Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

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

** **

**For the Quarterly Period Ended March 31, 2010**

** **

**Or**

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

 

**For the transition periodfrom                to                **

 

**Commissionfile number 001-33761**

 

**PZENAINVESTMENT MANAGEMENT, INC.**

(Exact Name of Registrant asSpecified in its Charter)

 

| **Delaware**                    | ** ** | **20-8999751**      |
|---------------------------------|------------|---------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer    |
| Incorporation or Organization)  |       | Identification No.) |

 

**120 West45th Street**

**New York, New York 10036**

(Address of PrincipalExecutive Offices) (Zip Code)

 

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

 

**NotApplicable**(Former name, former address, and former fiscal year if changed since lastreport)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 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 mark whether the registrant is a large accelerated filer,an accelerated filer, a non-accelerated filer or a smaller reporting company.See the definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

As of May 7, 2010, there were 9,367,659 outstanding shares of theregistrant’s Class A common stock, par value $0.01 per share.

 

As of May 7, 2010, there were 54,960,918 outstanding shares of theregistrant’s Class B common stock, par value $0.000001 per share.

 

 

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| ** **    | ** ** | ** **                                                                                                                                                                 | ** ** | **Page** |
|---------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| ** **    | ** ** | **PART I  — FINANCIAL INFORMATION**                                                                                                                              |       |     |
| Item 1.  |       | Consolidated  Statements of Financial Condition of Pzena Investment Management, Inc.  as of March 31, 2010 (unaudited) and December 31, 2009                |       | 1        |
|          |       | Consolidated  Statements of Operations (unaudited) of Pzena Investment  Management, Inc. for the Three Months Ended March 31, 2010 and  March 31, 2009 |       | 2        |
|          |       | Consolidated  Statements of Cash Flows (unaudited) of Pzena Investment  Management, Inc. for the Three Months Ended March 31, 2010 and  March 31, 2009 |       | 3        |
|          |       | Consolidated  Statement of Changes in Equity (unaudited) of Pzena Investment  Management, Inc. for the Three Months Ended March 31, 2010                    |       | 4        |
|          |       | Notes to the  Consolidated Financial Statements (unaudited)                                                                                                                |       | 5        |
| Item 2.  |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                |       | 18       |
| Item 3.  |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                |       | 28       |
| Item 4.  |       | Controls and  Procedures                                                                                                                                                   |       | 29       |
|          |       |                                                                                                                                                                       |       |     |
| ** **    | ** ** | **PART II  — OTHER INFORMATION**                                                                                                                                 |       |     |
| Item 1.  |       | Legal Proceedings                                                                                                                                                          |       | 30       |
| Item 1A. |       | Risk Factors                                                                                                                                                               |       | 30       |
| Item 2.  |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                               |       | 30       |
| Item 3.  |       | Defaults Upon  Senior Securities                                                                                                                                           |       | 30       |
| Item 4.  |       | (Removed and Reserved)                                                                                                                                                     |       | 30       |
| Item 5.  |       | Other Information                                                                                                                                                          |       | 30       |
| Item 6.  |       | Exhibits                                                                                                                                                                   |       | 30       |

 

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**CAUTIONARY STATEMENT REGARDING FORWARD-LOOKINGSTATEMENTS**

 

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

 

Forward-looking statements are subject to known and unknown risks anduncertainties and are based on potentially inaccurate assumptions that couldcause actual results to differ materially from those expected or implied by theforward-looking statements. Our actual results could differ materially fromthose anticipated in forward-looking statements for many reasons, including thefactors described in Item 1A, “Risk Factors” in Part I of our AnnualReport on Form 10-K for our fiscal year ended December 31, 2009.  Accordingly, you should not unduly rely onthese forward-looking statements, which speak only as of the date of thisQuarterly Report.  We undertake no obligationto publicly revise any forward-looking statements to reflect circumstances orevents after the date of this Quarterly Report, or to reflect the occurrence ofunanticipated events.  You should,however, review the factors and risks we describe in the reports we will filefrom time to time with the Securities and Exchange Commission, or SEC, afterthe date of this Quarterly Report on Form 10-Q.

 

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

 

·      ouranticipated future results of operations and operating cash flows;

 

·      ourbusiness strategies and investment policies;

 

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

 

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

 

·      potentialgrowth opportunities available to us;

 

·      therecruitment and retention of our employees;

 

·      ourexpected levels of compensation for our employees;

 

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

 

·      ourexpected tax rate;

 

·      changesin interest rates;

 

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

 

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

 

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

 

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**PART I. FINANCIALINFORMATION**

 

**Item 1. FinancialStatements.**

 

**PZENAINVESTMENT MANAGEMENT, INC.**

**CONSOLIDATED STATEMENTS OF FINANCIALCONDITION**

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

 
| ** **                                                                                                                                                               | ** ** | **As  of**         | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                               | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**    | ** ** | ** ** | ** ** |
|                                                                                                                                                                     |       |               |       |   |   |
| **ASSETS**                                                                                                                                                               |       |               |       |   |   |
| Cash  and Cash Equivalents                                                                                                                                               |       | $                  | 19,661     |   | $ | 15,908 |   |
| Restricted  Cash                                                                                                                                                         |       | 1,411              |       | 1,407 |   |
| Due  from Broker                                                                                                                                                         |       | 16                 |       | 116 |   |
| Advisory  Fees Receivable                                                                                                                                                |       | 13,454             |       | 13,378 |   |
| Investments  in Equity Securities, at Fair Value                                                                                                                         |       | 8,701              |       | 7,951 |   |
| Receivable  from Related Parties                                                                                                                                         |       | 67                 |       | 149 |   |
| Other  Receivables                                                                                                                                                       |       | 96                 |       | 36 |   |
| Prepaid  Expenses and Other Assets                                                                                                                                       |       | 619                |       | 504 |   |
| Deferred  Tax Asset, Net of Valuation Allowance of $62,172 and $60,252, respectively                                                                                     |       | 7,858              |       | 6,754 |   |
| Property  and Equipment, Net of Accumulated Depreciation of $2,492 and $2,385,  respectively                                                                             |       | 2,214              |       | 2,315 |   |
| TOTAL  ASSETS                                                                                                                                                            |       | $                  | 54,097     |   | $ | 48,518 |   |
|                                                                                                                                                                     |       |               |       |   |   |
| **LIABILITIES AND EQUITY**                                                                                                                                               |       |               |       |   |   |
| Liabilities:                                                                                                                                                             |       |               |       |   |   |
| Accounts  Payable and Accrued Expenses                                                                                                                                   |       | $                  | 5,265      |   | $ | 3,644 |   |
| Due  to Broker                                                                                                                                                           |       | 7                  |       | 731 |   |
| Senior  Subordinated Notes                                                                                                                                               |       | 7,500              |       | 10,000 |   |
| Liability  to Selling and Converting Shareholders                                                                                                                        |       | 7,001              |       | 5,642 |   |
| Other  Liabilities                                                                                                                                                       |       | 949                |       | 1,143 |   |
| TOTAL  LIABILITIES                                                                                                                                                       |       | 20,722             |       | 21,160 |   |
|                                                                                                                                                                     |       |               |       |   |   |
| Equity:                                                                                                                                                                  |       |               |       |   |   |
| Preferred  Stock (Par Value $0.01; 200,000,000 Shares Authorized; None Outstanding)                                                                                      |       | —             |       | — |   |
| Class A  Common Stock (Par Value $0.01; 750,000,000 Shares Authorized; 9,367,659 and  8,633,041 Shares Issued and Outstanding in 2010 and 2009, respectively)       |       | 93                 |       | 86 |   |
| Class B  Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 54,931,418  and 55,659,236 Shares Issued and Outstanding in 2010 and 2009, respectively) |       | —             |       | — |   |
| Additional  Paid-In Capital                                                                                                                                              |       | 10,559             |       | 10,104 |   |
| Accumulated  Deficit                                                                                                                                                     |       | (936               | )          | (1,920 | ) |
| Total  Pzena Investment Management, Inc.’s Equity                                                                                                              |       | 9,716              |       | 8,270 |   |
| Non-Controlling  Interests                                                                                                                                               |       | 23,659             |       | 19,088 |   |
| TOTAL  EQUITY                                                                                                                                                            |       | 33,375             |       | 27,358 |   |
| TOTAL  LIABILITIES AND EQUITY                                                                                                                                            |       | $                  | 54,097     |   | $ | 48,518 |   |

 

 See accompanying notes to consolidatedfinancial statements 

 

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**PZENAINVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OFOPERATIONS**

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

 
| ** **                                                                                                      | ** ** | **For  the Three Months** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                                      | ** ** | **Ended  March 31,** | ** ** |
| ** **                                                                                                      | ** ** | **2010**                  | ** ** | **2009** | ** ** |
|                                                                                                            |       |                      |       |   |   |
| **REVENUE**                                                                                                     |       | $                         | 19,150     |   | $ | 13,671 |   |
|                                                                                                            |       |                      |       |   |   |
| **EXPENSES**                                                                                                    |       |                      |       |   |   |
| Compensation  and Benefits Expense                                                                              |       | 7,388                     |       | 6,040 |   |
| General  and Administrative Expenses                                                                            |       | 1,921                     |       | 2,453 |   |
| TOTAL  OPERATING EXPENSES                                                                                       |       | 9,309                     |       | 8,493 |   |
| Operating  Income                                                                                               |       | 9,841                     |       | 5,178 |   |
|                                                                                                            |       |                      |       |   |   |
| **OTHER INCOME/(EXPENSE)**                                                                                      |       |                      |       |   |   |
| Interest  and Dividend Income                                                                                   |       | 73                        |       | 120 |   |
| Interest  Expense                                                                                               |       | (155                      | )          | (450 | ) |
| Realized  and Unrealized Gain/(Loss), Net on Equity Securities                                                  |       | 464                       |       | (1,820 | ) |
| Other  Expense                                                                                                  |       | (1,047                    | )          | (580 | ) |
| Total  Other Expense                                                                                            |       | (665                      | )          | (2,730 | ) |
| Income  Before Income Taxes                                                                                     |       | 9,176                     |       | 2,448 |   |
| Income  Tax Benefit                                                                                             |       | (99                       | )          | (274 | ) |
| Consolidated  Net Income                                                                                        |       | 9,275                     |       | 2,722 |   |
| Less:  Net Income Attributable to Non-Controlling Interests                                                     |       | 8,291                     |       | 2,240 |   |
| Net  Income Attributable to Pzena Investment Management, Inc.                                              |       | $                         | 984        |   | $ | 482 |   |
|                                                                                                            |       |                      |       |   |   |
| Earnings  per Share - Basic and Diluted Attributable to Pzena Investment Management,  Inc. Common Stockholders: |       |                      |       |   |   |
| Net  Income for Basic Earnings per Share                                                                        |       | $                         | 984        |   | $ | 482 |   |
| Basic  Earnings per Share                                                                                       |       | $                         | 0.11       |   | $ | 0.07 |   |
| Basic  Weighted Average Shares Outstanding                                                                      |       | 8,633,041                 |       | 6,948,037 |   |
|                                                                                                            |       |                      |       |   |   |
| Net  Income for Diluted Earnings per Share                                                                      |       | $                         | 5,722      |   | $ | 2,776 |   |
| Diluted  Earnings per Share                                                                                     |       | $                         | 0.09       |   | $ | 0.04 |   |
| Diluted  Weighted Average Shares Outstanding                                                                    |       | 65,005,989                |       | 64,192,792 |   |

 

 See accompanying notes to consolidatedfinancial statements 

 

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**PZENAINVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(inthousands)**

 
| ** **                                                                        | ** ** | **For  the Three Months** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                        | ** ** | **Ended  March 31,** | ** ** |
| ** **                                                                        | ** ** | **2010**                  | ** ** | **2009** | ** ** |
|                                                                              |       |                      |       |   |   |
| **OPERATING ACTIVITIES**                                                          |       |                      |       |   |   |
| Consolidated  Net Income                                                          |       | $                         | 9,275      |   | $ | 2,722 |   |
| Adjustments  to Reconcile Net Income to Net Cash Provided by Operating Activities |       |                      |       |   |   |
| Cash  Provided by Operating Activities:                                           |       |                      |       |   |   |
| Depreciation                                                                      |       | 107                       |       | 121 |   |
| Non-Cash  Compensation                                                            |       | 842                       |       | 251 |   |
| Director  Share Grant                                                             |       | 13                        |       | 280 |   |
| Realized  and Unrealized (Gain)/Loss, Net on Equity Securities                    |       | (464                      | )          | 1,820 |   |
| Increase  in Liability to Selling and Converting Shareholders                     |       | 1,026                     |       | 602 |   |
| Deferred  Income Taxes                                                            |       | (771                      | )          | (667 | ) |
|                                                                              |       |                      |       |   |   |
| Changes  in Operating Assets and Liabilities:                                     |       |                      |       |   |   |
| Advisory  Fees Receivable                                                         |       | (76                       | )          | 3,290 |   |
| Due  from Broker                                                                  |       | 100                       |       | 4 |   |
| Restricted  Cash                                                                  |       | (4                        | )          | — |   |
| Prepaid  Expenses and Other Assets                                                |       | (133                      | )          | (147 | ) |
| Due  to Broker                                                                    |       | (724                      | )          | (6 | ) |
| Accounts  Payable, Accrued Expenses, and Other Liabilities                        |       | 1,293                     |       | 727 |   |
| Purchases  of Equity Securities                                                   |       | (1,153                    | )          | (2,572 | ) |
| Proceeds  from Sale of Equity Securities                                          |       | 866                       |       | 3,431 |   |
| **Net Cash Provided by Operating Activities**                                     | ** ** | **10,197**                | ** ** | **9,856** | ** ** |
|                                                                              |       |                      |       |   |   |
| **INVESTING ACTIVITIES**                                                          |       |                      |       |   |   |
| Receivable  from Related Parties                                                  |       | 40                        |       | 2 |   |
| Purchases  of Property and Equipment                                              |       | (7                        | )          | — |   |
| **Net Cash Provided by Investing Activities**                                     | ** ** | **33**                    | ** ** | **2** | ** ** |
|                                                                              |       |                      |       |   |   |
| **FINANCING ACTIVITIES**                                                          |       |                      |       |   |   |
| Distributions  to Non-Controlling Interests                                       |       | (3,976                    | )          | (2,574 | ) |
| Retirement  of B Units                                                            |       | (2                        | )          | — |   |
| Term  Loan and Senior Subordinated Notes Repayment                                |       | (2,500                    | )          | (8,000 | ) |
| **Net Cash Used in Financing Activities**                                         | ** ** | **(6,478**                | **)**      | **(10,574** | **)** |
| ** **                                                                        | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **NET CHANGE IN CASH**                                                            | ** ** | **$**                     | **3,752**  | ** ** | **$** | **(716** | **)** |
|                                                                              |       |                      |       |   |   |
| **CASH AND CASH EQUIVALENTS - Beginning of Period**                               |       | $                         | 15,908     |   | $ | 27,421 |   |
| Net  Change in Cash                                                               |       | 3,752                     |       | (716 | ) |
| **CASH AND CASH EQUIVALENTS - End of Period**                                     |       | $                         | 19,660     |   | $ | 26,705 |   |
|                                                                              |       |                      |       |   |   |
| Supplementary  Cash Flow Information:                                             |       |                      |       |   |   |
| Interest  Paid                                                                    |       | $                         | 155        |   | $ | 467 |   |
| Income  Taxes Paid                                                                |       | $                         | 823        |   | $ | 619 |   |

 

 See accompanying notes to consolidated financialstatements 

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITEDCONSOLIDATED STATEMENT OF CHANGES IN EQUITY**

**(inthousands, except share amounts)**

 
| ** **                            | ** ** | **Shares  of  Class A  Common Stock** | ** ** | **Shares  of  Class B  Common Stock** | ** ** | **Class A  Common Stock** | ** ** | **Additional  Paid-In Capital** | ** ** | **(Accumulated  Deficit)** | ** ** | **Non-Controlling  Interests** | ** ** | **Total**  | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|----------------------------|------------|--------------------------------|------------|------------|------------|
|                                  |       |                                       |       |                                       |       |                           |       |                            |       |                       |       |                           |       |       |       |
| **Balance at December 31, 2009** | ** ** | **8,633,041**                              | ** ** | **55,659,236**                             | ** ** | **$**                          | **86**     | ** **                      | **$**      | **10,104**                 | ** ** | **$**                          | **(1,920** | **)**      | **$**      | **19,088** | ** ** | **$** | **27,358** | ** ** |
| Unit Conversion                       |       | 734,618                                    |       | (734,618                                   | )          | 7                              |       | 368                             |       | —                     |       | (318                           | )          | **57**     | ** ** |
| Retirement of Class B Units      |       | —                                     |       | (700                                       | )          | —                         |       | —                          |       | —                     |       | (2                             | )          | **(2**     | **)**      |
| Directors’ Shares                |       | —                                     |       | —                                     |       | —                         |       | —                          |       | —                     |       | 13                             | ** ** | **13**     | ** ** |
| Amortization of Non-Cash Compensation |       | —                                     |       | 7,500                                      |       | —                         |       | 87                              |       | —                     |       | 563                            | ** ** | **650**    | ** ** |
| Net Income                            |       | —                                     |       | —                                     |       | —                         |       | —                          |       | 984                        |       | 8,291                          | ** ** | **9,275**  | ** ** |
| Capital Distribution                  |       | —                                     |       | —                                     |       | —                         |       | —                          |       | —                     |       | (3,976                         | )          | **(3,976** | **)**      |
| **Balance at March 31, 2010**    | ** ** | **9,367,659**                              | ** ** | **54,931,418**                             | ** ** | **$**                          | **93**     | ** **                      | **$**      | **10,559**                 | ** ** | **$**                          | **(936**   | **)**      | **$**      | **23,659** | ** ** | **$** | **33,375** | ** ** |

 

Seeaccompanying notes to consolidated financial statements

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements**

 

**Note 1—Organization**

 

Pzena Investment Management, Inc.(the “Company”) functions as the holding company through which the business ofits operating company, Pzena Investment Management, LLC, isconducted.  The Company was incorporatedin the State of Delaware on May 8, 2007. On October 30, 2007, the Company consummated an initial publicoffering.  Concurrently with theconsummation of the Company’s initial public offering, the operating agreementof Pzena Investment Management, LLC (the “operating agreement”) wasamended and restated such that, among other things, the Company became the solemanaging member of Pzena Investment Management, LLC.  The acquisition of the operating company’smembership interests by the Company was treated as a reorganization of entitiesunder common control.  As a result ofthese transactions, as of and subsequent to October 30, 2007, (i) theCompany has consolidated the financial results of Pzena InvestmentManagement, LLC with its own and reflected the membership interest in itthat it does not own as a non-controlling interest in its consolidatedfinancial statements, and (ii) the Company recognizes income generatedfrom its economic interest in Pzena Investment Management, LLC’s netincome.

 

Pzena Investment Management, LLC is aninvestment adviser which is registered under the Investment Advisers Act of1940 and is headquartered in New York, New York.  As of March 31, 2010, the Companymanaged assets in a variety of value-oriented investment strategies across awide range of market capitalizations in both U.S. and non-U.S. capital markets.

 

The Company, through its investment in its operatingcompany, has consolidated the results of operations and financial condition ofthe following private investment partnerships as of March 31, 2010:

 
| ** **                                   | ** ** | ** **                                      | ** ** | **Ownership at**        |
|----------------------------------------------|------------|-------------------------------------------------|------------|-------------------------|
| **Entity**                                   | ** ** | **Type  of Entity (Date of Formation)**         | ** ** | **March 31, 2010** |
| Pzena Large Cap Value Fund                   |       | Massachusetts Trust (11/01/2002)                |       | 99.9%                   |
| 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%                   |

 

**Note 2—Significant Accounting Policies**

 

***Basis of Presentation:***

 

The consolidated financial statements are preparedin conformity with U.S. generally accepted accounting principles (“GAAP”) andrelated Securities and Exchange Commission (“SEC”) 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”).  As required by the *Consolidation Topic* of the Financial Accounting StandardsBoard Accounting Standards Codification (“FASB ASC”), the Company alsoconsolidates non-variable-interest entities in which it acts as the generalpartner or managing member.  All of theseentities represent private investment partnerships over which the Companyexercises or exercised control. Non-controlling interests recorded on the consolidated financialstatements of the Company include the non-controlling interests of the outsideinvestors in each of these entities, as well as those of the operatingcompany.  All significant inter-companytransactions and balances have been eliminated.

 

The Pzena Global Value Service and the Pzena Europe,Australasia, and Far East (“EAFE”) Value Service (formerly known as the InternationalValue Service) are limited liability companies whose managing members are orwere members of the executive committee of the operating company, or theoperating company itself.  Until December 31,2009, neither of these entities were considered variable-interest entities, asthe members of the executive committee of the operating company and/or theoperating company had substantive interests in the partnerships.  Each of these limited liability companieswere considered entities “similar” to limited partnerships, and are subject tothe guidance of the *Consolidation Topic*of the FASB ASC.  Under each of theirrespective operating agreements, none of these entities’ non-managing membershave the ability to remove the managing member under any circumstance, nor dothey have any participating rights.  As aresult, nothing substantive existed to overcome the presumption of control bythe managing member, as required by the *ConsolidationTopic* of the FASB ASC.  Sincethe managing members of these entities were either the operating company, orone of the controlling persons of the operating company, their results ofoperations and financial position had been consolidated through December 30,2009.

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

Effective December 31, 2009, substantially allof the Company’s investments in the Pzena Global Value Service and the PzenaEAFE Value Service, held to satisfy the Company’s obligations under its deferredcompensation program, were reallocated to the Pzena Large Cap Value Fund.  Also effective December 31, 2009, theinvestments of the operating company’s executive committee members in the PzenaGlobal Value Service and the Pzena EAFE Value Service were transferred to aseparately-managed account.  As neitherthe Company nor the members of the operating company’s executive committee hadsubstantive interests in the partnerships subsequent to the removal of theseinvestments, as of December 31, 2009, these entities were deemedvariable-interest entities.  The Companyis not considered the primary beneficiary of these entities.  Correspondingly, the Pzena Global ValueService and the Pzena EAFE Value Service were deconsolidated effective December 31,2009.  The results of operations andfinancial position of each of these entities were consolidated up until December 30,2009.

 

All of the consolidated investment partnerships are,or were, investment companies under the American Institute of Certified PublicAccountants Audit and Accounting Guide for Investment Companies.  The Company has retained the specializedaccounting for these partnerships pursuant to the *Consolidation Topic* of the FASB ASC.  Thus, the Company reports the investmentpartnerships’ investments in equity securities at fair value, with net realizedand unrealized gains and losses reported in earnings in the consolidatedstatements of operations.

 

The Company records in its own equity its pro-ratashare of transactions that impact the operating company’s net equity, includingequity and option issuances and adjustments to accumulated other comprehensiveincome.  The operating company’s pro-ratashare of such transactions are recorded as adjustments to additional paid-incapital or non-controlling interests, as applicable, on the consolidatedstatements of financial position.

 

The Company acts as the investment manager forseveral variable-interest entities.  Allof these entities are vehicles through which the Company offers its GlobalValue and/or its EAFE Value Strategies. The Company is not considered the primary beneficiary of any of theseentities.  Correspondingly, their resultsof operations and financial condition are not consolidated by the Company.  The total net assets of these variable-interestentities was approximately $547.5 million and $522.1 million at March 31,2010 and December 31, 2009, respectively. The Company is not exposed to losses as a result of its involvement withthese entities because it has no direct investment in them.

 

***Management’s Use of Estimates:***

 

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities, disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses for the period.  Actual results could differ from thoseestimates.

 

***Fair Values of FinancialInstruments:***

 

The carrying amounts of all financial instruments inthe consolidated statements of financial condition, including investments inequity securities, approximate their fair value.

 

***Revenue Recognition:***

 

Revenue, comprised of advisory fee income, isrecognized over the period in which advisory services are provided.  Advisory fee income includes management feesthat are calculated based on percentages of assets under management (“AUM”),generally billed quarterly, either in arrears or advance, depending on theircontractual terms.  Advisory fee incomealso includes incentive fees that may be earned by the Company depending on theinvestment return of the AUM.  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 AUM to determinethe incentive fees earned.  In general,returns are calculated on an annualized basis over the contract’s measurementperiod, which usually extends up to three years.  Incentive fees are generally payableannually.  Following the preferred methodidentified in the *Revenue Recognition Topic*of the FASB ASC, such incentive fee income is recorded at the conclusion of thecontractual performance period, when all contingencies are resolved.  

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

***Earnings per Share:***

 

Basic earnings per share is computed by dividing theCompany’s net income or loss attributable to the Company’s common stockholdersby the weighted average number of shares outstanding during the reportingperiod.  Diluted earnings per shareadjusts this calculation to reflect the impact of all outstanding operatingcompany Class B units, outstanding operating company phantom Class Bunits, and outstanding options granted under the Pzena Investment Management,LLC 2006 Equity Incentive Plan (the “2006 Plan”) and the Pzena InvestmentManagement, Inc. 2007 Equity Incentive Plan (the “2007 Plan”), to theextent they would have a dilutive effect on net income per share for thereporting period.  Net income for dilutedearnings per share generally assumes all operating company Class B unitsare converted into Company stock at the beginning of the reporting period andthe resulting change to Company net income associated with its increasedinterest in the operating company is taxed at the Company’s effective tax rate.

 

For the three months ended March 31, 2010 and2009, the Company’s diluted net income was determined as follows:

 
| ** **                                                     | ** ** | **For the Three Months** | ** ** |
|----------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                     | ** ** | **Ended March 31,** | ** ** |
| ** **                                                     | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**       | ** ** |
|                                                           |       |                     |       |   |   |
| Non-Controlling Interests of Pzena Investment  Management, LLC |       | $                        | 8,291      |   | $ | 3,566 |   |
| Less: Assumed Corporate Income Taxes                           |       | 3,553                    |       | 1,272 |   |
| Assumed After-Tax Income of Pzena Investment Management,  LLC  |       | $                        | 4,738      |   | $ | 2,294 |   |
|                                                           |       |                     |       |   |   |
| Assumed After-Tax Income of Pzena Investment  Management, LLC  |       | $                        | 4,738      |   | $ | 2,294 |   |
| Net Income of Pzena Investment Management, Inc.           |       | 984                      |       | 482 |   |
| Diluted Net Income                                             |       | $                        | 5,722      |   | $ | 2,776 |   |

 

For the three months ended March 31, 2010,1,620,060 options to purchase operating company units, 961,750 options topurchase Class A common stock, and 84,916 phantom operating company unitswere excluded from the calculation of diluted net income per share, as theirinclusion would have had an antidilutive effect for the period.  For the three months ended March 31,2009, 3,153,122 options to purchase operating company units, and 153,829phantom operating company units were excluded from the calculation of dilutednet income per share, as their inclusion would have had a similarlyantidilutive effect for the period.

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

For the three months ended March 31, 2010 and2009, the Company’s basic and diluted earnings per share were determined asfollows:

 
| ** **                                               | ** ** | **For the Three Months**            | ** ** |
|----------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | **Ended March 31,**            | ** ** |
| ** **                                               | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| ** **                                               | ** ** | **(in thousands, except share and** | ** ** |
| ** **                                               | ** ** | **per-share amounts)**              | ** ** |
|                                                     |       |                                |       |   |   |
| Net Income for Basic Earnings per Share                  |       | $                                   | 984        |   | $ | 482 |   |
| Basic Weighted Average Shares Outstanding                |       | 8,633,041                           |       | 6,948,037 |   |
| Basic Earnings per Share                                 |       | $                                   | 0.11       |   | $ | 0.07 |   |
|                                                     |       |                                |       |   |   |
| Net Income for Diluted Earnings per Share                |       | $                                   | 5,722      |   | $ | 2,776 |   |
| Dilutive Effect of Operating Company Class B  Units |       | 55,696,236                          |       | 57,244,755 |   |
| Dilutive Effect of Phantom Units                         |       | 17,022                              |       | — |   |
| Dilutive Effect of Options                               |       | 659,690                             |       | — |   |
| Diluted Weighted Average Shares Outstanding              |       | 65,005,989                          |       | 64,192,792 |   |
| Diluted Earnings per Share                               |       | $                                   | 0.09       |   | $ | 0.04 |   |

 

***Cash and Cash Equivalents:***

 

At March 31, 2010, cash and cash equivalentswas $19.7 million, inclusive of $0.2 million held by the Company’sconsolidated subsidiaries.  The Companyconsiders all highly-liquid debt instruments with an original maturity of threemonths or less at the time of purchase to be cash equivalents.  The Company maintains its cash in bankdeposit and other accounts whose balances, at times, exceed federally insuredlimits.

 

Interest on cash and cash equivalents is recorded asinterest income on an accrual basis on the consolidated statements ofoperations.

 

***Restricted Cash:***

 

The Company maintains a compensating balance of$1.4 million at March 31, 2010 as collateral for a letter of creditissued by a third party in lieu of a cash security deposit, as required by theCompany’s lease for its New York office space. Such amounts are recorded in restricted cash on the consolidatedstatements of financial condition.

 

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

 

Due to/from broker consists primarily of cashbalances and amounts receivable/payable for unsettled securities transactionsheld/initiated at the clearing brokers of the Company’s consolidated investmentpartnerships.

 

***Investments in Securities:***

 

Investments in equity securities represent thesecurities held by the Company and its consolidated investmentpartnerships.  All such securities arerecorded at fair value, with net realized and unrealized gains and lossesreported in earnings in the consolidated statements of operations.

 

The *Fair ValueMeasurements and Disclosures Topic* of the FASB ASC defines fairvalue as the price that would be received to sell an asset, or paid to transfera liability, in an orderly transaction between market participants at themeasurement date.  The *Fair Value Measurements and Disclosures Topic*of the FASB ASC also establishes a framework for measuring fair value and avaluation hierarchy based upon the transparency of inputs used in the valuationof an asset or liability.  Classificationwithin the hierarchy is based upon the lowest level of input that issignificant to the fair value measurement. The valuation hierarchy contains three levels: (i) valuation inputsare unadjusted quoted market prices for identical assets or liabilities inactive markets (Level 1); (ii) valuation inputs are quoted prices foridentical assets or liabilities in markets that are not active, quoted marketprices for similar assets and liabilities in active markets, and otherobservable inputs directly or indirectly related to the asset or liabilitybeing measured (Level 2); and (iii) valuation inputs are unobservableand significant to the fair value measurement (Level 3).  Additionally, entities are required todisclose in interim and annual periods the inputs and valuation techniques usedto measure fair value and define assets and liabilities measured at fair valueby major class.

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

The Company’s fair value measurements relate to itsinvestments in equity securities, which are primarily exchange-tradedsecurities with quoted prices in active markets.  The fair value measurements of the securitieshave been classified as Level 1.

 

The following table presents these instruments’ fairvalue at March 31, 2010:

 
| ** **        | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|-------------------|------------|--------------------|------------|-------------|------------|-------------|------------|
| ** **        | ** ** | **(in thousands)** | ** ** |
| ** **        | ** ** | ** **         | ** ** | ** **  | ** ** | ** **  | ** ** |
| Assets:           |       |               |       |        |       |        |       |
| Equity Securities |       | $                  | 8,701      |        | $          | —      |       | $ | — |   |
|              |       |               |       |        |       |        |       |
| Total Fair Value  |       | $                  | 8,701      |        | $          | —      |       | $ | — |   |

 

The following table presents these instruments’ fairvalue at December 31, 2009:

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

 

***Securities Valuation:***

 

Investments in equity securities which are traded ona national securities exchange are carried at fair value based on the lastreported sales price on the valuation date. If no reported sales occurred on the valuation date, investments insecurities are valued at the bid price. Securities transactions are recorded on the trade date.

 

The net realized gain or loss on sales of securitiesis determined on a specific identification basis and is included in realizedand unrealized gain/(loss), net on equity securities in the consolidatedstatements of operations.

 

***Concentrations of Credit Risk:***

 

Financial instruments that potentially subject theCompany to concentrations of credit risk consist principally of cash and cashequivalents, amounts due from brokers, and advisory fees receivable.  The Company maintains its cash and temporarycash investments in bank deposits and other accounts whose balances, at times,exceed federally insured limits.

 

The concentration of credit risk with respect toadvisory fees receivable is generally limited due to the short payment termsextended to clients by the Company.  On aperiodic basis, the Company evaluates its advisory fees receivable andestablishes an allowance for doubtful accounts, if necessary, based on ahistory of past write-offs and collections and current credit conditions.  For the three months ended March 31,2010 and 2009, approximately 9.6% and 12.2%, respectively, of the Company’sadvisory fees were generated from an advisory agreement with one client.  At March 31, 2010 and December 31,2009, no allowance for doubtful accounts has been deemed necessary.

 

***Financial Instruments:***

 

On February 28, 2008, the operating companyentered into an interest rate swap agreement, as discussed further inNote 9.  This interest rate swap wassubsequently unwound in conjunction with the termination of the creditagreement in September 2009.  Thecounterparty to this agreement was a major financial institution.  The Company’s swap agreement was designatedas a trading derivative and the fair value was recorded in other liabilities,with changes to the swap’s fair value recognized as a component of otherincome/(expense).  For the three monthsended March 31, 2009, the Company recognized less than $0.1 millionin other income related to such changes.

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

Pursuant to the guidance in the *Derivatives and Hedging Topic* of the FASBASC, it is a requirement to disclose balance sheet and income statement amountsof derivatives, as well as their locations within the financialstatements.  The following tablesummarizes the impact of the Company’s derivative financial instruments on itsresults of operations for the three months ended March 31, 2009:

 

| **Derivatives  Not Accounted For As Hedging Instruments Under the Derivatives and Hedging  Topic of the FASB ASC** | ** ** | **Statement of  Operations Account** | ** ** | **Amount of Income  Recognized in  Income of Derivative** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                         | ** ** | ** **                           | ** ** | **(in thousands)**                                        | ** ** |
|                                                                                                               |       |                                 |       |                                                      |       |
| Interest Rate Contracts                                                                                            |       | Other Income                         |       | $                                                         | 25         |   |
| Total                                                                                                              |       |                                 |       | $                                                         | 25         |   |

 

***Property and Equipment:***

 

Property and equipment is carried at cost, lessaccumulated depreciation and amortization. Depreciation is provided on a straight-line basis over the estimateduseful lives of the respective assets, which range from three to sevenyears.  Leasehold improvements areamortized on a straight-line basis over the shorter of the useful life of theimprovements or the remaining lease term.

 

***Business Segments:***

 

The Company views its operations as comprising oneoperating segment.

 

***Income Taxes:***

 

The Company is a “C” corporation under the InternalRevenue Code, and thus liable for federal, state, and local taxes on the incomederived from its economic interest in its operating company.  The operating company is a limited liabilitycompany that has elected to be treated as a partnership for tax purposes.  It has not made a provision for federal orstate income taxes because it is the individual responsibility of each of theoperating company’s members (including the Company) to separately report theirproportionate share of the operating company’s taxable income or loss.  Similarly, the income of the Company’sconsolidated investment partnerships is not subject to income taxes, since itis allocated to each partnership’s individual partners.  The operating company has made a provisionfor New York City Unincorporated Business Tax (“UBT”).

 

The Company and its consolidated subsidiariesaccount for all federal, state, and local taxation pursuant to the asset andliability method, which requires deferred income tax assets and liabilities tobe recorded for temporary differences between the financial statement and taxbases of assets and liabilities that will result in taxable or deductibleamounts in the future, based on enacted tax laws and rates applicable to theperiods in which the temporary differences are expected to affect taxableincome.  Valuation allowances areestablished, when necessary, to reduce deferred tax assets to the amount morelikely than not to be realized.  At March 31,2010, the Company had a $62.2 million valuation allowance against the deferredtax asset recorded as part of the Company’s initial public offering and thesubsequent exchanges of Class B units for shares of its Class Acommon stock.  At December 31, 2009,the Company had a $60.3 million valuation allowance against this deferredtax asset.  The income tax provision, orbenefit, is the tax payable or refundable for the period, plus or minus thechange during the period in deferred tax assets and liabilities.  The Company records its deferred taxliabilities as a component of other liabilities on the consolidated statementsof financial condition.

 

***Foreign Currency:***

 

Investment securities and other assets andliabilities denominated in foreign currencies are remeasured into U.S. dollaramounts at the date of valuation. Purchases and sales of investment securities, and income and expenseitems denominated in foreign currencies, are remeasured into U.S. dollaramounts on the respective dates of such transactions.

 

The Company does not isolate that portion of theresults of its operations resulting from changes in foreign exchange rates oninvestments from the fluctuations arising from changes in market prices ofsecurities held.  Such fluctuations areincluded in the realized and unrealized gain/(loss), net on equity securitiesin the consolidated statements of operations.

 

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**Pzena InvestmentManagement, Inc.**

**UnauditedNotes to the Consolidated Financial Statements (Continued)**

 

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

 

Reported net realized foreign exchange gains orlosses arise from sales of foreign currencies, currency gains or lossesrealized between the trade and settlement dates on securities transactions, andthe difference between the amounts of dividends, interest, and foreignwithholding taxes recorded on the Company’s books and the U.S. dollarequivalent of the amounts actually received or paid.  Net realized foreign exchange gains andlosses arise from changes in the fair values of assets and liabilitiesresulting from changes in exchange rates.

 

***Recent Accounting Pronouncements***

 

In June 2009, the FASB issued a new standardthat requires an enterprise to perform a qualitative analysis to determinewhether its variable-interests give it a controlling financial interest in avariable interest entity (VIE).  Underthe standard, an enterprise has a controlling financial interest when it has (a) thepower 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. An enterprise that holds a controlling financial interest in a VIE isdeemed to be the primary beneficiary of the VIE and is required to consolidatethe VIE.  The standard also requires anongoing assessment of whether an enterprise is the primary beneficiary of avariable-interest entity, and additional disclosures about an enterprise’sinvolvement in VIEs, and any significant changes in risk exposure due to thatinvolvement.  The standard is effectivefor fiscal years beginning after November 15, 2009.  In November 2009, the FASB issued aproposed standard update, which defers the consolidation criteria requirementsof this new standard for assets managers’ interests in entities that apply thespecialized accounting guidance for investment companies, or that have theattributes of investment companies.  Asof the January 27, 2010 FASB meeting, the FASB decided to make officialthe deferral of this standard for certain investment entities.  The Company has evaluated its interests inentities and determined that the standard is applicable for the Company’sinvestment in its operating company, but that the Company meets the criteriafor deferral provided in this standard for its consolidated funds.  The Company adopted the updated guidance on January 1,2010, and it had no impact on the Company’s consolidated financialstatements.  The Company is monitoringfor future guidance updates for its interests in its consolidated subsidiaries.

 

In January 2010,the FASB issued Accounting Standards Update No. 2010-06 (“ASU 2010-06”),which amends the use of fair value measures and the related disclosures.  ASU 2010-06 requires new disclosures fortransfers in and out of Level 1 and Level 2 fair value measurements.  The Company adopted ASU 2010-06 during the threemonths ended March 31, 2010, and its adoption had no significant impact onthe Company’s consolidated financial statements.

 

**Note 3—Property and Equipment**

 

Property and equipment, net, is comprised of thefollowing:

 
| ** **                                      | ** ** | **As of**          | ** ** |
|-------------------------------------------------|------------|--------------------|------------|
| ** **                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | **2010**           | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** ** |
|                                            |       |               |       |   |   |
| Leasehold Improvements                          |       | $                  | 2,145      |   | $ | 2,145 |   |
| Furniture and Fixtures                          |       | 1,162              |       | 1,163 |   |
| Computer Hardware                               |       | 944                |       | 948 |   |
| Office Equipment                                |       | 243                |       | 243 |   |
| Computer Software                               |       | 212                |       | 201 |   |
| Total                                           |       | 4,706              |       | 4,700 |   |
| Less: Accumulated Depreciation and Amortization |       | (2,492             | )          | (2,385 | ) |
| Total                                           |       | $                  | 2,214      |   | $ | 2,315 |   |

 

Depreciation is included in general andadministrative expenses and totaled $0.1 million for each of the threemonths ended March 31, 2010 and 2009.

 

**Note 4—Related Party Transactions**

 

For the three months ended March 31, 2010 and2009, the Company earned $1.4 million and $0.9 million, respectively,in investment advisory fees from unconsolidated entities for which it acts asthe investment manager.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 4—Related Party Transactions (continued)**

 

At both March 31, 2010 and December 31, 2009, the Company had$0.1 million remaining of an advance to an international investment company fororganization and start-up costs, which is included in receivable from relatedparties on the consolidated statements of financial condition.  The Company is the sponsor and investmentmanager of this entity.

 

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

 

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

 

On October 28, 2008, the Company issued an aggregate of$16.0 million principal amount of Senior Subordinated Notes to entitiesestablished by Richard S. Pzena, the Company’s Chief Executive Officer, for thebenefit of certain of his family members, an entity controlled by a CompanyDirector, and a former employee.  On December 31,2009, the Company repaid a total of $6.0 million principal amountoutstanding of Senior Subordinated Notes to the entity controlled by theCompany Director and a former employee. On March 31, 2010, the Company repaid a total of $2.5 millionprincipal amount outstanding of the Senior Subordinated Notes pro-rata to theentities established by Richard S. Pzena. At March 31, 2010, the remaining principal amount outstanding ofthe Senior Subordinated Notes was $7.5 million, all of which was held bythe entities established by Richard S. Pzena.

 

**Note 5—Commitments and Contingencies**

 

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

 

The Company leases office space under a non-cancelable operating leaseagreement which expires on October 31, 2015.  The Company reflects minimum lease expense ona straight-line basis over the lease term. Lease expenses totaled $0.5 million and $0.6 million for the threemonths ended March 31, 2010 and 2009, respectively, and are included ingeneral and administrative expenses.

 

**Note 6—Compensation and Benefits**

 

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

 

| ** **                               | ** ** | **For  the Three Months** | ** ** |
|------------------------------------------|------------|---------------------------|------------|
| ** **                               | ** ** | **Ended  March 31,** | ** ** |
| ** **                               | ** ** | **2010**                  | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **(in  thousands)**       | ** ** |
|                                     |       |                      |       |   |   |
| Cash  Compensation and Other Benefits    |       | $                         | 6,546      |   | $ | 5,789 |   |
| Non-Cash  Compensation                   |       | 842                       |       | 251 |   |
| Total  Compensation and Benefits Expense |       | $                         | 7,388      |   | $ | 6,040 |   |

 

For the three months ended March 31, 2010 and 2009, the Companygranted no options to purchase capital units of the operating company and nooptions to purchase shares of Class A common stock pursuant to its 2006 Planand 2007 Plan.

 

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**Pzena Investment Management, Inc.**

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

 

**Note 6—Compensation and Benefits (continued)**

 

For the three months ended March 31, 2010 and 2009, the operatingcompany granted 7,000 and 30,000, respectively, restricted Class B unitsto certain members pursuant to its 2006 Plan. These unit grants each vest ratably over a four-year period commencing January 1,2010 and 2009, respectively.  Theamortization of these awards was not material for the three months ended March 31,2010 and 2009.

 

Pursuant to the Pzena Investment Management, LLC Amended and RestatedBonus Plan (the “Bonus Plan”), which became effective January 1, 2007,eligible employees whose cash compensation is in excess of certain thresholdshave a portion of that excess mandatorily deferred.  Amounts deferred may be credited to aninvestment account, take the form of phantom Class B units, or be investedin money market funds at the employee’s discretion, and vest ratably over fouryears.  At March 31, 2010 and December 31,2009, the liability associated with deferred compensation investment accountswas approximately $0.2 million and $0.4 million, respectively, andhas been included as a component of other liabilities on the consolidatedstatement of financial condition.  Forthe three months ended March 31, 2010 and 2009, the Company recognizedapproximately $0.3 million and $0.2 million, respectively, incompensation and benefits expense associated with the amortization of alldeferred compensation awards.

 

As of March 31, 2010 and December 31, 2009, the Company hadapproximately $4.7 million and $5.3 million, respectively, in unrecordedcompensation expense related to unvested operating company phantom units issuedpursuant to our deferred compensation plan, operating company Class B unit andoption grants issued under the Company’s 2006 Plan, and stock option grantsissued under our 2007 Plan.

 

**Note 7—Short Term Borrowings**

 

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

 

**Note 8—Term Loan**

 

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

 

**Note 9—Interest Rate Swap**

 

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

 

On February 28, 2008, the Company entered into an interest rateswap agreement that commenced on July 23, 2008.  This interest rate swap was subsequentlyunwound in conjunction with the termination of the credit agreement in September 2009.  The swap obligated the Company to pay a2.825% fixed rate of interest on the notional amount and required thecounterparty to pay the Company a floating interest rate based on the monthlyLIBOR interest rate.  The spread on thecredit agreement was in addition to these amounts.

 

During 2009, the Company reduced the notional amount of its interestrate swap in tandem with the reductions in principal amounts outstanding undera credit agreement.  The amount paid tothe counterparty in exchange for these reductions for the three months ended March 31,2009 was approximately $0.2 million. For the three months ended March 31, 2009, the Company recognizedapproximately $0.1 million in other income associated with the change infair value of the swap agreement.

 

**Note 10—Income Taxes**

 

The operating company is a limited liability company that has electedto be treated as a partnership for tax purposes.  Neither it, nor the Company’s other consolidatedsubsidiaries, has made a provision for federal or state income taxes because itis the individual responsibility of each of these entities’ members (includingthe Company) to separately report their proportionate share of the respectiveentity’s taxable income or loss.  Theoperating company has made a provision for New York City UBT.  Subsequent to the offering and reorganizationon October 30, 2007, the Company, as a “C” corporation under the InternalRevenue Code, is liable for 

 

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**Pzena Investment Management, Inc.**

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

 

**Note 10—Income Taxes (continued)**

 

federal,state, and local taxes on the income derived from its economic interest in itsoperating company, which is net of UBT. Correspondingly, in its consolidated financial statements, the Companyreports both the operating company’s provision for UBT, as well as itsprovision for federal, state, and local corporate taxes.

 

The components of the income tax benefit are as follows:

 
| ** **                     | ** ** | **For  the Three Months** | ** ** |
|--------------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | **Ended  March 31,** | ** ** |
| ** **                     | ** ** | **2010**                  | ** ** | **2009** | ** ** |
| ** **                     | ** ** | **(in  thousands)**       | ** ** |
| Current  Provision:            |       |                      |       |   |   |
| Unincorporated  Business Taxes |       | $                         | 671        |   | $ | 393 |   |
| Local  Corporate Tax           |       | —                    |       | — |   |
| State  Corporate Tax           |       | —                    |       | — |   |
| Federal  Corporate Tax         |       | —                    |       | — |   |
| Total  Current Provision       |       | $                         | 671        |   | $ | 393 |   |
|                           |       |                      |       |   |   |
| Deferred  Provision:           |       |                      |       |   |   |
| Unincorporated  Business Taxes |       | $                         | (56        | ) | $ | (55 | ) |
| Local  Corporate Tax           |       | 58                        |       | 21 |   |
| State  Corporate Tax           |       | 111                       |       | 41 |   |
| Federal  Corporate Tax         |       | 383                       |       | 140 |   |
| Total  Deferred Provision      |       | $                         | 496        |   | $ | 147 |   |
|                           |       |                      |       |   |   |
| Change  in Valuation Allowance |       | (1,266                    | )          | (814 | ) |
|                           |       |                      |       |   |   |
| Total  Income Tax Benefit      |       | $                         | (99        | ) | $ | (274 | ) |

 

For the three months ended March 31, 2010 and 2009, the Company’staxable income/(loss) was determined as follows:

 
| ** **                                   | ** ** | **For  the Three Months** | ** ** |
|----------------------------------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **Ended  March 31,** | ** ** |
| ** **                                   | ** ** | **2010**                  | ** ** | **2009** | ** ** |
| ** **                                   | ** ** | **(in  thousands)**       | ** ** |
|                                         |       |                      |       |   |   |
| Income  Before Taxes                         |       | $                         | 9,176      |   | $ | 2,448 |   |
| Unincorporated  Business Taxes               |       | (615                      | )          | (338 | ) |
| Non-Controlling  Interests                   |       | (8,291                    | )          | (2,240 | ) |
| Income/(Loss)  Before Corporate Income Taxes |       | $                         | 270        |   | $ | (130 | ) |

 

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

 

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

 

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

 

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**Pzena Investment Management, Inc.**

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

 

**Note 10—Income Taxes (continued)**

 

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

 

Based on the net proceeds of the offering and tax basis of theoperating company as of October 30, 2007, this election gave rise to adeferred tax asset of approximately $68.7 million.  In December 2008, the Companyestablished a $62.7 million valuation allowance to reduce the net deferred taxasset to an amount more likely than not to be realized.  This deferred tax asset remains available tothe Company and can be used to reduce taxable income in future years.  The Company similarly reduced the associatedliability to selling and converting shareholders to reflect this change in theestimated realization of the asset.

 

As discussed further in Note 14, Shareholders’ Equity, below, on March 31,2010, and March 3, 2009, certain of the operating company’s membersexchanged an aggregate of 734,618 and 2,445,973, respectively, of their Class Bunits for an equivalent number of shares of Company Class A commonstock.  The Company elected to step upits tax basis in the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair values of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $3.6 million deferred tax asset and a corresponding$3.0 million liability to converting shareholders on March 31, 2010, and a$2.5 million deferred tax asset and a corresponding $2.2 millionliability to converting shareholders on March 3, 2009.  The Company assessed the realizability of thedeferred tax asset associated with each of these exchanges and determined thata portion of their benefits would go unutilized.  Consequently, the Company established a$3.2 million and a $2.4 valuation allowance on March 31, 2010 and March 3,2009, respectively, to reduce the deferred tax asset to an amount more likelythan not to be realized.  These deferredtax assets remain available to the Company and can be used to reduce taxableincome in future years.  The Companysimilarly reduced the associated liability to selling and convertingshareholders by $2.7 million and $2.0 million at March 31, 2010 and March 3,2009, respectively, to reflect this change in the estimated realization of theasset.  As required by the *Income Taxes Topic* of the FASB ASC, the Companyrecorded the effects of these transactions in equity.

 

During the three months ended March 31, 2010 and 2009, includingthe effects of the conversion discussed earlier, the Company’s valuationallowance was reduced by approximately $1.3 million and $0.8 million,respectively, due to revised estimates of future taxable income.  To reflect this change in the estimatedrealization of the asset, the Company correspondingly increased its liabilityto selling and converting shareholders by $1.0 million and $0.6 millionfor the three months ended March 31, 2010 and 2009, respectively.  The effects of these changes to the deferredtax asset and liability to selling and converting shareholders were recorded asa component of the income tax provision and other expense, respectively, on theconsolidated statements of operations. As of March 31, 2010 and December 31, 2009, the net values ofall deferred tax assets were approximately $7.9 million and$6.8 million, respectively.

 

As of March 31, 2010 and December 31, 2009, the net values ofthe liability to selling and converting shareholders were approximately$7.0 million and $5.6 million, respectively.

 

The change in the Company’s net deferred tax assets for the threemonths ended March 31, 2010 is summarized as follows:

 
| ** **                         | ** ** | ** **           | ** ** | ** ** | ** ** | **Valuation** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------|------------|------------|------------|---------------|------------|------------|------------|
| ** **                         | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Allowance** | ** ** | **Total**  | ** ** |
| ** **                         | ** ** | **(in  thousands)**  | ** ** |
| ** **                         | ** ** | ** **           | ** ** |
| Balance  at December 31, 2009 |       | $                    | 65,006     |       | $          | 2,001         |       | $          | (60,253    | ) | $ | 6,754 |   |
| Deferred  Tax Expense              |       | (726                 | )          | 173        |       | —        |       | (553       | )          |
| Unit  Conversion                   |       | 3,577                |       | —     |       | (3,186        | )          | 391        |       |
| Change  in Valuation Allowance     |       | —               |       | —     |       | 1,266         |       | 1,266      |       |
| Balance  at March 31, 2010    |       | $                    | 67,857     |       | $          | 2,174         |       | $          | (62,173    | ) | $ | 7,858 |   |

 

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**Pzena Investment Management, Inc.**

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

 

**Note 10—Income Taxes (continued)**

 

The change in the Company’s net deferred tax assets for the threemonths ended March 31, 2009 is summarized as follows:

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

 

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

 

Investments in equity securities consisted of the following at March 31,2010:

 
| ** ** | ** ** | **Cost**   | ** ** | **Unrealized  Gain** | ** ** | **Fair  Value** | ** ** |
|------------|------------|------------|------------|----------------------|------------|-----------------|------------|
| ** ** | ** ** | ** ** | ** ** | **(in  thousands)**  | ** ** | ** **      | ** ** |
| ** ** | ** ** | ** ** | ** ** | ** **           | ** ** | ** **      | ** ** |
| Equities   |       | $          | 7,793      |                 | $          | 908             |       | $ | 8,701 |   |
|            |            |            |            |                      |            |                 |            |  |  |  |

 

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

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

 

**Note 12—Non-Controlling Interests**

 

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

 
| ** **                                                    | ** ** | **For  the Three Months** | ** ** |
|---------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                    | ** ** | **Ended  March 31,** | ** ** |
| ** **                                                    | ** ** | **2010**                  | ** ** | **2009** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**       | ** ** |
| ** **                                                    | ** ** | ** **                | ** ** | ** ** | ** ** |
| Non-Controlling  Interest of Pzena Investment Management, LLC |       | $                         | 8,291      |   | $ | 3,566 |   |
| Non-Controlling  Interest of Consolidated Subsidiaries        |       | —                    |       | (1,326 | ) |
| Non-Controlling  Interests                                    |       | $                         | 8,291      |   | $ | 2,240 |   |

 

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

 

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

 

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**Pzena Investment Management, Inc.**

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

 

**Note 14—Shareholders’ Equity**

 

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

 

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

 

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

 

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

 

Pursuant to the amended and restated operating agreement of the operatingcompany, each vested Class B unit is exchangeable for a share of theCompany’s Class A common stock, subject to certain exchange timing andvolume limitations.

 

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

 

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

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

 

**Note 15—Subsequent Events**

 

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

 

On April 27, 2010, the Company’s board of directors declared aquarterly dividend of $0.03 per share of Class A common stock, payable on June 3,2010 to shareholders of record as of May 20, 2010.  The liability associated with this payment,and the corresponding obligation to the operating company members, will berecorded in dividends payable on the consolidated statements of financialcondition. 

 

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

 

**Overview**

 

We are an investment management firm that utilizes aclassic value investment approach in each of our investment strategies. Wecurrently manage assets in a variety of value-oriented investment strategiesacross a wide range of market capitalizations in both U.S. and non-U.S. capitalmarkets.  At March 31, 2010, ourassets under management, or AUM, was $15.4 billion.  We manage separate accounts on behalf ofinstitutions and high net worth individuals and act as a sub-investment adviserfor a variety of SEC-registered mutual funds and offshore funds.

 

We function as the holding company through which thebusiness of our operating company, Pzena Investment Management, LLC, isconducted.  Following our initial publicoffering and reorganization on October 30, 2007, we became the solemanaging member of Pzena Investment Management, LLC.  As such, we now control its business andaffairs and, therefore, consolidate its financial results with ours.  In light of our employees’ and otherinvestors’ collective membership interest in our operating company, we reflecttheir ownership as a non-controlling interest in our consolidated financialstatements.  As a result, subsequent to October 30,2007, our income is generated by our economic interest in our operating company’snet income.  As of March 31, 2010,the holders of Class A common stock (through the Company) and the holdersof Class B units of the operating company held approximately 14.6% and85.4%, respectively, of the economic interests in the operations of thebusiness.

 

**Revenue**

 

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

 

Our advisory fees are primarily driven by the levelof our AUM.  Our AUM increases ordecreases with the net inflows or outflows of funds into our various investmentstrategies and with the investment performance thereof.  In order to increase our AUM and expand ourbusiness, we must develop and market investment strategies that suit theinvestment needs of our target clients and provide attractive returns over thelong term.  The value and composition ofour AUM, and our ability to continue to attract clients, will depend on avariety of factors including, among other things:

 

·                  our ability to educate our target clientsabout our classic value investment strategies and provide them with exceptionalclient service;

 

·                  the relative investment performance of ourinvestment strategies, as compared to competing products and market indices;

 

·                  competitive conditions in the investmentmanagement and broader financial services sectors;

 

·                  general economic conditions;

 

·                  investor sentiment and confidence; and

 

·                  our decision to close strategies when we deemit to be in the best interests of our clients.

 

For our institutional accounts, we are paid feesaccording to a schedule, which varies by investment strategy.  The substantial majority of these accountspay us management fees pursuant to a schedule in which the rate we earn on theAUM declines as the amount of AUM increases. Certain of these clients pay us fees according to the performance oftheir accounts relative to certain agreed-upon benchmarks, which results in aslightly lower base fee, but allows us to earn higher fees if the relevantinvestment strategy outperforms the agreed-upon benchmark.

 

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Pursuant to our sub-investment advisory agreementswith our retail clients, we are generally paid a management fee according to aschedule in which the rate we earn on the AUM declines as the amount of AUMincreases.  Certain of these funds pay usfixed rate management fees.  Due to thesubstantially larger account size of certain of these accounts, the averageadvisory fees we earn on them, as a percentage of AUM, are lower than theadvisory fees we earn on our institutional accounts.

 

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

 

Our advisory fees may fluctuate based on a number offactors, including the following:

 

·                  changes in AUM due to appreciation ordepreciation of our investment portfolios, and the levels of the contributionand withdrawal of assets by new and existing clients;

 

·                  distribution of AUM among our investmentstrategies, which have different fee schedules;

 

·                  distribution of AUM between institutionalaccounts and retail accounts, for which we generally earn lower overalladvisory fees; and

 

·                  the level of our performance with respect toaccounts on which we are paid incentive fees.

 

**Expenses**

 

Our expenses consist primarily of compensation andbenefits expenses, as well as general and administrative expenses.  These expenses may fluctuate due to a numberof factors, including the following:

 

·                  variations in the level of total compensationexpense due to, among other things, bonuses, awards of equity to our employeesand members of our operating company, changes in our employee count and mix,and competitive factors; and

 

·                  expenses, such as rent, professional servicefees and data-related costs, incurred, as necessary, to run our business.

 

**Compensation and Benefits Expense**

 

Our largest expense is compensation and benefits,which includes the salaries, bonuses, equity-based compensation and relatedbenefits and payroll costs attributable to our members and employees.  Compensation and benefits packages arebenchmarked against relevant industry and geographic peer groups in order toattract and retain qualified personnel. The table included in the section below describes the components of ourcompensation expense for the three months ended March 31, 2010 and 2009:

 
| ** **                              | ** ** | **For the Three Months** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|
| ** **                              | ** ** | **Ended March 31,** | ** ** |
| ** **                              | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| ** **                              | ** ** | **(in thousands)**       | ** ** |
|                                    |       |                     |       |   |   |
| Cash Compensation and Other Benefits    |       | $                        | 6,546      |   | $ | 5,789 |   |
| Other Non-Cash Compensation             |       | 842                      |       | 251 |   |
| Total Compensation and Benefits Expense |       | $                        | 7,388      |   | $ | 6,040 |   |

 

Pursuant to the Pzena Investment Management, LLC2006 Equity Incentive Plan (the “2006 Plan”) and the Pzena InvestmentManagement, Inc. 2007 Equity Incentive Plan (“the 2007 Plan,” together the“2006 and 2007 Plans”), we have issued restricted Class B units andoptions to acquire Class B units in our operating company, and options toacquire shares of our Class A common stock, all of which vest ratably overthe respective award’s vesting period. We used a fair-value method in recording the compensation expenseassociated with the granting of these stock-based compensation awards.  Under this method, compensation expense ismeasured at the grant date based on the estimated fair value of the award andis recognized over the award’s vesting period. The fair value of the units is determined by reference to the marketprice of our Class A common stock on the date of grant, since these unitsare exchangeable for shares of our Class A common stock on a one-for-one basis.  The fair value of the options to acquire Class Bunits and options to acquire shares of our Class A common stock isdetermined by using an appropriate option pricing model on the grant date.

 

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On January 1, 2007, we instituted a deferredcompensation plan, in which employees who earn in excess of $600,000 per yearare required to defer a portion of their compensation in excess of thisamount.  These deferred amounts may beinvested, at the employee’s discretion, in certain of our investmentstrategies, restricted phantom units of our operating company, or money marketfunds.  Amounts deferred in any period reducethat period’s cash compensation expense and vest ratably over a four-yearperiod beginning on January 1 of the next year.  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 March 31, 2010, we had approximately$4.7 million in unrecorded compensation expense related to unvestedoperating company phantom units issued pursuant to our deferred compensationplan, operating company Class B unit and option grants issued under our2006 Plan, and stock and option grants issued under our 2007 Plan.  We expect that the amortization of theseamounts will be approximately $2.0 million for the remainder of 2010, $2.6million for 2011, and $0.1 million for 2012, with a negligible amount amortizedthereafter.

 

**General and Administrative Expenses**

 

General and administrative expenses includeprofessional and outside services fees, office expenses, depreciation and thecosts associated with operating and maintaining our research, trading andportfolio accounting systems.  Ouroccupancy-related costs and professional services expenses, in particular,generally increase or decrease in relative proportion to the overall size andscale of our business operations.

 

As a result of our offering on October 30,2007, we have incurred, and expect to continue to incur, additional expensesassociated with being a public company for, among other things, director andofficer insurance, director fees, SEC reporting and compliance (includingSarbanes-Oxley compliance), professional fees, transfer agent fees, and othersimilar expenses.  These additionalexpenses have and will continue to reduce our net income.

 

**Other Income/(Expense)**

 

Other income/(expense) is derived primarily frominvestment income or loss arising from our investments in various privateinvestment vehicles that we employ to incubate new strategies, interest expenseon our outstanding debt, mark-to-market movements on our swap agreement priorto its termination, and interest income generated on our excess cashbalances.  Other income/(expense) is alsoaffected by changes in our estimates of the liability due to our selling andconverting shareholders associated with payments owed to them under the taxreceivable agreement which was executed in connection with our reorganizationand offering on October 30, 2007. As discussed further below, under “Tax Receivable Agreement,” thisliability represents 85% of the amount of cash savings, if any, in U.S.federal, state, and local income tax that we realize as a result of theamortization of the increases in tax basis generated from the Company’sacquisitions of operating company units from its selling and convertingshareholders.  Amounts waived by ourselling and converting shareholders reduce this liability.  We expect the interest and investmentcomponents of other income/(expense), in the aggregate, to fluctuate based onmarket conditions and the performance of our investment strategies.

 

**Non-Controlling Interests**

 

Our operating company has historically consolidatedthe results of operations of the private investment partnerships over which weexercise a controlling influence.  Afterour reorganization, we became the sole managing member of our operating companyand now control its business and affairs and, therefore, consolidate itsfinancial results with ours.  In light ofour employees’ and outside investors’ interest in our operating company, wehave reflected their membership interests as a non-controlling interest in ourconsolidated financial statements.  As aresult, subsequent to October 30, 2007, our income is generated by oureconomic interest in our operating company’s net income.  As of March 31, 2010, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 14.6% and 85.4%, respectively, of theeconomic interests in the operations of the business.

 

**Income Tax Provision/(Benefit)**

 

While our operating company has historically notbeen subject to U.S. federal and certain state income taxes, it has beensubject to New York City Unincorporated Business Tax.  As a result of our reorganization, we aresubject to taxes applicable to C-corporations. As such, our effective tax rate has increased as a result of ourreorganization.  Valuation allowances areestablished, 

 

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whennecessary, to reduce deferred tax assets to the amount more likely than not tobe realized.  As of March 31, 2010and  December 31, 2009, the Company’svaluation allowance against the deferred tax asset associated with our acquisitionof operating company units in conjunction with the offering and subsequentexchanges was $62.2 million and $60.3 million, respectively.

 

**Operating Results**

 

***General***

 

Our earnings and cash flows are heavily dependentupon prevailing financial market conditions. Significant increases or decreases in the various securities markets,particularly the equities markets, can have a material impact on our results ofoperations, financial condition, and cash flows.

 

Beginning in the second half of 2007 and continuingthrough the quarter ended March 31, 2009, the performance of ourinvestment strategies was negatively impacted by significant volatility in theequity markets.  Performance prior to March 31,2009 was influenced by our overweight investment exposure to the financialservices sector in particular. Subsequent to March 31, 2009, all of our investment strategiesexperienced substantial improvement in their performance, and significantlyoutperformed their respective benchmarks. As a result, our assets under management increased by $6.8 billion,or 79.1%, from $8.6 billion at March 31, 2009, to $15.4 billionat March 31, 2010, due to positive performance of $6.6 billion and netinflows of $0.2 billion.

 

For the three months ended March 31, 2010, we experiencednet outflows of $0.1 million, consisting of gross outflows of$0.8 billion, partially offset by gross inflows of $0.7 billion.  Our institutional accounts experienced grossinflows of $0.4 billion, which were partially offset by $0.3 billion in grossoutflows.  The institutional grossinflows were mainly attributable to existing clientcontributions.  Institutionalgross outflows are frequently due to a wide range of client decisions. For thethree months ended March 31, 2010, these decisions included: rebalancing totarget portfolio weight following a strong twelve-month performance period,adoption of de-risking strategies, adjustment of portfolio target weights, andchanges by plan decision-makers and investment committees.  For the three months ended March 31,2010, our retail accounts experienced $0.5 billion in gross outflows and$0.3 billion in gross inflows.  

 

During the three months ended March 31, 2009,we experienced net outflows of $0.4 million, consisting of gross outflows of$1.2 billion, offset by gross inflows of $0.8 billion.  Our institutional accounts experienced grossoutflows of $0.6 billion, which were partially offset by $0.5 billionin gross inflows.  As noted above,institutional gross outflows arise as the result of a variety of clientdecisions.  For the three months endedMarch 31, 2009, these decisions were largely driven by the market’s decline,severely impacting plan sponsors’ own access to liquidity.  Since alternative asset classes generallyhave more restrictive redemption rights, some clients turned to their publicequity managers to access liquidity.  Forthe three months ended March 31, 2009, our retail accounts experienced$0.6 billion in gross outflows and $0.3 billion in gross inflows.

 

Our average AUM fluctuates based on changes in themarket value of accounts advised and managed by us, and on fund flows.  Accordingly, given our higher average AUMlevels, our revenues for the three months ended March 31, 2010 haveincreased compared to our revenues for the three months ended March 31,2009.  An increase in revenue typicallyresults in higher operating income and net income.

 

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***Assets Under Management and Flows***

 

The change in AUM in our institutional accounts andour retail accounts for the three months ended March 31, 2010 and 2009 andthe twelve months ended March 31, 2010 is described below:

 
| ** **                         | ** ** | **For the Three Months** | ** ** | **For the Twelve Months** | ** ** |
|------------------------------------|------------|--------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **Ended March 31,** | ** ** | **Ended March 31,**  | ** ** |
| **Assets  Under Management**       | ** ** | **2010**                 | ** ** | **2009**                  | ** ** | **2010** | ** ** |
| ** **                         | ** ** | **(in billions)**        | ** ** | **(in billions)**         | ** ** |
| Institutional Accounts             |       |                     |       |                      |       |   |   |
| Beginning of Period Assets         |       | $                        | 10.7       |                      | $          | 7.4 |   | $ | 6.0 |   |
| *Inflows*                          | * *   | *0.4*                    | * *   | *0.5*                     | * *   | *2.6* | * * |
| *Outflows*                         | * *   | *(0.3*                   | *)*        | *(0.6*                    | *)*        | *(1.7* | *)* |
| Net Flows                          |       | 0.1                      |       | (0.1                      | )          | 0.9 |   |
| Market Appreciation/(Depreciation) |       | 0.9                      |       | (1.3                      | )          | 4.8 |   |
| End of Period Assets               |       | $                        | 11.7       |                      | $          | 6.0 |   | $ | 11.7 |   |
| Retail Accounts                    |       |                     |       |                      |       |   |   |
| Beginning of Period Assets         |       | $                        | 3.6        |                      | $          | 3.3 |   | $ | 2.6 |   |
| *Inflows*                          | * *   | *0.3*                    | * *   | *0.3*                     | * *   | *1.4* | * * |
| *Outflows*                         | * *   | *(0.5*                   | *)*        | *(0.6*                    | *)*        | *(2.1* | *)* |
| Net Flows                          |       | (0.2                     | )          | (0.3                      | )          | (0.7 | ) |
| Market Appreciation/(Depreciation) |       | 0.3                      |       | (0.4                      | )          | 1.8 |   |
| End of Period Assets               |       | $                        | 3.7        |                      | $          | 2.6 |   | $ | 3.7 |   |
| Total                              |       |                     |       |                      |       |   |   |
| Beginning of Period Assets         |       | $                        | 14.3       |                      | $          | 10.7 |   | $ | 8.6 |   |
| *Inflows*                          | * *   | *0.7*                    | * *   | *0.8*                     | * *   | *4.0* | * * |
| *Outflows*                         | * *   | *(0.8*                   | *)*        | *(1.2*                    | *)*        | *(3.8* | *)* |
| Net Flows                          |       | (0.1                     | )          | (0.4                      | )          | 0.2 |   |
| Market Appreciation/(Depreciation) |       | 1.2                      |       | (1.7                      | )          | 6.6 |   |
| End of Period Assets               |       | $                        | 15.4       |                      | $          | 8.6 |   | $ | 15.4 |   |

 

At March 31, 2010, our $15.4 billion of AUMwere invested in various value-oriented investment strategies representingdistinct geographical segments of the U.S., Global, and Europe, Australasia,and Far East (“EAFE”) markets.  Thefollowing table describes the allocation of our AUM, as of March 31, 2010and 2009, among our investment strategies:

 
| ** **               | ** ** | **AUM at March 31,** | ** ** |
|--------------------------|------------|---------------------------|------------|
| **Investment  Strategy** | ** ** | **2010**                  | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(in billions)**         | ** ** |
| ** **               | ** ** | ** **                | ** ** | ** ** | ** ** |
| U.S. Value Strategies    |       | $                         | 10.5       |   | $ | 6.5 |   |
| Global Value Strategies  |       | 2.9                       |       | 1.5 |   |
| EAFE Value Strategies    |       | 2.0                       |       | 0.6 |   |
| Total                    |       | $                         | 15.4       |   | $ | 8.6 |   |

 

*Three Months Ended March 31, 2010 versus March 31,2009*

 

At March 31, 2010, the Company managed$15.4 billion in total assets, an increase of $6.8 billion, or 79.1%,from $8.6 billion at March 31, 2009. The year-over-year increase in AUM was primarily due to$6.6 billion in market appreciation. Improving overall economic conditions contributed to theperformance-related increase in our AUM. Our institutional accounts experienced net inflows of $0.1 billionand our retail accounts experienced net outflows of $0.2 billion for thethree months ended March 31, 2010. The net inflows in our institutional accounts were driven primarily byexisting client contributions.

 

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At March 31, 2010, the Company managed$11.7 billion in institutional accounts and $3.7 billion in retailaccounts, for a total of $15.4 billion in assets.  For the three months ended March 31,2010, assets in institutional accounts increased by $1.0 billion, or 9.4%,due to $0.9 billion in market appreciation and $0.4 billion in grossinflows, offset by $0.3 billion in gross outflows.  For the three months ended March 31,2010, assets in retail accounts increased by $0.1 billion, or 2.8%, as a resultof $0.3 billion in market appreciation and $0.3 billion in grossinflows, offset by $0.5 billion in gross outflows.

 

At March 31, 2010, institutional accountsrepresented 76.0% of our total AUM, compared to 70.0% at March 31,2009.  At March 31, 2010, our EAFE Valueand Global Value investment strategies accounted for 31.8% of our AUM, comparedto 24.4% at March 31, 2009.

 

***Revenues***

 

Our revenues from advisory fees earned on ourinstitutional and retail accounts for the three months ended March 31,2010 and 2009 is described below:

 
| ** **             | ** ** | **For the Three Months** | ** ** |
|------------------------|------------|--------------------------|------------|
| ** **             | ** ** | **Ended March 31,** | ** ** |
| **Revenue**            | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| ** **             | ** ** | **(in millions)**        | ** ** |
| ** **             | ** ** | ** **               | ** ** | ** ** | ** ** |
| Institutional Accounts |       | $                        | 16.2       |   | $ | 11.1 |   |
| Retail Accounts        |       | 3.0                      |       | 2.6 |   |
| Total                  |       | $                        | 19.2       |   | $ | 13.7 |   |

 

*Three Months Ended March 31, 2010 versus March 31,2009*

 

Our total revenue increased $5.5 million, or40.1%, to $19.2 million for the three months ended March 31, 2010,from $13.7 million for the three months ended March 31, 2009.  This change was driven primarily by anincrease in weighted-average AUM, which increased $5.2 billion, or 56.5%,to $14.4 billion for the three months ended March 31, 2010 from$9.2 billion for the three months ended March 31, 2009.

 

Our weighted average fee rate was 0.532% and 0.594%for the three months ended March 31, 2010 and 2009, respectively.  The decrease in the weighted average fee ratewas due primarily to an increase in the average size of the Company’sinstitutional accounts.  The Company’stiered fee schedules typically charge lower rates as account size increases.  Weighted-average assets in institutionalaccounts increased $4.5 billion, or 70.3%, to $10.9 billion for thethree months ended March 31, 2010, from $6.4 billion at March 31,2009, and had a weighted average fee rate of 0.594% and 0.691% for the threemonths ended March 31, 2010 and 2009, respectively.  Weighted-average assets in retail accountsincreased $0.7 billion, or 25.0%, to $3.5 billion for the threemonths ended March 31, 2010, from $2.8 billion for the three monthsended March 31, 2009, and had a weighted average fee rate of 0.341% and0.371% for the three months ended March 31, 2010 and 2009,respectively.  Theyear-over-year decrease was due to the timing of asset flows in our retailaccounts and the effects of the voluntary partial fee waiver on the JohnHancock Classic Value Fund.  Our waiverexpires in May 2010.

 

***Expenses***

 

Our operating expenses are driven primarily by ourcompensation costs.  The table belowdescribes the components of our compensation expense for the three months endedMarch 31, 2010 and 2009:

 
| ** **                              | ** ** | **For the Three Months** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|
| ** **                              | ** ** | **Ended March 31,** | ** ** |
| ** **                              | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| ** **                              | ** ** | **(in thousands)**       | ** ** |
|                                    |       |                     |       |   |   |
| Cash Compensation and Other Benefits    |       | $                        | 6,546      |   | $ | 5,789 |   |
| Other Non-Cash Compensation             |       | 842                      |       | 251 |   |
| Total Compensation and Benefits Expense |       | $                        | 7,388      |   | $ | 6,040 |   |

 

 

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*Three Months Ended March 31, 2010 versus March 31,2009*

 

Total operating expenses increased by $0.8 million,or 9.4%, to $9.3 million for the three months ended March 31, 2010, from$8.5 million for the three months ended March 31, 2009.  This increase was primarily attributable toincreases in discretionary bonus accruals.

 

Compensation and benefits expense increased by$1.4 million, or 23.3%, to $7.4 million for the three months ended March 31,2010, from $6.0 million for the three months ended March 31,2009.  This increase was primarily aresult of increases in discretionary bonus accruals, as discussed above.  Our employee count increased from 67 at March 31,2009 to 68 at March 31, 2010.

 

General and administrative expenses decreased by$0.6 million, or 24.0%, to $1.9 million for the three months ended March 31,2010, from $2.5 million for the three months ended March 31,2009.  This decrease was mainlyattributable to decreases in professional services fees and data systems costs.

 

***Other Expense***

 

*Three Months Ended March 31,2010 versus March 31, 2009*

 

Other expense was $0.7 million for the three monthsended March 31, 2010, and consisted primarily of $1.0 million in otherexpense associated with an increase in the Company’s liability to its sellingand converting shareholders associated with changes in the realizability of itsrelated deferred tax asset, and $0.2 million in interest expense, offset by$0.5 million in income related to the positive performance of the Company’sinvestments in its own products.  Otherexpense was $2.7 million for the three months ended March 31, 2009, andconsisted primarily of $1.8 million in charges related to the negativeperformance of the Company’s investments in its own products, $0.6 million inother expense associated with an increase in the Company’s liability to itsselling and converting shareholders associated with changes in therealizability of its related deferred tax asset, and $0.4 million in interestexpense, offset by $0.1 million in interest and dividend income.

 

***Income Tax Benefit***

 

*Three Months Ended March 31,2010 versus March 31, 2009*

 

Theincome tax benefit was $0.1 million for the three months ended March 31,2010, and $0.3 million for the three months ended March 31, 2009. The income tax benefit for the three months ended March 31, 2010 and 2009was generated primarily by reductions of $1.3 million and $0.8 million,respectively, to the valuation allowance against the Company’s deferred taxasset associated with its tax receivable agreement.  Exclusive of theseadjustments, the remaining income tax provision for the three months ended March 31,2010 consisted of $0.6 million in operating company unincorporated businesstaxes and $0.6 million in corporate income taxes.  For the three monthsended March 31, 2009, the remaining income tax provision consisted of $0.3million in operating company unincorporated business taxes and $0.2 million incorporate income taxes.  The increase in these taxes was primarilyattributable to an increase in taxable income.  A comparison of theeffective tax rate for the three months ended March 31, 2010 to that ofthe three months ended March 31, 2009 is not meaningful due to thevaluation allowance adjustments.

 

***Non-ControllingInterests***

 

*Three Months Ended March 31,2010 versus March 31, 2009*

 

Net income attributable to non-controlling interestswas $8.3 million for the three months ended March 31, 2010, andconsisted almost entirely of $8.3 million associated with our employees’and outside investors’ interest in the income of the operating company.  Net income attributable to non-controllinginterests was $2.2 million for the three months ended March 31, 2009,and consisted of $3.5 million associated with our employees’ and outsideinvestors’ interest in the income of the operating company, offset by the$1.3 million effect of the absorption, by our consolidated subsidiaries,of their share of the losses of our consolidated investment partnerships.  The increase in the interest in the earningsof the operating company is primarily a result of the increase in ourweighted-average AUM, which had a corresponding positive impact on revenues andincome.  The decrease in our consolidatedsubsidiaries’ interest in the earnings of our consolidated investmentpartnerships is primarily a result of the deconsolidation of the Pzena GlobalValue Service and the Pzena EAFE Value Service on December 31, 2009.

 

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***Non-GAAP Net Income***

 

Our results for the three months ended March 31, 2010 and 2009included adjustments related to our tax receivable agreement and the associatedliability to our selling and converting shareholders.  Excluding these adjustments, diluted netincome and diluted net income per share was $5.5 million and $0.08,respectively, for the three months ended March 31, 2010, and$2.6 million and $0.04, respectively, for the year ended March 31,2009.  We believe that excluding theseadjustments provides information to better analyze the Company’s operationsbetween periods and over time. Investors should consider these non-GAAPmeasures in addition to, and not as a substitute for, financial measuresprepared in accordance with GAAP.

 

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

 
| ** **                                                                                                        | ** ** | **For  the Three Months**                                | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Ended  March 31,**                                | ** ** |
| ** **                                                                                                        | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                                                                                                        | ** ** | **(in  thousands, except share and  per-share amounts)** | ** ** |
|                                                                                                              |       |                                                     |       |   |   |
| GAAP  Net Income                                                                                                  |       | $                                                        | 984        |   | $ | 482 |   |
| Net  Effect of Tax Receivable Agreement                                                                           |       | (240                                                     | )          | (212 | ) |
| Non-GAAP  Net Income                                                                                              |       | $                                                        | 744        |   | $ | 270 |   |
|                                                                                                              |       |                                                     |       |   |   |
| GAAP  Non-Controlling Interest of Pzena Investment Management, LLC                                                |       | $                                                        | 8,291      |   | $ | 3,566 |   |
| Less:  Assumed Corporate Income Taxes                                                                             |       | 3,553                                                    |       | 1,272 |   |
| Assumed  After-Tax Income of Pzena Investment Management, LLC                                                     |       | $                                                        | 4,738      |   | $ | 2,294 |   |
| Non-GAAP  Net Income of Pzena Investment Management, Inc.                                                    |       | 744                                                      |       | 270 |   |
| Non-GAAP  Diluted Net Income                                                                                      |       | $                                                        | 5,482      |   | $ | 2,564 |   |
|                                                                                                              |       |                                                     |       |   |   |
| Non-GAAP  Diluted Earnings Per Share Attributable to Pzena Investment  Management, Inc. Common Stockholders: |       |                                                     |       |   |   |
| Non-GAAP  Net Income for Diluted Earnings per Share                                                               |       | $                                                        | 5,482      |   | $ | 2,564 |   |
| Non-GAAP  Diluted Earnings per Share                                                                              |       | $                                                        | 0.08       |   | $ | 0.04 |   |
| Non-GAAP  Diluted Weighted Average Shares Outstanding                                                             |       | 65,005,989                                               |       | 64,192,792 |   |

 

**Liquidity and Capital Resources**

 

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

 

At March 31, 2010, our cash and cash equivalents was $19.7million, inclusive of $0.2 million in cash held by our consolidatedinvestment partnerships.  Advisory feesreceivable were $13.5 million.  Wealso had approximately $6.6 million in marketable equity securities, netof approximately $2.1 million in investments set aside to satisfy ourobligations 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 March 31, 2010, our AUM and revenues increased by 79.1% and 40.1%,respectively, compared to the three months ended March 31, 2009.  These increases contributed to a 3.0%increase in our cash provided by operating activities during the comparableperiods.

 

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

 

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

 

As discussed further below in “Term Loan and Senior Subordinated Notes,”on October 28, 2008, the operating company issued an aggregate of$16.0 million principal amount of Senior Subordinated Notes to entities establishedby Richard S. Pzena, the Company’s Chief Executive Officer, for the benefit ofcertain of his family members, an entity controlled by a Company director, anda former employee.  At March 31,2010, the remaining principal amount outstanding of Senior Subordinated Noteswas $7.5 million, all of which was held by the entities established byRichard S. Pzena. Although we are comfortable with our current capitalstructure, in the current economic environment, it is uncertain whetheradditional or alternative sources of debt or equity financing would beavailable on acceptable terms.

 

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

 

We believe that the repayment of our term loan, reductions in the levelof our Senior Subordinated debt, and our ability to vary cash compensationlevels have provided us with an appropriate degree of flexibility in providingfor our liquidity needs.

 

**Dividend Policy**

 

We are a holding company and have no material assets other than ourownership of membership interests in our operating company.  As a result, we depend upon distributionsfrom our operating company to pay any dividends that our board of directors maydeclare to be paid to our Class A common stockholders. When, and if, our board of directors declares any such dividends, wethen cause our operating company to make distributions to us in an amountsufficient to cover the amount of the dividends declared.  Our dividend policy has certain risks and limitations,particularly with respect to liquidity. We may not pay dividends to our Class A common shareholders inamounts that have been paid to them in the past, or at all, if, among otherthings, we do not have the cash necessary to pay our intended dividends.  To the extent we do not have cash on handsufficient to pay dividends in the future, we may decide not to paydividends.  By paying cash dividendsrather than investing that cash in our future growth, we risk slowing the paceof our growth, or not having a sufficient amount of cash to fund our operationsor unanticipated capital expenditures, should the need arise.

 

**Term Loan and Senior Subordinated Notes**

 

During the year ended December 31, 2009, we repaid the remaining$22.0 million of the principal amount outstanding under our termloan.  Concurrently with the terminationof this term loan, a security interest in our accounts receivable and one ofour subsidiaries was released by the lender in September 2009.

 

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 thebenefit of certain of his family members, an entity controlled by a Companydirector, and the former employee.  On December 31,2009, the Company repaid a total of $6.0 million principal amountoutstanding of Senior Subordinated Notes to the entity controlled by theCompany director and a former employee. On March 31, 2010, the Company repaid a total of $2.5 millionprincipal amount pro rata to the entities established by Richard S. Pzena.  At March 31, 2010, the remainingprincipal amount outstanding of Senior Subordinated Notes was$7.5 million, all of which was held by the entities established by RichardS. Pzena.

 

**Tax Receivable Agreement**

 

Our purchase of Class B units of our operating companyconcurrently with our initial public offering, and the subsequent and futureexchanges by holders of Class B units of our operating company for sharesof our Class A common stock (pursuant to the exchange rights provided forin the operating company’s operating agreement), has resulted in, and isexpected to continue to result in, increases in our share of the tax basis ofthe tangible and intangible assets of our operating company at the time of ouracquisitions and 

 

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thesesubsequent and future exchanges, which will increase the tax depreciation andamortization deductions that otherwise would not have been available tous.  These increases in tax basis and taxdepreciation and amortization deductions have reduced, and are expected tocontinue to reduce, the amount of tax that we would otherwise be required topay in the future.  We have entered intoa tax receivable agreement with the current members of our operating company,the one member of our operating company immediately prior to our initial publicoffering who sold all of its Class B units to us in connection with ourinitial public offering, and any future holders of Class B units, thatrequires us to pay them 85% of the amount of cash savings, if any, in U.S.federal, state and local income tax that we actually realize (or are deemed torealize in the case of an early termination payment by us, or a change incontrol, as described in the tax receivable agreement) as a result of theincreases in tax basis described above and certain other tax benefits relatedto entering into the tax receivable agreement, including tax benefitsattributable to payments under the tax receivable agreement.

 

In October 2008, the selling unitholders agreed to waive anypayments that we were required to make to them for the 2008 and 2009 tax yearspursuant to the tax receivable agreement.

 

**Cash Flows**

 

Operating activities provided $10.2 million and $9.9 millionfor the three months ended March 31, 2010 and 2009, respectively.  The year-over-year increase in cash flowsfrom operating activities was driven primarily by an increase in weightedaverage AUM from $9.2 billion for the three months ended March 31,2009, to $14.4 billion for the three months ended March 31, 2010,which had a corresponding positive impact on total revenues.

 

Investing activities consist primarily of investments in affiliates andother investment partnerships, as well as capital expenditures.  Investing activities provided less than $0.1million for each of the three months ended March 31, 2010 and 2009.

 

Financing activities consist primarily of borrowing arrangements anddistributions to non-controlling interests.  Financing activities used $6.5 million and $10.6 million for thethree months ended March 31, 2010 and 2009, respectively.   The year-over-year decrease in cash used infinancing activities is due primarily to a $5.5 million reduction in repaymentson our outstanding debt, partially offset by a $1.4 million increase indistributions to non-controlling interests.

 

**Off-Balance Sheet Arrangements**

 

We did not have any off-balance sheet arrangements as of March 31,2010.

 

**Critical Accounting Policies and Estimates**

 

The preparation of our consolidated financial statements in accordancewith U.S. generally accepted accounting principles (“GAAP”) requires managementto make estimates and judgments that affect our reported amounts of assets,liabilities, revenues and expenses and related disclosure of contingent assetsand liabilities.  We base our estimateson historical experience and on various other assumptions that are believed tobe reasonable under current circumstances, the results of which form the basisfor making judgments about the carrying value of assets and liabilities thatare not readily available from other sources. We evaluate our estimates on an ongoing basis.  Actual results may differ from theseestimates under different assumptions or conditions.

 

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

 

***Consolidation***

 

Our policy is to consolidate all majority-owned subsidiaries in whichwe have a controlling financial interest and variable-interest entities ofwhich we are deemed to be the primary beneficiary.  We also consolidate non-variable-interestentities which we control as the general partner or managing member. We assessour consolidation practices regularly, as circumstances dictate.  All significant inter-company transactionsand balances have been eliminated.

 

***Income Taxes***

 

We are a C-corporation under the Internal Revenue Code, and thus liablefor federal, state and local taxes on the income derived from our economicinterest in our operating company.  Theoperating company is a limited liability company that has elected 

 

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tobe treated as a partnership for tax purposes. Our operating company has not made a provision for federal or state incometaxes because it is the responsibility of each of the operating company’smembers (including us) to separately report their proportionate share of theoperating company’s taxable income or loss. Similarly, the income of ourconsolidated 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 Unincorporated Business Tax (“UBT”).

 

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

 

We believe that the accounting estimate related to the$62.2 million valuation allowance, assessed as of March 31, 2010 againstthe deferred tax asset associated with our acquisitions of operating company Class Bunits, is a critical accounting estimate because the underlying assumptions canchange from period to period.  Forexample, tax law changes, or variances in future projected operatingperformance, could result in a change in the valuation allowance.  If we were not able to realize all or part ofour net deferred tax assets in the future, an adjustment to our deferred taxassets valuation allowance would be charged to income tax expense in the periodsuch determination was made.

 

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

 

**Recent Accounting Pronouncements**

 

In June 2009, the FASB issued a new standard that requires anenterprise to perform a qualitative analysis to determine whether itsvariable-interests give it a controlling financial interest in a variableinterest entity (VIE).  Under thestandard, an enterprise has a controlling financial interest when it has (a) thepower 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. An enterprise that holds a controlling financial interest in a VIE isdeemed to be the primary beneficiary of the VIE and is required to consolidatethe VIE.  The standard also requires anongoing assessment of whether an enterprise is the primary beneficiary of avariable-interest entity, and additional disclosures about an enterprise’sinvolvement in VIEs, and any significant changes in risk exposure due to thatinvolvement.  The standard is effectivefor fiscal years beginning after November 15, 2009.  In November 2009, the FASB issued aproposed standard update, which defers the consolidation criteria requirementsof this new standard for assets managers’ interests in entities that apply thespecialized accounting guidance for investment companies, or that have theattributes of investment companies.  Asof the January 27, 2010 FASB meeting, the FASB decided to make officialthe deferral of this standard for certain investment entities.  We have evaluated our interests in entitiesand determined that the standard is applicable for our investment in ouroperating company, but that we meet the criteria for deferral provided in thisstandard for our consolidated funds.  We adopted the updated guidance on January 1,2010, and it had no impact on our consolidated financial statements.  We are monitoring for futureguidance updates for our interests in our consolidated subsidiaries.

 

In January 2010,the FASB issued Accounting Standards Update No. 2010-06 (“ASU 2010-06”),which amends the use of fair value measures and the related disclosures.  ASU 2010-06 requires new disclosures fortransfers in and out of Level 1 and Level 2 fair value measurements.  We adopted ASU 2010-06 during the threemonths ended March 31, 2010, and its adoption had no significant impact onour consolidated financial statements.

 

**Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

**Market Risk**

 

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

 

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the global financial markets, could alsosignificantly affect the estimates, judgments, and assumptions used in thevaluation of our financial instruments.

 

All of our revenue for the three months endedMarch 31, 2010 and 2009 was derived from advisory fees, which aretypically based on the market value of AUM, which can be affected by adversechanges in interest rates, foreign currency exchange and equity prices.  Accordingly, a decline in the prices ofsecurities would cause our revenue and earnings to decline due to a decrease inthe 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 earnings 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 marketable securities. At March 31, 2010, the fair value of these assets was $8.7million.  Assuming a 10% increase ordecrease, the fair value would have increased or decreased by $0.9 million at March 31,2010.

 

***Interest Rate Risk***

 

Since the interest on the Company’s remaining $7.5 million ofSenior Subordinated Notes is at a fixed rate, the Company does not have anyexposure to interest rate risk at March 31, 2010.

 

**Item 4.   Controls and Procedures.**

 

During the course of their review of ourconsolidated financial statements as of March 31, 2010, our management,including our Chief Executive Officer and Chief Financial Officer, evaluatedthe effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based on that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that, as of March 31,2010, our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Exchange Act). were effective to ensure that information we are required todisclose in reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in SEC rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure.

 

There have not been any changes in ourinternal control over financial reporting during the three months ended March 31,2010 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

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

 

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

 

**Item 1A. Risk Factors.**

 

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

 

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

 

None.

 

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

 

None.

 

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

 

**Item 5. Other Information.**

 

None.

 

**Item 6. Exhibits.**

 
| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                            |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Amendment,  effective March 24, 2010, to Amended and Restated Operating Agreement of  Pzena Investment Management, LLC, dated as of October 30, 2007, by and  among Pzena Investment Management, Inc. as the Managing Member of Pzena  Investment Management, LLC and those Class B members whose signatures  are affixed thereto |
| 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 requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

Dated: May 7, 2010

 

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

 

 

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

 

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