance recorded against this deferred taxasset.  The income tax provision, orbenefit, 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:***

 

Investmentsecurities and other assets and liabilities denominated in foreign currenciesare remeasured into U.S. dollar amounts at the date of valuation.  Purchases and sales of investment securities,and income and expense items denominated in foreign currencies, are remeasuredinto U.S. dollar amounts on the respective dates of such transactions.

 

TheCompany does not isolate that portion of the results of its operationsresulting from changes in foreign exchange rates on investments from thefluctuations arising from changes in market prices of securities held.  Such fluctuations are included in therealized and unrealized gain/(loss), net on equity securities in theconsolidated statements of operations.

 

Reportednet realized foreign exchange gains or losses arise from sales of foreigncurrencies, currency gains or losses realized between the trade and settlementdates on securities transactions, and the difference between the amounts ofdividends, interest, and foreign withholding taxes recorded on the Company’sbooks 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.

 

***Recent Accounting Pronouncements:***

 

InJune 2009, the FASB issued a new standard that requires an enterprise toperform a qualitative analysis to determine whether its variable-interests giveit a controlling financial interest in a VIE. Under the standard, an enterprise has a controlling financial interestwhen it has (a) the power to direct the activities of a VIE that mostsignificantly impact the entity’s economic performance, and (b) theobligation to absorb losses of the entity or the right to receive benefits fromthe entity that could potentially be significant to the VIE.  An enterprise that holds a controllingfinancial interest in a VIE is deemed to be the primary beneficiary of the VIEand is required to consolidate the VIE. The standard also requires an ongoing assessment of whether anenterprise is the primary beneficiary of a VIE, and additional disclosuresabout an enterprise’s involvement in VIEs, and any significant changes in riskexposure due to that involvement.  Thestandard is effective for fiscal years beginning after November 15,2009.  In November 2009, the FASBissued a proposed standard update, which defers the consolidation criteriarequirements of this new standard for assets managers’ interests in entitiesthat apply the specialized accounting guidance for investment companies, orthat have the attributes of investment companies.  As of January 27, 2010, the FASB decidedto make official the deferral of this standard for certain investmententities.  The Company has evaluated itsinterests in VIEs and determined that the standard is applicable for theCompany’s investment in its operating company, but that the Company meets thecriteria for deferral provided in this standard for its VIEs.  The Company adopted the updated guidance onJanuary 1, 2010, and it had no impact on the Company’s consolidatedfinancial statements.  The Company ismonitoring future guidance for updates on the treatment of its interests in itsVIEs.

 

**Note 3—Property and Equipment**

 

Propertyand equipment, net, is comprised of the following:

 
| ** **                                       | ** ** | **As of**          | ** ** |
|--------------------------------------------------|------------|--------------------|------------|
| ** **                                       | ** ** | **June 30,**  | ** ** | **December 31,** | ** ** |
| ** **                                       | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
|                                             |       |               |       |   |   |
| Leasehold  Improvements                          |       | $                  | 2,145      |   | $ | 2,145 |   |
| Furniture  and Fixtures                          |       | 1,162              |       | 1,163 |   |
| Computer  Hardware                               |       | 944                |       | 948 |   |
| Office  Equipment                                |       | 243                |       | 243 |   |
| Computer  Software                               |       | 212                |       | 201 |   |
| Total                                            |       | 4,706              |       | 4,700 |   |
| Less:  Accumulated Depreciation and Amortization |       | (2,596             | )          | (2,385 | ) |
| Total                                            |       | $                  | 2,110      |   | $ | 2,315 |   |

 

Depreciationis included in general and administrative expenses and totaled$0.1 million for each of the three months ended June 30, 2010 and2009.  Such expenses totaled $0.2 millionfor each of the six months ended June 30, 2010 and 2009.

 

**Note 4—Related Party Transactions**

 

Forthe three and six months ended June 30, 2010, the Company earned$1.3 million and $2.7 million, respectively, in investment advisoryfees from unconsolidated entities for which it acts as the investmentmanager.  For the three and six monthsended June 30, 2009, such advisory fees totaled $1.2 million and $2.1million, respectively.

 

11

----

 

**Pzena InvestmentManagement, Inc.**

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

 

At both June 30, 2010 and December 31, 2009, the Company hadless than $0.1 million remaining of an advance to an international investmentcompany for organization and start-up costs, which is included in receivablefrom related parties on the consolidated statements of financialcondition.  The Company is the sponsorand investment manager of this entity.

 

At December 31, 2009, receivables from related parties includedless than $0.1 million of loans to employees.  No such loans existed at June 30,2010.  These loans were in the form offorgivable promissory notes, which were amortized through compensation expensepursuant to their terms.  For the threemonths ended June 30, 2010, no amortization was recognized as compensationand benefits expense.  For the threemonths ended June 30, 2009, less than $0.1 million of suchamortization was recognized as compensation and benefits expense.  For each of the six months ended June 30,2010 and 2009, such amortization totaled less than $0.1 million.

 

Certain qualified employees of the Company have the ability to openindividual accounts, or invest in certain of the Company’s consolidatedinvestment partnerships, without being assessed advisory fees.  Investments by employees in individualaccounts are permitted only at the discretion of the executive committee of theCompany, but are generally not subject to the same minimum investment levelsthat are required of outside investors.

 

On October 28, 2008, the 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 thebenefit of certain of his family members, an entity controlled by a CompanyDirector, and a former employee.  OnDecember 31, 2009, the Company repaid a total of $6.0 millionprincipal amount outstanding of Senior Subordinated Notes to the entitycontrolled by the Company Director and a former employee.  On March 31, 2010, the Company repaid atotal of $2.5 million principal amount outstanding of the Senior SubordinatedNotes pro-rata to the entities established by Richard S. Pzena.  During the three months ended June 30,2010, the Company repaid the remaining $7.5 million principal amountoutstanding of Senior Subordinated Notes held by the entities established byRichard S. Pzena.

 

**Note 5—Commitments and Contingencies**

 

In the normal course of business, the Company enters into agreementsthat include indemnities in favor of third parties, such as engagement letterswith advisors and consultants.  Incertain cases, the Company may have recourse against third parties with respectto these indemnities.  The Company maintainsinsurance policies that may provide coverage against certain claims under theseindemnities.  The *Guarantees Topic* of the FASB ASC providesaccounting and disclosure requirements for certain guarantees.  The Company has had no claims or paymentspursuant to these agreements, and it believes the likelihood of a claim being madeis remote.  Utilizing the methodology inthe *Guarantees Topic* of the FASBASC, the Company’s estimate of the value of such guarantees is de minimis;therefore, no accrual has been made in the consolidated financial statements.

 

The Company leases office space under a non-cancelable operating leaseagreement which expires on October 31, 2015.  The Company reflects minimum lease expense ona straight-line basis over the lease term. Lease expenses totaled $0.5 million for each of the three months ended June 30,2010 and 2009, and are included in general and administrative expenses.  Such expenses totaled $1.1 million for eachof the six months ended June 30, 2010 and 2009.

 

**Note 6—Compensation and Benefits**

 

Compensation and benefits expense to employees and members is comprisedof the following:

 
| ** **                               | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                               | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **(in thousands)**       | ** ** |
|                                     |       |                     |       |                    |       |   |   |   |   |
| Cash  Compensation and Other Benefits    |       | $                        | 6,441      |                    | $          | 5,673 |   | $ | 12,987 |   | $ | 11,462 |   |
| Non-Cash  Compensation                   |       | 822                      |       | 310                     |       | 1,664 |   | 561 |   |
| Total  Compensation and Benefits Expense |       | $                        | 7,263      |                    | $          | 5,983 |   | $ | 14,651 |   | $ | 12,023 |   |

 

For the three and six months ended June 30, 2010 and 2009, theCompany granted no options to purchase capital units of the operating companyand no options to purchase shares of Class A common stock pursuant to its2006 Plan and 2007 Plan.

 

For the three and six months ended June 30, 2010 and 2009, theoperating company granted 7,000 and 30,000, respectively, restrictedClass B units to certain members pursuant to its 2006 Plan.  These unit grants each vest ratably over afour-year period commencing January 1, 2010 and 2009, respectively.  The amortization of these awards was notmaterial for the three and six months ended June 30, 2010 and 2009.

 

Pursuant to the Pzena Investment Management, LLC Amended and RestatedBonus Plan (the “Bonus Plan”), which became effective January 1, 2007,eligible employees whose cash compensation is in excess of certain thresholdshave a portion of that excess mandatorily deferred.  Amounts deferred may take the form of phantomClass B units, or be invested in third-party funds at the employee’sdiscretion, and vest ratably over four years. At both June 30, 2010 and December 31, 2009, the liabilityassociated with deferred compensation investment accounts was approximately$0.4 million, and has been included as a component of other liabilities 

 

12

----

 

**Pzena InvestmentManagement, Inc.**

**Unaudited Notes to the ConsolidatedFinancial Statements (Continued)**

 

onthe consolidated statements of financial condition.  For the three months ended June 30, 2010and 2009, the Company recognized approximately $0.3 million and$0.2 million, respectively, in compensation and benefits expenseassociated with the amortization of all deferred compensation awards.  For the six months ended June 30, 2010and 2009, the Company recognized approximately $0.6 million and$0.4 million, respectively, in such expense.

 

As of June 30, 2010 and December 31, 2009, the Company hadapproximately $4.1 million and $5.3 million, respectively, in unrecordedcompensation expense related to unvested operating company phantom units issuedpursuant to our deferred compensation plan, operating company Class B unitand option grants issued under the Company’s 2006 Plan, and Class A stockoption grants issued under our 2007 Plan.

 

**Note 7—Short Term Borrowings**

 

The operating company had a $1.8 million revolving credit facility thatwas terminated in September 2009. No balance was outstanding and no amounts were drawn down against thefacility over the course of its existence.

 

**Note 8—Term Loan**

 

During the year ended December 31, 2009, the Company repaid theremaining $22.0 million of the principal amount outstanding under its termloan.  Concurrently with the terminationof this term loan, the security interest previously granted in the accountsreceivable of the Company was released in September 2009.

 

**Note 9—Interest Rate Swap**

 

The Company manages its exposure to changes in market rates ofinterest.  The Company’s use ofderivative instruments was limited to an interest rate swap used to manage theinterest rate exposure related to the credit agreement, referenced above, whichwas terminated in September 2009.

 

On February 28, 2008, the Company entered into an interest rateswap agreement that commenced on July 23, 2008.  This interest rate swap was subsequentlyunwound in conjunction with the termination of the credit agreement inSeptember 2009.  The swap obligatedthe Company to pay a 2.825% fixed rate of interest on the notional amount andrequired the counterparty to pay the Company a floating interest rate based onthe monthly LIBOR interest rate.  Thespread on the credit agreement was in addition to these amounts.

 

During 2009, the Company reduced the notional amount of its interestrate swap in tandem with the reductions in principal amounts outstanding undera credit agreement.  The amounts paid tothe counterparty in exchange for these reductions for the three and six monthsended June 30, 2009 were approximately $0.1 million and $0.3 million,respectively.  For the three and sixmonths ended June 30, 2009, the Company recognized less than $0.1 millionand $0.1 million, respectively, in other expense associated with thechange in fair value of the swap agreement.

 

13

----

 

**Pzena InvestmentManagement, Inc.**

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

 

**Note 10—Income Taxes**

 

The operating company is a limited liability company that has electedto be treated as a partnership for tax purposes.  Neither it, nor the Company’s otherconsolidated subsidiaries, has made a provision for federal or state incometaxes because it is the individual responsibility of each of these entities’members (including the Company) to separately report their proportionate shareof 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 itsprovision for federal, state, and local corporate taxes.

 

The components of the income tax provision/(benefit) are as follows:

 
| ** **                            | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|---------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                            | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                  |       | **(in  thousands)**      |       |
| Current  Provision:                   |       |                     |       |                    |       |   |   |   |   |
| Unincorporated  Business Taxes        |       | $                        | 678        |                    | $          | 462 |   | $ | 1,349 |   | $ | 855 |   |
| Local  Corporate Tax                  |       | —                   |       | —                  |       | — |   | — |   |
| State  Corporate Tax                  |       | —                   |       | —                  |       | — |   | — |   |
| Federal  Corporate Tax                |       | —                   |       | —                  |       | — |   | — |   |
| Total  Current Provision              |       | $                        | 678        |                    | $          | 462 |   | $ | 1,349 |   | $ | 855 |   |
|                                  |       |                     |       |                    |       |   |   |   |   |
| Deferred  Provision:                  |       |                     |       |                    |       |   |   |   |   |
| Unincorporated  Business Taxes        |       | $                        | (56        | )                       | $          | (56 | ) | $ | (112 | ) | $ | (111 | ) |
| Local  Corporate Tax                  |       | 58                       |       | 43                      |       | 116 |   | 63 |   |
| State  Corporate Tax                  |       | 110                      |       | 82                      |       | 221 |   | 123 |   |
| Federal  Corporate Tax                |       | 378                      |       | 281                     |       | 761 |   | 422 |   |
| Total  Deferred Provision             |       | $                        | 490        |                    | $          | 350 |   | $ | 986 |   | $ | 497 |   |
|                                  |       |                     |       |                    |       |   |   |   |   |
| Change  in Valuation Allowance        |       | 1,379                    |       | (876                    | )          | 113 |   | (1,690 | ) |
|                                  |       |                     |       |                    |       |   |   |   |   |
| Total  Income Tax Provision/(Benefit) |       | $                        | 2,547      |                    | $          | (64 | ) | $ | 2,448 |   | $ | (338 | ) |

 

For the three and six months ended June 30, 2010 and 2009, theCompany’s taxable income was determined as follows:

 
| ** **                            | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|---------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                            | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                            | ** ** | **(in thousands)**       | ** ** |
|                                  |       |                     |       |                    |       |   |   |   |   |
| Income  Before Taxes                  |       | $                        | 10,328     |                    | $          | 9,212 |   | $ | 19,504 |   | $ | 11,660 |   |
| Unincorporated  Business Taxes        |       | (622                     | )          | (406                    | )          | (1,237 | ) | (744 | ) |
| Non-Controlling  Interests            |       | (7,308                   | )          | (8,455                  | )          | (15,599 | ) | (10,695 | ) |
| Income  Before Corporate Income Taxes |       | $                        | 2,398      |                    | $          | 351 |   | $ | 2,668 |   | $ | 221 |   |

 

14

----

 

**Pzena InvestmentManagement, Inc.**

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

 

The *Income Taxes Topic* ofthe FASB ASC establishes the minimum threshold for recognizing, and a systemfor measuring, the benefits of tax return positions in financialstatements.  It is the Company’s policyto recognize accrued interest, and penalties associated with uncertain tax positions,as part of the tax provision.  For thethree and six months ended June 30, 2010 and 2009, no such expenses wererecognized.  As of June 30, 2010 andDecember 31, 2009, no such accruals were recorded.

 

The Company and the operating company are generally no longer subjectto U.S. Federal or state and local income tax examinations by tax authoritiesfor any year prior to 2006.  All taxyears subsequent to, and including, 2006 are considered open and subject to examinationby tax authorities.

 

Prior to October 30, 2007, the operating company was a cash basistaxpayer.  As a result of the Company’sacquisition of Class B units in conjunction with the offering, theoperating company was required to become an accrual basis taxpayer.  Pursuant to Section 481 of the InternalRevenue Code, the cumulative difference between the two methods of taxpayingare amortizable over four years.  Thesedifferences generated approximately $0.1 million and $0.2 million indeferred tax liabilities as of June 30, 2010 and December 31, 2009,respectively.  Such amounts are recordedin other liabilities in the consolidated statements of financial condition.

 

The acquisition of the operating company Class B units noted abovehas allowed the Company to make an election under Section 754 of theInternal Revenue Code (“Section 754”) to step up its tax basis in the netassets acquired.  This step up isdeductible for tax purposes over a 15-year period.  Pursuant to a Tax Receivable Agreement signedbetween the members of the operating company and the Company, 85% of the cashsavings generated by this election will be distributed to the selling andconverting shareholders upon the realization of this benefit.

 

Based on the net proceeds of the offering and tax basis of theoperating company as of October 30, 2007, this election gave rise to adeferred tax asset of approximately $68.7 million.  In December 2008, the Companyestablished a $62.7 million valuation allowance to reduce the net deferred taxasset to an amount more likely than not to be realized.  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.

 

As discussed further in Note 14, Shareholders’ Equity, below, on March 31,2010, and March 3, 2009, certain of the operating company’s membersexchanged an aggregate of 734,618 and 2,445,973, respectively, of their Class Bunits for an equivalent number of shares of Company Class A commonstock.  The Company elected to step upits tax basis in the incremental assets acquired in accordance withSection 754.  Based on theexchange-date fair values of the Company’s common stock and the tax basis ofthe operating company, this election gave rise to a $3.6 million deferred taxasset and a corresponding $3.0 million liability to converting shareholders on March 31,2010, and a $2.5 million deferred tax asset and a corresponding$2.2 million liability to converting shareholders on March 3,2009.  The Company assessed therealizability of the deferred tax asset associated with each of these exchangesand determined that a portion of their benefits would go unutilized.  Consequently, at March 31, 2010 and March 3,2009, the Company established valuation allowances of $3.2 million and$2.4 million, respectively, to reduce the deferred tax asset to, at each date,an amount more likely than not to be realized. These deferred tax assets remain available to the Company and can beused to reduce taxable income in future years. The Company similarly reduced the associated liability to selling andconverting shareholders by $2.7 million and $2.0 million at March 31,2010 and March 3, 2009, respectively, to reflect this change in theestimated realization of the asset.  Asrequired by the *Income Taxes Topic*of the FASB ASC, the Company recorded the effects of these transactions inequity.

 

During the three months ended June 30, 2010 and 2009, the Company’svaluation allowance was increased by approximately $1.4 million and reduced byapproximately $0.9 million, respectively, due to revised estimates offuture taxable income.  To reflect thischange in the estimated realization of the asset, the Company correspondinglydecreased its liability to selling and converting shareholders by $1.1 millionfor the three months ended June 30, 2010 and increased its liability toselling and converting shareholders by $0.6 million for the three months ended June 30,2009.  During the six months ended June 30,2010 and 2009, including the effects of the conversion discussed earlier, theCompany’s valuation allowance was increased by approximately $0.1 million andreduced by approximately $1.7 million, respectively, due to revised estimatesof future taxable income.  To reflectthis change in the estimated realization of the asset, the Companycorrespondingly decreased its liability to selling and converting shareholdersby $0.1 million for the six months ended June 30, 2010 and increased itsliability to selling and converting shareholders by $1.2 million for the sixmonths ended June 30, 2009.  Theeffects of these changes to the deferred tax asset and liability to selling andconverting shareholders were recorded as a component of the income taxprovision and other expense, respectively, on the consolidated statements ofoperations.  As of June 30, 2010 andDecember 31, 2009, the net values of all deferred tax assets wereapproximately $5.9 million and $6.8 million, respectively.

 

As of June 30, 2010 and December 31, 2009, the net values ofthe liability to selling and converting shareholders were approximately$5.9 million and $5.6 million, respectively.

 

15

----

 

**Pzena InvestmentManagement, Inc.**

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

 

The change in the Company’s net deferred tax assets for the three andsix months ended June 30, 2010 is summarized as follows:

 
| ** **                         | ** ** | ** **           | ** ** | ** ** | ** ** | **Valuation** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|------------|------------|
| ** **                         | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Allowance** | ** ** | **Net**    | ** ** |
| ** **                         | ** ** | **(in thousands)**   | ** ** |
|                               |       |                 |       |       |       |          |       |       |       |
| Balance  at December 31, 2009 |       | $                    | 65,006     |       | $          | 2,001         |       | $          | (60,253    | ) | $ | 6,754 |   |
| Deferred  Tax Expense              |       | (726                 | )          | 173        |       | —        |       | (553       | )          |
| Unit  Conversion                   |       | 3,577                |       | —     |       | (3,186        | )          | 391        |       |
| Change  in Valuation Allowance     |       | —               |       | —     |       | 1,266         |       | 1,266      |       |
| Balance  at March 31, 2010    |       | $                    | 67,857     |       | $          | 2,174         |       | $          | (62,173    | ) | $ | 7,858 |   |
| Deferred  Tax Expense              |       | (849                 | )          | 303        |       | —        |       | (546       | )          |
| Change  in Valuation Allowance     |       | —               |       | —     |       | (1,379        | )          | (1,379     | )          |
| Balance  at June 30, 2010     |       | $                    | 67,008     |       | $          | 2,477         |       | $          | (63,552    | ) | $ | 5,933 |   |

 

The change in the Company’s net deferred tax assets for the three andsix months ended June 30, 2009 is summarized as follows:

 
| ** **                         | ** ** | ** **           | ** ** | ** ** | ** ** | **Valuation** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|------------|------------|
| ** **                         | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Allowance** | ** ** | **Net**    | ** ** |
| ** **                         | ** ** | **(in thousands)**   | ** ** |
|                               |       |                 |       |       |       |          |       |       |       |
| 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 |   |
| Deferred  Tax Expense              |       | (726                 | )          | 320        |       | —        |       | (406       | )          |
| Change  in Valuation Allowance     |       | —               |       | —     |       | 876           |       | 876        |       |
| Balance  at June 30, 2009     |       | $                    | 66,460     |       | $          | 1,617         |       | $          | (63,399    | ) | $ | 4,678 |   |

 

**Note 11—Investments in Equity Securities, at FairValue**

 

Investments in equity securities consisted of the following at June 30,2010:

 
| ** ** | ** ** | **Cost**   | ** ** | **Unrealized Loss** | ** ** | **Fair Value** | ** ** |
|------------|------------|------------|------------|---------------------|------------|----------------|------------|
| ** ** | ** ** | ** ** | ** ** | **(in thousands)**  | ** ** | ** **     | ** ** |
| ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **     | ** ** |
| Equities   |       | $          | 4,095      |                | $          | (15            | )          | $ | 4,080 |   |
|            |            |            |            |                     |            |                |            |  |  |  |

 

Investments in equity securities consisted of the following atDecember 31, 2009:

 
| ** ** | ** ** | **Cost**   | ** ** | **Unrealized Gain** | ** ** | **Fair Value** | ** ** |
|------------|------------|------------|------------|---------------------|------------|----------------|------------|
| ** ** | ** ** | ** ** | ** ** | **(in thousands)**  | ** ** | ** **     | ** ** |
| ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **     | ** ** |
| Equities   |       | $          | 7,321      |                | $          | 630            |       | $ | 7,951 |   |
|            |            |            |            |                     |            |                |            |  |  |  |

 

16

----

 

**Pzena InvestmentManagement, Inc.**

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

 

**Note 12—Non-Controlling Interests**

 

Non-controlling interests in the operations of the Company’s operatingcompany and consolidated subsidiaries are comprised of the following:

 
| ** **                                                    | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                                                    | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**       | ** ** |
| ** **                                                    | ** ** | ** **               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-Controlling  Interest of Pzena Investment Management, LLC |       | $                        | 7,470      |                    | 6,119      |   | $ | 15,761 |   | 9,685 |   |
| Non-Controlling  Interest of Consolidated Subsidiaries        |       | (162                     | )          | 2,336                   |       | (162 | ) | 1,010 |   |
| Non-Controlling  Interests                                    |       | $                        | 7,308      |                    | $          | 8,455 |   | $ | 15,599 |   | $ | 10,695 |   |
|                                                               |            |                          |            |                         |            |  |  |  |  |  |  |  |  |

 

**Note 13—Members’ Equity Interests of OperatingCompany**

 

Except as otherwise provided by law, the liability of a member of theoperating company is limited to the amount of its capital account.  A member may transfer or assign all or anypart of its membership interest with the prior written consent of PzenaInvestment Management, Inc., which may be withheld in its solediscretion.  Any transferee admitted as amember shall succeed to the capital account, or portion thereof, transferred orassigned, as if no such transfer or assignment had occurred.

 

**Note 14—Shareholders’ Equity**

 

The Company was incorporated in the State of Delaware on May 8,2007.  On October 30, 2007, theCompany consummated an initial public offering of shares of its Class A commonstock, par value $0.01 per share.  Thesenet proceeds were used to purchase Class B units of the operatingcompany.  Concurrently with theconsummation of the Company’s initial public offering, the operating agreementof the operating company was amended and restated such that, among otherthings, (i) the Company became the sole managing member of the operatingcompany, (ii) the Class B units of the operating company that theCompany acquired were reclassified as Class A units of the operatingcompany, and (iii) the holders of the remaining outstanding Class Bunits of the operating company were reclassified as Class B units of theoperating company.  Class A andClass B units of the operating company have the same economic rights perunit.  As of June 30, 2010, theholders of Class A common stock (through the Company) and the holders ofClass B units of the operating company held approximately 14.6% and 85.4%,respectively, of the economic interests in the operations of the business.  As of December 31, 2009, the holders ofClass A common stock (through the Company) and the holders of Class Bunits of the operating company held approximately 13.4% and 86.6%,respectively, of the economic interests in the operations of the business.

 

Each holder of a Class B unit of the operating company is issued acorresponding share of the Company’s Class B common stock, par value$0.000001 per share, in exchange for 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 the Company’s 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 the operating company to issue additional Class Bunits to 

 

17

----

 

**Pzena InvestmentManagement, Inc.**

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

 

employeespursuant to its equity incentive plan, these additional holders of Class Bunits would be entitled to receive a corresponding number of shares of theCompany’s Class B common stock (including if the Class B unitsawarded are subject to vesting).

 

All holders of the Company’s Class B common stock have enteredinto a stockholders’ agreement, pursuant to which they agreed to vote allshares of Class B common stock then held by them, and acquired in thefuture, together on all matters submitted to a vote of the common stockholders.

 

The outstanding shares of the Company’s Class A common stockrepresent 100% of the rights of the holders of all classes of the Company’scapital stock to receive distributions, except that holders of Class Bcommon stock will have the right to receive the class’s par value upon theCompany’s liquidation, dissolution or winding up.

 

Pursuant to the operating agreement of the operating company, eachvested Class B unit is exchangeable for a share of the Company’s Class Acommon stock, subject to certain exchange timing and volume limitations.

 

On March 31, 2010, and March 3, 2009, certain of theoperating company’s members exchanged an aggregate of 734,618 and 2,445,973,respectively, of their Class B units for an equivalent number of shares ofCompany Class A common stock.  Theseacquisitions of additional operating company membership interests were treatedas reorganizations of entities under common control as required by the *Business Combinations Topic* of the FASBASC.

 

The incremental assets and liabilities assumed in the exchanges wererecorded on March 31, 2010 and March 3, 2009 as follows:

 

 
| ** **                                              | ** ** | **March 31,** | ** ** | **March 3,** | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| ** **                                              | ** ** | **2010**           | ** ** | **2009**          | ** ** |
| ** **                                              | ** ** | **(in thousands)** | ** ** |
| ** **                                              | ** ** | ** **         | ** ** | ** **        | ** ** |
| Pzena  Investment Management, LLC Members’ Capital |       | $                  | 10,140     |              | $          | 33,788 |   |
| Pzena  Investment Management, LLC Accumulated Deficit   |       | (9,824             | )          | (33,679           | )          |
| Realizable  Deferred Tax Asset                          |       | 391                |       | 152               |       |
| Net  Tax Receivable Liability to Converting Unitholders |       | (332               | )          | (129              | )          |
| Total                                                   |       | $                  | 375        |              | $          | 132 |   |
|                                                    |       |               |       |              |       |
| Common  Stock, at Par                                   |       | $                  | 7          |              | $          | 25 |   |
| Additional  Paid-in Capital                             |       | 368                |       | 107               |       |
| Total                                                   |       | $                  | 375        |              | $          | 132 |   |

 

**Note 15—Subsequent Events**

 

As required by the *Subsequent EventsTopic* of the FASB ASC, the Company evaluated subsequent eventsthrough the issuance date of its financial statements.

 

On July 27, 2010, the Company’s Board of Directors declared aquarterly dividend of $0.03 per share of Class A common stock, payable onSeptember 2, 2010 to shareholders of record as of August 19, 2010.

 

18

----

 

**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**Overview**

 

Weare an investment management firm that utilizes a classic value investmentapproach in each of our investment strategies. We currently manage assets in avariety of value-oriented investment strategies across a wide range of marketcapitalizations in both U.S. and non-U.S. capital markets.  At June 30, 2010, our assets undermanagement, or AUM, was $13.1 billion. We manage separate accounts on behalf of institutions and high net worthindividuals and act as a sub-investment adviser for a variety of SEC-registeredmutual funds and offshore funds.

 

Wefunction as the holding company through which the business of our operatingcompany, Pzena Investment Management, LLC, is conducted.  Following our initial public offering andreorganization on October 30, 2007, we became the sole managing member ofPzena Investment Management, LLC. As such, we now control its business and affairs and, therefore,consolidate its financial results with ours. In light of our employees’ and other investors’ collective membershipinterest in our operating company, we reflect their ownership as anon-controlling interest in our consolidated financial statements.  As a result, subsequent to October 30,2007, our income is generated by our economic interest in our operating company’snet income.  As of June 30, 2010,the holders of Class A common stock (through the Company) and the holdersof Class B units of the operating company held approximately 14.6% and85.4%, respectively, of the economic interests in the operations of thebusiness.

 

**Revenue**

 

Wegenerate revenue primarily from management fees and incentive fees, which wecollectively refer to as our advisory fees, by managing assets on behalf ofinstitutional accounts and for retail clients, which are generally open-endmutual funds catering primarily to retail clients.  Our advisory fee income is recognized overthe period in which investment management services are provided.  Following the preferred method identified inthe *Revenue Recognition Topic* ofthe Financial Accounting Standards Board Accounting Standards Codification (“FASBASC”), income from incentive fees is recorded at the conclusion of thecontractual performance period, when all contingencies are resolved.

 

Ouradvisory fees are primarily driven by the level of our AUM.  Our AUM increases or decreases with the netinflows or outflows of funds into our various investment strategies and withthe investment performance thereof.  Inorder to increase our AUM and expand our business, we must develop and marketinvestment strategies that suit the investment needs of our target clients andprovide attractive returns over the long term. The value and composition of our AUM, and our ability to continue toattract clients, will depend on a variety of factors including, among otherthings:

 

·                  our ability toeducate our target clients about our classic value investment strategies andprovide them with exceptional client service;

 

·                  the relativeinvestment performance of our investment strategies, as compared to competingproducts and market indices;

 

·                  competitiveconditions in the investment management and broader financial services sectors;

 

·                  generaleconomic conditions;

 

·                  investorsentiment and confidence; and

 

·                  our decision toclose strategies when we deem it to be in the best interests of our clients.

 

Forour institutional accounts, we are paid fees according to a schedule, whichvaries by investment strategy.  Thesubstantial majority of these accounts pay us management fees pursuant to aschedule in which the rate we earn on the AUM declines as the amount of AUMincreases.  Certain of these clients payus fees according to the performance of their accounts relative to certainagreed-upon benchmarks, which results in a slightly lower base fee, but allowsus to earn higher fees if the relevant investment strategy outperforms theagreed-upon benchmark.

 

Pursuantto our sub-investment advisory agreements with our retail clients, we aregenerally paid a management fee according to a schedule in which the rate weearn on the AUM declines as the amount of AUM increases.  Certain of these funds pay us fixed ratemanagement fees.  Due to thesubstantially larger account size of certain of these accounts, the average advisoryfees we earn on them, as a percentage of AUM, are lower than the advisory feeswe earn on our institutional accounts.

 

Themajority of advisory fees we earn on institutional accounts are based on thevalue of AUM at a specific date on a 

 

19

----

 

quarterlybasis, either in arrears or advance. Generally, advisory fees on certain of our institutional accounts, andwith respect to most of our retail accounts, are calculated based on theaverage of the monthly or daily market values. Advisory fees are generally adjusted for any cash flows into or out of aportfolio, where the cash flow represents greater than 10% of the value of theportfolio.  While a specific group ofaccounts may use the same fee rate, the method used to calculate the fee accordingto the fee rate schedule may differ as described above.

 

Ouradvisory fees may fluctuate based on a number of factors, including thefollowing:

 

·                  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 institutional accounts and retail accounts, for which we generallyearn lower overall advisory fees; and

 

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

 

**Expenses**

 

Ourexpenses consist primarily of compensation and benefits expenses, as well asgeneral and administrative expenses. These expenses may fluctuate due to a number of factors, including thefollowing:

 

·                  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**

 

Ourlargest expense is compensation and benefits, which includes the salaries,bonuses, equity-based compensation and related benefits and payroll costsattributable to our members and employees. Compensation and benefits packages are benchmarked against relevantindustry and geographic peer groups in order to attract and retain qualifiedpersonnel.  The table included in thesection below describes the components of our compensation expense for thethree and six months ended June 30, 2010 and 2009:

 
| ** **                               | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                               | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **(in thousands)**       | ** ** |
|                                     |       |                     |       |                    |       |   |   |   |   |
| Cash  Compensation and Other Benefits    |       | $                        | 6,441      |                    | $          | 5,673 |   | $ | 12,987 |   | $ | 11,462 |   |
| Other  Non-Cash Compensation             |       | 822                      |       | 310                     |       | 1,664 |   | 561 |   |
| Total  Compensation and Benefits Expense |       | $                        | 7,263      |                    | $          | 5,983 |   | $ | 14,651 |   | $ | 12,023 |   |

 

Pursuantto the Pzena Investment Management, LLC 2006 Equity Incentive Plan (the “2006Plan”) and the Pzena Investment Management, Inc. 2007 Equity IncentivePlan (“the 2007 Plan,” together the “2006 and 2007 Plans”), we have issuedrestricted Class B units and options to acquire Class B units in ouroperating company, and options to acquire shares of our Class A commonstock, all of which vest ratably over the respective award’s vestingperiod.  We used a fair-value method inrecording the compensation expense associated with the granting of thesestock-based compensation awards.  Underthis method, compensation expense is measured at the grant date based on theestimated fair value of the award and is recognized over the award’s vestingperiod.  The fair value of the units isdetermined by reference to the market price of our Class A common stock onthe date of grant, since these units are exchangeable for shares of ourClass A common stock on a one-for-one basis.  The fair value of the options to acquireClass B units and options to acquire shares of our Class A commonstock is determined by using an appropriate option pricing model on the grantdate.

 

20

----

 

OnJanuary 1, 2007, we instituted a deferred compensation plan, in whichemployees who earn in excess of $600,000 per year are required to defer a portionof their compensation in excess of this amount. These deferred amounts may take the form of phantom Class B units,or be invested in a variety of third-party funds at the employee’s discretion,and vest ratably over four years. Amounts deferred in any period reduce that period’s cash compensationexpense and vest ratably over a four-year period beginning on January 1 ofthe next year.  Should additional amountsbe deferred in future periods, we would expect the non-cash portion of ourcompensation expense to increase as the existing and subsequently deferredamounts are amortized through income.

 

Asof June 30, 2010, we had approximately $4.1 million in unrecordedcompensation expense related to unvested operating company phantom units issuedpursuant to our deferred compensation plan, operating company Class B unitand option grants issued under our 2006 Plan, and Class A stock and optiongrants issued under our 2007 Plan.  Weexpect that the amortization of the existing unvested amounts will be approximately$1.3 million for the remainder of 2010, $2.6 million for 2011, and $0.1million for 2012, with a negligible amount amortized thereafter.

 

**General and Administrative Expenses**

 

Generaland administrative expenses include professional and outside services fees,office expenses, depreciation and the costs associated with operating andmaintaining our research, trading and portfolio accounting systems.  Our occupancy-related costs and professionalservices expenses, in particular, generally increase or decrease in relativeproportion to the overall size and scale of our business operations.

 

Asa result of our offering on October 30, 2007, we have incurred, and expectto continue to incur, additional expenses associated with being a publiccompany for, among other things, director and officer insurance, director fees,SEC reporting and compliance (including Sarbanes-Oxley compliance),professional fees, transfer agent fees, and other similar expenses.  These additional expenses have and willcontinue to reduce our net income.

 

**Other Income/(Expense)**

 

Otherincome/(expense) is derived primarily from the investment income or loss whicharose from our investments in various private investment vehicles that weemployed to incubate new strategies prior to their redemption during the threemonths ended June 30, 2010, the non-controlling interest allocation of theincome or loss of our consolidated investment partnerships to their outsideinvestors, interest expense on our outstanding debt prior to its extinguishment,mark-to-market movements on our swap agreement prior to its termination, andinterest income generated on our cash balances. Other income/(expense) is also affected by changes in our estimates ofthe liability due to our selling and converting shareholders associated withpayments owed to them under the tax receivable agreement which was executed inconnection with our reorganization and offering on October 30, 2007.  As discussed further below, under “TaxReceivable Agreement,” this liability represents 85% of the amount of cashsavings, if any, in U.S. federal, state, and local income tax that we realizeas a result of the amortization of the increases in tax basis generated fromthe Company’s acquisitions of operating company units from its selling andconverting shareholders.  Amounts waivedby our selling and converting shareholders have, and would, reduce thisliability.  We expect the interest andinvestment components, if any, of other income/(expense), in the aggregate, tofluctuate based on market conditions.

 

**Non-Controlling Interests**

 

Ouroperating company has historically consolidated the results of operations ofthe private investment partnerships over which we exercise a controllinginfluence.  After our reorganization, webecame the sole managing member of our operating company and now control itsbusiness and affairs and, therefore, consolidate its financial results withours.  In light of our employees’ andoutside investors’ 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 June 30, 2010, the holders of Class A common stock(through the Company) and the holders of Class B units of the operatingcompany held approximately 14.6% and 85.4%, respectively, of the economicinterests in the operations of the business.

 

**Income Tax Provision/(Benefit)**

 

Whileour operating company has historically not been subject to U.S. federal andcertain state income taxes, it has been subject to New York City UnincorporatedBusiness Tax.  As a result of ourreorganization, we are subject to taxes applicable to C-corporations.  As such, our effective tax rate has increasedas a result of our reorganization. Valuation allowances are established, when necessary, to reduce deferredtax assets to the amount more likely than not to be realized.  As of June 30, 2010 and  December 31, 2009, the Company’svaluation allowance against the deferred tax asset associated with ouracquisition of operating company units in conjunction with the offering andsubsequent exchanges was $63.6 million and $60.3 million,respectively.

 

21

----

 

**Operating Results**

 

***General***

 

Ourearnings and 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.

 

Beginningin the second half of 2007 and continuing through the quarter endedMarch 31, 2009, the performance of our investment strategies was negativelyimpacted by significant volatility in the equity markets.  Performance prior to March 31, 2009 wasinfluenced by our overweight investment exposure to the financial servicessector in particular.  Subsequent toMarch 31, 2009, all of our investment strategies experienced substantialimprovement in their performance, and significantly outperformed theirrespective benchmarks.  As a result, ourassets under management increased by $2.5 billion, or 23.6%, from$10.6 billion at June 30, 2009, to $13.1 billion at June 30,2010, due to positive performance of $2.2 billion and net inflows of $0.3billion.

 

Forthe three months ended June 30, 2010, we experienced net outflows of $0.3billion, consisting of gross outflows of $1.0 billion, offset by grossinflows of $0.7 billion.  Ourinstitutional accounts experienced gross outflows of $0.5 billion, which wereoffset by $0.3 billion in gross inflows. For the six months ended June 30, 2010, we experienced net outflowsof $0.4 billion, consisting of gross outflows of $1.8 billion, offset bygross inflows of $1.4 billion.  Ourinstitutional accounts experienced gross outflows of $0.8 billion, which wereoffset by $0.7 billion in gross inflows. Institutional gross outflows are frequently due to a wide range of clientdecisions.  For the three and six monthsended June 30, 2010, these decisions included: rebalancing to targetportfolio weight following a strong performance period, adoption of de-riskingstrategies, adjustment of portfolio target weights, and changes by plandecision-makers and investment committees. The institutional gross inflows were mainly attributable to existingclient contributions.

 

Forthe three months ended June 30, 2010, our retail accounts experienced$0.5 billion in gross outflows and $0.4 billion in grossinflows.  For the six months ended June 30,2010, our retail accounts experienced $1.0 billion in gross outflows and$0.7 billion in gross inflows.

 

Ouraverage AUM fluctuates based on changes in the market value of accounts advisedand managed by us, and on fund flows. Accordingly, given our higher average AUM levels, our revenues for thethree and six months ended June 30, 2010 have increased compared to ourrevenues for the three and six months ended June 30, 2009.  An increase in revenue typically results inhigher operating income and net income.

 

22

----

 

***Assets Under Management and Flows***

 

 

Thechange in AUM in our institutional accounts and our retail accounts for thethree and six months ended June 30, 2010 and 2009 and the twelve monthsended June 30, 2010 is described below:

 

 
| ** **                          | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** | **For the Twelve Months** | ** ** |
|-------------------------------------|------------|--------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** | **Ended June 30,**   | ** ** |
| **Assets  Under Management**        | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010**                  | ** ** | **2009** | ** ** | **2010** | ** ** |
| ** **                          | ** ** | ** **               | ** ** | ** **              | ** ** | **(in billions)**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Institutional  Accounts             |       |                     |       |                    |       |                      |       |   |   |   |   |
| Beginning  of Period Assets         |       | $                        | 11.7       |                    | $          | 6.0                       |       | $ | 10.7 |   | $ | 7.4 |   | $ | 7.5 |   |
| *Inflows*                           | * *   | *0.3*                    | * *   | *0.3*                   | * *   | *0.7*                     | * *   | *0.8* | * * | *2.5* | * * |
| *Outflows*                          | * *   | *(0.5*                   | *)*        | *(0.6*                  | *)*        | *(0.8*                    | *)*        | *(1.2* | *)* | *(1.6* | *)* |
| Net  Flows                          |       | (0.2                     | )          | (0.3                    | )          | (0.1                      | )          | (0.4 | ) | 0.9 |   |
| Market  Appreciation/(Depreciation) |       | (1.5                     | )          | 1.8                     |       | (0.6                      | )          | 0.5 |   | 1.6 |   |
| End  of Period Assets               |       | $                        | 10.0       |                    | $          | 7.5                       |       | $ | 10.0 |   | $ | 7.5 |   | $ | 10.0 |   |
| Retail  Accounts                    |       |                     |       |                    |       |                      |       |   |   |   |   |
| Beginning  of Period Assets         |       | $                        | 3.7        |                    | $          | 2.6                       |       | $ | 3.6 |   | $ | 3.3 |   | $ | 3.1 |   |
| *Inflows*                           | * *   | *0.4*                    | * *   | *0.3*                   | * *   | *0.7*                     | * *   | *0.6* | * * | *1.5* | * * |
| *Outflows*                          | * *   | *(0.5*                   | *)*        | *(0.4*                  | *)*        | *(1.0*                    | *)*        | *(1.0* | *)* | *(2.1* | *)* |
| Net  Flows                          |       | (0.1                     | )          | (0.1                    | )          | (0.3                      | )          | (0.4 | ) | (0.6 | ) |
| Market  Appreciation/(Depreciation) |       | (0.5                     | )          | 0.6                     |       | (0.2                      | )          | 0.2 |   | 0.6 |   |
| End  of Period Assets               |       | $                        | 3.1        |                    | $          | 3.1                       |       | $ | 3.1 |   | $ | 3.1 |   | $ | 3.1 |   |
| Total                               |       |                     |       |                    |       |                      |       |   |   |   |   |
| Beginning  of Period Assets         |       | $                        | 15.4       |                    | $          | 8.6                       |       | $ | 14.3 |   | $ | 10.7 |   | $ | 10.6 |   |
| *Inflows*                           | * *   | *0.7*                    | * *   | *0.6*                   | * *   | *1.4*                     | * *   | *1.4* | * * | *4.0* | * * |
| *Outflows*                          | * *   | *(1.0*                   | *)*        | *(1.0*                  | *)*        | *(1.8*                    | *)*        | *(2.2* | *)* | *(3.7* | *)* |
| Net  Flows                          |       | (0.3                     | )          | (0.4                    | )          | (0.4                      | )          | (0.8 | ) | 0.3 |   |
| Market  Appreciation/(Depreciation) |       | (2.0                     | )          | 2.4                     |       | (0.8                      | )          | 0.7 |   | 2.2 |   |
| End  of Period Assets               |       | $                        | 13.1       |                    | $          | 10.6                      |       | $ | 13.1 |   | $ | 10.6 |   | $ | 13.1 |   |

 

AtJune 30, 2010, our $13.1 billion of AUM was invested in variousvalue-oriented investment strategies representing distinct geographicalsegments.  The following table describesthe allocation of our AUM, as of June 30, 2010 and 2009, among ourinvestment strategies: 

 
| ** **                                                             | ** ** | **AUM at June 30,** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------|------------|
| **Investment  Strategy**                                               | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| ** **                                                             | ** ** | **(in billions)**        | ** ** |
| ** **                                                             | ** ** | ** **               | ** ** | ** ** | ** ** |
| U.S.  Value Strategies                                                 |       | $                        | 8.8        |   | $ | 8.1 |   |
| Global  Value Strategies                                               |       | 2.6                      |       | 1.8 |   |
| Europe,  Australasia, and Far East (“EAFE”) Value Strategies |       | 1.7                      |       | 0.7 |   |
| Total                                                                  |       | $                        | 13.1       |   | $ | 10.6 |   |

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

AtJune 30, 2010, we managed $13.1 billion in total assets, an increaseof $2.5 billion, or 23.6%, from $10.6 billion at June 30, 2009.  The year-over-year increase in AUM wasprimarily due to $2.2 billion in market appreciation.  Improving overall economic conditionscontributed to the performance-related increase in our AUM.

 

AtJune 30, 2010, we managed $10.0 billion in institutional accounts and$3.1 billion in retail accounts, for a total of $13.1 billion inassets.  For the three months ended June 30,2010, assets in institutional accounts decreased by $1.7 billion, or14.5%, from $11.7 billion at June 30, 2009, to $10.0 billion at June 30,2010, due to $1.5 billion in market depreciation and $0.5 billion in grossoutflows, offset by $0.3 billion in gross inflows.  For the three months ended June 30,2010, assets in retail accounts decreased by $0.6 billion, or 16.2%, from $3.7billion at June 30 2009, to $3.1 billion at June 30, 2010, as aresult of $0.5 billion in market depreciation and $0.5 billion ingross outflows, offset by $0.4 billion in gross inflows.

 

23

----

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

AtJune 30, 2010, we managed $13.1 billion in total assets, an increaseof $2.5 billion, or 23.6%, from $10.6 billion at June 30, 2009.  The year-over-year increase in AUM wasprimarily due to $2.2 billion in market appreciation.  Improving overall economic conditionscontributed to the performance-related increase in our AUM.

 

AtJune 30, 2010, we managed $10.0 billion in institutional accounts and$3.1 billion in retail accounts, for a total of $13.1 billion inassets.  For the six months ended June 30,2010, assets in institutional accounts decreased by $0.7 billion, or 6.5%,due to $0.6 billion in market depreciation and $0.8 billion in grossoutflows, offset by $0.7 billion in gross inflows.  For the six months ended June 30, 2010,assets in retail accounts decreased by $0.5 billion, or 13.9%, as a result of$0.2 billion in market depreciation and $1.0 billion in grossoutflows, offset by $0.7 billion in gross inflows.

 

AtJune 30, 2010, institutional accounts represented 76.3% of our total AUM,compared to 70.8% at June 30, 2009. At June 30, 2010, our Global Value and EAFE Value investmentstrategies accounted for 32.8% of our AUM, compared to 23.6% at June 30,2009.

 

***Revenues***

 

Ourrevenues from advisory fees earned on our institutional and retail accounts forthe three and six months ended June 30, 2010 and 2009 is described below:

 
| ** **              | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|-------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| **Revenue**             | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **              | ** ** | **(in thousands)**       | ** ** |
| ** **              | ** ** | ** **               | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Institutional  Accounts |       | $                        | 16,133     |                    | $          | 11,548 |   | $ | 32,265 |   | $ | 22,628 |   |
| Retail  Accounts        |       | 3,255                    |       | 2,684                   |       | 6,273 |   | 5,276 |   |
| Total                   |       | $                        | 19,388     |                    | $          | 14,232 |   | $ | 38,538 |   | $ | 27,904 |   |

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

Ourtotal revenue increased $5.2 million, or 36.6%, to $19.4 million for thethree months ended June 30, 2010, from $14.2 million for the threemonths ended June 30, 2009.  Thischange was driven primarily by an increase in weighted average AUM, whichincreased $4.5 billion, or 45.0%, to $14.5 billion for the threemonths ended June 30, 2010, from $10.0 billion for the three monthsended June 30, 2009.

 

Ourweighted average fee rate was 0.533% and 0.568% for the three months ended June 30,2010 and 2009, respectively.  Thedecrease in the weighted average fee rate was due primarily to an increase inthe average size of our institutional accounts. Our tiered fee schedules typically charge lower rates as account sizeincreases.  Weighted average assets ininstitutional accounts increased $3.9 billion, or 54.9%, to$11.0 billion for the three months ended June 30, 2010, from$7.1 billion for the three months ended June 30, 2009, and had aweighted average fee rate of 0.585% and 0.651% for the three months ended June 30,2010 and 2009, respectively.  Weightedaverage assets in retail accounts increased $0.6 billion, or 20.7%, to$3.5 billion for the three months ended June 30, 2010, from$2.9 billion for the three months ended June 30, 2009, and had aweighted average fee rate of 0.371% and 0.367% for the three months ended June 30,2010 and 2009, respectively.  Theyear-over-year increase was due to the timing of asset flows in our retailaccounts and the expiration of the voluntary partial fee waiver on the JohnHancock Classic Value Fund, which ended in May 2010.

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

Ourtotal revenue increased $10.6 million, or 38.0%, to $38.5 million for thesix months ended June 30, 2010, from $27.9 million for the six monthsended June 30, 2009.  This changewas driven primarily by an increase in weighted average AUM, which increased$4.6 billion, or 47.4%, to $14.3 billion for the six months ended June 30,2010, from $9.7 billion for the six months ended June 30, 2009.

 

Ourweighted average fee rate was 0.538% and 0.572% for the six months ended June 30,2010 and 2009, respectively.  Thedecrease in the weighted average fee rate was due primarily to an increase inthe average size of our institutional accounts. Our tiered fee schedules typically charge lower rates as account sizeincreases.  Weighted average assets ininstitutional accounts increased $4.0 billion, or 58.8%, to$10.8 billion for the six months ended June 30, 2010, from$6.8 billion for the six months ended June 30, 2009, and had aweighted average fee rate of 0.595% and 0.660% for the six months ended June 30,2010 and 2009, respectively.  

 

24

----

 

Weightedaverage assets in retail accounts increased $0.6 billion, or 20.7%, to$3.5 billion for the six months ended June 30, 2010, from$2.9 billion for the six months ended June 30, 2009, and had aweighted average fee rate of 0.359% and 0.364% for the six months ended June 30,2010 and 2009, respectively.  Theyear-over-year decrease in weighted average fee rate for retail assets was dueto the timing of asset flows in our retail accounts and the effects of thevoluntary partial fee waiver on the John Hancock Classic Value Fund, whichcommenced in May 2009 and expired in May 2010.

 

***Expenses***

 

Ouroperating expenses are driven primarily by our compensation costs.  The table below describes the components ofour compensation expense for the three and six months ended June 30, 2010and 2009:

 
| ** **                               | ** ** | **For the Three Months** | ** ** | **For the Six Months**  | ** ** |
|------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **Ended June 30,**  | ** ** | **Ended June 30,** | ** ** |
| ** **                               | ** ** | **2010**                 | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **(in thousands)**       | ** ** |
|                                     |       |                     |       |                    |       |   |   |   |   |
| Cash  Compensation and Other Benefits    |       | $                        | 6,441      |                    | $          | 5,673 |   | $ | 12,987 |   | $ | 11,462 |   |
| Other  Non-Cash Compensation             |       | 822                      |       | 310                     |       | 1,664 |   | 561 |   |
| Total  Compensation and Benefits Expense |       | $                        | 7,263      |                    | $          | 5,983 |   | $ | 14,651 |   | $ | 12,023 |   |

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

Totaloperating expenses increased by $1.4 million, or 17.5%, to $9.4 million for thethree months ended June 30, 2010, from $8.0 million for the three monthsended June 30, 2009.  This increasewas primarily attributable to increases in discretionary bonus accruals.

 

Compensationand benefits expense increased by $1.3 million, or 21.7%, to$7.3 million for the three months ended June 30, 2010, from$6.0 million for the three months ended June 30, 2009.  This increase was primarily a result ofincreases in discretionary bonus accruals. Our employee count increased from 67 at June 30, 2009 to 70 at June 30,2010.

 

Generaland administrative expenses increased by $0.2 million, or 10.0%, to$2.2 million for the three months ended June 30, 2010, from$2.0 million for the three months ended June 30, 2009.  This increase was mainly attributable toincreases in research- and marketing-related travel expenses.

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

Totaloperating expenses increased by $2.3 million, or 14.0%, to $18.7 million forthe six months ended June 30, 2010, from $16.4 million for the six monthsended June 30, 2009.  This increasewas primarily attributable to increases in discretionary bonus accruals.

 

Compensationand benefits expense increased by $2.7 million, or 22.5%, to$14.7 million for the six months ended June 30, 2010, from$12.0 million for the six months ended June 30, 2009.  This increase was primarily a result ofincreases in discretionary bonus accruals. Our employee count increased from 67 at June 30, 2009 to 70 at June 30,2010.

 

Generaland administrative expenses decreased by $0.3 million, or 6.8%, to$4.1 million for the six months ended June 30, 2010, from$4.4 million for the six months ended June 30, 2009.  This decrease was mainly attributable todecreases in professional fees.

 

***Other Income/(Expense)***

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

Otherincome/(expense) was income of $0.4 million for the three months ended June 30,2010.  Exclusive of $1.1 million in otherincome associated with a decrease in our liability to our selling andconverting shareholders associated with changes in the realizability of ourrelated deferred tax asset, other income/(expense) was an expense of $0.7million.  This expense consistedprimarily of $0.9 million in expense related to the negative performance ofinvestments in our own products, partially offset by $0.2 million ofmiscellaneous income.  Of the $0.9million in expense related to the negative performance of investments in ourown products, $0.2 million was attributable to the outside interests of ourinvestment partnerships.

 

25

----

 

Otherincome/(expense) was income of $2.9 million for the three months ended June 30,2009.  Exclusive of $0.6 million in otherexpense associated with an increase in our liability to our selling andconverting shareholders associated with changes in the realizability of our relateddeferred tax asset, other income/(expense) was income of $3.5 million.  This income consisted primarily of $3.7million in income related to the positive performance of investments in our ownproducts and $0.1 million of miscellaneous income, offset by $0.3 million innet interest expense.  Of the $3.7million in income related to the positive performance of investments in our ownproducts, $2.3 million was attributable to the outside interests of ourinvestment partnerships.

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

Otherincome/(expense) was an expense of $0.3 million for the six months ended June 30,2010.  Exclusive of $0.1 million in otherincome associated with a decrease in our liability to our selling andconverting shareholders associated with changes in the realizability of ourrelated deferred tax asset, other income/(expense) was an expense of $0.4million.  This expense consistedprimarily of $0.4 million in expense related to the negative performance of ourinvestments in our own products.  Of this$0.4 million, $0.2 million was attributable to the outside interests of ourinvestment partnerships.

 

Otherincome/(expense) was income of $0.2 million for the six months ended June 30,2009.  Exclusive of $1.2 million in otherexpense associated with an increase in our liability to our selling andconverting shareholders associated with changes in the realizability of ourrelated deferred tax, other income/(expense) was income of $1.4 million.  This income consisted primarily of $1.9 millionin income related to the positive performance of our investments in our ownproducts and $0.1 million in miscellaneous income, offset by $0.6 million innet interest expense.  Of the $1.9million in income related to the positive performance of our investments in ourown products, $1.0 million was attributable to the outside interests of ourinvestment partnerships.

 

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

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

Theincome tax provision/(benefit) was a provision of $2.5 million for the threemonths ended June 30, 2010.  Thisprovision was generated primarily by an increase of $1.4 million to thevaluation allowance against our deferred tax asset associated with our taxreceivable agreement.  Exclusive of thisadjustment, the remaining income tax provision for the three months ended June 30,2010 consisted of $0.6 million in operating company unincorporated businesstaxes and $0.5 million in corporate income taxes.   The income tax provision/(benefit) for thethree months ended June 30, 2009 was a benefit of $0.1 million and wasgenerated primarily by a reduction of $0.9 million to the valuation allowanceagainst our deferred tax asset associated with our tax receivableagreement.  Exclusive of this adjustment, the remaining income taxprovision for the three months ended June 30, 2009 consisted of $0.4million in operating company unincorporated business taxes and $0.4 million incorporate income taxes.  A comparison of the effective tax rate for thethree months ended June 30, 2010 to that of the three months ended June 30,2009 is not meaningful due to the valuation allowance adjustments.

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

Theincome tax provision/(benefit) was a provision of $2.4 million for the sixmonths ended June 30, 2010. Exclusive of an increase of $0.1 million to the income tax provisionrelated to an increase to the valuation allowance against our deferred taxasset associated with our tax receivable agreement, the remaining income taxprovision for the six months ended June 30, 2010 consisted of $1.2 millionin operating company unincorporated business taxes and $1.1 million incorporate income taxes.   The incometax provision/(benefit) for the six months ended June 30, 2009 was a benefitof $0.3 million and was generated primarily by a reduction of $1.6 million tothe valuation allowance against our deferred tax asset associated with our taxreceivable agreement.  Exclusive of this adjustment, the remaining incometax provision for the six months ended June 30, 2009 consisted of $0.7million in operating company unincorporated business taxes and $0.6 million incorporate income taxes.  A comparison of the effective tax rate for thesix months ended June 30, 2010 to that of the six months ended June 30,2009 is not meaningful due to the valuation allowance adjustments.

 

***Non-Controlling Interests***

 

*Three Months Ended June 30, 2010 versus June 30,2009*

 

Netincome attributable to non-controlling interests was $7.3 million for thethree months ended June 30, 2010, and consisted almost entirely of$7.5 million associated with our employees’ and outside investors’interest in the income of the operating company, offset by $0.2 million of theabsorption, by our consolidated subsidiaries, of their share of the losses ofour consolidated investment partnerships. Net income attributable to non-controlling interests was$8.5 million for the three months ended June 30, 2009, and consistedof $6.1 million associated with our employees’ and outside investors’interest in the income of the operating company and 

 

26

----

 

$2.4 millionof income from our consolidated subsidiaries’ interest in the earnings of ourconsolidated investment partnerships. The increase in the interest in the earnings of the operating company isprimarily a result of the increase in our weighted average AUM, which had acorresponding positive impact on revenues and income.  The decrease in our consolidated subsidiaries’interest in the earnings of our consolidated investment partnerships isprimarily a result of the deconsolidation of the Pzena Global Value Service andthe Pzena EAFE Value Service on December 31, 2009.

 

*Six Months Ended June 30, 2010 versus June 30,2009*

 

Netincome attributable to non-controlling interests was $15.6 million for thesix months ended June 30, 2010, and consisted almost entirely of$15.8 million associated with our employees’ and outside investors’interest in the income of the operating company, offset by $0.2 million of theabsorption, by our consolidated subsidiaries, of their share of the losses ofour consolidated investment partnerships. Net income attributable to non-controlling interests was$10.7 million for the six months ended June 30, 2009, and consistedof $9.7 million associated with our employees’ and outside investors’interest in the income of the operating company and $1.0 million of incomefrom our consolidated subsidiaries’ interest in the earnings of ourconsolidated investment partnerships. The increase in the interest in the earnings of the operating company isprimarily a result of the increase in our weighted average AUM, which had acorresponding positive impact on revenues and income.  The decrease in our consolidated subsidiaries’interest in the earnings of our consolidated investment partnerships isprimarily a result of the deconsolidation of the Pzena Global Value Service andthe Pzena EAFE Value Service on December 31, 2009.

 

***Non-GAAP Net Income***

 

Our results for the three and six months ended June 30, 2010 and2009 included adjustments related to our tax receivable agreement and theassociated liability to our selling and converting shareholders.  Excluding these adjustments, diluted netincome and diluted net income per share was $5.0 million and $0.08,respectively, for the three months ended June 30, 2010, and$4.0 million and $0.06, respectively, for the three months ended June 30,2009.  On a similar basis, diluted netincome and diluted net income per share was $10.5 million and $0.16,respectively, for the six months ended June 30, 2010, and$6.4 million and $0.10, respectively, for the six months ended June 30,2009.  We believe that excluding theseadjustments provides information to better analyze our operations betweenperiods and over time. Investors should consider these non-GAAP measures inaddition to, and not as a substitute for, financial measures prepared in accordancewith GAAP.

 

A reconciliation of the non-GAAP measures to the most comparable GAAPmeasures is included below:

 
| ** **                                                                                                        | ** ** | **For the Three Months**                               | ** ** | **For the Six Months**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                        | ** ** | **Ended June 30,**                                | ** ** | **Ended June 30,** | ** ** |
| ** **                                                                                                        | ** ** | **2010**                                               | ** ** | **2009**                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                                        | ** ** | **(in thousands, except share and per-share amounts)** | ** ** |
|                                                                                                              |       |                                                   |       |                    |       |   |   |   |   |
| GAAP  Net Income                                                                                                  |       | $                                                      | 473        |                    | $          | 821 |   | $ | 1,457 |   | $ | 1,303 |   |
| Net  Effect of Tax Receivable Agreement                                                                           |       | 261                                                    |       | (274                    | )          | 21 |   | (486 | ) |
| Non-GAAP  Net Income                                                                                              |       | $                                                      | 734        |                    | $          | 547 |   | $ | 1,478 |   | $ | 817 |   |
|                                                                                                              |       |                                                   |       |                    |       |   |   |   |   |
| GAAP  Non-Controlling Interest of Pzena Investment Management, LLC                                                |       | $                                                      | 7,470      |                    | $          | 6,119 |   | $ | 15,761 |   | $ | 9,685 |   |
| Less:  Assumed Corporate Income Taxes                                                                             |       | 3,201                                                  |       | 2,622                   |       | 6,754 |   | 4,150 |   |
| Assumed  After-Tax Income of Pzena Investment Management, LLC                                                     |       | $                                                      | 4,269      |                    | $          | 3,497 |   | $ | 9,007 |   | $ | 5,535 |   |
| Non-GAAP  Net Income of Pzena Investment Management, Inc.                                                    |       | 734                                                    |       | 547                     |       | 1,478 |   | 817 |   |
| Non-GAAP  Diluted Net Income                                                                                      |       | $                                                      | 5,003      |                    | $          | 4,044 |   | $ | 10,485 |   | $ | 6,352 |   |
|                                                                                                              |       |                                                   |       |                    |       |   |   |   |   |
| Non-GAAP  Diluted Earnings Per Share Attributable to Pzena Investment  Management, Inc. Common Stockholders: |       |                                                   |       |                    |       |   |   |   |   |
| Non-GAAP  Net Income for Diluted Earnings per Share                                                               |       | $                                                      | 5,003      |                    | $          | 4,044 |   | $ | 10,485 |   | $ | 6,352 |   |
| Non-GAAP  Diluted Earnings per Share                                                                              |       | $                                                      | 0.08       |                    | $          | 0.06 |   | $ | 0.16 |   | $ | 0.10 |   |
| Non-GAAP  Diluted Weighted Average Shares Outstanding                                                             |       | 65,021,332                                             |       | 64,778,860              |       | 65,012,960 |   | 64,566,604 |   |

 

27

----

 

**Liquidityand Capital Resources**

 

Historically, the working capital needs of our business have primarilybeen met through cash generated by our operations.  Distributions to members of our operatingcompany and loan amortization payments have been our largest use of cash fromfinancing activities.  Investingactivities have historically been investments in our own investment strategiesand, to a lesser extent, capital expenditures.

 

AtJune 30, 2010, our cash and cash equivalents was $23.6 million, inclusiveof $2.1 million set aside to satisfy our obligations under our deferredcompensation program and $0.1 million in cash held by our consolidatedinvestment partnerships.  Advisory feesreceivable were $13.3 million.

 

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 June 30, 2010, our weighted average AUM and revenues increased by45.0% and 36.6%, respectively, compared to the three months ended June 30,2009.  These increases contributed to an80.0% increase in our cash provided by operating activities for the comparableperiod.  As of and for the six monthsended June 30, 2010, our weighted average AUM and revenues increased by47.4% and 38.0%, respectively, compared to the six months ended June 30,2009.  These increases contributed to a37.9% increase in our cash provided by operating activities for the comparableperiod.

 

In determining the sufficiency of liquidity and capital resources tofund our business, we regularly monitor our liquidity position, including,among other things, cash, working capital, investments, long-term liabilities,lease commitments, debt obligations, and operating company distributions.  Further, we consider cash compensation, oneof our largest expenses, as sufficiently variable such that it can be adjustedto mitigate any potential decline in revenue we may experience in the nexttwelve months.  We continuously evaluateour staffing requirements and compensation levels with reference to our ownliquidity position and external peer benchmarking data.  The result of this review directly influencesmanagement’s recommendations to our Board of Directors with respect to suchstaffing and compensation levels.

 

We anticipate that distributions to the members of our operatingcompany, which consisted of 34 of our employees, certain unaffiliated persons,two former employees, and us, will continue to be a material financingactivity.

 

During the three months ended June 30, 2010, we repaid theremaining $7.5 million principal amount outstanding of the Senior SubordinatedNotes held by the entities established by Richard S. Pzena.  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, if required,would be available on acceptable terms.

 

We do not anticipate meaningful outlays for internal investment orcapital expenditures over the next twelve months.

 

We believe that the repayment of our term loan and Senior SubordinatedNotes and our ability to vary cash compensation levels have provided us with anappropriate degree of flexibility in providing for our liquidity needs.

 

**DividendPolicy**

 

We are a holding company and have no material assets other than ourownership of membership interests in our operating company.  As a result, we depend upon distributionsfrom our operating company to pay any dividends that our Board of Directors maydeclare to be paid to our Class A common stockholders.  When, and if, our Board of Directors declaresany such dividends, we then cause our operating company to make distributionsto us in an amount sufficient to cover the amount of the dividendsdeclared.  Our dividend policy hascertain risks and limitations, particularly with respect to liquidity.  We may not pay dividends to our Class Acommon shareholders in amounts that have been paid to them in the past, or atall, if, among other things, we do not have the cash necessary to pay ourintended dividends.  To the extent we donot have cash on hand sufficient to pay dividends in the future, we may decidenot to pay dividends.  By paying cashdividends rather than investing that cash in our future growth, we risk slowingthe pace of our growth, or not having a sufficient amount of cash to fund ouroperations or unanticipated capital expenditures, should the need arise.

 

**Term Loan and Senior Subordinated Notes**

 

During the year ended December 31, 2009, we used cash generatedfrom operations to repay the remaining $22.0 million of the principalamount outstanding under our term loan. Concurrently with the termination of this term loan, a security interestin our accounts receivable and one of our subsidiaries was released by thelender in September 2009.

 

28

----

 

During the three months ended June 30, 2010, we used cash on handto repay the remaining $7.5 million principal amount outstanding of the SeniorSubordinated Notes held by the entities established by Richard S. Pzena.

 

**TaxReceivable Agreement**

 

Our purchase of Class B units of our operating companyconcurrently with our initial public offering, and the subsequent and futureexchanges by holders of Class B units of our operating company for sharesof our Class A common stock (pursuant to the exchange rights provided forin the operating company’s operating agreement), has resulted in, and isexpected to continue to result in, increases in our share of the tax basis ofthe tangible and intangible assets of our operating company at the time of ouracquisitions and these subsequent and future exchanges, which will increase thetax depreciation and amortization deductions that otherwise would not have beenavailable to us.  These increases in taxbasis and tax depreciation and amortization deductions have reduced, and areexpected to continue to reduce, the amount of tax that we would otherwise berequired to pay in the future.  We haveentered into a tax receivable agreement with the current members of ouroperating company, the one member of our operating company immediately prior toour initial public offering who sold all of its Class B units to us in connectionwith our initial public offering, and any future holders of Class B units,that requires 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 anypayments that we were required to make to them for the 2008 and 2009 tax yearspursuant to the tax receivable agreement.

 

**Cash Flows**

 

Operating activities provided $14.5 million and $8.1 millionfor the three months ended June 30, 2010 and 2009, respectively.  Operating activities provided$24.7 million and $17.9 million for the six months ended June 30,2010 and 2009, respectively.  Theyear-over-year increase in cash flows from operating activities was drivenprimarily by an increase in weighted average AUM from $10.0 billion forthe three months ended June 30, 2009, to $14.5 billion for the threemonths ended June 30, 2010, and an increase in weighted average AUM from$9.7 billion for the six months ended June 30, 2009, to$14.3 billion for the six months ended June 30, 2010, which had acorresponding positive impact on total revenues.

 

Investing activities consist primarily of investments in affiliates andother investment partnerships, as well as capital expenditures.  Investing activities provided $2.8 millionand $2.9 million for the three months and six months ended June 30, 2010,respectively, and less than $0.1 million for both the three and six monthsended June 30, 2009.  The cashprovided for the three and six months ended June 30, 2010 consistedprimarily of $2.8 million of proceeds from the disposition of certain of ourinvestments in our products.

 

Financing activities consist primarily of borrowing arrangements anddistributions to and contributions from non-controlling interests.  Financing activities used $13.4 millionand $8.9 million for the three months ended June 30, 2010 and 2009,respectively.  The $4.5 million increasein financing activities is primarily attributable to a $5.0 million increase indistributions to non-controlling interests, a $3.5 million increase inprincipal repayments associated with our debt obligations, and a $0.3 millionincrease in dividends paid, offset by a $4.3 million increase in contributionsfrom non-controlling interests.

 

Financing activities used $19.9 million and $19.5 million for the sixmonths ended June 30, 2010 and 2009, respectively.   The $0.4 million increase in financingactivities is primarily attributable to a $6.4 million increase indistributions to non-controlling interests and a $0.3 million increase individends paid, offset by a $4.3 million increase in contributions fromnon-controlling interests and a $2.0 million decrease in principal repaymentsassociated with our debt obligations.

 

**Off-Balance Sheet Arrangements**

 

We did not have any off-balance sheet arrangements as of June 30,2010.

 

**Critical Accounting Policies andEstimates**

 

The preparation of our consolidated financial statements in accordancewith U.S. generally accepted accounting principles (“GAAP”) requires managementto make estimates and judgments that affect our reported amounts of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities.  We base our estimateson historical experience and on various other assumptions that are believed tobe reasonable under current circumstances, the results of which form the basisfor making 

 

29

----

 

judgmentsabout the carrying value of assets and liabilities that are not readilyavailable from other sources.  Weevaluate our estimates on an ongoing basis. Actual results may differ from these estimates under differentassumptions or conditions.

 

Accounting policies are an integral part of our financialstatements.  A thorough understanding ofthese accounting policies is essential when reviewing our reported results ofoperations and our financial condition. Management believes that the criticalaccounting policies discussed below involve additional management judgment dueto the sensitivity of the methods and assumptions used.

 

***Consolidation***

 

Our policy is to consolidate all majority-owned subsidiaries in whichwe have a controlling financial interest and variable interest entities (“VIEs”)of which we are deemed to be the primary beneficiary.  We also consolidate non-VIEs which we controlas the general partner or managing member. We assess our consolidationpractices regularly, as circumstances dictate. All significant inter-company transactions and balances have beeneliminated.

 

***Income Taxes***

 

We are a C-corporation under the Internal Revenue Code, and thus liablefor federal, state and local taxes on the income derived from our economicinterest in our operating company.  Theoperating company is a limited liability company that has elected to be treatedas a partnership for tax purposes.  Ouroperating company has not made a provision for federal or state income taxesbecause it is the responsibility of each of the operating company’s members(including us) to separately report their proportionate share of the operatingcompany’s taxable income or loss. Similarly, the income of our consolidatedinvestment partnerships is not subject to income taxes, as such income isallocated to each partnership’s individual partners.  The operating company has made a provisionfor New York City Unincorporated Business Tax (“UBT”).

 

We recognize deferred tax assets and liabilities for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases, net operating loss carryforwards and tax credits.  A valuation allowance is maintained fordeferred tax assets that we estimate are more likely than not to beunrealizable based on available evidence at the time the estimate is made.  Determining the valuation allowance requiressignificant management judgments and assumptions.  In determining the valuation allowance, weuse historical and forecasted future operating results, based upon approvedbusiness plans, including a review of the eligible carryforward periods, taxplanning opportunities and other relevant considerations.  Each quarter, we re-evaluate our estimaterelated to the valuation allowance, including our assumptions about futureprofitability.

 

We believe that the accounting estimate related to the$63.6 million valuation allowance, assessed as of June 30, 2010 againstthe deferred tax asset associated with our acquisitions of operating companyClass B units, is a critical accounting estimate because the underlyingassumptions can change from period to period. For example, tax law changes, or variances in future projected operatingperformance, could result in a change in the valuation allowance.  If we were not able to realize all or part ofour net deferred tax assets in the future, an adjustment to our deferred taxassets valuation allowance would be charged to income tax expense in the periodsuch determination was made.

 

Management judgment is required in determining our provision for incometaxes, evaluating our tax positions and establishing deferred tax assets andliabilities.  The calculation of our taxliabilities involves dealing with uncertainties in the application of complextax regulations.  If our estimate of taxliabilities proves to be less than the ultimate assessment, a further charge toearnings would result.

 

**RecentAccounting Pronouncements**

 

InJune 2009, the FASB issued a new standard that requires an enterprise toperform a qualitative analysis to determine whether its variable-interests giveit a controlling financial interest in a VIE. Under the standard, an enterprise has a controlling financial interestwhen it has (a) the power to direct the activities of a VIE that mostsignificantly impact the entity’s economic performance, and (b) theobligation to absorb losses of the entity or the right to receive benefits fromthe entity that could potentially be significant to the VIE.  An enterprise that holds a controllingfinancial interest in a VIE is deemed to be the primary beneficiary of the VIEand is required to consolidate the VIE. The standard also requires an ongoing assessment of whether anenterprise is the primary beneficiary of a VIE, and additional disclosuresabout an enterprise’s involvement in VIEs, and any significant changes in riskexposure due to that involvement.  Thestandard is effective for fiscal years beginning after November 15,2009.  In November 2009, the FASBissued a proposed standard update, which defers the consolidation criteriarequirements of this new standard for assets managers’ interests in entitiesthat apply the specialized accounting guidance for investment companies, orthat have the attributes of investment companies.  As of January 27, 2010, the FASB decidedto make official the deferral of this standard 

 

30

----

 

forcertain investment entities.  We have evaluatedour interests in entities and determined that the standard is applicable forour investment in our operating company, but that we meet the criteria fordeferral provided in this standard for our consolidated funds.  We adopted the updated guidance onJanuary 1, 2010, and it had no impact on our consolidated financialstatements.  We are monitoring futureguidance for updates on the treatment of our interests in our consolidatedsubsidiaries.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk.**

 

**Market Risk**

 

Our exposure to market risk is directlyrelated to our role as investment adviser for the institutional separateaccounts we manage and the retail clients for which we act as a sub-investmentadviser.  Global markets have experiencedunprecedented volatility, and the current economic environment ischallenging.  Market conditions have, inthe recent past, resulted in a significant reduction in our AUM, which in turndirectly impacted our revenues and net income. A resumption of the economic downturn, and volatility in the globalfinancial markets, could also significantly affect the estimates, judgments,and assumptions used in the valuation of our financial instruments.

 

All of our revenue for the three and sixmonths ended June 30, 2010 and 2009 was derived from advisory fees, whichare typically based on the market value of AUM, which can be affected byadverse changes in interest rates, foreign currency exchange and equityprices.  Accordingly, a decline in theprices of securities would cause our revenue and earnings to decline due to adecrease in the value of the assets we manage. In addition, such a decline could cause our clients to withdraw theirfunds in favor of investments offering higher returns or lower risk, which wouldcause our revenue and earnings to decline further.

 

***Interest RateRisk***

 

We have no exposure to interest rate risk at June 30, 2010.

 

**Item 4.   Controls and Procedures.**

 

During the course of their review of ourconsolidated financial statements as of June 30, 2010, our management,including our Chief Executive Officer and Chief Financial Officer, evaluatedthe effectiveness of our disclosure controls and procedures pursuant toRule 13a-15 under the Securities Exchange Act of 1934, as amended (the“Exchange Act”).  Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that, as of June 30, 2010, our disclosure controls andprocedures (as defined in Rule 13a-15(e) under the Exchange Act) wereeffective to ensure that information we are required to disclose in reportsthat 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 have not been any changes in ourinternal control over financial reporting during the three and six months endedJune 30, 2010 that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

31

----

 

**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

In the normal course of business, we may be subject to various legaland administrative proceedings.

 

Currently, there are no material legal proceedings pending against us.

 

**Item 1A.  Risk Factors.**

 

There are no material changes from the risk factors set forth inPart 1, Item 1A of the Company’s 2009 Annual Report onForm 10-K.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds.**

 

None.

 

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

 

None.

 

**Item 4.****(Removed and Reserved).**

 

**Item 5.  Other Information.**

 

None.

 

**Item 6.  Exhibits.**

 
| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 |

 

32

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

Dated: August 4, 2010

 
|   | 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* |

 

33

----