Table ofContents

 

 

 

**UNITEDSTATESSECURITIES 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, 2009**                                                                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                                                                                                                | ** **                                                                                              |
| **Or**                                                                                                                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                                                                                                                | ** **                                                                                              |
| o                                                                                                                                                                                                                                                                                                                         | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
| ** **                                                                                                                                                                                                                                                                                                                | ** **                                                                                              |
| **For the  transition period from                       to                       ** |

 

**Commission file number 001-33761**

 

**PZENAINVESTMENT MANAGEMENT, INC.**

(Exact Name of Registrant asSpecified in its Charter)

 

| **Delaware**

(State or Other  Jurisdiction of  Incorporation or Organization) | ** ** | **20-8999751**

(I.R.S. Employer  Identification No.) |
|--------------------------------------------------------------------------------|------------|-------------------------------------------------------|

 

**120 West 45th StreetNew York, New York 10036**

(Address of PrincipalExecutive Offices)

 

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

 

**NotApplicable**

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

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate web site, if any, everyInteractive Date File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files). Yes o    No o

 

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

 

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

 

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

 

As of August 10, 2009,there were 8,633,041 outstanding shares of the registrant’s Class A commonstock, par value $0.01 per share.

 

As of August 10, 2009,there were 55,637,962 outstanding shares of the registrant’s Class Bcommon stock, par value $0.000001 per share.

 

 

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**FORM 10-Q**

**TABLE OFCONTENTS**

 
| ** **   | ** ** | ** **                                                                                                                                                                  | ** ** | **Page** |
|--------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|         | ** ** | **PART I — FINANCIAL INFORMATION**                                                                                                                                |       |     |
| Item 1. |       | Consolidated Statements of Financial  Condition of Pzena Investment Management, Inc. as of June 30, 2009  (unaudited) and December 31, 2008                  |       | 1        |
|         |       | Consolidated Statements of Operations  (unaudited) of Pzena Investment Management, Inc. for the Three and Six  Months Ended June 30, 2009 and June 30, 2008  |       | 2        |
|         |       | Consolidated  Statements of Cash Flows (unaudited) of Pzena Investment  Management, Inc. for the Three and Six Months Ended June 30, 2009  and June 30, 2008 |       | 3        |
|         |       | Consolidated Statements of  Changes in Equity (unaudited) of Pzena Investment Management, Inc. for  the Six Months Ended June 30, 2009 and June 30, 2008     |       | 4        |
|         |       | Notes to the Consolidated Financial Statements  (unaudited)                                                                                                                 |       | 5        |
| Item 2. |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                 |       | 24       |
| Item 3. |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                 |       | 36       |
| Item 4  |       | Controls and  Procedures                                                                                                                                                    |       | 36       |
|         |       |                                                                                                                                                                        |       |     |
|         | ** ** | **PART II  — OTHER INFORMATION**                                                                                                                                  |       |     |
| Item 1. |       | Legal Proceedings                                                                                                                                                           |       | 38       |
| Item 1A |       | Risk Factors                                                                                                                                                                |       | 38       |
| Item 2. |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                |       | 38       |
| Item 3. |       | Defaults Upon  Senior Securities                                                                                                                                            |       | 38       |
| Item 4. |       | Submission of  Matters to a Vote of Security Holders                                                                                                                        |       | 38       |
| Item 5. |       | Other Information                                                                                                                                                           |       | 39       |
| Item 6  |       | Exhibits                                                                                                                                                                    |       | 39       |

 

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**CAUTIONARY STATEMENT REGARDING FORWARD-LOOKINGSTATEMENTS**

 

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

 

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

 

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

 

·                  our anticipatedfuture results of operations and operating cash flows;

 

·                  our businessstrategies and investment policies;

 

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

 

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

 

·                  potentialgrowth opportunities available to us;

 

·                  the recruitmentand retention of our employees;

 

·                  our expectedlevels of compensation for our employees;

 

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

 

·                  our expectedtax rate;

 

·                  changes ininterest rates;

 

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

 

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

 

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

 

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements.**

** **

**PZENA INVESTMENT MANAGEMENT, INC.**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

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

 
| ** **                                                                                                                                                               | ** ** | **As of**               | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                               | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**         | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                               |       |                    |       |   |   |
| Cash and Cash Equivalents                                                                                                                                                |       | $                       | 25,892     |   | $ | 27,421 |   |
| Due from Broker                                                                                                                                                          |       | 35                      |       | 41 |   |
| Advisory Fees Receivable                                                                                                                                                 |       | 10,612                  |       | 13,606 |   |
| Investments in Equity  Securities, at Fair Value                                                                                                                         |       | 15,199                  |       | 14,045 |   |
| Receivable from Related  Parties                                                                                                                                         |       | 127                     |       | 191 |   |
| Other Receivables                                                                                                                                                        |       | 59                      |       | 74 |   |
| Prepaid Expenses and Other  Assets                                                                                                                                       |       | 677                     |       | 949 |   |
| Deferred Tax Asset                                                                                                                                                       |       | 4,678                   |       | 3,444 |   |
| Property and Equipment,  Net of Accumulated Depreciation of $2,154 and $1,913, respectively                                                                              |       | 2,513                   |       | 2,748 |   |
| TOTAL ASSETS                                                                                                                                                             |       | $                       | 59,792     |   | $ | 62,519 |   |
| ** **                                                                                                                                                               |       |                    |       |   |   |
| **LIABILITIES  AND EQUITY**                                                                                                                                              |       |                    |       |   |   |
| Liabilities:                                                                                                                                                             |       |                    |       |   |   |
| Accounts Payable and  Accrued Expenses                                                                                                                                   |       | $                       | 7,474      |   | $ | 4,338 |   |
| Due to Broker                                                                                                                                                            |       | 31                      |       | 47 |   |
| Due to Principals                                                                                                                                                        |       | 653                     |       | — |   |
| Term Loan                                                                                                                                                                |       | 10,000                  |       | 22,000 |   |
| Senior Subordinated Debt  to Related Parties                                                                                                                             |       | 16,000                  |       | 16,000 |   |
| Liability to Selling and  Converting Shareholders                                                                                                                        |       | 3,121                   |       | 1,787 |   |
| Other Liabilities                                                                                                                                                        |       | 1,270                   |       | 2,007 |   |
| TOTAL LIABILITIES                                                                                                                                                        |       | 38,549                  |       | 46,179 |   |
|                                                                                                                                                                     |       |                    |       |   |   |
| Equity:                                                                                                                                                                  |       |                    |       |   |   |
| Preferred Stock (Par Value  $0.01; 200,000,000 Shares Authorized; None Outstanding)                                                                                      |       | —                  |       | — |   |
| Class A Common Stock  (Par Value $0.01; 750,000,000 Shares Authorized; 8,633,041and 6,187,068  Shares Issued and Outstanding in 2009 and 2008, respectively)        |       | 86                      |       | 61 |   |
| Class B Common Stock  (Par Value $0.000001; 750,000,000 Shares Authorized; 55,529,751 and  57,975,724 Shares Issued and Outstanding in 2009 and 2008, respectively) |       | —                  |       | — |   |
| Additional Paid-In Capital                                                                                                                                               |       | 9,813                   |       | 9,749 |   |
| Accumulated Deficit                                                                                                                                                      |       | (3,986                  | )          | (5,289 | ) |
| Total Pzena Investment  Management, Inc.’s Equity                                                                                                              |       | 5,913                   |       | 4,521 |   |
| Non-Controlling Interests                                                                                                                                                |       | 15,330                  |       | 11,819 |   |
| TOTAL EQUITY                                                                                                                                                             |       | 21,243                  |       | 16,340 |   |
| TOTAL LIABILITIES AND  EQUITY                                                                                                                                            |       | $                       | 59,792     |   | $ | 62,519 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                               | ** ** | **For the Three Months Ended  June 30,** | ** ** | **For the Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                                      | ** ** | **2008**                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **REVENUE**                                                                              |       | $                                             | 14,232     |                                        | $          | 28,305 |   | $ | 27,904 |   | $ | 58,317 |   |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **EXPENSES**                                                                             |       |                                          |       |                                        |       |   |   |   |   |
| Compensation and Benefits Expense                                                        |       | 5,983                                         |       | 8,662                                       |       | 12,023 |   | 17,613 |   |
| General and Administrative Expenses                                                      |       | 1,973                                         |       | 2,652                                       |       | 4,426 |   | 5,695 |   |
| TOTAL OPERATING EXPENSES                                                                 |       | 7,956                                         |       | 11,314                                      |       | 16,449 |   | 23,308 |   |
| Operating Income                                                                         |       | 6,276                                         |       | 16,991                                      |       | 11,455 |   | 35,009 |   |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **OTHER INCOME/(EXPENSE)**                                                               |       |                                          |       |                                        |       |   |   |   |   |
| Interest and Dividend Income                                                             |       | 127                                           |       | 541                                         |       | 247 |   | 1,037 |   |
| Interest Expense                                                                         |       | (405                                          | )          | (1,056                                      | )          | (855 | ) | (2,037 | ) |
| Realized and Unrealized  Gain/(Loss), Net on Equity Securities and Securities Sold Short |       | 3,729                                         |       | (3,300                                      | )          | 1,909 |   | (6,880 | ) |
| Other Income/(Expense)                                                                   |       | (515                                          | )          | 26                                          |       | (1,096 | ) | 12 |   |
| Total Other Income/(Expense)                                                             |       | 2,936                                         |       | (3,789                                      | )          | 205 |   | (7,868 | ) |
| Income Before Income Taxes                                                               |       | 9,212                                         |       | 13,202                                      |       | 11,660 |   | 27,141 |   |
| Income Tax Provision/(Benefit)                                                           |       | (64                                           | )          | 1,456                                       |       | (338 | ) | 2,998 |   |
| Consolidated Net Income                                                                  |       | 9,276                                         |       | 11,746                                      |       | 11,998 |   | 24,143 |   |
| Less: Net Income Attributable to Non-Controlling Interests                               |       | 8,455                                         |       | 10,966                                      |       | 10,695 |   | 22,543 |   |
| Net Income Attributable to Pzena Investment Management, Inc.                        |       | $                                             | 821        |                                        | $          | 780 |   | $ | 1,303 |   | $ | 1,600 |   |

 

Earnings Per Share — Basicand Diluted Attributable to Pzena Investment Management, Inc. CommonStockholders:

 
| Net Income for Basic Earnings per Share     |   | $          | 821    |       | $      | 780        |   | $          | 1,303  |   | $ | 1,600  |   |
|---------------------------------------------|--------|------------|--------|------------|--------|------------|--------|------------|--------|--------|---|--------|--------|
| Basic Earnings per Share                    |   | $          | 0.10   |       | $      | 0.13       |   | $          | 0.17   |   | $ | 0.26   |   |
| Basic Weighted Average Shares Outstanding   |   | 8,633,041  |   | 6,123,494  |   | 7,795,194  |   | 6,121,590  |   |
|                                        |   |       |   |       |   |       |   |       |   |
| Net Income for Diluted Earnings per Share   |   | $          | 4,330  |       | $      | 8,124      |   | $          | 6,860  |   | $ | 16,722 |   |
| Diluted Earnings per Share                  |   | $          | 0.07   |       | $      | 0.13       |   | $          | 0.11   |   | $ | 0.26   |   |
| Diluted Weighted Average Shares Outstanding |   | 64,778,860 |   | 64,080,857 |   | 64,566,604 |   | 64,079,122 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                               | ** ** | **For the Three Months Ended  June 30,** | ** ** | **For the Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                                      | ** ** | **2008**                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
| **OPERATING ACTIVITIES**                                                                 |       |                                          |       |                                        |       |   |   |   |   |
| Consolidated Net Income                                                                  |       | $                                             | 9,276      |                                        | $          | 11,746 |   | $ | 11,998 |   | $ | 24,143 |   |
| Adjustments  to Reconcile Net Income to Cash Provided by Operating Activities:           |       |                                          |       |                                        |       |   |   |   |   |
| Depreciation                                                                             |       | 120                                           |       | 118                                         |       | 241 |   | 233 |   |
| Non-Cash Compensation                                                                    |       | 310                                           |       | 389                                         |       | 561 |   | 633 |   |
| Director Share Grant                                                                     |       | —                                        |       | —                                      |       | 280 |   | 140 |   |
| Realized and Unrealized (Gain)/Loss, Net on Equity  Securities and Securities Sold Short |       | (3,729                                        | )          | 3,300                                       |       | (1,909 | ) | 6,880 |   |
| Increase in Liability to Selling and Converting  Shareholders                            |       | 602                                           |       | —                                      |       | 1,204 |   | — |   |
| Deferred Income Taxes                                                                    |       | (526                                          | )          | 517                                         |       | (1,193 | ) | 1,064 |   |
| Changes in Operating Assets and Liabilities:                                             |       |                                          |       |                                        |       |   |   |   |   |
| Advisory Fees Receivable                                                                 |       | (296                                          | )          | 1,128                                       |       | 2,994 |   | 5,564 |   |
| Due from Broker                                                                          |       | 2                                             |       | (12                                         | )          | 6 |   | 179 |   |
| Prepaid Expenses and Other Assets                                                        |       | 153                                           |       | 46                                          |       | 6 |   | 1,157 |   |
| Due to Broker                                                                            |       | (10                                           | )          | 3,330                                       |       | (16 | ) | (645 | ) |
| Due to Principals                                                                        |       | 57                                            |       | —                                      |       | 653 |   | — |   |
| Accounts Payable, Accrued Expenses and Other  Liabilities                                |       | 2,194                                         |       | 1,776                                       |       | 2,325 |   | 3,284 |   |
| Purchases of Equity Securities and Securities Sold  Short                                |       | (2,285                                        | )          | (5,309                                      | )          | (4,857 | ) | (22,145 | ) |
| Proceeds from Sale of Equity Securities and  Securities Sold Short                       |       | 2,184                                         |       | 5,190                                       |       | 5,615 |   | 11,857 |   |
| **Net Cash Provided by Operating  Activities**                                           | ** ** | **8,052**                                     | ** ** | **22,219**                                  | ** ** | **17,908** | ** ** | **32,344** | ** ** |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **INVESTING ACTIVITIES**                                                                 |       |                                          |       |                                        |       |   |   |   |   |
| Receivable from Related Parties                                                          |       | 47                                            |       | (1                                          | )          | 49 |   | 31 |   |
| Purchases of Property and Equipment                                                      |       | (6                                            | )          | (33                                         | )          | (6 | ) | (82 | ) |
| **Net Cash Provided by/(Used in) Investing  Activities**                                 | ** ** | **41**                                        | ** ** | **(34**                                     | **)**      | **43** | ** ** | **(51** | **)** |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **FINANCING ACTIVITIES**                                                                 |       |                                          |       |                                        |       |   |   |   |   |
| Contributions from Non-Controlling Interests                                             |       | —                                        |       | 100                                         |       | — |   | 6,933 |   |
| Distributions to Non-Controlling Interests                                               |       | —                                        |       | (15                                         | )          | — |   | (1,095 | ) |
| Capital Distribution                                                                     |       | —                                        |       | —                                      |       | (9 | ) | — |   |
| Term Loan Repayment                                                                      |       | (4,000                                        | )          | (3,000                                      | )          | (12,000 | ) | (3,000 | ) |
| Dividends                                                                                |       | —                                        |       | (672                                        | )          | — |   | (1,344 | ) |
| Distributions to Members                                                                 |       | (4,906                                        | )          | (17,391                                     | )          | (7,471 | ) | (23,764 | ) |
| **Net Cash Used in Financing  Activities**                                               | ** ** | **(8,906**                                    | **)**      | **(20,978**                                 | **)**      | **(19,480** | **)** | **(22,270** | **)** |
| **NET CHANGE IN CASH**                                                                   | ** ** | **$**                                         | **(813**   | **)**                                       | **$**      | **1,207** | ** ** | **$** | **(1,529** | **)** | **$** | **10,023** | ** ** |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS—Beginning  of Period**                                  |       | $                                             | 26,705     |                                        | $          | 36,000 |   | $ | 27,421 |   | $ | 27,184 |   |
| Net Change in Cash                                                                       |       | (813                                          | )          | 1,207                                       |       | (1,529 | ) | 10,023 |   |
| **CASH AND CASH EQUIVALENTS—End of  Period**                                        |       | $                                             | 25,892     |                                        | $          | 37,207 |   | $ | 25,892 |   | $ | 37,207 |   |
| ** **                                                                               |       |                                          |       |                                        |       |   |   |   |   |
| Supplementary Cash Flow Information:                                                     |       |                                          |       |                                        |       |   |   |   |   |
|  Interest Paid                                                                      |       | $                                             | 392        |                                        | $          | 1,032 |   | $ | 859 |   | $ | 2,014 |   |
|  Income Taxes  Paid                                                                 |       | $                                             | 753        |                                        | $          | 1,650 |   | $ | 1,372 |   | $ | 3,042 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY**

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

 
| ** **                                                                       | ** ** | **Shares of  Class A  Common  Stock** | ** ** | **Shares of  Class B  Common  Stock** | ** ** | **Class A  Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other****Comprehensive****Income** | ** ** | **Retained  Earnings/********(Accumulated  Deficit)** | ** ** | **Non-  Controlling  Interests** | ** ** | **Total**   | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------|------------|-------------|------------|
| **Balance at December 31, 2008**                                            | ** ** | **6,187,068**                                   | ** ** | **57,975,724**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **9,749**                                         | ** ** | **$**                                                 | **—** | ** **                       | **$**      | **(5,289**  | **)**      | **$** | **11,819** | ** ** | **$** | **16,340** | ** ** |
| Unit Conversion                                                                  |       | 2,445,973                                       |       | (2,445,973                                      | )          | 25                              |       | 107                              |       | —                                            |       | —                                                |       | (108                             | )          | **24**      | ** ** |
| Amortization of Non-Cash Compensation                                            |       | —                                          |       | —                                          |       | —                          |       | 43                               |       | —                                            |       | —                                                |       | 318                              | ** ** | **361**     | ** ** |
| Net Income                                                                       |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                            |       | 1,303                                                 |       | 10,695                           | ** ** | **11,998**  | ** ** |
| Capital Distribution                                                             |       | —                                          |       | —                                          |       | (86                             | )          | (9                               | )          | —                                            |       | —                                                |       | (7,394                           | )          | **(7,480**  | **)**      |
| **Balance at June 30, 2009**                                                | ** ** | **8,633,041**                                   | ** ** | **55,529,751**                                  | ** ** | **$**                           | **86**     | ** **                       | **$**      | **9,813**                                         | ** ** | **$**                                                 | —     | ** **                       | **$**      | **(3,986**  | **)**      | **$** | **15,330** | ** ** | **$** | **21,243** | ** ** |
| ** **                                                                       |       |                                            |       |                                            |       |                            |       |                             |       |                                              |       |                                                  | ** ** | ** **                       | ** ** | ** **  | ** ** |
| **Balance at December 31, 2007**                                            | ** ** | **6,111,118**                                   | ** ** | **57,937,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **(2,043**                                        | **)**      | **$**                                                 | **—** | ** **                       | **$**      | **61**      | ** ** | **$** | **16,355** | ** ** | **$** | **14,434** | ** ** |
| Issuance of Class A Common Stock                                            |       | 12,376                                          |       | —                                          |       | —                          |       | 11                               | ** ** | **—**                                        |       | —                                                |       | 118                              | ** ** | **129**     | ** ** |
| Issuance of Class B Common Stock and  Amortization of Non-Cash Compensation |       | —                                          |       | 13,000                                          |       | —                          |       | 28                               |       | —                                            |       | —                                                |       | 266                              | ** ** | **294**     | ** ** |
| Net Income                                                                       |       | —                                          |       | —                                          |       | —                          |       | —                           | ** ** | **—**                                        |       | 1,600                                                 |       | 22,543                           | ** ** | **24,143**  | ** ** |
| Capital Contributions                                                            |       | —                                          |       | —                                          |       | —                          |       | 172                              | ** ** | **—**                                        |       | —                                                |       | 5,838                            | ** ** | **6,010**   | ** ** |
| Accumulated Other Comprehensive Income                                           |       | —                                          |       | —                                          |       | —                          |       | —                           |       | 67                                                |       | —                                                |       | 635                              | ** ** | **702**     | ** ** |
| Equity Effect of Operating Company Net Deficit on  Non-Controlling Interests     |       | —                                          |       | —                                          |       | —                          |       | 3,467                            |       | —                                            |       | —                                                |       | (3,467                           | )          | **—**  | ** ** |
| Capital Distribution                                                             |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                            |       | —                                                |       | (23,764                          | )          | **(23,764** | **)**      |
| Class A Cash Dividends Declared ($0.11 per  share)                          |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                            |       | (1,347                                                | )          | —                           | ** ** | **(1,347**  | **)**      |
| **Balance at June 30, 2008**                                                | ** ** | **6,123,494**                                   | ** ** | **57,950,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **1,635**                                         | ** ** | **$**                                                 | **67**     | ** **                       | **$**      | **314**     | ** ** | **$** | **18,524** | ** ** | **$** | **20,601** | ** ** |

 

See accompanying notes to consolidatedfinancial statements

 

4

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Table of Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements**

 

**Note 1—Organization**

 

Pzena Investment Management, Inc. (the “Company”) functions as theholding company through which the business of its operating company, PzenaInvestment Management, LLC, is conducted. The Company was incorporated inthe State of Delaware on May 8, 2007. Concurrently with the consummation of the Company’s initial publicoffering, on October 30, 2007, the Operating Agreement of Pzena InvestmentManagement, LLC (the “Operating Agreement”) was amended and restated suchthat, among other things, the Company became the sole managing member of PzenaInvestment Management, LLC.  Theacquisition of the operating company’s membership interests by the Company wastreated as a reorganization of entities under common control pursuant to theguidance set forth in Financial Accounting Standards Board (“FASB”), TechnicalBulletin No. 85-5, *Issues Relating toAccounting for Business Combinations* (“FTB 85-5”).  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) theCompany recognizes income generated from its economic interest in PzenaInvestment Management, LLC’s net income.

 

Pzena InvestmentManagement, LLC is an investment adviser which is registered under theInvestment Advisers Act of 1940 and is headquartered in New York, NewYork.  As of June 30, 2009, theCompany managed assets in a variety of value-oriented investment strategiesacross a wide range of market capitalizations in both U.S. and internationalcapital markets.

 

The Company, through itsinvestment in its operating company, has consolidated the results of operationsand financial condition of the following private investment partnerships as of June 30,2009:

 
| **Entity**                                    | ** ** | **Type of  Entity (Date of Formation)**         | ** ** | **Ownership  at  June 30,  2009** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|
| Pzena Large Cap Value Fund                    |       | Massachusetts Trust (11/01/2002)                |       | 99.6%                                  |       |
| Pzena International Value  Service            |       | Delaware Limited Liability Company (12/22/2003) |       | 17.5%                                  |       |
| Pzena Global Value Service                    |       | Delaware Limited Liability Company (12/22/2003) |       | 0.6%                                   |       |
| Pzena Emerging Markets  Country Value Service |       | Delaware Limited Liability Company (12/28/2007) |       | 99.9%                                  |       |
| Pzena Emerging Markets  Focused Value Service |       | Delaware Limited Liability Company (12/28/2007) |       | 99.9%                                  |       |

 

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

 

**Note 2—SignificantAccounting Policies**

 

***Basis of Presentation:***

 

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

 

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

 

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**Pzena Investment Management, Inc.**

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

 

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

 

or were, either the operating company or oneof the controlling persons of the operating company, their results ofoperations and financial position have been consolidated.

 

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

 

All of the consolidatedinvestment partnerships are, or were, investment companies under the AmericanInstitute of Certified Public Accountants Audit and Accounting Guide forInvestment Companies.  The Company hasretained the specialized accounting for these partnerships pursuant to EmergingIssues Task Force Issue No. 85-12, *Retentionof Specialized Accounting for Investments in Consolidation* (“EITF 85-12”).  Thus, the Company reports the investmentpartnerships’ investments in equity securities and securities sold short atfair value, with net realized and unrealized gains and losses reported inearnings in the consolidated statements of operations.

 

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

 

The Company acts as theinvestment manager for four trusts and one offshore investment company, each ofwhich are considered variable-interest entities.  All of these entities are vehicles throughwhich the Company offers its Global Value and/or International Valuestrategies.  The Company is notconsidered the primary beneficiary of any of these entities.  Correspondingly, their results of operationsand financial condition are not consolidated by the Company.  The total net assets of thesevariable-interest entities were approximately $412.7 million and$446.0 million at June 30, 2009 and December 31, 2008,respectively.  The Company is not exposedto losses as a result of its involvement with these entities because it has nodirect investment in them.

 

***Management’s Use of Estimates:***

 

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

 

***Fair Values of FinancialInstruments:***

 

The carrying amounts of allfinancial instruments in the consolidated statements of financial condition,including investments in equity securities, approximate their fair value.

 

***Revenue Recognition:***

 

Revenue, comprised ofadvisory fee income, is recognized over the period in which investmentmanagement services are provided. Advisory fee income includes management fees that are calculated basedon percentages of assets under management (“AUM”), generally billed quarterly,either in arrears or advance, depending on their contractual terms.  Advisory fee income also includes incentivefees that may be earned by the Company depending on the investment return ofthe assets under management.  Incentivefee arrangements generally entitle the Company to participate, on afixed-percentage basis, in any returns generated in excess of an agreed-uponbenchmark.  The Company’s participationpercentage in such return differentials is then multiplied by assets undermanagement to determine the incentive fees earned.  Returns are calculated on an annualized basisover the contract’s measurement period, which may extend up to threeyears.  Incentive fees are generallypayable annually.  Pursuant to thepreferred accounting method under Emerging Issues Task Force Issue D-96, *Accounting for Management Fees Based on a Formula*(“EITF D-96”), such incentive fee income is recorded at the conclusion of thecontractual performance period, when all contingencies are resolved.  The Company recognized no such incentive feesfor the three and six months ended June 30, 2009 and 2008.

 

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**Pzena Investment Management, Inc.**

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

 

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

 

***Earnings per Share:***

 

Basic earnings per share iscomputed by dividing the Company’s net income or loss attributable to theCompany’s common stockholders by the weighted-average number of sharesoutstanding during the reporting period. Diluted earnings per share adjusts this calculation to reflect theimpact of all outstanding operating company membership units, as well asoutstanding operating company options and phantom units, to the extent theywould have a dilutive effect on net income per share for the reportingperiod.  Net income for diluted earningsper share generally assumes all operating company membership units areconverted into Company stock at the beginning of the reporting period and theresulting change to Company net income associated with its increased interestin the operating company is taxed at the Company’s effective tax rate.

 

For the three and six monthsended June 30, 2009 and 2008, the Company’s diluted net income wasdetermined as follows:

 

| ** **                                                     | ** ** | **For the  Three Months** | ** ** |
|----------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                     | ** ** | **Ended  June 30,**  | ** ** |
| ** **                                                     | ** ** | **2009**                  | ** ** | **2008** | ** ** |
| ** **                                                     | ** ** | **(in  thousands)**       | ** ** |
|                                                           |       |                      |       |   |   |
| Non-Controlling Interests  of Pzena Investment Management, LLC |       | $                         | 6,119      |   | $ | 12,735 |   |
| Less: Assumed Corporate  Income Taxes                          |       | (2,610                    | )          | (5,391 | ) |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                         | 3,509      |   | $ | 7,344 |   |
|                                                           |       |                      |       |   |   |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                         | 3,509      |   | $ | 7,344 |   |
| Net Income of Pzena  Investment Management, Inc.          |       | 821                       |       | 780 |   |
| Diluted Net Income.                                            |       | $                         | 4,330      |   | $ | 8,124 |   |

 

| ** **                                                     | ** ** | **For the Six  Months**  | ** ** |
|----------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                     | ** ** | **Ended  June 30,** | ** ** |
| ** **                                                     | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                                                     | ** ** | **(in  thousands)**      | ** ** |
|                                                           |       |                     |       |   |   |
| Non-Controlling Interests  of Pzena Investment Management, LLC |       | $                        | 9,685      |   | $ | 26,212 |   |
| Less: Assumed Corporate  Income Taxes                          |       | (4,128                   | )          | (11,090 | ) |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                        | 5,557      |   | $ | 15,122 |   |
|                                                           |       |                     |       |   |   |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                        | 5,557      |   | $ | 15,122 |   |
| Net Income of Pzena  Investment Management, Inc.          |       | 1,303                    |       | 1,600 |   |
| Diluted Net Income.                                            |       | $                        | 6,860      |   | $ | 16,722 |   |

 

For the three and six monthsended June 30, 2009, 954,310 options to purchase operating company unitsand 67,371 phantom operating company units were excluded from the calculationof diluted net income per share, as their inclusion would have had anantidilutive effect for the period.  Forthe three and six months ended June 30, 2008, 954,310 options to purchaseoperating company units and 89,826 phantom units were excluded from thecalculation of diluted net income per share, as their inclusion would have hada similarly antidilutive effect.

 

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**Pzena Investment Management, Inc.**

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

 

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

 

For the three and six monthsended June 30, 2009 and 2008, the Company’s basic and diluted earnings pershare were determined as follows (in thousands, except for share and per-shareamounts):

 

| ** **                                   | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                         |       |                                                 |       |   |   |
| Net Income for Basic  Earnings per Share     |       | $                                                    | 821        |   | $ | 780 |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,633,041                                            |       | 6,123,494 |   |
| Basic Earnings per Share                     |       | $                                                    | 0.10       |   | $ | 0.13 |   |
|                                         |       |                                                 |       |   |   |
| Net Income for Diluted  Earnings per Share   |       | $                                                    | 4,330      |   | $ | 8,124 |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,633,041                                            |       | 6,123,494 |   |
| Dilutive Effect of  Operating Company Units  |       | 55,559,751                                           |       | 57,950,910 |   |
| Dilutive Effect of Phantom  Units            |       | 586,068                                              |       | 6,453 |   |
| Diluted Weighted Average  Shares Outstanding |       | 64,778,860                                           |       | 64,080,857 |   |
| Diluted Earnings per Share                   |       | $                                                    | 0.07       |   | $ | 0.13 |   |

 

| ** **                                   | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                   | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
|                                         |       |                                               |       |   |   |
| Net Income for Basic  Earnings per Share     |       | $                                                  | 1,303      |   | $ | 1,600 |   |
| Basic Weighted Average  Shares Outstanding   |       | 7,795,194                                          |       | 6,121,590 |   |
| Basic Earnings per Share                     |       | $                                                  | 0.17       |   | $ | 0.26 |   |
| Net Income for Diluted  Earnings per Share   |       | $                                                  | 6,860      |   | $ | 16,722 |   |
| Basic Weighted Average  Shares Outstanding   |       | 7,795,194                                          |       | 6,121,590 |   |
| Dilutive Effect of  Operating Company Units  |       | 56,397,598                                         |       | 57,950,910 |   |
| Dilutive Effect of Phantom  Units            |       | 373,812                                            |       | 6,622 |   |
| Diluted Weighted Average  Shares Outstanding |       | 64,566,604                                         |       | 64,079,122 |   |
| Diluted Earnings per Share                   |       | $                                                  | 0.11       |   | $ | 0.26 |   |

 

***Cash and Cash Equivalents:***

 

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

 

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

 

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

 

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

 

***Investments in Equity Securities, atFair Value:***

 

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

 

The Company adopted theprovisions of Statement of Financial Accounting Standard No. 157, *Fair Value Measurements* (“SFAS 157”),on January 1, 2008.  SFAS 157defines fair value as the price that would be received to sell an asset, orpaid to transfer a liability, in an orderly transaction between marketparticipants at the measurement date.  SFAS 157also establishes a framework for 

 

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**Pzena Investment Management, Inc.**

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

 

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

 

measuring fair value and a valuationhierarchy based upon the transparency of inputs used in the valuation of anasset or liability.  Classificationwithin the hierarchy is based upon the lowest level of input that issignificant to the fair value measurement. The valuation hierarchy contains three levels: (i) valuation inputsare unadjusted quoted market prices for identical assets or liabilities inactive markets (Level 1); (ii) valuation inputs are quoted prices foridentical assets or liabilities in markets that are not active, quoted marketprices for similar assets and liabilities in active markets and otherobservable inputs directly or indirectly related to the asset or liabilitybeing measured (Level 2); and (iii) valuation inputs are unobservableand significant to the fair value measurement (Level 3).

 

In April 2009, the FASBissued FASB Staff Position Statement of Financial Accounting Standard (“SFAS”) No. 157-4,“Determining Fair Value When the Volume and Level of Activity for the Asset orLiability Have Significantly Decreased and Identifying Transactions That AreNot Orderly” (“FSP”), effective for fiscal years and interimperiods ending after June 15,2009.  This FSP provides additional guidance for estimating fairvalue in accordance with SFAS No. 157 when the volume and level ofactivity for the asset or liability have significantly decreased in relation tonormal market activity.  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 category.

 

The Company’s fair value measurements relate to its interest rate swap,as well as its investments in equity securities, which are primarilyexchange-traded securities with quoted prices in active markets.  The fair value measurement of the interestrate swap has been determined primarily based upon the market prices forinterest rate swaps with similar provisions and the use of forward interestrate curves.  The interest rate swap hasbeen classified as Level 2 and recorded in other liabilities on theconsolidated statement of financial condition. The fair value measurements of the securities have been classified asLevel 1.

 

The following table presents these instruments’ fair value at June 30,2009 (in thousands):

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Assets:            |       |        |       |        |       |        |       |
| Equity Securities  |       | $           | 15,199     |        | $          | —      |       | $ | — |   |
| Liabilities:       |       |        |       |        |       |        |       |
| Interest Rate Swap |       | —      |       | (230        | )          | —      |       |
| Total Fair Value   |       | $           | 15,199     |        | $          | (230        | )          | $ | — |   |

 

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

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

 

***Securities Valuation:***

 

Investments in equitysecurities which are traded on a national securities exchange are carried atfair value based on the last reported sales price on the valuation date.  If no reported sales occurred on thevaluation date, investments in securities are valued at the bid price.  Securities transactions are recorded on thetrade date.

 

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

 

***Concentrations of Credit Risk:***

 

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

 

The concentration of creditrisk with respect to advisory fees receivable is generally limited due to theshort payment terms extended to clients by the Company.  On a periodic basis, the Company evaluatesits advisory fees receivable and establishes an allowance for doubtfulaccounts, if necessary, based on a history of past write-offs and collectionsand current credit conditions.

 

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**Pzena Investment Management, Inc.**

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

 

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

 

For the three months ended June 30, 2009and 2008, approximately 11.2% and 14.1%, respectively, of the Company’sadvisory fees were generated from an advisory agreement with one client.  For the six months ended June 30, 2009and 2008, fees generated from this agreement comprised 11.9% and 14.9%,respectively, of the Company’s total advisory fees.  At June 30, 2009 and December 31,2008, no allowance for doubtful accounts has been deemed necessary.

 

***Financial Instruments:***

 

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

 

During the quarter ended September 30,2008, the Company changed the designation of its swap agreement from a cashflow hedge to a trading derivative, as a significant portion of the cash flowsassociated with the original forecasted transaction were probable to not occurdue to amortization payments required be made pursuant to the terms of itsamended Credit Agreement.  Accordingly,the Company reclassified the cumulative changes in fair value related to thisswap from accumulated other comprehensive income to other income/(expense).  The Company has recorded all subsequentchanges to the swap’s fair value as a component of other income/(expense).  This expense was less than $0.1 million forthe three months ended June 30, 2009. For the six months ended June 30, 2009, the Company recognizedapproximately $0.1 million in other expense related to such changes.  For each of the three and six months ended June 30,2008, the Company recognized approximately $0.1 million in other accumulatedcomprehensive income associated with the change in fair value of the swapagreement.

 

At June 30, 2009 and December 31,2008, the approximate fair value of the liability associated with the swapagreement was $0.2 million and $0.6 million, respectively, and has beenincluded in other liabilities on the statements of financial condition.

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its results of operations for the three months ended June 30,2009 and 2008 (in thousands):

 

| **Derivatives  Not Accounted For As Hedging** | ** ** | **Statement  of**       | ** ** | **Amount of Loss  Recognized********In Income on Derivative** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|---------------------------------------------------------------|------------|
| **Instruments  Under SFAS 133**               | ** ** | **Operations  Account** | ** ** | **2009**                                                      | ** ** | **2008** | ** ** |
|                                          |       |                    |       |                                                          |       |   |   |
| Interest Rate Contracts                       |       | Other Expense           |       | $                                                             | 43         |   | $ | — |   |
| Total                                         |       |                    |       | $                                                             | 43         |   | $ | — |   |

 

The following table summarizes the impact of the Company’s derivative financialinstruments on its results of operations for the six months ended June 30,2009 and 2008 (in thousands):

 

| **Derivatives  Not Accounted For As Hedging** | ** ** | **Statement  of**       | ** ** | **Amount of  Loss Recognized********In Income on Derivative** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|---------------------------------------------------------------|------------|
| **Instruments  Under SFAS 133**               | ** ** | **Operations  Account** | ** ** | **2009**                                                      | ** ** | **2008** | ** ** |
|                                          |       |                    |       |                                                          |       |   |   |
| Interest Rate Contracts                       |       | Other Expense           |       | $                                                             | 68         |   | $ | — |   |
| Total                                         |       |                    |       | $                                                             | 68         |   | $ | — |   |

 

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**Pzena Investment Management, Inc.**

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

 

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

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its financial position as of June 30, 2009 (inthousands):

 
| ** **                                                                | ** ** | **Asset  Derivatives**                          | ** ** | **Liability  Derivatives** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------|------------|
| **Derivatives Not Accounted For  As Hedging  Instruments Under SFAS 133** | ** ** | **Statement  of  Financial  Condition Account** | ** ** | **Fair  Value**            | ** ** | **Statement  of  Financial  Condition Account** | ** ** | **Fair  Value** | ** ** |
|                                                                      |       |                                            |       |                       |       |   |   |   |   |
| Interest Rate Contracts                                                   |       | —                                          |       | $                          | —     |   | Other  Liabilities |   | $ | 230 |   |
| Total                                                                     |       |                                            |       | $                          | —     |   |   |   | $ | 230 |   |

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its financial position as of December 31, 2008(in thousands):

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

 

***Property and Equipment:***

 

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

 

***Business Segments:***

 

The Company views itsoperations as comprising one operating segment.

 

***Income Taxes:***

 

The Company is a “C”corporation under the Internal Revenue Code, and thus liable for federal, stateand local taxes on the income derived from its economic interest in itsoperating company.  The operating companyis a limited liability company that has elected to be treated as a partnershipfor tax purposes.  It has not made aprovision for federal or state income taxes because it is the individualresponsibility of each of the operating company’s members (including theCompany) to separately report their proportionate share of the operatingcompany’s taxable income or loss. Similarly, the income of the Company’s consolidated investmentpartnerships is not subject to income taxes, as it is allocated to eachpartnership’s individual partners.  Theoperating company has made a provision for New York City UnincorporatedBusiness Tax (“UBT”).

 

The Company and itsconsolidated subsidiaries account for all state, local and federal taxationpursuant to the asset and liability method, which requires deferred income taxassets and liabilities to be recorded for temporary differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or deductible amounts in the future, based on enacted tax laws andrates applicable to the periods in which the temporary differences are expectedto affect taxable income.  Valuationallowances are established, when necessary, to reduce deferred tax assets tothe amount more likely than not to be realized. At June 30, 2009 and December 31, 2008, the Company had a$63.4 million and a $62.7 million valuation allowance, respectively,against the deferred tax asset recorded as part of the Company’s acquisitionsof operating company membership units. The income tax provision, or credit, is the tax payable or refundablefor the period, plus or minus the change during the period in deferred taxassets and liabilities.  The Companyrecords its deferred tax liabilities as a component of other liabilities on theconsolidated statements of financial condition.

 

***Foreign Currency:***

 

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

 

11

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**Pzena Investment Management, Inc.**

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

 

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

 

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

 

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

 

***New Accounting Pronouncements:***

 

In June 2009,the FASB issued SFAS No. 167, “*Amendmentsto FASB Interpretation No. 46(R)*” (“SFAS 167”). SFAS 167 amendsFASB Interpretation No. 46(R), “*VariableInterest Entities*” for determining whether an entity is a  SFAS 167 variable interest entity (“VIE”) andrequires an enterprise to perform an analysis to determine whether theenterprise’s variable interest or interests give it a controlling financialinterest in a VIE.  Under SFAS 167, anenterprise has a controlling financial interest when it has a) the powerto direct the activities of a VIE that most significantly impact the entity’seconomic performance and b) the obligation to absorb losses of the entityor the right to receive benefits from the entity that could potentially besignificant to the VIE.  SFAS 167 alsorequires an enterprise to assess whether it has an implicit financialresponsibility to ensure that a VIE operates as designed when determiningwhether it has power to direct the activities of the VIE that mostsignificantly impact the entity’s economic performance.  SFAS 167 also requires ongoing assessments ofwhether an enterprise is the primary beneficiary of a VIE, requires enhanceddisclosures and eliminates the scope exclusion for qualifying special-purposeentities.  SFAS 167 is effective forinterim and annual periods beginning after November 15, 2009.  Earlier application is prohibited.  The Company is currently evaluating theimpact the adoption of SFAS 167 will have on its consolidated financialstatements.

 

In June 2009,the FASB issued SFAS No. 168 “*The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles—a replacement of FASB Statement No. 162*”(“SFAS 168”).  The FASB AccountingStandards Codification (“Codification”) will be the single source ofauthoritative nongovernmental U.S. generally accepted accountingprinciples.  Rules and interpretivereleases of the SEC under authority of federal securities laws are also sourcesof authoritative GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods ending after September 15,2009.  All existing accounting standardsare superseded as described in SFAS 168. All other accounting literature not included in the Codification isnonauthoritative.  The Codification isnot expected to have a significant impact on the Company’s consolidatedfinancial statements.

 

**Note 3—Property and Equipment**

 

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

 
| ** **                                       | ** ** | **As of**                     | ** ** |
|--------------------------------------------------|------------|-------------------------------|------------|
| ** **                                       | ** ** | **June 30,********2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                       | ** ** | **(in  thousands)**           | ** ** |
|                                             |       |                          |       |   |   |
| Computer Hardware                                |       | $                             | 927        |   | $ | 921 |   |
| Computer Software                                |       | 191                           |       | 191 |   |
| Furniture and Fixtures                           |       | 1,161                         |       | 1,161 |   |
| Office Equipment                                 |       | 243                           |       | 243 |   |
| Leasehold Improvements                           |       | 2,145                         |       | 2,145 |   |
| Total                                            |       | 4,667                         |       | 4,661 |   |
| Less: Accumulated  Depreciation and Amortization |       | (2,154                        | )          | (1,913 | ) |
| Total                                            |       | $                             | 2,513      |   | $ | 2,748 |   |

 

Depreciation is included ingeneral and administrative expenses and totaled $0.1 million for each ofthe three months ended June 30, 2009 and 2008.  Such expenses totaled $0.2 million foreach of the six months ended June 30, 2009 and 2008.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 4—Related Party Transactions**

 

For the three and six monthsended June 30, 2009, the Company earned $1.2 million and$2.1 million, respectively, in investment advisory fees fromunconsolidated entities for which it acts as the investment manager.  For the three and six months ended June 30,2008, such advisory fees totaled $1.9 million and $3.7 million,respectively.

 

At June 30, 2009 and December 31,2008, the Company had advanced $0.1 million to an international investmentcompany for organization and start-up costs, which are included in receivablefrom related parties on the consolidated statements of financial condition. TheCompany is the sponsor and investment manager of this entity.

 

At June 30, 2009, loansto employees included in receivables from related parties was less than $0.1million.  At December 31, 2008, thisamount was $0.1 million. These loans are in the form of forgivable promissorynotes which are amortized through compensation expense pursuant to their terms.

 

Certain qualified employeesof the Company have the ability to open separately-managed accounts, or investin certain of the Company’s consolidated investment partnerships, without beingassessed advisory fees.  Investments byemployees in separately-managed accounts are permitted only at the discretionof the Executive Committee of the Company, but are generally not subject to thesame minimum investment levels that are required of outside investors.

 

During the quarter ended June 30,2008, an unaffiliated shareholder who held more than 10% of the Company’s outstandingshares sold shares in transactions deemed to be short-swing sales.  Under Section 16(b) of theSecurities Exchange Act of 1934, the shareholder was required to disgorge tothe Company the $0.2 million in profits realized from these stocksales.  The Company recognized theseproceeds as a capital contribution and reflected a corresponding increase toadditional paid-in capital in its consolidated statements of changes inequity.  Proceeds from these transactionsdid not affect the Company’s consolidated statements of operations.

 

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

 

**Note 5—Commitments and Contingencies**

 

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

 

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

 

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**Pzena Investment Management, Inc.**

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

 

**Note 5—Commitments and Contingencies (continued)**

 

The Company leases officespace under two non-cancelable operating lease agreements which expire on October 31,2015.  The Company reflects lease expenseon a straight-line basis over the lease term. Lease expenses totaled $0.5 million for each of the three months ended June 30,2009 and 2008.  Such expenses totaled$1.1 million for each of the six months ended June 30, 2009 and 2008.

 

**Note 6—Retirement Plan**

 

Prior to 2009, the Companymaintained a defined contribution pension plan which covered substantially allmembers and employees.  The Company madecontributions to the plan at the discretion of management.  Under the terms of the plan, all suchcontributions vested immediately. Company contributions for the three and six months ended June 30,2008 were $0.4 million and $0.9 million, respectively.  These expenses are included in compensationand benefits expense in the consolidated statements of operations.

 

**Note 7—Compensationand Benefits**

 

For the three months ended June 30,2009 and 2008, compensation and benefits expense to employees and members iscomprised of the following:

 

| ** **                               | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                  | ** ** |
|                                     |       |                                                 |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                    | 5,673      |   | $ | 8,373 |   |
| Other Non-Cash  Compensation             |       | 310                                                  |       | 289 |   |
| Total Compensation and  Benefits Expense |       | $                                                    | 5,983      |   | $ | 8,662 |   |

 

For the six months ended June 30,2009 and 2008, compensation and benefits expense to employees and members iscomprised of the following:

 

| ** **                               | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                | ** ** |
|                                     |       |                                               |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                  | 11,462     |   | $ | 16,980 |   |
| Other Non-Cash  Compensation             |       | 561                                                |       | 633 |   |
| Total Compensation and  Benefits Expense |       | $                                                  | 12,023     |   | $ | 17,613 |   |

 

For the three and six monthsended June 30, 2009, no options to purchase capital units pursuant to the PzenaInvestment Management, LLC 2006 Equity Incentive Plan (“the Plan”) were grantedby the Company.  For the six months endedJune 30, 2008, the operating company granted 446,000 such options.  No such grants occurred for the three monthsended June 30, 2008.  The optionsgranted in 2008 had varying vesting schedules and were issued at strike pricesequal to the assessed fair market value per unit at the time of awardissuance.  The Company determined thatthe total grant-date fair value of the options awarded in 2008 wasapproximately $1.2 million, using the Black-Scholes option pricing model.  The Company recognized approximately $0.1million in compensation and benefits expense associated with the amortizationof these awards for each of the three and six months ended June 30, 2009and 2008.

 

For the three months ended June 30,2009 and 2008, the Company did not grant any options.  For the six months ended June 30, 2009and 2008, the Company granted 30,000 and 13,000, respectively, restricted Class Bunits to certain members pursuant to the Plan. These unit grants each vest ratably over a four-year period commencing January 1,2009 and 2008, respectively.  Theamortization of these awards was less than $0.1 million for the three and sixmonths ended June 30, 2009 and 2008.

 

Pursuantto the operating company’s Bonus Plan, which became effective January 1,2007, eligible employees whose cash compensation is in excess of certainthresholds have a portion of that excess mandatorily deferred.  Amounts deferred may be credited to aninvestment account or take the form of phantom Class B units, or investedin money market funds at the employee’s discretion, and vest ratably over fouryears.  On January 1, 2008, theoperating company issued 86,458 phantom Class B units as part of its BonusPlan.  In December 2008,participants in the Company’s deferred compensation program converted a portionof their holdings in investment accounts into an aggregate of 89,826 phantomClass B units.  No such phantomunits were granted for the three and six

 

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**Pzena Investment Management, Inc.**

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

 

**Note 7—Compensationand Benefits (continued)**

 

monthsended June 30, 2009.  Alloutstanding phantom units vest ratably over a four-year period that commenced January 1,2008.  At June 30, 2009 and December 31, 2008,the liability associated with deferred compensation investment accounts wasapproximately $0.2 million and $0.3 million, respectively, and has beenincluded as a component of other liabilities on the consolidated statements offinancial condition.  For the three andsix months ended June 30, 2009, the Company recognized approximately $0.2million and $0.4 million, respectively, in compensation and benefitsexpense associated with the amortization of all deferred compensation awards.

 

**Note 8—Short Term Borrowings**

 

Simultaneously with theCredit Agreement described below, on July 23, 2007, the operating companyobtained a $20.0 million revolving credit facility, expiring on July 23,2010, in order to finance its short term working capital needs.  This facility carries a commitment fee of0.2% on any unused amounts, and the Company’s approximately $1.8 millionletter of credit reduces the amounts otherwise available to be used.  On February 11, 2008, the operatingcompany entered into Amendment No. 1 to its Credit Agreement.  The amendment changed a number of CreditAgreement provisions, including reducing the capacity of the revolving creditfacility from $20.0 million to $5.0 million.  On September 19, 2008, the operatingcompany entered into Amendment No. 2 to its Credit Agreement.  The amendment reduced the capacity of therevolving credit facility from $5.0 million to $3.0 million andextended its maturity to July 23, 2011. On October 28, 2008, the operating company entered into Amendment No. 3to its Credit Agreement, which reduced the capacity of the revolving creditfacility to the value of its letter of credit, approximately$1.8 million.  As of and for theperiods ended June 30, 2009 and December 31, 2008, no balance wasoutstanding against the facility.

 

**Note 9—Debt**

 

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

 

On February 11, 2008,the operating company entered into Amendment No. 1 to the CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$15.0 billion and generate consolidated earnings before interest, taxes,depreciation and amortization (“EBITDA”), as defined, of at least$40.0 million in any consecutive four fiscal quarterly periods.  Pursuant to the terms of the amendedagreement, term loan amortization was required beginning in any period whenassets under management were less than $20.0 billion and ending whenassets under management was greater than $21.5 billion.  Further, a 50% excess cash flow sweep wasrequired if assets under management were below $17.5 billion.  Additionally, the LIBOR interest rate optionwas increased to LIBOR plus 1.50%.  Forthe period from February 11, 2008 through July 23, 2008, the interestrate in effect was 6.91%, which was equal to the twelve-month LIBOR rate ineffect at the time of the closing of the agreement of 5.41%, plus 1.50%.  During the quarter ended June 30, 2008,the Company’s assets under management fell below $20 billion.  On June 30, 2008, the Company made arequired amortization payment of $3.0 million.

 

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

 

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

 

(i)                                     the minimumassets under management financial covenant was eliminated;

 

(ii)                                  the excess cashflow mandatory repayment was eliminated;

 

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**Pzena Investment Management, Inc.**

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

 

**Note 9—Debt (continued)**

 

(iii)                               the commitmentsunder the revolving credit facility were reduced from $3.0 million toapproximately $1.8 million;

 

(iv)                              with respect toloans borrowed at base rate, the margin added to base rate was increased from0.00% to 0.75%; with respect to loans borrowed at LIBOR, the margin was notmodified;

 

(v)                                 certainadditional restrictions were placed on the operating company’s ability to makeRestricted Payments (as defined in the Credit Agreement), including dividends;and

 

(vi)                          amendments weremade to certain covenants in order to permit the incurrence of subordinateddebt by the operating company.

 

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

 

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

 

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

 

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

 

Pursuant to the CreditAgreement and the Senior Subordinated Notes, the operating company would be indefault if it ever failed to pay required interest and amortization payments ina timely fashion.  Further, the CreditAgreement stipulates that the operating company would be in default thereunderif it defaults on its Senior Subordinated Notes.  Such events of default would permit thelender under the applicable debt agreement to accelerate the debtthereunder.  No such occurrence of accelerationoccurred during the three and six months ended June 30, 2009 and 2008.

 

During the three monthsended March 31, 2009, the Company repaid $8.0 million of theprincipal amount outstanding under the Credit Agreement.  The Company repaid $4.0 million of theprincipal amount outstanding under the Credit Agreement during the three monthsended June 30, 2009.

 

**Note 10—Interest Rate Swap**

 

The Company manages itsexposure to changes in market rates of interest.  The Company’s use of derivative instrumentsis limited to an interest rate swap used to manage the interest rate exposurerelated to its Credit Agreement.  TheCompany monitors its position and the credit rating of the counterparty anddoes not anticipate non-performance by such counterparty.

 

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

 

During the three monthsended September 30, 2008, the Company changed the designation of its swapagreement from a cash flow hedge to a trading derivative, as a significantportion of the cash flows associated with the original forecasted transaction wereprobable to not occur due to the amortization payments required to be madepursuant to the terms of its amended Credit Agreement.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 10—Interest Rate Swap (continued)**

 

Accordingly, the Company reclassified thecumulative changes in fair value related to this swap from accumulated othercomprehensive income to other income/(expense). This expense was less than $0.1 million for the three months ended June 30,2009.  The Company records all changes tothe swap’s fair value as a component of other income/(expense).  For the six months ended June 30, 2009,the Company recognized approximately $0.1 million in other expense related tosuch changes.  For each of the three andsix months ended June 30, 2008, the Company recognized approximately $0.1million in other accumulated comprehensive income associated with the change infair value of the swap agreement.

 

Concurrently with thereductions in principal outstanding under the Credit Agreement in 2008, theCompany reduced the notional amount of its interest rate swap to$22.0 million.  The amounts paid tothe counterparty in exchange for these reductions were approximately$0.1 million.  During 2009, theCompany reduced the notional amount of its interest rate swap to $10.0million.  The amounts paid to the counterpartyin exchange for these reductions were approximately $0.1 million and $0.3million for the three and six months ended June 30, 2009, respectively.

 

**Note 11—Income Taxes**

 

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

 

For the three months ended June 30,2009 and 2008, the Company’s taxable income was determined as follows:

 

| ** **                            | ** ** | **For the  Three Months** | ** ** |
|---------------------------------------|------------|---------------------------|------------|
| ** **                            | ** ** | **Ended  June 30,**  | ** ** |
| ** **                            | ** ** | **2009**                  | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(in  thousands)**       | ** ** |
|                                  |       |                      |       |   |   |
| Income Before Taxes                   |       | $                         | 9,212      |   | $ | 13,202 |   |
| Unincorporated Business  Taxes        |       | (406                      | )          | (885 | ) |
| Non-Controlling Interests             |       | (8,455                    | )          | (10,966 | ) |
| Income Before Corporate  Income Taxes |       | $                         | 351        |   | $ | 1,351 |   |

 

For the six months ended June 30,2009 and 2008, the Company’s taxable income was determined as follows:

 

| ** **                            | ** ** | **For the Six  Months**  | ** ** |
|---------------------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **Ended  June 30,** | ** ** |
| ** **                            | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(in  thousands)**      | ** ** |
|                                  |       |                     |       |   |   |
| Income Before Taxes                   |       | $                        | 11,660     |   | $ | 27,141 |   |
| Unincorporated Business  Taxes        |       | (744                     | )          | (1,825 | ) |
| Non-Controlling Interests             |       | (10,695                  | )          | (22,543 | ) |
| Income Before Corporate  Income Taxes |       | $                        | 221        |   | $ | 2,773 |   |

 

In September 2006, the FASBissued Interpretation No.48, *Accounting forUncertainty in Income Taxes* (“FIN 48”).  FIN 48 establishes the minimum thresholdfor recognizing, and a system for measuring, the benefits of tax returnpositions in financial statements.  It isthe Company’s policy to recognize accrued interest and penalties associatedwith uncertain tax positions as part of the tax provision.  For the three months and six months ended June 30,2009 and 2008, no such expenses were recognized.  As of June 30, 2009 and December 31,2008, no accruals were recorded.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 11—Income Taxes (continued)**

 

The Company and theoperating company are generally no longer subject to U.S. federal, or state andlocal income tax examinations by tax authorities for any year prior to2005.  All tax years subsequent to andincluding 2005 are considered open and subject to examination by taxauthorities.

 

The components of the incometax provision/(benefit) are as follows (in thousands):

 

| ** **                                  | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                  | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| Current Provision:                          |       |                                                 |       |   |   |
| Unincorporated Business  Taxes              |       | $                                                    | 462        |   | $ | 939 |   |
| Local Corporate Tax                         |       | —                                               |       | — |   |
| State Corporate Tax                         |       | —                                               |       | — |   |
| Federal Corporate Tax                       |       | —                                               |       | — |   |
| Total Current Provision                     |       | $                                                    | 462        |   | $ | 939 |   |
| Deferred Provision:                         |       |                                                 |       |   |   |
| Unincorporated Business  Taxes              |       | $                                                    | (56        | ) | $ | (54 | ) |
| Local Corporate Tax                         |       | 43                                                   |       | 62 |   |
| State Corporate Tax                         |       | 82                                                   |       | 107 |   |
| Federal Corporate Tax                       |       | 281                                                  |       | 402 |   |
| Total Deferred Provision                    |       | $                                                    | 350        |   | $ | 517 |   |
| Deferred Income Tax  Valuation Allowance    |       | (876                                                 | )          | — |   |
| Total Provision/(Benefit)  for Income Taxes |       | $                                                    | (64        | ) | $ | 1,456 |   |

 

| ** **                                  | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                  | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| Current Provision:                          |       |                                               |       |   |   |
| Unincorporated Business  Taxes              |       | $                                                  | 855        |   | $ | 1,934 |   |
| Local Corporate Tax                         |       | —                                             |       | — |   |
| State Corporate Tax                         |       | —                                             |       | — |   |
| Federal Corporate Tax                       |       | —                                             |       | — |   |
| Total Current Provision                     |       | $                                                  | 855        |   | $ | 1,934 |   |
| Deferred Provision:                         |       |                                               |       |   |   |
| Unincorporated Business  Taxes              |       | $                                                  | (111       | ) | $ | (109 | ) |
| Local Corporate Tax                         |       | 63                                                 |       | 126 |   |
| State Corporate Tax                         |       | 123                                                |       | 222 |   |
| Federal Corporate Tax                       |       | 422                                                |       | 825 |   |
| Total Deferred Provision                    |       | $                                                  | 497        |   | $ | 1,064 |   |
| Deferred Income Tax  Valuation Allowance    |       | (1,690                                             | )          | — |   |
| Total Provision/(Benefit)  for Income Taxes |       | $                                                  | (338       | ) | $ | 2,998 |   |

 

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

 

The acquisition of theoperating company membership units noted above has allowed the Company to makean election under Section 754 of the Internal Revenue Code (“Section 754”)to step up its tax basis in the net assets acquired.  This step up is deductible for tax purposesover a 15-year period.  Based on the netproceeds of the offering and tax basis of the operating company as of October 30,2007, this election gave rise to a deferred tax asset of approximately $68.1million and $66.1 million at June 30, 2009 and December 31, 2008,respectively.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 11—Income Taxes (continued)**

 

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

 

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

 

The Company determined that,after weighing both the positive and negative evidence discussed above, aportion of the benefits associated with this deferred tax asset were morelikely than not to go unrealized due to estimates of future taxableincome.  As a result, on September 30,2008, the Company established a $62.7 million valuation allowance toreduce the net deferred tax asset to an amount more likely than not to berealized.  This deferred tax assetremains available to the Company and can be used to reduce taxable income infuture years.  The Company similarlyreduced the associated liability to selling and converting shareholders toreflect this change in the estimated realization of the asset.  On September 30, 2008, the Companyrecorded an approximate $53.3 million increase to other income associatedwith this reduction in the liability to selling and converting shareholders.

 

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

 

As discussed further in Note15 below, on March 3, 2009, certain of the operating company’s membersexchanged an aggregate of 2,445,973 of their Class B units for anequivalent number of shares of Company Class A common stock.   The Company elected to step up its tax basisin the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair value of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $2.5 million deferred tax asset and a corresponding$2.2 million liability to selling and converting shareholders under the TaxReceivable Agreement.  Using themethodology described above, the Company assessed the realizability of thedeferred tax asset associated with this exchange and determined that a portionof its benefits would go unutilized. Consequently, the Company established a $2.4 million valuation allowanceto reduce the deferred tax asset to an amount more likely than not to berealized.  This deferred tax assetremains available to the Company and can be used to reduce taxable income infuture years.  The Company similarlyreduced the associated liability to selling and converting shareholders toreflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging IssuesTask Force Issue No. 94-10, *Accounting by a Companyfor the Income Tax Effects of Transactions among or with Its Shareholders underFASB Statement No.109* (“EITF 94-10”), the Company recorded theeffects of these transactions in equity.

 

During the three and sixmonths ended June 30, 2009, the Company reduced its valuation allowance byapproximately $0.9 million and $1.7 million, respectively, due to revisedestimates of future taxable income.  Toreflect this change in the estimated realization of the asset, the Companycorrespondingly increased its liability to selling and converting shareholdersby $0.6 million for the three months ended June 30, 2009, and by $1.2million for the six months ended June 30, 2009.  The effects of these changes to the deferredtax asset and liability to selling and converting shareholders were recorded asa component of the provision for income taxes and other expense, respectively,on the consolidated statements of operations. As of June 30, 2009 and December 31, 2008, the net values ofthis deferred tax asset were approximately $4.7 million and$3.4 million, respectively.

 

As of June 30, 2009 andDecember 31, 2008, the liability to selling and converting shareholderswas approximately $3.1 million and $1.8 million, respectively.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 11—Income Taxes (continued)**

 

The change in the Company’s net deferred tax assets for the threemonths ended June 30, 2009 is summarized as follows (in thousands):

 
| ** **                     | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Valuation  Allowance** | ** ** | **Total**  | ** ** |
|--------------------------------|------------|----------------------|------------|------------|------------|--------------------------|------------|------------|------------|
| ** **                     | ** ** | ** **           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** |
| 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 |   |

 

The change in the Company’s net deferred tax assets for the six monthsended June 30, 2009 is summarized as follows (in thousands):

 
| ** **                        | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Valuation  Allowance** | ** ** | **Total**  | ** ** |
|-----------------------------------|------------|----------------------|------------|------------|------------|--------------------------|------------|------------|------------|
| ** **                        | ** ** | ** **           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** |
| Balance at December 31, 2008 |       | $                    | 65,368     |       | $          | 785                      |       | $          | (62,709    | ) | $ | 3,444 |   |
| Deferred Tax Expense              |       | (1,440               | )          | 832        |       | —                   |       | (608       | )          |
| Unit Conversion                   |       | 2,532                |       | —     |       | (2,380                   | )          | 152        |       |
| Change in Valuation  Allowance    |       | —               |       | —     |       | 1,690                    |       | 1,690      |       |
| Balance at June 30,  2009    |       | $                    | 66,460     |       | $          | 1,617                    |       | $          | (63,399    | ) | $ | 4,678 |   |

 

**Note 12—Investments in Equity Securities, at Fairvalue**

 

Investments in equitysecurities consisted of the following at June 30, 2009:

 

| ** ** | ** ** | **Cost**            | ** ** | **Unrealized  Gain/(Loss)** | ** ** | **Fair Value** | ** ** |
|------------|------------|---------------------|------------|-----------------------------|------------|----------------|------------|
| ** ** | ** ** | **(in  thousands)** | ** ** |
|       | ** ** | ** **          | ** ** | ** **                  | ** ** | ** **     | ** ** |
| Equities   |       | $                   | 20,098     |                        | $          | (4,899         | )          | $ | 15,199 |   |
|            |            |                     |            |                             |            |                |            |  |  |  |

 

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

 

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

 

**Note 13—Non-Controlling Interests**

 

The Company did notinitially record a non-controlling interest associated with the acquisition ofits operating company, as the post-offering net equity of the operating companywas less than zero.  Pursuant to theguidance in Emerging Issues Task Force Issue No. 95-7, *Implementation Issues Related to the Treatment ofMinority Interest in Certain Real Estate Trusts* (“EITF 95-7”),a non-controlling interest in the equity of the operating company was recordedafter the initial deficit that existed at acquisition was extinguished in 2008.

 

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**Pzena Investment Management, Inc.**

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

 

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

 

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

 

| ** **                                                    | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**                                  | ** ** |
|                                                          |       |                                                 |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                                                    | 6,119      |   | $ | 12,735 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 2,336                                                |       | (1,769 | ) |
| Non-Controlling Interests                                     |       | $                                                    | 8,455      |   | $ | 10,966 |   |

** **

| ** **                                                    | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**                                | ** ** |
|                                                          |       |                                               |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                                                  | 9,685      |   | $ | 26,212 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 1,010                                              |       | (3,669 | ) |
| Non-Controlling Interests                                     |       | $                                                  | 10,695     |   | $ | 22,543 |   |

 

Non-controlling interests inthe equity of the Company’s operating company and consolidated subsidiaries aresummarized as follows at June 30, 2009 and December 31, 2008:

 

| ** **                                                    | ** ** | **As of**                     | ** ** |
|---------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                    | ** ** | **June 30,********2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**           | ** ** |
|                                                          |       |                          |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                             | 5,900      |   | $ | 3,397 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 9,430                         |       | 8,422 |   |
| Non-Controlling Interests                                     |       | $                             | 15,330     |   | $ | 11,819 |   |

 

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

 

For the three and six monthsended June 30, 2009, no options to purchase capital units pursuant to thePzena Investment Management, LLC 2006 Equity Incentive Plan (“the Plan”) weregranted by the Company.  For the sixmonths ended June 30, 2008, the operating company granted 446,000 suchoptions.  No such options were grantedfor the three months ended June 30, 2008. The options granted for the six months ended June 30, 2008 hadvarying vesting schedules and were issued at strike prices equal to theassessed fair market value per unit at the time of award issuance.  The Company determined that the totalgrant-date fair value of the options awarded during the six months ended June 30,2008 was approximately $1.2 million, using the Black-Scholes option pricingmodel.

 

On January 1, 2009 and2008, the operating company granted 30,000 and 13,000, respectively, restrictedClass B units to certain members pursuant to the Pzena InvestmentManagement, LLC 2006 Equity Incentive Plan.  On January 1, 2008, the operatingcompany also issued 86,458 phantom Class B units as part of its BonusPlan.  In December 2008, participants inthe Company’s deferred compensation program converted a portion of theirholdings in investment accounts into an aggregate of 89,826 phantom Class Bunits.  No such phantom units weregranted for the three and six months ended June 30, 2009.  All outstanding phantom units vest ratablyover a four-year period that commenced January 1, 2008.

 

Exceptas otherwise provided by law, the liability of a member of the operatingcompany is limited to the amount of its capital account.  A member may transfer or assign all, or anypart of, its membership interest to any other party (a “Transferee”).  A Transferee of such membership interestshall not become a member unless its membership in the operating company is unanimously approved by the thenexisting member(s) in writing.  AnyTransferee admitted as a member shall succeed to the capital account or portion thereof transferred orassigned, as if no such transfer or assignment had occurred.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 15—Shareholders’ Equity**

 

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

 

On October 30, 2007,the Company consummated an initial public offering of 6,100,000 shares of its Class Acommon stock, par value $0.01 per share, for net proceeds of approximately$98.9 million, after payment of underwriting discounts and offeringexpenses.  These net proceeds were usedto purchase 6,100,000 membership units of the operating company, representing 9.5%of its then outstanding membership units, from its two outside investors andone former employee.  Concurrently withthe consummation of the Company’s initial public offering, the OperatingAgreement of the operating company was amended and restated such that, amongother things, (i) the Company became the sole managing member of theoperating company, (ii) the 6,100,000 membership units of the operatingcompany that the Company acquired were reclassified as Class A units ofthe operating company, (iii) an additional 11,118 Class A units wereissued to the Company in respect of its issuance of 11,112 shares of Class Acommon stock to certain directors of the Company on October 30, 2007, andcontribution of the $100 initial investment the Company received in exchangefor issuance of six shares of Class A common stock on May 10, 2007,and (iv) the holders of the remaining 90.5% of the outstanding membershipunits of the operating company were reclassified as Class B units of theoperating company.  Class A and Class Bunits of the operating company have the same economic rights per unit.  Accordingly, immediately following theconsummation of the offering and reorganization, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 9.5% and 90.5%, respectively, of theeconomic interests in the operations of the business.  As of June 30, 2009, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 13.4% and 86.6%, respectively, of theeconomic interests in the operations of the business.

 

For each membership unit ofthe operating company that was reclassified as a Class B unit in thereorganization, the Company issued the holder one share of its Class Bcommon stock, par value $0.000001 per share, in exchange for the payment ofthis par value.  Each share of theCompany’s Class B common stock entitles its holder to five votes, untilthe first time that the number of shares of Class B common stockoutstanding constitutes less than 20% of the number of all shares of our commonstock outstanding.  From this time andthereafter, each share of the Company’s Class B common stock entitles itsholder to one vote.  When a Class Bunit is exchanged for a share of the Company’s Class A common stock orforfeited, a corresponding share of the Company’s Class B common stockwill automatically be redeemed and cancelled. Conversely, to the extent that the Company causes Pzena InvestmentManagement, LLC to issue additional Class B units to 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).

 

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

 

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

 

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

 

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

 

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**Pzena Investment Management, Inc.**

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

 

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

 

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

 

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

 

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

 

The Company elected to stepup its tax basis in the incremental assets acquired.  Based on the exchange-date fair value of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $2.5 million deferred tax asset and a corresponding$2.2 million liability to selling and converting shareholders under the TaxReceivable Agreement.  The Companyassessed the realizability of the deferred tax asset associated with thisexchange and determined that a portion of its benefits would go unutilized.  Consequently, the Company established a $2.4million valuation allowance to reduce the deferred tax asset to an amount morelikely than not to be realized.  Thisdeferred tax asset remains available to the Company and can be used to reducetaxable income in future years.  TheCompany similarly reduced the associated liability to selling and convertingshareholders to reflect this change in the estimated realization of theasset.  Pursuant to the guidance ofEmerging Issues Task Force Issue No. 94-10, *Accountingby a Company for the Income Tax Effects of Transactions among or with ItsShareholders under FASB Statement No.109* (“EITF 94-10”), the Companyrecorded the effects of these transactions in equity.

 

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

 

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

 

**Note 16—SubsequentEvents**

 

In May 2009, the FASB issued SFAS No. 165, “SubsequentEvents” (“SFAS 165”). This new pronouncement establishes principles andstandards related to the accounting for and disclosure of events that occurafter the balance sheet date but before the financial statements are issued.SFAS 165 requires an entity to recognize, in the financial statements,subsequent events that provide additional information regarding conditions thatexisted at the balance sheet date. Subsequent events that provide informationabout conditions that did not exist at the balance sheet date shall not berecognized in the financial statements under SFAS 165. SFAS 165 is effectivefor financial statements issued for fiscal years and interim periods beginningafter June 15, 2009. The adoption of SFAS 165 did not have a material impact onthe Company’s consolidated financial statements.

 

Pursuant to SFAS 165, the Companyevaluated subsequent events through the issuance date of its financialstatements on August 10, 2009.  Thefollowing subsequent event was not recognized in the financial statements as ofJune 30, 2009:

 

On July 23, 2009, theCompany repaid $5.0 million of the principal amount outstanding under theCredit Agreement.

 

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

 

**Overview**

 

We are an investmentmanagement firm that utilizes a classic value investment approach in each ofour investment strategies.  We currentlymanage assets in a variety of value-oriented investment strategies across awide range of market capitalizations in both U.S. and international capitalmarkets.  At June 30, 2009, ourassets under management, or AUM, was $10.6 billion.  We manage separate accounts on behalf ofinstitutions and high net worth individuals and act as sub-investment adviserfor a variety of SEC-registered mutual funds and offshore funds.

 

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

 

**Revenue**

 

We generate revenue frommanagement fees and incentive fees, which we collectively refer to as ouradvisory fees, by managing assets on behalf of separate accounts and acting asa sub-investment adviser for mutual funds and certain other investmentfunds.  Our advisory fee income isrecognized over the period in which investment management services areprovided.  Pursuant to the preferredaccounting method under Emerging Issues Task Force Issue D-96, *Accounting for Management Fees Based on a Formula*(“EITF D-96”), income from incentive fees is recorded at the conclusion of thecontractual performance period, when all contingencies are resolved.

 

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

 

·                  our ability 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.

 

For our separately-managedaccounts, we are paid fees according to a schedule, which varies by investmentstrategy.  The substantial majority ofthese accounts pay us management fees pursuant to a schedule in which the ratewe earn on the AUM declines as the amount of AUM increases.  Certain of these clients pay us feesaccording to the performance of their accounts relative to certain agreed-uponbenchmarks, which results in a slightly lower base fee, but allow us to earnhigher fees if the relevant investment strategy outperforms the agreed-uponbenchmark.

 

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

 

The majority of advisoryfees we earn on separately-managed accounts are based on the value of AUM at aspecific date on a quarterly basis, either in arrears or advance.  Advisory fees on certain of ourseparately-managed accounts, and with respect to most of the mutual funds thatwe sub-advise, are calculated based on the average of the monthly or dailymarket value.  Advisory fees are also 

 

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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 feeaccording to the fee rate schedule may differ as described above.

 

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

 

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

 

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

 

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

 

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

 

**Expenses**

 

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

 

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

 

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

 

**Compensation and Benefits Expense**

 

Our largest expense iscompensation and benefits, which includes the salaries, bonuses, equity-basedcompensation and related benefits and payroll costs attributable to our membersand employees.  Compensation and benefitspackages are benchmarked against relevant industry and geographic peer groupsin order to attract and retain qualified personnel.  Cash compensation has declined due to lowerrevenue-based variable compensation costs and a decline in headcount.  The table included in the section belowdescribes the components of our compensation expense for the three and sixmonths ended June 30, 2009 and 2008:

 

| ** **                               | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                   | ** ** |
| ** **                               | ** ** | ** **                                           | ** ** |
| Cash Compensation and  Other Benefits    |       | $                                                    | 5,673      |   | $ | 8,373 |   |
| Other Non-Cash  Compensation             |       | 310                                                  |       | 289 |   |
| Total Compensation and  Benefits Expense |       | $                                                    | 5,983      |   | $ | 8,662 |   |

 

| ** **                               | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                | ** ** |
| ** **                               | ** ** | ** **                                         | ** ** |
| Cash Compensation and  Other Benefits    |       | $                                                  | 11,462     |   | $ | 16,980 |   |
| Other Non-Cash  Compensation             |       | 561                                                |       | 633 |   |
| Total Compensation and  Benefits Expense |       | $                                                  | 12,023     |   | $ | 17,613 |   |

 

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

 

On January 1, 2007, weinstituted a deferred compensation plan, in which employees who earn in excessof $600,000 per year are required to defer a portion of their compensation inexcess of this amount.  These deferredamounts may be invested, at the employee’s discretion, in certain of ourinvestment strategies, restricted phantom units of our operating company, ormoney market funds.  Amounts deferred inany period reduce that period’s cash compensation expense and vest ratably overa four-year period 

 

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beginning on January 1 of the next calendaryear.  Therefore, the amortization of aratable portion of 2007 deferred amounts has been reflected in our expenses forthe three and six months ended June 30, 2009 and 2008.  Should additional amounts be deferred infuture periods, we would expect the non-cash portion of our compensationexpense to increase as the existing and subsequently deferred amounts areamortized through income.

 

As of June 30, 2009, wehad approximately $1.7 million in unrecorded compensation expense relatedto phantom operating company units issued pursuant to our deferred compensationplan and operating company unit and option grants issued under our PIM LLC 2006Equity Incentive Plan.  We expect that theamortization of these amounts will be approximately $0.7 million for eachof the next three years, with a negligible amount amortized thereafter.

 

**General and Administrative Expenses**

 

General and administrativeexpenses include professional and outside services fees, office expenses,depreciation and the costs associated with operating and maintaining ourresearch, 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.

 

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

 

**Other Income/(Expense)**

 

Other income/(expense) isderived primarily from investment income or loss arising from our investmentsin various private investment vehicles that we employ to incubate newstrategies, interest expense on our amended Credit Agreement and Senior SubordinatedNotes, mark-to-market movements on our swap agreement, and interest incomegenerated on our excess 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 implementedsubsequent to our reorganization and offering on October 30, 2007.  As discussed further below, under “TaxReceivable Agreement”,  this liabilityrepresents 85% of the amount of cash savings, if any, in U.S. federal, stateand local income tax that we realize as a result of the amortization of theincreases in tax basis generated from the Company’s acquisition of operatingcompany units from its selling and converting shareholders.  Amounts waived by our selling and convertingshareholders reduce this liability.  Weexpect the interest and investment components of other income, in theaggregate, to fluctuate based on market conditions and the performance of ourinvestment strategies.

 

**Non-Controlling Interests**

 

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

 

**Income Tax Provision/(Benefit)**

 

While our operating companyhas historically not been subject to U.S. federal and certain state incometaxes, it has been subject to New York City Unincorporated Business Tax.  As a result of our reorganization, we are nowsubject to taxes applicable to C-corporations. As such, our effective tax rate has increased as a result of ourreorganization.  Valuation allowances areestablished, when necessary, to reduce deferred tax assets to the amountexpected to be realized.  As of June 30,2009 and December 31, 2008, the Company recorded a $63.4 million and a$62.7 million valuation allowance, respectively, against the deferred tax assetassociated with our acquisition of operating company units in conjunction withthe offering.

 

**Operating Results**

 

***General***

 

Our earnings and cash flowsare heavily dependent upon prevailing financial market conditions.  Significant increases or decreases in thevarious securities markets, particularly the equities markets, can have amaterial impact on our results of operations, financial condition, and cashflows.

 

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Beginning in the second halfof 2007 and continuing through the quarter ended March 31, 2009,performance of our investment strategies was negatively impacted by significantvolatility in the equity markets. Performance prior to 2009 was influenced by our overweight investmentexposure to the financial services sector in particular.  As a result, our assets under managementdeclined by $7.9 billion, or 42.7%, from $18.5 billion at June 30,2008 to $10.6 billion at June 30, 2009, due to negative performanceof $4.5 billion and net outflows of $3.4 billion.

 

During the three monthsended June 30, 2009, we experienced gross outflows of $1.0 billion,which were partially offset by gross inflows of $0.6 billion.  Our sub-advised accounts experienced grossoutflows of $0.7 billion, which were partially offset by $0.3 billionin gross inflows.  Our separately-managedaccounts experienced $0.3 billion in gross outflows, offset entirely by$0.3 billion in gross inflows.  The$0.4 billion in overall net outflows was mainly attributable to the weakerperformance of our sub-advised funds compared to that of their peers.

 

During the six months ended June 30,2009, we experienced gross outflows of $2.2 billion, which were partiallyoffset by gross inflows of $1.4 billion. Our sub-advised accounts experienced gross outflows of$1.4 billion, which were partially offset by $0.6 billion in grossinflows.  Our separately-managed accountsexperienced $0.8 billion in gross outflows, offset entirely by $0.8billion in gross inflows.  The$0.8 billion in overall net outflows was mainly attributable to the weakerperformance of our sub-advised funds compared to that of their peers.

 

Our average AUM fluctuatesbased on changes in the market value of accounts advised and sub-advised by us,and on fund flows.  Accordingly, givenour lower AUM levels, our revenues during 2009 are expected to decline from thecomparable 2008 periods.  A decrease inrevenue results in lower operating income and net income.

 

We expect that we willexperience continued pressure on our operating margins in the future if AUMwere to continue to decline.  We expectour operating expenses to decline modestly in 2009 from the comparable 2008periods, as we identify and implement potential cost savings opportunities.

 

***Assets Under Management and Flows***

 

The change in AUM in ourseparately-managed accounts and our sub-advised accounts for the three and sixmonths ended June 30, 2009 and 2008 is described below:

 

| ** **                   | ** ** | **For the  Three  Months  Ended June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|
| **Assets Under Management**  | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in  billions)**                              | ** ** |
| Separately-Managed  Accounts |       |                                            |       |   |   |
| Beginning of Period Assets   |       | $                                               | 5.3        |   | $ | 12.5 |   |
| *Inflows*                    | * *   | *0.3*                                           | * *   | *0.8* | * * |
| *Outflows*                   | * *   | *(0.3*                                          | *)*        | *(0.2* | *)* |
| Net Flows                    |       | —                                          |       | 0.6 |   |
| Performance                  |       | 1.5                                             |       | (1.7 | ) |
| End of Period Assets         |       | $                                               | 6.8        |   | $ | 11.4 |   |
| Sub-Advised Accounts         |       |                                            |       |   |   |
| Beginning of Period Assets   |       | $                                               | 3.3        |   | $ | 7.9 |   |
| *Inflows*                    | * *   | *0.3*                                           | * *   | *1.4* | * * |
| *Outflows*                   | * *   | *(0.7*                                          | *)*        | *(1.3* | *)* |
| Net Flows                    |       | (0.4                                            | )          | 0.1 |   |
| Performance                  |       | 0.9                                             |       | (0.9 | ) |
| End of Period Assets         |       | $                                               | 3.8        |   | $ | 7.1 |   |
| Total                        |       |                                            |       |   |   |
| Beginning of Period Assets   |       | $                                               | 8.6        |   | $ | 20.4 |   |
| *Inflows*                    | * *   | *0.6*                                           | * *   | *2.2* | * * |
| *Outflows*                   | * *   | *(1.0*                                          | *)*        | *(1.5* | *)* |
| Net Flows                    |       | (0.4                                            | )          | 0.7 |   |
| Performance                  |       | 2.4                                             |       | (2.6 | ) |
| End of Period Assets         |       | $                                               | 10.6       |   | $ | 18.5 |   |

 

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| ** **                   | ** ** | **For the Six  Months  Ended June 30,** | ** ** |
|------------------------------|------------|----------------------------------------------|------------|
| **Assets Under Management**  | ** ** | **2009**                                     | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in  billions)**                           | ** ** |
| Separately-Managed  Accounts |       |                                         |       |   |   |
| Beginning of Period Assets   |       | $                                            | 6.4        |   | $ | 14.0 |   |
| *Inflows*                    | * *   | *0.8*                                        | * *   | *1.8* | * * |
| *Outflows*                   | * *   | *(0.8*                                       | *)*        | *(1.4* | *)* |
| Net Flows                    |       | —                                       |       | 0.4 |   |
| Performance                  |       | 0.4                                          |       | (3.0 | ) |
| End of Period Assets         |       | $                                            | 6.8        |   | $ | 11.4 |   |
| Sub-Advised Accounts         |       |                                         |       |   |   |
| Beginning of Period Assets   |       | $                                            | 4.3        |   | $ | 9.6 |   |
| *Inflows*                    | * *   | *0.6*                                        | * *   | *1.9* | * * |
| *Outflows*                   | * *   | *(1.4*                                       | *)*        | *(2.6* | *)* |
| Net Flows                    |       | (0.8                                         | )          | (0.7 | ) |
| Performance                  |       | 0.3                                          |       | (1.8 | ) |
| End of Period Assets         |       | $                                            | 3.8        |   | $ | 7.1 |   |
| Total                        |       |                                         |       |   |   |
| Beginning of Period Assets   |       | $                                            | 10.7       |   | $ | 23.6 |   |
| *Inflows*                    | * *   | *1.4*                                        | * *   | *3.7* | * * |
| *Outflows*                   | * *   | *(2.2*                                       | *)*        | *(4.0* | *)* |
| Net Flows                    |       | (0.8                                         | )          | (0.3 | ) |
| Performance                  |       | 0.7                                          |       | (4.8 | ) |
| End of Period Assets         |       | $                                            | 10.6       |   | $ | 18.5 |   |

 

At June 30, 2009, our$10.6 billion of AUM were invested in eleven value-oriented investmentstrategies which represent distinct capitalization segments of the U.S. andinternational markets.  The followingtable describes the allocation of our AUM as of June 30, 2009 among oursix largest investment strategies and the aggregate of our other investmentstrategies:

 

| **Investment  Strategy** | ** ** | **AUM at********June 30, 2009** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **(in  billions)**                        | ** ** |
|                     |       |                                      |       |
| Large Cap Value          |       | $                                         | 5.5        |   |
| Value Service            |       | 1.7                                       |       |
| Global Value             |       | 1.8                                       |       |
| Small Cap Value          |       | 0.6                                       |       |
| International Value      |       | 0.2                                       |       |
| Mid Cap Value            |       | 0.2                                       |       |
| Other Strategies(1)      |       | 0.6                                       |       |
| Total                    |       | $                                         | 10.6       |   |

 

----

(1)                             Our five otherinvestment strategies are: Financial Opportunities Service, Diversified Value,European Value, All Cap Value, and International Diversified Value.

 

*ThreeMonths Ended June 30, 2009 versus June 30, 2008*

 

At June 30, 2009, theCompany managed $10.6 billion in total assets, a decrease of$7.9 billion, or 42.7%, from $18.5 billion at June 30, 2008.  The year-over-year decrease in AUM was dueprimarily to $4.5 billion in market depreciation, and, to a lesser extent,net outflows of $3.4 billion. Generally negative economic conditions and our 2008 overweightinvestment exposure to the financial services sector in particular contributedto the performance-related decline in our AUM. Our sub-advised accounts experienced net outflows of $0.4 billionfor the three months ended June 30, 2009. These net outflows were driven in part by our investment strategies’underperformance relative to their respective benchmarks and client assetre-balancing in response to the volatile economic environment.

 

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The Company managed$6.8 billion in separately-managed accounts and $3.8 billion insub-advised accounts, for a total of $10.6 billion in assets at June 30,2009.  Assets in separately-managedaccounts increased by $1.5 billion, or 28.3%, during the three monthsended June 30, 2009, due to $1.5 billion in market appreciation.  Assets in sub-advised funds increased by $0.5billion, or 15.2%, during the three months ended June 30, 2009, as aresult of $0.9 billion in market appreciation and $0.3 billion in grossinflows, offset by $0.7 billion in gross outflows.

 

*Six Months Ended June 30, 2009 versus June 30,2008*

 

At June 30, 2009, theCompany managed $10.6 billion in total assets, a decrease of$7.9 billion, or 42.7%, from $18.5 billion at June 30,2008.  The year-over-year decrease in AUMwas due primarily to $4.5 billion in market depreciation, and, to a lesserextent, net outflows of $3.4 billion.

 

The Company managed$6.8 billion in separately-managed accounts and $3.8 billion insub-advised accounts, for a total of $10.6 billion in assets at June 30,2009.  Assets in separately-managedaccounts increased by $0.4 billion, or 6.3%, during the six months ended June 30,2009, due to $0.4 billion in market appreciation.  This compared to a decrease inseparately-managed accounts of $2.6 billion, or 18.6%, during the six monthsended June 30, 2008, which resulted from $3.0 billion in marketdepreciation, offset by $0.4 billion in net inflows.  Assets in our sub-advised funds decreased by$0.5 billion or 11.6%, during the six months ended June 30, 2009, asa result of $0.8 in net outflows offset by $0.3 billion of marketappreciation.  This compared to adecrease in sub-advised accounts of $2.5 billion, or 26.0%, during the sixmonths ended June 30, 2008, due to $1.8 billion of marketdepreciation and $0.7 billion in net outflows.

 

At June 30, 2009,separately-managed accounts represented 64.2% of our total AUM, as compared to61.6% at June 30, 2008.  At June 30,2009, our Global Value and International Value investment strategies accountedfor 18.9% of our AUM, compared to 16.8% at June 30, 2008.

 

***Revenues***

 

Our revenues from advisoryfees earned on our separately-managed accounts and our sub-advised accounts forthe three and six months ended June 30, 2009 and 2008 is described below:

 

| ** **                   | ** ** | **Three Months Ended********June 30,** | ** ** |
|------------------------------|------------|---------------------------------------------|------------|
| **Revenue**                  | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in millions)**                           | ** ** |
|                         |       |                                        |       |   |   |
| Separately-Managed  Accounts |       | $                                           | 10.2       |   | $ | 20.6 |   |
| Sub-Advised Accounts         |       | 4.0                                         |       | 7.7 |   |
| Total                        |       | $                                           | 14.2       |   | $ | 28.3 |   |

* *

| ** **                   | ** ** | **Six Months Ended********June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| **Revenue**                  | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                   | ** ** | **(in millions)**                         | ** ** |
|                         |       |                                      |       |   |   |
| Separately-Managed  Accounts |       | $                                         | 20.2       |   | $ | 42.2 |   |
| Sub-Advised Accounts         |       | 7.7                                       |       | 16.1 |   |
| Total                        |       | $                                         | 27.9       |   | $ | 58.3 |   |

 

*Three Months Ended June 30, 2009 versus June 30,2008*

 

Our total revenue decreased$14.1 million, or 49.8%, to $14.2 million for the three months ended June 30,2009, from $28.3 million for the three months ended June 30,2008.  This change was driven primarilyby a reduction in weighted-average AUM, which decreased $10.4 billion, or51.0%, to $10.0 billion for the three months ended June 30, 2009 from$20.4 billion from the three months ended June 30, 2008.

 

Our weighted average feeswere 0.568% and 0.555% for the three months ended June 30, 2009 and 2008,respectively.  The increase in weightedaverage fees was primarily due to the higher mix of assets in our separately-managed Global Value andInternational Value strategies,which generally carry higher fees than our domestic strategies.  Weighted-average assets inseparately-managed accounts decreased $6.4 billion, or 50.4%, to$6.3 billion, for the three months ended June 30, 2009, from$12.7 billion at June 30, 2008, and had weighted average fees of0.655% and 0.649% for the three months ended June 30, 2009 and 2008,respectively.  The year-over-yearincrease in weighted-average fees was primarily due to the higher mix of assetsin the Company’s Global Value and International Value strategies.  Weighted-average assets in sub-advisedaccounts decreased $4.0 billion, or 52.0%,

 

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to $3.7 billion for the three monthsended June 30, 2009, from $7.7 billion for the three months ended June 30,2008, and had weighted average fees of 0.423% and 0.401% for the three monthsended June 30, 2009 and 2008, respectively.  This increase in weighted average fees wasgenerated primarily by the timing of asset flows in our sub-advised accounts.

 

*Six Months Ended June 30, 2009 versus June 30,2008*

 

Our total revenue decreased$30.4 million, or 52.1%, to $27.9 million for the six months ended June 30,2008, from $58.3 million for the six months ended June 30, 2008.  This decrease was driven primarily by adecrease in weighted-average AUM, which decreased $11.6 billion, or 54.5%,to $9.7 billion for the six months ended June 30, 2009, from$21.3 billion for the six months ended June 30, 2008.

 

Our weighted average feeswere 0.572% and 0.546% for the six months ended June 30, 2009 and 2008,respectively. Weighted-average assets in separately-managed accounts decreased$7.1 billion, or 54.2%, to $6.0 billion for the six months ended June 30,2009, from $13.1 billion for the six months ended June 30, 2008, andhad weighted average fees of 0.673% and 0.643% for the six months ended June 30,2009 and 2008, respectively. Weighted-average assets in sub-advised accounts decreased$4.5 billion, or 54.9%, to $3.7 billion for the six months ended June 30,2009, from $8.2 billion for the six months ended June 30, 2008, andhad weighted average fees of 0.408% and 0.392% for the six months ended June 30,2009 and 2008, respectively.

 

***Expenses***

 

Our operating expenses aredriven primarily by our compensation costs. The table below describes the components of our compensation expense forthe three and six months ended June 30, 2009 and 2008.

 
| ** **                               | ** ** | **For the  Three Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                  | ** ** |
|                                     |       |                                                 |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                    | 5,673      |   | $ | 8,373 |   |
| Other Non-Cash  Compensation             |       | 310                                                  |       | 289 |   |
| Total Compensation and  Benefits Expense |       | $                                                    | 5,983      |   | $ | 8,662 |   |

 
| ** **                               | ** ** | **For the Six  Months********Ended June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                | ** ** |
|                                     |       |                                               |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                  | 11,462     |   | $ | 16,980 |   |
| Other Non-Cash  Compensation             |       | 561                                                |       | 633 |   |
| Total Compensation and  Benefits Expense |       | $                                                  | 12,023     |   | $ | 17,613 |   |

 

*Three Months Ended June 30, 2009 versus June 30,2008*

 

Total operating expensesdecreased by $3.3 million, or 29.2%, to $8.0 million for the three months endedJune 30, 2009, from $11.3 million for the three months ended June 30,2008.  This decline was primarily a resultof overall reductions in bonus-related and variable compensation costs, as wellas decreases in professional services and data systems expenses.

 

Compensation and benefitsexpense decreased by $2.7 million, or 31.0%, to $6.0 million for thethree months ended June 30, 2009, from $8.7 million for the threemonths ended June 30, 2008.  Thisdecline was primarily a result of lower cash compensation arising from reducedstaffing levels and firmwide decreases in bonus-related and AUM-based variablecompensation expense.  Our employee countdecreased from 74 at June 30, 2008 to 67 at June 30, 2009.  The year-over-year decrease in headcount wasprimarily the result of staff reductions in back office operations undertakenin the fourth quarter of 2008, as well as natural attrition throughout theyear.

 

General and administrativeexpenses decreased by $0.7 million, or 25.9%, to $2.0 million for thethree months ended June 30, 2009, from $2.7 million for the threemonths ended June 30, 2008.  Thisdecrease was mainly attributable to decreases in professional services fees anddata systems costs arising from ongoing efforts to contain costs.

 

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*Six Months Ended June 30, 2009 versus June 30,2008*

 

Total operating expenses decreased by $6.9 million, or 29.6%,to $16.4 million for the six months ended June 30, 2009, from$23.3 million for the six months ended June 30, 2008.  This decrease was primarily attributable tofirm-wide reductions in staffing and bonus-related and variable compensationcosts, as well as decreases in professional services and data systems expenses.

 

Compensation and benefits expense decreased by$5.6 million, or 31.8%, to $12.0 million for the six months ended June 30,2009, from $17.6 million for the six months ended June 30, 2008.  This decrease was primarily attributable tofirm-wide reductions in bonus-related and variable compensation costs.  Our employee count decreasedfrom 74 at June 30, 2008 to 67 at June 30, 2009.  The year-over-year decrease in headcount wasprimarily a result of staff reductions in back office operations undertaken inthe fourth quarter of 2008, as well as natural attrition throughout the year.

 

General and administrativeexpenses decreased by $1.3 million, or 22.8%, to $4.4 million for thesix months ended June 30, 2009, from $5.7 million for the six monthsended June 30, 2008.  This decreasewas mainly attributable to decreases in professional services fees and datasystems costs

 

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

 

*Three Months Ended June 30, 2009 versus June 30,2008*

 

Other income/(expense)was a positive $2.9 million for the three months ended June 30, 2009, andconsisted primarily of $3.7 million in income related to the positiveperformance of the Company’s investments in its own products and $0.1 millionin interest and dividend income.  Thisincome was partially offset by $0.4 million in interest expense and $0.6million in other expense associated with an increase in the Company’s liabilityto its selling and converting shareholders associated with changes in therealizability of its related deferred tax asset.  Other income/(expense) was a negative $3.8million for the three months ended June 30, 2008.  The primary reasons for this year-over-year increasewere due to the favorable performance of the Company’s investments in its ownproducts in 2009, as well as reduced interest expense.  These year-over-year increases were partiallyoffset by the adjustments to the Company’s liability to its selling andconverting shareholders.

 

*Six Months Ended June 30, 2009 versus June 30,2008*

 

Other income/(expense) wasa positive $0.2 million for the six months ended June 30, 2009, andconsisted primarily of $1.9 million in income related to the positiveperformance of Company’s investments in its own products, largely offset byinterest expense and adjustments to the Company’s liability to its selling andconverting shareholders.  For the sixmonths ended June 30, 2008, other income/(expense) was a negative $7.9million and consisted primarily of $6.9 million in expense related to thenegative performance of Company’s investments in its own products and $2.0million in interest expense, partially offset by $1.0 million in interest anddividend income.  The year-over-yearincrease was driven primarily by the favorable performance of the Company’sinvestments in its own products in 2009, as well as reduced interestexpense.  These year-over-year increaseswere partially offset by the adjustments to the Company’s liability to itsselling and converting shareholders.

 

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

 

*Three Months Ended June 30, 2009 versus June 30,2008*

 

The Company recognized a$0.1 million income tax benefit for the second quarter of 2009, and recorded a$1.5 million provision for the second quarter of 2008.  The 2009 income tax benefit was generatedprimarily by reductions in the valuation allowance to the Company’s deferredtax asset associated with its tax receivable agreement.  The Company recorded a $0.9 million reductionin the valuation allowance in the three months ending June 30, 2009.

 

*Six Months Ended June 30, 2009 versus June 30,2008*

 

The Company recognized a$0.3 million income tax benefit for the six months ended June 30, 2009,and recorded a $3.0 million provision for the six months ended June 30,2008.  The 2009 income tax benefit wasgenerated primarily by reductions in the valuation allowance to the Company’sdeferred tax asset associated with its tax receivable agreement.  The Company recorded a $1.7 million reductionin the six months ending June 30, 2009.

 

***Non-Controlling Interests***

 

*Three Months Ended June 30, 2009 versus June 30,2008*

 

Net income attributable tonon-controlling interests was $8.5 million for the three months ended June 30,2009, and consisted of $6.1 million associated with our employees’ andoutside investors’ interest in the income of the operating company and $2.3million associated with our consolidated subsidiaries’ interest in the incomeof our consolidated investment partnerships. For the three months ended June 30, 2008, net income attributableto non-controlling interests was $11.0 million and consisted of $12.7 millionassociated with our employees’ and outside investors’ interest in the income ofthe operating company, offset by the $1.7 million effect of theabsorption, by our consolidated subsidiaries, of their share of the losses ofour consolidated investment partnerships. 

 

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The change in net income attributable tonon-controlling interests reflects primarily the decline in ourweighted-average AUM, which had a corresponding negative impact on revenues andincome, offset by the positive return on the investments in our consolidatedinvestment partnership in 2009, compared to the negative return in 2008.

 

*Six Months Ended June 30, 2009 versus June 30,2008*

 

Non-controlling interestswere $10.7 million for the six months ended June 30, 2009, andconsisted of $9.7 million associated with our employees’ and outside investors’interest in the income of the operating company and $1.0 million associatedwith our consolidated subsidiaries’ interest in the income of our consolidatedinvestment partnerships.  For the sixmonths ended June 30, 2008, non-controlling interests were $22.5 million,and consisted of $26.2 million associated with our employees’ and outsideinvestors’ interest in the income of the operating company, offset by the $3.7million effect of the absorption, by our consolidated subsidiaries, of theirshare of the losses of our consolidated investment partnerships.  The change in non-controlling interestsreflects primarily the decline in our weighted-average AUM, which had acorresponding negative impact on our revenues and income.

 

**Liquidity and Capital Resources**

 

Historically, the workingcapital needs of our business have primarily been met through cash generated byour operations.  Distributions to membersof our operating company and loan amortization payments have been our largestuse of cash from financing activities. Investing activities have historically been investments in our owninvestment strategies and, to a lesser extent, capital expenditures.

 

At June 30, 2009, ourcash and cash equivalents was $25.9 million, inclusive of $0.3 million incash held by our consolidated investment partnerships.  Advisory fees receivable was$10.6 million.  We also hadapproximately $4.7 million in equity securities, net of $9.4 millionin non-controlling interests and approximately $1.1 million in investmentsset aside to satisfy our obligations under our deferred compensation program.

 

Weexpect to fund the liquidity needs of our business in the next twelve months,and over the long term, primarily through cash generated from operations.  As an investment management firm, ourbusiness has been materially affected by conditions in the global financialmarkets 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, 2009, our AUM and revenues declined by 42.7% and 49.8%, respectively, compared withthe three months ended June 30, 2008.  As of and for the six months ended June 30, 2009, our AUM andrevenues declined by 42.7% and 52.1%, respectively, compared withthe six months ended June 30, 2008. These reductions contributed to a 63.8% and 44.6% decline in our cashprovided by operating activities during the three and six month periods ended June 30,2009, respectively.  To the extent thatour AUM experiences declines, the cash provided by operating activities may benegatively impacted.

 

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

 

We anticipate that taxallocations to the members of our operating company, which, as of June 30,2009, consisted of 26 of our employees, certain unaffiliated persons, oneformer employee and us, will continue to be a material financing activity.  Under the terms and conditions of our amendedCredit Agreement and Senior Subordinated Notes, we have suspended our dividendpayment to shareholders.  Cashdistributions to operating company members for partnership tax allocations areexpected to decline should the taxable income of the operating companydecrease.

 

As discussed further below,on October 28, 2008, our operating company entered into a third amendmentto its Credit Agreement and issued $16.0 million in Senior Subordinated Notesto entities established by Richard S. Pzena, the Company’s CEO, for thebenefit of certain of his family members, an entity controlled by a companydirector and a former employee.  Theproceeds of the notes and $9.0 million of cash reserves were used toreduce the principal amounts outstanding under the Credit Agreement.  The amendment to the Credit Agreement, amongother things, eliminated all financial covenants and the excess cash flowsweep, and reduced availability under the revolving credit facility from$3.0 million to $1.8 million. It also requires us to make mandatory quarterly principal repayments of$2.0 million and precludes us from paying dividends to shareholders.  As of June 30, 2009, we had$10.0 million and $16.0 million outstanding under the Credit Agreementand the Senior Subordinated Notes, respectively.  As a result of prepayments we have made tothe principal amount outstanding under the Credit Agreement, as of June 30,2009, we are currently not obligated to make required amortization paymentsuntil July 2010.  Although we arecomfortable with our current capital 

 

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structure, in the current economicenvironment, it is uncertain whether additional or alternative sources of debtor equity financing would be available on acceptable terms.  We have never drawn on our current revolvingcredit facility for liquidity needs and do not anticipate needing to draw onsuch a facility in the forseeable future.

 

We do not anticipatemeaningful outlays for internal investment or capital expenditures over thenext six months.

 

We believe that theamendment of our Credit Agreement, elimination of the dividend, reductions inheadcount and ability to vary cash compensation levels have provided us with anappropriate degree of flexibility in providing for our liquidity needs.

 

**Dividend Policy**

 

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

 

**Credit Agreement**

 

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

 

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

 

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

 

i.                  the minimum assets undermanagement financial covenant was eliminated;

 

ii.               the excess cash flowmandatory repayment was eliminated;

 

iii.            the commitments under therevolving credit facility were reduced from $3.0 million to approximately$1.8 million;

 

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iv.           with respect to loansborrowed at base rate, the margin added to base rate was increased from 0.00%to 0.75%; with respect to loans borrowed at LIBOR, the margin was not modified;

 

v.              certain additionalrestrictions were placed on the operating company’s ability to make RestrictedPayments (as defined in the Credit Agreement), including dividends; and

 

vi.           amendments to certaincovenants in order to permit the incurrence of subordinated debt by theoperating company.

 

Conditions precedent to theexecution of Amendment No.3 included, among others, (i) the repayment bythe operating company of $25.0 million of the $47.0 million principalamount outstanding under the Credit Agreement as of October 28, 2008, and (ii) thegrant by the operating company and one of its subsidiaries of a securityinterest in their accounts receivable.

 

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

 

During the three monthsended March 31, 2009, the Company used cash generated from operations torepay $8.0 million of the principal amount outstanding under the CreditAgreement.  The Company used cash generatedfrom operations to repay $4.0 million of the principal amount in the threemonths ending June 30, 2009.

 

**Tax Receivable Agreement**

 

Our purchase of membershipunits of our operating company concurrently with our initial public offering,and the subsequent and future exchanges by holders of Class B units of ouroperating company for shares of our Class A common stock (pursuant to theexchange rights provided for in the Operating Company’s operating agreement),has resulted in, and are expected to continue to result in, increases in ourshare of the tax basis of the tangible and intangible assets of our operatingcompany at the time of our acquisition and these future exchanges, which willincrease the tax depreciation and amortization deductions that otherwise wouldnot have been available to us.  Theseincreases in tax basis and tax depreciation and amortization deductions havereduced and are expected to continue to reduce, the amount of tax that we wouldotherwise be required to pay in the future. We have entered into a tax receivable agreement with the current membersof our operating company, the one member of our operating company immediatelyprior to our initial public offering who sold all of its membership units to usin connection with our initial public offering, and any future holders of Class Bunits, 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 aredeemed to realize in the case of an early termination payment by us, or achange in control, as described in the tax receivable agreement) as a result ofthe increases in tax basis described above and certain other tax benefitsrelated to entering into the tax receivable agreement, including tax benefitsattributable to payments under the tax receivable agreement.

 

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

 

**Cash Flows**

 

Operating activitiesprovided $8.1 million for the three months ended June 30, 2009, comparedwith $22.2 million for the three months ended June 30, 2008.  Operating activities provided$17.9 million for the six months ended June 30, 2009, compared with$32.3 million for the six months ended June 30, 2008.  This decline in cash flows from operatingactivities was driven primarily by a decrease in weighted average AUM from$20.4 billion for the three months ended June 30, 2008, to$10.0 billion for the three months ended June 30, 2009, and adecrease in weighted average AUM from $21.3 billion for the six months ended June 30,2008 to $9.7 billion for the six months ended June 30, 2009, whichnegatively impacted total revenues and earnings.

 

Investing activities consistprimarily of investments in investment partnerships and capitalexpenditures.  Investing activities werenot material for the three and six months ended June 30, 2009 and 2008.

 

Financing activities consistprimarily of distributions to members and contributions from, and distributionsto, the non-controlling interests of our consolidated subsidiaries.  Financing activities used $8.9 millionfor the three months ended June 30, 2009, compared with $21.0 millionfor the three months ended June 30, 2008. For the six months ended June 30,2009, financing activities used $19.5 million, compared to$22.3 million for the six months ended June 30, 2008.  The decrease in cash used in financingactivities is due primarily to reductions in distributions to members andcontributions from non-controlling interests.

 

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**Off-Balance Sheet Arrangements**

 

We did not have anyoff-balance sheet arrangements as of June 30, 2009.

 

**Critical Accounting Policies and Estimates**

 

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

 

Accounting policies are anintegral part of our financial statements. A thorough understanding of these accounting policies is essential whenreviewing our reported results of operations 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 consolidateall majority-owned subsidiaries in which we have a controlling financialinterest and variable-interest entities where we are deemed to be the primarybeneficiary.  We also consolidatenon-variable-interest entities which we control as the general partner ormanaging member.  We assess ourconsolidation practices regularly, as circumstances dictate.  All significant inter-company transactionsand balances have been eliminated.

 

***Income Taxes***

 

We are a “C” corporationunder the Internal Revenue Code, and thus liable for federal, state and localtaxes on the income derived from our economic interest in our operatingcompany.  The operating company is alimited liability company that has elected to be treated as a partnership fortax purposes.  Our operating company hasnot made a provision for federal or state income taxes because it is theresponsibility of each of the operating company’s members (including us) toseparately report their proportionate share of the operating company’s taxableincome or loss.  Similarly, the income ofour consolidated investment partnerships is not subject to income taxes, as suchincome is allocated to each partnership’s individual partners.  The operating company has made a provisionfor New York City UBT.

 

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

 

We believe that theaccounting estimate related to the $63.4 million valuation allowance,assessed as of June 30, 2009 against the deferred tax asset associatedwith our acquisitions of operating company membership units, is a criticalaccounting estimate because the underlying assumptions can change from periodto period.  For example, tax law changes,or variances in future projected operating performance, could result in achange in the valuation allowance.  If wewere not able to realize all or part of our net deferred tax assets in thefuture, an adjustment to our deferred tax asset valuation allowance would becharged to income tax expense in the period such determination was made.

 

Management judgment isrequired in determining our provision for income taxes, evaluating our taxpositions and establishing deferred tax assets and liabilities.  The calculation of our tax liabilitiesinvolves dealing with uncertainties in the application of complex taxregulations.  If our estimate of taxliabilities proves to be less than the ultimate assessment, a further charge toearnings would result.

 

**Recently Issued Accounting Pronouncements**

 

In June 2009,the FASB issued SFAS No. 167, “*Amendmentsto FASB Interpretation No. 46(R)*” (“SFAS 167”). SFAS 167 amendsFASB Interpretation No. 46(R), “*VariableInterest Entities*” for determining whether an entity is a SFAS 167variable interest entity (“VIE”) and requires an enterprise to perform ananalysis to determine whether the enterprise’s variable interest or interestsgive it a controlling financial interest in a VIE.  Under SFAS 167, an enterprise has acontrolling financial interest when it has a) the power

 

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to direct the activities of a VIE that most significantly impact theentity’s economic performance, and b) the obligation to absorb losses ofthe entity or the right to receive benefits from the entity that couldpotentially be significant to the VIE. SFAS 167 also requires an enterprise to assess whether it has animplicit financial responsibility to ensure that a VIE operates as designedwhen determining whether it has power to direct the activities of the VIE thatmost significantly impact the entity’s economic performance.  SFAS 167 also requires ongoing assessments ofwhether an enterprise is the primary beneficiary of a VIE, requires enhanceddisclosures and eliminates the scope exclusion for qualifying special-purposeentities.  SFAS 167 is effective as ofthe beginning of each reporting entity’s first annual reporting period thatbegins after November 15, 2009. Earlier application is prohibited. The Company is currently evaluating the impact the adoption of SFAS 167will have on its consolidated financial statements.

 

In June 2009,the FASB issued SFAS No. 168 “*The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles—a replacement of FASB Statement No. 162*”(“SFAS 168”).  The FASB AccountingStandards Codification (the “Codification”) will be the single source ofauthoritative nongovernmental U.S. generally accepted accountingprinciples.  Rules and interpretive releasesof the SEC under authority of federal securities laws are also sources ofauthoritative GAAP for SEC registrants. SFAS 168 is effective for interim and annual periods ending after September 15,2009.  All existing accounting standardsare superseded as described in SFAS 168. All other accounting literature not included in the Codification.  The Codification is not expected to have asignificant impact on the Company’s consolidated financial statements.

 

**Item 3.  Quantitativeand Qualitative Disclosures About Market Risk.**

 

**Market Risk**

 

Our exposure to market risk is directlyrelated to our role as investment adviser for the separate accounts we manageand the funds for which we act as a sub-investment adviser.  Global markets have continued to experienceunprecedented volatility, and a challenging business climate is forecast forthe foreseeable future.  Marketconditions have resulted in a significant reduction in our assets undermanagement, which directly impacts our revenues and net income.  A continued economic downturn and volatilityin the global financial 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 months andsix months ended June 30, 2009 and 2008 was derived from advisory fees,which are typically based on the market value of our AUM, which can be affectedby adverse changes in interest rates, foreign currency exchange and equityprices.  Accordingly, a decline in the pricesof securities would cause our revenue and income to decline due to a decreasein the value of the assets we manage.  Inaddition, such a decline could cause our clients to withdraw their funds infavor of investments offering higher returns or lower risk, which would causeour revenue and income to decline further.

 

We are also subject to market risk due to adecline in the value of the holdings of our consolidated subsidiaries, whichconsist primarily of equity securities. At June 30, 2009, the fair value of these assets was $15.2million.  Assuming a 10% increase ordecrease, the fair value would have increased or decreased by $1.5 million at June 30,2009.

 

***Interest Rate Risk***

 

Theamount that our operating company borrowed pursuant to the Credit Agreement,will accrue interest at variable rates. The operating company entered into an interest rate swap agreement thatcommenced on July 23, 2008.  Theswap, which expires on July 23, 2010, obligates us to pay a 2.825% fixedrate of interest on the notional amount and requires the counterparty to pay usa floating interest rate based on the monthly LIBOR interest rate.  The spread on the Credit Agreement is inaddition to these amounts.  Interest ratechanges may, therefore, affect the amount of our interest payments related toany potential differential between the notional amount of the interest rateswap and amounts outstanding under the Credit Agreement.  Such changes would correspondingly affect ourfuture earnings and cash flows.  Inaddition, we have not entered any arrangement to hedge our exposure to interestrates from July 23, 2010 to July 23, 2011.  For this one year period, interest ratechanges would affect our future earnings and cash flows.  Based on the consolidated debt obligationsthat we have as of June 30, 2009, we believe that our hedge would beunaffected in the event that interest rates were to increase by one percentagepoint.

 

**Item4.  Controls and Procedures.**

 

Duringthe course of their review of our consolidated financial statements as of June 30,2009, our management, including our Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15(b) under the Securities Exchange Act of1934.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that, as of June 30,2009, our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934) were effective to ensure that informationwe are required to disclose in reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

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Therewas no change in our internal control over financial reporting (as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934) that occurred during the first six monthsof 2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

In the normal course of business, we may be subject tovarious legal and administrative proceedings. On November 21, 2007 and January 16, 2008, substantivelyidentical putative class action lawsuits were commenced in the United StatesDistrict Court for the Southern District of New York against the Company andRichard S. Pzena, the Company’s chief executive officer, seeking remedies underSection 11 of the Securities Act of 1933, as amended.  The Court consolidated the lawsuits andappointed co-lead plaintiffs, who filed a consolidated amended complaint.  The consolidated amended complaint named as defendantsthe Company, Richard S. Pzena, and two of the underwriters of the Company’sinitial public offering, Goldman Sachs & Co, Inc. and UBSSecurities LLC.  Plaintiffs soughtto represent a class of all persons who purchased or otherwise acquired Class Acommon stock issued pursuant or traceable to the Company’s initial public offering.  The consolidated amended complaint allegedthat the registration statement and prospectus relating to the initial publicoffering of the Company’s Class A common stock contained materialmisstatements and omissions and wrongfully failed to disclose net redemptionsin the John Hancock Classic Value Fund, for which the Company acts assub-investment advisor.  The consolidatedamended complaint sought damages in an unspecified amount including rescissionor rescissory damages.  The Court grantedCompany’s motion to dismiss the consolidated amended complaint and, on September 4,2008, the Court entered a judgment in favor of the Company.  Plaintiffs have appealed the Court’s judgmentto the United States Court of Appeals for the Second Circuit, and that appealis pending.  The Company believes thatthe allegations and claims are without merit and will continue to contest theseclaims vigorously.

 

**Item 1A. Risk Factors.**

 

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

 

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

 

None.

 

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

 

None.

 

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

 

The Annual Meeting ofStockholders of the Company was held in New York, New York on May 19,2009.  At that meeting, the stockholdersconsidered and acted upon the following proposals:

 

*Proposal1: Election of Directors.*  Bythe vote reflected below, the stockholders elected the following individuals asdirectors to hold office until the 2010 Annual Meeting of Stockholders of theCompany:

 
| **Director**          | ** ** | **Class A  Shares  “For”** | ** ** | **Class B  Shares  “For”** | ** ** | **Class A  Shares  “Withheld”** | ** ** | **Class B  Shares  “Withheld”** | ** ** |
|-----------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| Richard S. Pzena      |       | 6,814,068                                 |       | 51,172,610                                |       | 77,067                                         |       | 0                                              |       |
| Steven M. Galbraith   |       | 6,819,839                                 |       | 51,172,610                                |       | 71,296                                         |       | 0                                              |       |
| Joel M. Greenblatt    |       | 6,817,040                                 |       | 51,172,610                                |       | 74,095                                         |       | 0                                              |       |
| Richard P. Meyerowich |       | 6,817,426                                 |       | 51,172,610                                |       | 73,709                                         |       | 0                                              |       |
| Ronald W. Tysoe       |       | 5,970,978                                 |       | 51,172,610                                |       | 920,157                                        |       | 0                                              |       |

 

*Proposal2: Ratification of Independent Auditors.*  The stockholders voted to ratify theappointment of Ernst & Young LLP as independent auditors for theCompany for its fiscal year ending December 31, 2009.  Voting was as follows:

 
| ** **                     | ** ** | **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|--------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| **Class A  common stock** |       | 6,843,003  |       | 45,823      |       | 2,309       |       |
| **Class B  common stock** |       | 51,172,610 |       | 0           |       | 0           |       |

 

*Proposal 3*: By the vote reflected below, the stockholders approved an amendment tothe Pzena Investment Management, Inc. 2007 Equity Incentive Plan to authorizean additional 6,419,279 shares of the Company’s Class A common stock forissuance under the Plan:

 
| ** **                     | ** ** | **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|--------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| **Class A  common stock** |       | 2,418,179  |       | 2,299,172   |       | 1,701       |       |
| **Class B  common stock** |       | 51,172,610 |       | 0           |       | 0           |       |

 

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**Item 5. Other Information.**

 

None.

 

**Item 6. Exhibits.**

 
| **Exhibit** | ** ** | **Description  of Exhibit**                                                                                                                                   |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Amendment No.1, effective May 19, 2009, to thePzena Investment  Management, Inc. 2007 Equity Incentive Plan                                         |
| 31.1        |       | Certification of Chief Executive Officer pursuant to Exchange Act  Rule 13a-14(a)/15(d)-14(a)                                                            |
| 31.2        |       | Certification of Chief Financial Officer pursuant to Exchange Act  Rule 13a-14(a)/15(d)-14(a)                                                            |
| 32.1        |       | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| 32.2        |       | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
| Dated: August 10, 2009 |                                   |
|-----------------------------|----------------------------------------|
|                        |                                   |
|                        | PZENA INVESTMENT MANAGEMENT, INC. |
|                        |                                   |
|                        |                                   |
|                        | By:                                    | /s/ RICHARD S. PZENA |
|                        |                                   | Name: | Richard S. Pzena |
|                        |                                   | Title: | *Chief Executive Officer* |
|                        | * *                               | * * |
|                        |                                   | * * |
|                        | By:                                    | /s/ GREGORY S. MARTIN |
|                        |                                   | Name: | Gregory S. Martin |
|                        |                                   | Title: | *Chief Financial Officer* |

 

40

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