x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
| x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
March 31, 2011
o Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
| o | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Delaware | 20-8999751 | |
(State or Other Jurisdiction of | (I.R.S. Employer | |
Incorporation or Organization) | Identification No.) |
(Do not check if a smaller reporting company) Page 1 2 4 5 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS As of September 30, December 31, 2010 2009 (unaudited) ASSETS Cash and Cash Equivalents $ 26,801 $ 15,908 Restricted Cash 1,420 1,407 Due from Broker 13 116 Advisory Fees Receivable 14,248 13,378 Investments, at Fair Value 3,058 7,951 Receivable from Related Parties 80 149 Other Receivables 53 36 Prepaid Expenses and Other Assets 637 504 Deferred Tax Asset, Net of Valuation Allowance of $61,366 and $60,252, respectively 7,554 6,754 Property and Equipment, Net of Accumulated Depreciation of $2,686 and $2,385, respectively 2,005 2,315 TOTAL ASSETS $ 55,869 $ 48,518 LIABILITIES AND EQUITY Liabilities: Accounts Payable and Accrued Expenses $ 11,455 $ 3,644 Due to Broker 16 731 Senior Subordinated Notes — 10,000 Liability to Selling and Converting Shareholders 7,608 5,642 Other Liabilities 1,245 1,143 TOTAL LIABILITIES 20,324 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 10,689 10,104 Retained Earnings/(Accumulated Deficit) 194 (1,920 ) Total Pzena Investment Mangement, Inc.’s Equity 10,976 8,270 Non-Controlling Interests 24,569 19,088 TOTAL EQUITY 35,545 27,358 TOTAL LIABILITIES AND EQUITY $ 55,869 $ 48,518 For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 REVENUE $ 18,482 $ 16,813 $ 57,020 $ 44,717 EXPENSES Compensation and Benefits Expense 7,375 6,232 22,026 18,255 General and Administrative Expenses 1,837 1,904 5,927 6,330 TOTAL OPERATING EXPENSES 9,212 8,136 27,953 24,585 Operating Income 9,270 8,677 29,067 20,132 OTHER INCOME/(EXPENSE) Interest and Dividend Income 85 116 270 363 Interest Expense — (376 ) (232 ) (1,231 ) Net Realized and Unrealized Gain from Investments 544 4,152 137 6,061 Increase in Liability to Selling and Converting Shareholders (1,725 ) (2,382 ) (1,633 ) (3,586 ) Other Expense 3 41 72 149 Total Other Income/(Expense) (1,093 ) 1,551 (1,386 ) 1,756 Income Before Income Taxes 8,177 10,228 27,681 21,888 Income Tax Provision/(Benefit) (1,075 ) (2,040 ) 1,373 (2,379 ) Consolidated Net Income 9,252 12,268 26,308 24,267 Less: Net Income Attributable to Non-Controlling Interests 8,033 10,836 23,632 21,531 Net Income Attributable to Pzena Investment Management, Inc. $ 1,219 $ 1,432 $ 2,676 $ 2,736 Net Income for Basic Earnings per Share $ 1,219 $ 1,432 $ 2,676 $ 2,736 Basic Earnings per Share $ 0.13 $ 0.17 $ 0.29 $ 0.34 Basic Weighted Average Shares Outstanding 9,367,659 8,633,041 9,125,477 8,077,545 Net Income for Diluted Earnings per Share $ 5,632 $ 6,051 $ 16,096 $ 12,889 Diluted Earnings per Share $ 0.09 $ 0.09 $ 0.25 $ 0.20 Diluted Weighted Average Shares Outstanding 64,993,746 64,994,278 65,006,198 64,756,331 Cash Dividends per Share of Class A Stock $ 0.03 $ — $ 0.06 $ — See accompanying notes to consolidated financial statements. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 OPERATING ACTIVITIES Consolidated Net Income $ 9,252 $ 12,268 $ 26,308 $ 24,267 Adjustments to Reconcile Net Income to Cash Provided by Operating Activities: Depreciation 108 121 322 362 Non-Cash Compensation 901 255 2,565 816 Director Share Grant 14 — 41 280 Net Realized and Unrealized Gain from Investments (544 ) (4,152 ) (137 ) (6,061 ) Increase in Liability to Selling and Converting Shareholders 1,725 2,382 1,633 3,586 Deferred Income Taxes (1,677 ) (2,611 ) (579 ) (3,804 ) Changes in Operating Assets and Liabilities: Advisory Fees Receivable (928 ) (2,113 ) (870 ) 881 Due from Broker 58 (19 ) 103 (13 ) Prepaid Expenses and Other Assets 16 (1,550 ) (120 ) (1,544 ) Due to Broker (79 ) (1 ) (715 ) (18 ) Due to Principles — (653 ) — — Accounts Payable, Accrued Expenses, and Other Liabilities 3,110 2,790 7,473 5,115 Purchases of Investments (2,336 ) (2,913 ) (5,847 ) (7,771 ) Proceeds from Sale of Equity Securities 304 3,891 7,279 9,507 Net Cash Provided by Operating Activities 9,924 7,695 37,456 25,603 INVESTING ACTIVITIES Restricted Cash (4 ) — (13 ) — Receivable from Related Parties (13 ) (43 ) 27 6 Purchases of Property and Equipment (3 ) — (13 ) (6 ) Net Cash Provided by/(Used In) Investing Activities (20 ) (43 ) 1 — FINANCING ACTIVITIES Distributions to Non-Controlling Interests (6,322 ) (4,719 ) (20,225 ) (12,199 ) Contributions from Non-Controlling Interests — 322 4,321 322 Retirement of B Units — — (2 ) — Term Loan and Senior Subordinated Notes Repayment — (10,000 ) (10,000 ) (22,000 ) Dividends (281 ) — (562 ) — Net Cash Used in Financing Activities (6,603 ) (14,397 ) (26,468 ) (33,877 ) NET CHANGE IN CASH $ 3,301 $ (6,745 ) $ 10,989 $ (8,274 ) CASH AND CASH EQUIVALENTS - Beginning of Period $ 23,596 $ 25,892 $ 15,908 $ 27,421 Effect of Deconsolidation of Affiliates (96 ) — (96 ) — Net Change in Cash 3,301 (6,745 ) 10,989 (8,274 ) CASH AND CASH EQUIVALENTS - End of Period $ 26,801 $ 19,147 $ 26,801 $ 19,147 Supplementary Cash Flow Information: Interest Paid $ — $ 332 $ 232 $ 1,191 Income Taxes Paid $ 643 $ 535 $ 2,597 $ 1,907 Shares of Shares of Retained Earnings/ Class A Class B Class A Additional (Accumulated Non-Controlling Common Stock Common Stock Common Stock Paid-In Capital Deficit) Interests Total Balance at December 31, 2009 8,633,041 55,659,236 $ 86 $ 10,104 $ (1,920 ) $ 19,088 $ 27,358 Unit Conversion 734,618 (734,618 ) 7 368 — (318 ) 57 Retirement of Class B Units — (700 ) — — — (2 ) (2 ) Directors’ Shares — — — 4 — 37 41 Amortization of Non-Cash Compensation — 7,000 — 276 — 1,679 1,955 Net Income — — — — 2,676 23,632 26,308 Contributions from Non-Controlling Interests — — — — — 4,321 4,321 Distributions to Non-Controlling Interests — — — (63 ) — (20,162 ) (20,225 ) Effect of Deconsolidation of Affiliates — — — — — (3,706 ) (3,706 ) Class A Cash Dividends Paid ($0.06 per share) — — — — (562 ) — (562 ) Balance at September 30, 2010 9,367,659 54,930,918 $ 93 $ 10,689 $ 194 $ 24,569 $ 35,545 Operating Company's Ownership at Legal Entity Type of Entity (Date of Formation) March 31, 2011 Pzena Investment Management, PTY Massachusetts Trust (11/01/2002) 0.0% condition. participation percentage in such return differentials is then multiplied by AUM to determine the incentive fees earned. In general, returns are calculated on an annualized basis over the contract’s measurement period, which usually extends rate, exclusive of adjustments associated with both the valuation allowance and the liability to selling and converting shareholders. When this conversion results in an increase in earnings per share or a decrease in loss per share, diluted net income and diluted earnings per share are assumed to be equal to basic net income and basic earnings per share for the reporting period. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Non-Controlling Interests of Pzena Investment Management, LLC $ 7,722 $ 8,082 $ 23,483 $ 17,767 Less: Assumed Corporate Income Taxes 3,309 3,463 10,063 7,614 Assumed After-Tax Income of Pzena Investment Management, LLC $ 4,413 $ 4,619 $ 13,420 $ 10,153 Assumed After-Tax Income of Pzena Investment Management, LLC $ 4,413 $ 4,619 $ 13,420 $ 10,153 Net Income of Pzena Investment Management, Inc. 1,219 1,432 2,676 2,735 Diluted Net Income $ 5,632 $ 6,051 $ 16,096 $ 12,888 For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands, except share and per-share amounts) Net Income for Basic Earnings per Share $ 1,219 $ 1,432 $ 2,676 $ 2,736 Basic Weighted Average Shares Outstanding 9,367,659 8,633,041 9,125,477 8,077,545 Basic Earnings per Share $ 0.13 $ 0.17 $ 0.29 $ 0.34 Net Income for Diluted Earnings per Share $ 5,632 $ 6,051 $ 16,096 $ 12,889 Dilutive Effect of Operating Company Class B Units 54,960,418 55,559,751 55,202,995 56,131,004 Dilutive Effect of Phantom Units 26,890 586,068 21,188 547,782 Dilutive Effect of Options 638,779 — 656,538 — Diluted Weighted Average Shares Outstanding 64,993,746 64,994,278 65,006,198 64,756,331 Diluted Earnings per Share $ 0.09 $ 0.09 $ 0.25 $ 0.20 at Fair Value: The Company’s fair value measurements relate to its consolidated Level 1 Level 2 Level 3 (in thousands) Assets: Equity Securities $ 759 $ — $ — Investments in Mutual Funds 2,299 — — Total Fair Value $ 3,058 $ — $ — March 31, 2011: Level 1 Level 2 Level 3 (in thousands) Assets: Equity Securities $ 7,951 $ — $ — Total Fair Value $ 7,951 $ — $ — 2010: Amount of Income Recognized Derivatives Not Accounted For As Hedging in Income of Derivative Instruments Under the Derivatives and Statement of For the Three Months For the Nine Months Hedging Topic of the FASB ASC Operations Account Ended September 30, 2009 Ended September 30, 2009 (in thousands) Interest Rate Contracts Other Income $ 20 $ 88 Total $ 20 $ 88 Property and Equipment: from changes in exchange rates. did not record any accumulated other comprehensive income. As of September 30, December 31, 2010 2009 (in thousands) Leasehold Improvements $ 2,145 $ 2,145 Furniture and Fixtures 1,164 1,163 Computer Hardware 930 948 Office Equipment 240 243 Computer Software 212 201 Total 4,691 4,700 Less: Accumulated Depreciation and Amortization (2,686 ) (2,385 ) Total $ 2,005 $ 2,315 2010. these VIEs. This entity is included in the unconsolidated VIEs, noted above, which the Company is not the primary beneficiary of. Consolidated Financial Statements (Continued) 2010. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Cash Compensation and Other Benefits $ 6,474 $ 5,977 $ 19,461 $ 17,439 Non-Cash Compensation 901 255 2,565 816 Total Compensation and Benefits Expense $ 7,375 $ 6,232 $ 22,026 $ 18,255 2010. Consolidated Financial Statements (Continued) For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Current Provision: Unincorporated Business Taxes $ 602 $ 572 $ 1,951 $ 1,426 Local Corporate Tax — — — — State Corporate Tax — — — — Federal Corporate Tax — — — — Total Current Provision $ 602 $ 572 $ 1,951 $ 1,426 Deferred Provision: Unincorporated Business Taxes $ (56 ) $ (56 ) $ (168 ) $ (167 ) Local Corporate Tax 60 57 176 121 State Corporate Tax 114 108 335 231 Federal Corporate Tax 391 372 1,152 793 Total Deferred Provision $ 509 $ 481 $ 1,495 $ 978 Change in Valuation Allowance (2,186 ) (3,093 ) (2,073 ) (4,783 ) Total Income Tax Provision/(Benefit) $ (1,075 ) $ (2,040 ) $ 1,373 $ (2,379 ) For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Income Before Taxes $ 8,177 $ 10,228 $ 27,681 $ 21,888 Unincorporated Business Taxes (546 ) (516 ) (1,783 ) (1,259 ) Non-Controlling Interests (8,033 ) (10,836 ) (23,632 ) (21,531 ) Income Before Corporate Income Taxes $ (402 ) $ (1,124 ) $ 2,266 $ (902 ) The acquisition of the operating company Class B units noted Company under the tax receivable agreement. If certain change of control events were to occur, the Company would be obligated to make an early termination payment. 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 Deferred Tax Expense (849 ) 303 — (546 ) Change in Valuation Allowance — — (1,379 ) (1,379 ) Balance at June 30, 2010 $ 67,008 $ 2,477 $ (63,552 ) $ 5,933 Deferred Tax Expense (801 ) 236 — (565 ) Change in Valuation Allowance — — 2,186 2,186 Balance at September 30, 2010 $ 66,207 $ 2,713 $ (61,366 ) $ 7,554 The change in the Company’s net deferred tax assets for the three 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 Deferred Tax Expense (726 ) 320 — (406 ) Change in Valuation Allowance — — 876 876 Balance at June 30, 2009 $ 66,460 $ 1,617 $ (63,399 ) $ 4,678 Deferred Tax Expense (727 ) 190 — (537 ) Change in Valuation Allowance — — 3,093 3,093 Balance at September 30, 2009 $ 65,733 $ 1,807 $ (60,306 ) $ 7,234 Cost Unrealized Gain Fair Value (in thousands) Investments $ 2,777 $ 281 $ 3,058 March 31, 2011: Cost Unrealized Gain Fair Value (in thousands) Investments $ 7,321 $ 630 $ 7,951 For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Non-Controlling Interest of Pzena Investment Management, LLC $ 7,722 8,082 $ 23,483 17,767 Non-Controlling Interest of Consolidated Subsidiaries 311 2,754 149 3,764 Non-Controlling Interests $ 8,033 $ 10,836 $ 23,632 $ 21,531 March 31, March 3, 2010 2009 (in thousands) Pzena Investment Management, LLC Members’ Capital $ 10,140 $ 33,788 Pzena Investment Management, LLC Accumulated Deficit (9,824 ) (33,679 ) Realizable Deferred Tax Asset 391 152 Net Tax Receivable Liability to Converting Unitholders (332 ) (129 ) Total $ 375 $ 132 Common Stock, at Par $ 7 $ 25 Additional Paid-in Capital 368 107 Total $ 375 $ 132 In evaluating the financial condition and results of operations, we also review certain non-GAAP measures of earnings, which exclude these items. Excluding these adjustments, non-GAAP diluted net income and non-GAAP diluted net income per share were $6.2 million and $0.10, respectively, for the three months ended March 31, 2011, and $5.5 million and $0.08, respectively, for the three months ended March 31, 2010. GAAP and non-GAAP net income for diluted earnings per share generally assumes all operating company membership units are converted into Company stock at the beginning of the reporting period, and the resulting change to our net income associated with our increased interest in the operating company is taxed at our effective tax rate. The Company’s effective tax rate, exclusive of adjustments related to our tax receivable agreement and the associated liability to selling and converting shareholders, was 42.8% and 42.6% for the three months ended years ended March 31, 2011 and 2010, respectively, as noted in the section “Operating Results—Income Tax Benefit,” below. our clients pay us fees according to the performance of their accounts relative to certain agreed-upon benchmarks, which results in a slightly lower base fee, but allows us to earn higher fees if the relevant investment strategy outperforms the agreed-upon benchmark. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Cash Compensation and Other Benefits $ 6,474 $ 5,977 $ 19,461 $ 17,439 Other Non-Cash Compensation 901 255 2,565 816 Total Compensation and Benefits Expense $ 7,375 $ 6,232 $ 22,026 $ 18,255 in 2014. conditions and the performance of our consolidated investment partnerships and other investments. March 31, 2011, our approximately $16.3 billion of AUM was invested in a variety of value-oriented investment strategies, representing distinct capitalization segments of U.S. and non-U.S. equity markets. The performance and AUM of our five largest investment strategies as of March 31, 2011 are further described below. We follow the same investment process for each of these strategies. Our investment strategies are distinguished by the market capitalization ranges from which we select securities for their portfolios, which we refer to as each strategy’s investment universe, as well as the regions in which we invest. While our investment process includes ongoing review of companies in the investment universes described below, our actual investments may include companies outside of the relevant market capitalization range at the time of our investment. In addition, the number of holdings typically found in the portfolios of each of our investment strategies may vary, as described below. management. For the three months ended For the three months ended Global Value investment strategies accounted for 35.0% of our AUM, compared to 31.8% at March 31, 2010. For the Three Months For the Nine Months For the Twelve Ended September 30, Ended September 30, September 30, Assets Under Management 2010 2009 2010 2009 2010 (in billions) Institutional Accounts Beginning of Period Assets $10.0 $7.5 $10.7 $7.4 $10.2 Inflows 0.6 0.9 1.3 1.8 2.2 Outflows (0.5 ) (0.3 ) (1.3 ) (1.5 ) (1.8 ) Net Flows 0.1 0.6 0.0 0.3 0.4 Market Appreciation 1.2 2.1 0.6 2.5 0.7 End of Period Assets $11.3 $10.2 $11.3 $10.2 $11.3 Retail Accounts Beginning of Period Assets $3.1 $3.1 $3.6 $3.3 $3.7 Inflows 0.3 0.3 1.0 0.9 1.5 Outflows (0.7 ) (0.4 ) (1.7 ) (1.5 ) (2.4 ) Net Flows (0.4 ) (0.1 ) (0.7 ) (0.6 ) (0.9 ) Market Appreciation 0.3 0.7 0.1 1.0 0.2 End of Period Assets $3.0 $3.7 $3.0 $3.7 $3.0 Total Beginning of Period Assets $13.1 $10.6 $14.3 $10.7 $13.9 Inflows 0.9 1.2 2.3 2.7 3.7 Outflows (1.2 ) (0.7 ) (3.0 ) (3.0 ) (4.2 ) Net Flows (0.3 ) 0.5 (0.7 ) (0.3 ) (0.5 ) Market Appreciation 1.5 2.8 0.7 3.5 0.9 End of Period Assets $14.3 $13.9 $14.3 $13.9 $14.3 AUM at September 30, Investment Strategy 2010 2009 (in billions) U.S. Value Strategies $ 9.2 $ 9.9 Global Value Strategies 3.2 2.4 Europe, Australasia, and Far East (“EAFE”) Value Strategies 1.9 1.6 Total $ 14.3 $ 13.9 processing sectors. For the Three Months For the Nine Months Ended September 30, Ended September 30, Revenue 2010 2009 2010 2009 (in thousands) Institutional Accounts $ 15,491 $ 13,839 $ 47,756 $ 36,466 Retail Accounts 2,991 2,974 9,264 8,251 Total $ 18,482 $ 16,813 $ 57,020 $ 44,717 March 31, 2010. To the extent that we experience reductions in weighted average AUM, either through negative market performance or net client outflows, our revenue will be adversely affected. was $0.2 million. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands) Cash Compensation and Other Benefits $ 6,474 $ 5,977 $ 19,461 $ 17,439 Other Non-Cash Compensation 901 255 2,565 816 Total Compensation and Benefits Expense $ 7,375 $ 6,232 $ 22,026 $ 18,255 2010: benefits expenses, as discussed below. non-cash compensation. our selling shareholders reduce this liability. Other income/(expense) was an expense of For the Three Months For the Nine Months Ended September 30, Ended September 30, 2010 2009 2010 2009 (in thousands, except share and per-share amounts) GAAP Net Income $ 1,219 $ 1,432 $ 2,676 $ 2,736 Net Effect of Tax Receivable Agreement 461 711 440 1,197 Non-GAAP Net Income $ 758 $ 721 $ 2,236 $ 1,539 GAAP Non-Controlling Interest of Pzena Investment Management, LLC $ 7,722 $ 8,082 $ 23,483 $ 17,767 Less: Assumed Corporate Income Taxes 3,309 3,463 10,063 7,613 Assumed After-Tax Income of Pzena Investment Management, LLC $ 4,413 $ 4,619 $ 13,420 $ 10,154 Non-GAAP Net Income of Pzena Investment Management, Inc. 758 721 2,236 1,539 Non-GAAP Diluted Net Income $ 5,171 $ 5,340 $ 15,656 $ 11,693 Non-GAAP Diluted Earnings Per Share Attributable to Pzena Investment Management, Inc. Common Stockholders: Non-GAAP Net Income for Diluted Earnings per Share $ 5,171 $ 5,340 $ 15,656 $ 11,693 Non-GAAP Diluted Earnings per Share $ 0.08 $ 0.08 $ 0.24 $ 0.18 Non-GAAP Diluted Weighted Average Shares Outstanding 64,993,746 64,994,278 65,006,198 64,756,331 Liquidity and Capital Resources We also had approximately $3.2 million in investments set aside to satisfy our obligations under our deferred compensation program. same periods. terms, if required. We believe that Delaware law. Critical Accounting Policies and Estimates taxable income. Management judgment is required in determining our provision for income taxes, evaluating our tax positions and establishing deferred tax assets and liabilities. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to earnings would result. Item 3. Quantitative and Qualitative Disclosures About Market Risk. March 31, 2011. Exhibit Description of Exhibit 31.1 Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a)/15(d)-14(a) 31.2 Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a)/15(d)-14(a) 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 SIGNATURES 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:. Yes o No xNovemberMay 4, 2010,2011, there were 9,367,6599,904,187 outstanding shares of the registrant’s Class A common stock, par value $0.01 per share.NovemberMay 4, 2010,2011, there were 54,960,41854,668,082 outstanding shares of the registrant’s Class B common stock, par value $0.000001 per share.33 19313233333333333333SIGNATURES 32 “project,”“project” or similar words or phrases, or the negatives of those words or phrases, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking.2009.2010. Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report. We undertake no obligation to publicly revise any forward-looking statements to reflect circumstances or events after the date of this Quarterly Report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we will file from time to time with the Securities and Exchange Commission, or SEC, after the date of this Quarterly Report on Form 10-Q.· our expectation with respect to the economy, capital markets, the market for asset management services, and other industry trends; and our expectation with respect to the economy, capital markets, the market for asset management services, and other industry trends; and· the impact of future legislation and regulation, and changes in existing legislation and regulation, on our business. As of March 31, December 31, 2011 2010 (unaudited) ASSETS Cash and Cash Equivalents $ 22,054 $ 16,381 Restricted Cash 1,421 1,420 Due from Broker 980 30 Advisory Fees Receivable 16,142 15,275 Investments, at Fair Value 6,893 3,323 Receivable from Related Parties 44 63 Other Receivables 85 210 Prepaid Expenses and Other Assets 734 914 Deferred Tax Asset, Net of Valuation Allowance of $60,641 and $59,431, respectively 9,324 8,834 Property and Equipment, Net of Accumulated Depreciation of $2,830 and $2,727, respectively 1,966 1,952 TOTAL ASSETS $ 59,643 $ 48,402 LIABILITIES AND EQUITY Liabilities: Accounts Payable and Accrued Expenses $ 5,798 $ 3,879 Due to Broker 1,774 - Liability to Selling and Converting Shareholders 9,580 9,287 Deferred Compensation Liability 339 875 Other Liabilities 558 565 TOTAL LIABILITIES 18,049 14,606 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; 9,904,187 and 9,367,659 Shares Issued and Outstanding in 2011 and 2010, respectively) 98 93 Class B Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 54,485,046 and 55,012,324 Shares Issued and Outstanding in 2011 and 2010, respectively) - - Additional Paid-In Capital 11,257 10,836 Retained Earnings/(Accumulated Deficit) 1,019 (357 ) Total Pzena Investment Mangement, Inc.'s Equity 12,374 10,572 Non-Controlling Interests 29,220 23,224 TOTAL EQUITY 41,594 33,796 TOTAL LIABILITIES AND EQUITY $ 59,643 $ 48,402 UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per-share amounts) For the Three Months Ended March 31, 2011 2010 REVENUE $ 21,788 $ 19,150 EXPENSES Compensation and Benefits Expense 8,388 7,388 General and Administrative Expenses 1,947 1,921 TOTAL OPERATING EXPENSES 10,335 9,309 Operating Income 11,453 9,841 OTHER INCOME/(EXPENSE) Interest Income 28 40 Dividend Income 11 33 Interest Expense - (155 ) Net Realized and Unrealized Gain from Investments 255 464 Increase in Liability to Selling and Converting Shareholders (117 ) (1,026 ) Other Expense (50 ) (21 ) Total Other Income/(Expense) 127 (665 ) Income Before Income Taxes 11,580 9,176 Income Tax Expense/(Benefit) 583 (99 ) Net Income 10,997 9,275 Less: Net Income Attributable to Non-Controlling Interests 9,340 8,291 Net Income Attributable to Pzena Investment Management, Inc. $ 1,657 $ 984 Net Income for Basic Earnings per Share $ 1,657 $ 984 Basic Earnings per Share $ 0.18 $ 0.11 Basic Weighted Average Shares Outstanding 9,385,543 8,633,041 Net Income for Diluted Earnings per Share $ 6,968 $ 5,722 Diluted Earnings per Share $ 0.11 $ 0.09 Diluted Weighted Average Shares Outstanding 65,199,988 65,005,989 Cash Dividends per Share of Class A Common Stock $ 0.03 - UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (in thousands, except share amounts) Shares of Shares of Retained Earnings/ Class A Class B Class A Additional (Accumulated Non-Controlling Common Stock Common Stock Common Stock Paid-In Capital Deficit) Interests Total Balance at December 31, 2010 9,367,659 55,012,324 $ 93 $ 10,836 $ (357 ) $ 23,224 $ 33,796 Unit Conversion 536,528 (536,528 ) 5 299 - (258 ) 46 Directors' Shares - - - 10 - 60 70 Amortization of Non-Cash Compensation - 9,250 - 123 - 721 844 Net Income - - - - 1,657 9,340 10,997 Distributions to Non-Controlling Interests - - - (11 ) - (6,285 ) (6,296 ) Effect of Consolidation of Affiliates - - - - - 2,418 2,418 Class A Dividends Declared and Paid ($.03 per share) - - - - (281 ) - (281 ) Balance at March 31, 2011 9,904,187 54,485,046 $ 98 $ 11,257 $ 1,019 $ 29,220 $ 41,594 Table of ContentsPZENA INVESTMENT MANAGEMENT, INC.UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except share and per-share amounts)PZENA INVESTMENT MANAGEMENT, INC.UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)See accompanying notes to consolidated financial statements. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the Three Months Ended March 31, 2011 2010 OPERATING ACTIVITIES Net Income $ 10,997 $ 9,275 Adjustments to Reconcile Net Income to Cash Provided by Operating Activities: Depreciation 103 107 Non-Cash Compensation 1,183 842 Director Share Grant 70 13 Net Realized and Unrealized Gain from Investments (255 ) (464 ) Change in Liability to Selling and Converting Shareholders 117 1,026 Deferred Income Taxes (185 ) (771 ) Changes in Operating Assets and Liabilities: Advisory Fees Receivable (867 ) (76 ) Due from Broker (548 ) 100 Restricted Cash (1 ) (4 ) Prepaid Expenses and Other Assets 312 (133 ) Due to Broker 1,768 (724 ) Accounts Payable, Accrued Expenses, and Other Liabilities 1,038 1,293 Tax Receivable Agreement Payments (84 ) - Purchases of Investments (11,400 ) (1,153 ) Proceeds from Sale of Investments 10,638 866 Net Cash Provided by Operating Activities 12,886 10,197 INVESTING ACTIVITIES Purchases of deferred compensation (1,433 ) - Proceeds from deferred compensation 847 - Receivable from Related Parties 19 40 Purchase of Property and Equipment (117 ) (7 ) Net Cash Provided by/(Used In) Investing Activities (684 ) 33 FINANCING ACTIVITIES Distributions to Non-Controlling Interests (6,296 ) (3,976 ) Retirement of B Units - (2 ) Term Loan and Senior Subordinated Notes Repayment - (2,500 ) Dividends (281 ) - Net Cash Used in Financing Activities (6,577 ) (6,478 ) NET CHANGE IN CASH $ 5,625 $ 3,752 CASH AND CASH EQUIVALENTS - Beginning of Period $ 16,381 $ 15,908 Effect of Consolidation of Affiliates 48 - Net Change in Cash 5,625 3,752 CASH AND CASH EQUIVALENTS - End of Period $ 22,054 $ 19,660 Supplementary Cash Flow Information: Interest Paid $ - $ 155 Income Taxes Paid $ 881 $ 823 PZENA INVESTMENT MANAGEMENT, INC.UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY(in thousands, except share amounts)See accompanying notes to consolidated financial statements. The Company was incorporated in the State of Delaware on May 8, 2007. On October 30, 2007, the Company consummated an initial public offering. Concurrently with the consummation of the Company’s initial public offering on October 30, 2007, the operating agreement of Pzena Investment Management, LLC (the “operating agreement”)the operating company was amended and restated such that, among other things, the Company became the sole managing member of Pzena Investment Management, LLC. The acquisition of the operating company’s membership interests by the Company was treated as a reorganization of entities under common control.company. As a result of these transactions, as of and subsequent to October 30, 2007,transactions: (i) the Company has consolidated the financial results of Pzena Investment Management, LLCthe operating company with its own, and reflected the membership interest in it that it does not own as a non-controlling interest in its consolidated financial statements,statements; and (ii) the Company recognizes income generated from its economic interest in Pzena Investment Management, LLC’sthe operating company’s net income.September 30, 2010,March 31, 2011, the Companyoperating company managed assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and non-U.S. capital markets.private investment partnershipentities as of September 30, 2010:March 31, 2011:Company’sSeptember 30, 2010 Australian Proprietary Limited Company (12/16/2009) 100.0% Pzena Investment Management Special Situations, LLC Delaware Limited Liability Company (12/01/2010) 99.9% Pzena Large Cap Value Fund Pzena International Value Service Delaware Limited Liability Company (12/22/2003) 0.0% ., which includes the Pzena Large Cap Value Fund, and the Pzena International Value Service. As required by the Consolidation Topic of the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), the Company also consolidates or consolidated non-variable-interest entities in which it acts as the general partner or managing member. All of these entities represent or represented private investment partnerships over which the Company exercises or exercised control. Non-controlling interests recorded on the consolidated financial statements of the Company include the non-controlling interests of the outside investors in each of these entities, as well as those of the operating company. All significant inter-company transactions and balances have been eliminated.Pzena Global Value Service andoperating company is the Pzenamanaging member of the Europe, Australasia, and Far East (“EAFE”)(EAFE) Value Service (formerly(legally known as the International Value Service) are, a limited liability companies whose managing memberscompany. Neither the Company, nor the operating company, holds an equity ownership percentage in this entity at March 31, 2011, or held an equity ownership percentage during the periods presented. Since the holders of the equity investment in this partnership lack a controlling financial interest, this entity is deemed a variable interest entity (“VIE”). As of February 1, 2011, as a result of a shift in the equity ownership of the entity on that date, the operating company is considered the primary beneficiary of this entity. Correspondingly, the EAFE Value Service was consolidated as of February 1, 2011. At March 31, 2011, total net assets of $2.0 million from the EAFE Value Service were included in investments, at fair value, on the consolidated statement of financial condition. or were members of the executive committee of the operating company, or the operating company itself. Until December 31, 2009, neither of these entities were considered VIEs, as the memberscompany. A majority of the executive committee oftrustees are not the operating company and/or the operating company were the majority holders of the equity investments and hadinvestment in this Trust. Since the holders of the equity investment in this partnership lack a controlling financial interests as managing membersinterest, this entity is deemed a VIE. The Company is considered the primary beneficiary of the partnerships. Eachthis VIE. At March 31, 2011, total net assets of these limited liability companies was considered an entity “similar” to a limited partnership, and was subject to the guidance of the Consolidation Topic of the FASB ASC. Under each of their respective operating agreements, none of these entities’ non-managing members had the ability to remove the managing member under any circumstance, nor did they have any participating rights. As a result, nothing substantive existed to overcome the presumption of control by the managing member, as required by the Consolidation Topic of the FASB ASC. Since the managing members of these entities were either the operating company, or one of the controlling persons of the operating company, their results of operations and financial position had been consolidated through December 30, 2009.Effective December 31, 2009, substantially all of the Company’s investments in the Pzena Global Value Service and the Pzena EAFE Value Service, held to satisfy the Company’s obligations under its deferred compensation program, were reallocated to$0.9 million from the Pzena Large Cap Value Fund. Also effective December 31, 2009,fund were included in investments, at fair value, on the investmentsconsolidated statement of the operating company’s executive committee members in the Pzena Global Value Service and the Pzena EAFE Value Service were transferred to a separately-managed account. Since the remaining holders of the equity investments in the partnerships subsequent to these transactions lacked a controlling financial interest in these partnerships, as of December 31, 2009, these entities were deemed VIEs. The Company is notconsideredprimary beneficiaryconsolidated investment partnerships are, or were, investment companies under the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies. The Company has retained the specialized accounting for these entities. Correspondingly,partnerships pursuant to the Pzena Global Value ServiceConsolidation of Partnerships and Similar Entities Subtopic of the Pzena EAFE Value Service were deconsolidated effective December 31, 2009. The resultsFASB ASC. Thus, the Company reports the investment partnerships’ investments in equity securities at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations and financial position of each of these entities were consolidated up until December 30, 2009. The Pzena Global Value Service and the Pzena EAFE Value Service, and other operations.its EAFE Value strategies. The total net assets of these VIEs was approximately $535.1$318.3 million and $522.1$515.6 million at September 30, 2010March 31, 2011 and December 31, 2009,2010, respectively. The Company is not exposed to losses as a result of its involvement with these entities sincebecause it has no direct investment in them.During the three months ended June 30, 2010, the Company redeemed its investments in the Pzena Large Cap Value Fund, the Pzena Emerging Markets Focused Value Service, and the Pzena Emerging Market Countries Value Service. The operating company maintained its controlling financial interest as the managing member of these entities. Correspondingly, these entities were deemed VIEs. Since certain members of the operating company’s executive committee were majority holders of the equity investments in the partnerships, the Company continued to be considered the primary beneficiary of these entities. As such, the results of operations and financial position of these entities were consolidated by the Company in accordance with the Consolidation Topic of the FASB ASC at June 30, 2010.During the three months ended September 30, 2010, the holder of the equity investments in the Pzena Emerging Markets Focused Value Service and the Pzena Emerging Market Countries Value Service became the managing member of these entities. This appointment gave the holder of the equity investments a controlling financial interest in these entities. Correspondingly, the Company was no longer deemed to control these entities. Each of these limited liability companies is considered an entity “similar” to a limited partnership, and is subject to the guidance of the Consolidation Topic of the FASB ASC. As a result, the Pzena Emerging Markets Focused Value Service and the Pzena Emerging Market Countries Value Service were deconsolidated during the three months ended September 30, 2010.The Company’s investments previously held in the Pzena Large Cap Value Fund to satisfy the Company’s obligations under its deferred compensation program have been transferred to third-party mutual funds and are included in investments in mutual funds at September 30, 2010.The consolidated investment partnership, the Pzena Large Cap Value Fund, is an investment company under the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies. The Company has retained the specialized accounting for this partnership pursuant to the Consolidation Topic of the FASB ASC. Thus, the Company reports the investment partnership’s investments in equity securities at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.including investments in equity securities and mutual funds, approximate their fair value.AUM.assets under management. Incentive fee arrangements generally entitle the Company to participate, on a fixed-percentage basis, in any returns generated in excess of an agreed-upon benchmark. The Company’sPzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)up to three years. Incentive fees are generally payable annually. Following the preferred method identified in the Revenue Recognition Topic of the FASB ASC, such incentive fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved. For the three months ended March 31, 2011 and 2010, the Company recognized approximately $0.3 million and $0.2 million, respectively, in incentive fee income.the Company’sits common stockholders by the weighted average number of shares outstanding during the reporting period. Diluted earnings per share adjusts this calculation to reflect the impact of all outstanding operating company Class Bmembership units, outstanding operating company phantom Class B units, andas well as outstanding options granted under the Pzena Investment Management, LLC 2006 Equity Incentive Plan (the “2006 Plan”) and the Pzena Investment Management, Inc. 2007 Equity Incentive Plan (the “2007 Plan”),phantom units, to the extent they would have a dilutive effect on net income per share for the reporting period. Net income or loss for diluted earnings per share generally assumes all operating company Class Bmembership units are converted into Company stock at the beginning of the reporting period and the resulting change to Company net income associated with its increased interest in the operating company is taxed at the Company’s effective tax rate.and nine months ended September 30,March 31, 2011 and 2010, and 2009, the Company’s diluted net income was determined as follows: For the Three Months Ended March 31, 2011 2010 (in thousands) Non-Controlling Interests of Pzena Investment Management, LLC $ 9,290 $ 8,291 Less: Assumed Corporate Income Taxes 3,979 3,553 Assumed After-Tax Income of Pzena Investment Management, LLC $ 5,311 $ 4,738 Assumed After-Tax Income of Pzena Investment Management, LLC $ 5,311 $ 4,738 Net Income of Pzena Investment Management, Inc. 1,657 984 Diluted Net Income $ 6,968 $ 5,722 each of the three and nine months ended September 30,March 31, 2011 and 2010, 1,620,060the following units and options to purchase operating company units 961,750 options to purchaseand shares of Class A common stock, and 44,916 phantom operating company units were excluded from the calculation of diluted net income per share, as their inclusion would have had an antidilutive effect for each period. For each of the three and nine months ended September 30, 2009, 954,310 options to purchase operating company units were excluded from the calculation of diluted net income per share, as their inclusion also would have had an antidilutive effect.respective periods: For the Three Months Ended March 31, 2011 2010 Options to Purchase Operating Company Units 992,976 1,620,060 Options to Purchase Shares of Class A Common Stock - 961,750 Phantom Operating Company Units - 84,916 Total 992,976 2,666,726 Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)and nine months ended September 30,March 31, 2011 and 2010, and 2009, the Company’s basic and diluted earnings per share were determined as follows: For the Three Months Ended March 31, 2011 2010 (in thousands, except share and per-share amounts) Net Income for Basic Earnings per Share $ 1,657 $ 984 Basic Weighted Average Shares Outstanding 9,385,543 8,633,041 Basic Earnings per Share $ 0.18 $ 0.11 Net Income for Diluted Earnings per Share $ 6,968 $ 5,722 Dilutive Effect of Operating Company B Units 55,003,690 55,696,236 Dilutive Effect of Phantom Units 95,894 17,022 Dilutive Effect of Options 714,861 659,690 Diluted Weighted Average Shares Outstanding 65,199,988 65,005,989 Diluted Earnings per Share $ 0.11 $ 0.09 September 30, 2010,March 31, 2011, cash and cash equivalents was $26.8$22.1 million. The Company considers all money market funds and highly-liquid debt instruments with an original maturity of three months or less at the time of purchase to be cash equivalents. The Company maintains its cash in bank deposit and other accounts whose balances, at times, exceed federally insured limits.onin the consolidated statements of operations.September 30, 2010March 31, 2011 as collateral for a letter of credit issued by a third party in lieu of a cash security deposit, as required by the Company’s lease for its New York office space. Such amounts are recorded in restricted cash onin the consolidated statements of financial condition.in Securities:in equity securities representat Fair Value represents the securities held by the Company and its consolidated investment partnerships.partnerships, as well as investments in mutual funds. All such securitiesinvestments are recorded at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)investment partnerships’ investments in equity securities, which are primarily exchange-traded securities with quoted prices in active markets, as well asand its investments in mutual funds. The fair value measurements of the equity securities and mutual funds have been classified as Level 1.September 30, 2010: Level 1 Level 2 Level 3 (in thousands) Assets: Equity Securities $ 3,680 $ - $ - Investments in Mutual Funds 3,213 - - Total Fair Value $ 6,893 $ - $ - 2009: Level 1 Level 2 Level 3 (in thousands) Assets: Equity Securities $ 842 $ - $ - Investments in Mutual Funds 2,481 - - Total Fair Value $ 3,323 $ - $ - sales price on the valuation date. If no reported equity sales occurred on the valuation date, equity investments in securities are valued at the bid price. Securities transactionsTransactions are recorded on the trade date.September 30,March 31, 2011 and 2010, approximately 8.5% and 2009, approximately 10.4% and 10.6%9.6%, respectively, of the Company’s advisory fees were generated from an advisory agreement with one client. For the nine months ended September 30, 2010 and 2009, fees generated from this agreement comprised 10.1% and 11.4%, respectively, of the Company’s total advisory fees. At September 30, 2010March 31, 2011 and December 31, 2009,2010, no allowance for doubtful accounts has been deemed necessary.Financial Instruments:On February 28, 2008, the operating company entered into an interest rate swap agreement, as discussed further in Note 9. This interest rate swap was subsequently unwound in conjunction with the termination of the credit agreement in September 2009. The counterparty to this agreement was a major financial institution. The Company’s swap agreement was designated as 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 other income/(expense). For each of the three and nine months ended September 30, 2009, the Company recognized less than $0.1 million in other income related to such changes.Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)Pursuant to the guidance in the Derivatives and Hedging Topic of the FASB ASC, it is a requirement to disclose balance sheet and income statement amounts of derivatives, as well as their locations within the consolidated financial statements. The following table summarizes the impact of the Company’s derivative financial instruments on its results of operations for the three and nine months ended September 30, 2009:September 30, 2010,March 31, 2011, the Company had a $61.4$60.6 million valuation allowance against the deferred tax asset recorded as part of the Company’s initial public offering and the subsequent exchanges of Class B units for shares of its Class A common stock. At December 31, 2009,2010, the Company had a $60.3$59.4 million valuation allowance against this deferred tax asset. The income tax provision,expense, or benefit, is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities. The Company records its deferred tax liabilities as a component of other liabilities onin the consolidated statements of financial condition.thatthe portion of the results of its operations resulting from the impact of changes in foreign exchange rates on its investments, from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included in the realized and unrealized gain/(loss), net on equity securitiesinvestments in the consolidated statements of operations.Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)Recent Accounting Pronouncements:In September 2009, the FASB issued a new standard that requires an enterprise to perform a qualitative analysis to determine whether its variable-interests give it a controlling financial interest in a VIE. Under the standard, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb lossesentity orCompany is the right to receive benefits from the entity that could potentially be significant to the VIE. An enterprise that holds a substantive interest and a controlling financial interest in a VIE is deemed to be the primary beneficiaryUnited States Dollar. The functional currency of the VIE and is required to consolidate the VIE. The standard also requires an ongoing assessment of whether an enterpriseCompany’s representative office in Australia is the primary beneficiary of a VIE,Australian Dollar. Assets and additional disclosures about an enterprise’s involvement in VIEs, and any significant changes in risk exposure due to that involvement. The standard is effective for fiscal years beginning after November 15, 2009. In November 2009, the FASB issued a proposed standard update, which defers the consolidation criteria requirementsliabilities of this new standard for assets managers’ interestsoffice are translated at the spot rate in entities that applyeffect at the specialized accounting guidance for investment companies, or that haveapplicable reporting date, and the attributesconsolidated statements of investment companies. In February 2010,operations are translated at the FASB issued further guidance which providedaverage exchange rates in effect during the applicable period. Any resulting unrealized cumulative translation adjustment is recorded net of taxes as a limited scope deferral for a reporting entity’s interestcomponent of accumulated other comprehensive income in an entity that meets allequity. As of the following conditions: (a) the entity has all the attributes of an investment company as defined under AICPA Audit and Accounting Guide, Investment Companies, or does not have all the attributes of an investment company but is an entity for which it is acceptable based on industry practice to apply measurement principles that are consistent with the AICPA Audit and Accounting Guide, Investment Companies, (b) the reporting entity does not have explicit or implicit obligations to fund any losses of the entity that could potentially be significant to the entity, and (c) the entity is not a securitization entity, asset-backed financing entity or an entity that was formerly considered a qualifying special-purpose entity. The reporting entity is required to perform a consolidation analysis for entities that qualify for the deferral in accordance with previously issued guidance on VIEs. The Company has evaluated the deferral guidelines and determined that the standard is applicable for the Company’s investment in its operating company, but thatMarch 31, 2011, the Company meets the criteria for deferral provided in this standard for its VIEs. The Company adopted the updated guidance on January 1, 2010, and it had no impact on the Company’s consolidated financial statements. The Company is monitoring future guidance for updates on the treatment of its interests in its VIEs. As of March 31, December 31, 2011 2010 (in thousands) Leasehold Improvements $ 2,145 $ 2,145 Furniture and Fixtures 1,164 1,164 Computer Hardware 1,002 887 Office Equipment 271 271 Computer Software 214 212 Total 4,796 4,679 Less: Accumulated Depreciation and Amortization (2,830 ) (2,727 ) Total $ 1,966 $ 1,952 September 30, 2010March 31, 2011 and 2009. Such expenses totaled $0.3 million and $0.4 million for the nine months ended September 30, 2010 and 2009, respectively.and nine months ended September 30,March 31, 2011 and 2010, the Company earned $1.4$1.0 million and $4.1$1.1 million, respectively, in investment advisory fees from unconsolidated entities forVIEs which it acts asreceive investment management services from the investment manager. ForCompany that are not consolidated. The Company is not the three and nine months ended September 30, 2009, such advisory fees totaled $1.1 million and $2.7 million, respectively.Tableprimary beneficiary of ContentsPzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)September 30, 2010March 31, 2011 and December 31, 2009,2010, the Company had less than $0.1 million remaining of an advance to an international investment company, for organization and start-up costs, which is included in receivable from related parties on the consolidated statements of financial condition. The Company is the sponsor and investment manager of this entity.2009,2010, receivables from related parties included less than $0.1 million of loans to employees. TheseFor the three months ended March 31, 2010, less than $0.1 million of amortization was recognized through compensation expense in accordance with the terms of loans that were in the form of forgivable promissory notes. The Company did not have any outstanding loans in the form of forgivable promissory notes which were amortized through compensation expense pursuant to their terms. For the three months ended September 30, 2010, no amortization was recognized as compensation and benefits expense. For the three months ended September 30, 2009, and the three and nine months ended September 30, 2010, less than $0.1 million of such amortization was recognized as compensation and benefits expense. At September 30, 2010, receivables from related parties included less than $0.1 million of loans to employees.Certain qualified employees of the Company have the ability to open individual accounts,at March 31, 2011 or invest in certain of the Company’s consolidated investment partnerships, without being assessed advisory fees. Investments by employees in individual accounts are permitted only at the discretion of the executive committee of the Company, but are generally not subjectDecember 31, 2010.same minimum investment levels that are required of outside investors.Companyoperating company issued an aggregate of $16.0 million principal amount of Senior Subordinated Notes to entities established by Richard S. Pzena, the Company’s Chief Executive Officer, for the benefit of certain of his family members, an entity controlled by a Company Director, and a former employee. OnThe Notes were repaid in full during the year ended December 31, 2009, the Company repaid a total of $6.0 million principal amount outstanding of Senior Subordinated Notes to the entity controlled by the Company Director and a former employee. During the nine months ended September 30, 2010, the Company repaid the remaining $10.0 million principal amount outstanding of the Senior Subordinated Notes to the entities established by Richard S. Pzena.minimis;minimis, and, therefore, no accrual has been made in the consolidated financial statements.$0.4 million and $0.5 million for each of the three months ended September 30,March 31, 2011 and 2010, and 2009, respectively, and are included in general and administrative expenses. Such expenses totaled $1.5 million and $1.6 million for the nine months ended September 30, 2010 and 2009, respectively. For the Three Months Ended March 31, 2011 2010 (in thousands) Cash Compensation and Other Benefits $ 7,205 $ 6,546 Non-Cash Compensation 1,183 842 Total Compensation and Benefits Expense $ 8,388 $ 7,388 and nine months ended September 30,March 31, 2011 and 2010, and 2009, the Company granted no options to purchase capital Class B units of the operating company and no options to purchase shares of Class A common stock pursuant to itsthe Pzena Investment Management, LLC 2006 Equity Incentive Plan (the “PIM LLC 2006 Equity Incentive Plan”) and the Pzena Investment Management, Inc. 2007 Equity Incentive Plan (the “2007 Equity Incentive Plan”), respectively.ninethree months ended September 30,March 31, 2011 and 2010, and 2009, the operating company granted 7,0006,000 and 30,000,7,000, respectively, restricted Class B units and the related shares of Class B common stock to certain members pursuant to itsthe PIM LLC 2006 Equity Incentive Plan. These unit grants each vest ratably over a four-year period commencing January 1, 20102011 and 2009,2010, respectively. The amortization of theseall unit-based awards was not material for the three and nine monthsPzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)ended September 30, 2010 and 2009. For the three months ended September 30, 2010March 31, 2011 and 2009, no such options were granted.third-partymoney market funds at the employee’s discretion, and vest ratably over four years. At both September 30, 2010March 31, 2011 and December 31, 2009,2010, the liability associated with deferred compensation investment accounts was approximately $0.6$0.3 million and $0.9 million, respectively, and has been included as a component of other liabilities on the consolidated statementsstatement of financial condition. For the three months ended September 30,March 31, 2011 and 2010, and 2009, the Company recognized approximately $0.4$0.5 million and $0.3 million, respectively, in compensation and benefits expense associated with the amortization of all deferred compensation awards. Fornine months ended September 30, 2010 and 2009, the Company recognized approximately $0.9 million and $0.6 million, respectively, in such expense.September 30, 2010March 31, 2011 and December 31, 2009,2010, the Company had approximately $3.4$3.7 million and $5.3$4.5 million, respectively, in unrecorded compensation expense related to unvested operating company phantom Class B units issued pursuant to our deferred compensation plan, operating company Class B unit and option grants issued under the Company’sPIM LLC 2006 Equity Incentive Plan, and Class A common stock option grants issued under ourthe 2007 Equity Incentive Plan.Short Term BorrowingsThe operating company had a $1.8 million revolving credit facility that was terminated in September 2009. No balance was outstanding and no amounts were drawn down against the facility over the course of its existence.Note 8—Term LoanDuring the year ended December 31, 2009, the Company repaid the remaining $22.0 million of the principal amount outstanding under its term loan. Concurrently with the termination of this term loan, the security interest previously granted in the accounts receivable of the Company was released in September 2009.Note 9—Interest Rate SwapThe Company manages its exposure to changes in market rates of interest. The Company’s use of derivative instruments was limited to an interest rate swap used to manage the interest rate exposure related to the credit agreement, referenced above, which was terminated in September 2009.On February 28, 2008, the Company entered into an interest rate swap agreement that commenced on July 23, 2008. This interest rate swap was subsequently unwound in conjunction with the termination of the credit agreement in September 2009. The swap obligated the Company to pay a 2.825% fixed rate of interest on the notional amount and required the counterparty to pay the Company a floating interest rate based on the monthly LIBOR interest rate. The spread on the credit agreement was in addition to these amounts.During 2009, the Company reduced the notional amount of its interest rate swap in tandem with the reductions in principal amounts outstanding under the credit agreement. The amounts paid to the counterparty in exchange for these reductions for the three and nine months ended September 30, 2009 were approximately $0.2 million and $0.5 million, respectively. For each of the three and nine months ended September 30, 2009, the Company recognized less than $0.1 million in other expense associated with the change in fair value of the swap agreement.Note 10—Income TaxesSubsequent to the offering and reorganization on October 30, 2007, theThe Company, as a “C” corporation under the Internal Revenue Code, is liable for federal, state and local taxes on the income derived from its economic interest in its operating company, which is net of UBT. Correspondingly, in its consolidated financial statements, the Company reports both the operating company’s provision for UBT, as well as its provision for federal, state and local corporate taxes. For the Three Months Ended March 31, 2011 2010 (in thousands) Current Provision: Unincorporated Business Taxes $ 768 $ 671 Local Corporate Tax - - State Corporate Tax - - Federal Corporate Tax - - Total Current Provision $ 768 $ 671 Deferred Provision: Unincorporated Business Taxes $ (1 ) $ (56 ) Local Corporate Tax 77 58 State Corporate Tax 136 111 Federal Corporate Tax 468 383 Total Deferred Provision $ 680 $ 496 Change in Valuation Allowance (865 ) (1,266 ) Total Income Tax Expense/(Benefit) $ 583 $ (99 ) For the Three Months Ended March 31, 2011 2010 (in thousands) Income Before Income Taxes $ 11,580 $ 9,176 Unincorporated Business Taxes (767 ) (615 ) Non-Controlling Interests (9,340 ) (8,291 ) Income Before Corporate Taxes $ 1,473 $ 270 The components of the income tax provision/(benefit) are as follows:For the three and nine months ended September 30, 2010 and 2009, the Company’s taxable income was determined as follows:as partin total Income Tax Expense/(Benefits) on the consolidated statement of the tax provision.operations. For the three and nine months ended September 30,March 31, 2011 and 2010, and 2009, no such expenses were recognized. As of September 30, 2010March 31, 2011 and December 31, 2009,2010, no such accruals were recorded.Prior to October 30, 2007, the operating company was a cash basis taxpayer. As a result of the Company’s acquisition of Class B units in conjunction with the offering, the operating company was required to become an accrual basis taxpayer. Pursuant to Section 481 of the Internal Revenue Code, the cumulative difference between the two methods of taxpaying are amortizable over four years. These differences generated approximately $0.1 million and $0.2 million in deferred tax liabilities as of September 30, 2010 and December 31, 2009, respectively. Such amounts are recorded in other liabilities in the consolidated statements of financial condition.Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)abovebelow has allowed the Company to make an election under Section 754 of the Internal Revenue Code (“Section 754”) to step up its tax basis in the net assets acquired. This step up is deductible for tax purposes over a 15-year period. Based on the net proceeds of the initial public offering and tax basis of the operating company, this election has given rise to a deferred tax asset of approximately $68.7 million.Tax Receivable Agreementtax receivable agreement signed between the members of the operating company and the Company, 85% of the cash savings generated by this election will be distributed to the selling and converting shareholders upon the realization of this benefit.Based on the net proceeds of the offering and tax basis of the operating company as of October 30, 2007, this election gave rise to a deferred tax asset of approximately $68.7 million. In December 2008,established a $62.7 million valuation allowanceexercises its right to reduceterminate the net deferred tax asset to an amount more likely than not to be realized. This deferred tax asset remains available toreceivable agreement early, the Company and canwill be usedobligated to reduce taxable income in future years. The Company similarly reducedmake an early termination payment to the associated liability to selling and converting shareholders, to reflect this changebased upon the net present value (based upon certain assumptions and deemed events set forth in the estimated realizationtax receivable agreement) of all payments that would be required to be paid by the asset.14,11, Shareholders’ Equity, below, on March 31, 2010,28, 2011, and March 3, 2009,31, 2010, certain of the operating company’s members exchanged an aggregate of 734,618536,528 and 2,445,973,734,618, respectively, of their Class B units for an equivalent number of shares of Company Class A common stock. The Company elected to step up its tax basis in the incremental assets acquired in accordance with Section 754. Based on the exchange-date fair values of the Company’s common stock and the tax basis of the operating company, this election gave rise to a $2.4 million deferred tax asset and a corresponding $2.0 million liability to converting shareholders on March 28, 2011, and 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 million liability to converting shareholders on March 3, 2009.2010. The Company assessed the realizability of the deferred tax asset associated with each of these exchanges and determined that a portion of each of their benefits would go unutilized. Consequently, atthe Company established a $2.1 million and a $3.2 valuation allowance on March 28, 2011 and March 31, 2010, and March 3, 2009, the Company established valuation allowances of $3.2 million and $2.4 million, respectively, to reduce the deferred tax asset to an amount more likely than not to be realized, at each date.realized. These deferred tax assets remain available to the Company and can be used to reduce taxable income in future years. The Company similarly reduced the associated liability to selling and converting shareholders by $2.7$1.8 million and $2.0$2.7 million at March 31, 201028, 2011 and March 3, 2009,31, 2010, respectively, to reflect this change in the estimated realization of the asset.these assets. As required by the Income Taxes Topic of the FASB ASC, the Company recorded the effects of these transactions in equity.September 30,March 31, 2011 and 2010, and 2009,including the Company reduced itseffects of the exchange discussed earlier, the Company’s valuation allowance was reduced by approximately $2.2$0.9 million and $3.1$1.3 million, respectively, due to revised estimates of future taxable income. To reflect this change in the estimated realization of the asset, the Company correspondingly increased its liability to selling and converting shareholders by $1.7$0.1 million and $2.4$1.0 million for the three months ended September 30,March 31, 2011 and 2010, and 2009, respectively. During the nine months ended September 30, 2010 and 2009, including the effects of the conversion discussed earlier, the Company’s valuation allowance was reduced by approximately $2.1 million and $4.8 million, respectively, due to revised estimates of future taxable income. To reflect this change in the estimated realization of the asset, the Company correspondingly increased its liability to selling and converting shareholders by $1.6 million and $3.6 million for the nine months ended September 30, 2010 and 2009, respectively. The effects of these changes to the deferred tax asset and liability to selling and converting shareholders were recorded as a component of the income tax provisionexpense/(benefit) and other expense, respectively, on the consolidated statements of operations. As of September 30, 2010March 31, 2011 and December 31, 2009,2010, the net values of all deferred tax assets were approximately $7.6$9.3 million and $6.8$8.8 million, respectively.September 30, 2010March 31, 2011 and December 31, 2009,2010, the net valuevalues of the liability to selling and converting shareholders waswere approximately $7.6$9.6 million and $5.6$9.3 million, respectively.and nine months ended September 30, 2010March 31, 2011 is summarized as follows: Valuation Section 754 Other Allowance Total (in thousands) Balance at December 31, 2010 $ 65,468 $ 2,797 $ (59,431 ) $ 8,834 Deferred Tax Expense (777 ) 96 - (681 ) Unit Exchange 2,381 - (2,075 ) 306 Change in Valuation Allowance - - 865 865 Balance at March 31, 2011 $ 67,072 $ 2,893 $ (60,641 ) $ 9,324 Pzena Investment Management, Inc.Unaudited Notes to the Consolidated Financial Statements (Continued)and nine months ended September 30, 2009March 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 Exchange 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 11—8—Investments, at Fair ValueSeptember 30, 2010: Cost Unrealized Gain Fair Value (in thousands) Equity Securities $ 3,272 $ 408 $ 3,680 Mutual Funds 2,826 387 3,213 Total $ 6,098 $ 795 $ 6,893 2009: Cost Unrealized Gain Fair Value (in thousands) Equity Securities $ 736 $ 106 $ 842 Mutual Funds 2,043 438 2,481 Total $ 2,779 $ 544 $ 3,323 12—9—Non-Controlling Interests For the Three Months Ended March 31, 2011 2010 (in thousands) Non-Controlling Interest of Pzena Investment Management, LLC $ 9,290 $ 8,291 Non-Controlling Interest of Consolidated Investment Partnerships 50 - Non-Controlling Interests $ 9,340 $ 8,291 13—10—Members’ Equity Interests of Operating CompanytransfereeTransferee admitted as a member shall succeed to the capital account, or portion thereof, transferred or assigned, as if no such transfer or assignment had occurred.14—11—Shareholders’ Equitywas incorporated infunctions as the State of Delaware on May 8, 2007. On October 30, 2007,holding company through which the Company consummated an initial public offering of sharesbusiness of its Class A common stock, par value $0.01 per share. These net proceeds were used to purchase Class B units of the operating company.company is conducted. Concurrently with the consummation of the Company’s initial public offering on October 30, 2007, the operating agreement of the operating company was amended and restated such that, among other things, (i) the Company became the sole managing member of the operating company. As a result of these transactions: (i) the Company has consolidated the financial results of the operating company with its own and reflected the membership interest in it that it does not own as a non-controlling interest in its consolidated financial statements; and (ii) the Company recognizes income generated from its economic interest in the operating company’s net income. Additionally, the Class B units of the operating company that the Company acquired were reclassified as Class A units of the operating company and (iii) the holders of the remaining outstanding Class B units of the operating company were reclassified as Class B units of the operating company. Class A and Class B units of the operating company have the same economic rights per unit. As of September 30,March 31, 2011, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 15.4% and 84.6%, respectively, of the economic interests in the operations of the business. As of December 31, 2010, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 14.6%14.5% and 85.4%85.5%, respectively, of the economic interests in the operations of the business. As of December 31, 2009, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 13.4% and 86.6%, respectively, of the economic interests in the operations of the business. holder of a Class B unit of the operating company is issuedhas a corresponding share of the Company’s Class B common stock, par value $0.000001 per share, that was issued in exchange for payment of this par value. Each share of the Company’s Class B common stock entitles its holder to five votes, until the first time that the number of shares of Class B common stock outstanding constitutes less than 20% of the number of all shares of the Company’s common stock outstanding. From this time and thereafter, each share of the Company’s Class B common stock entitles its holder to one vote. When a Class B unit is exchanged for a share of the Company’s Class A common stock or forfeited, a corresponding share of the Company’s Class B common stock will automatically be redeemed and cancelled. Conversely, to the extent that the Company causes the operating company to issue additional Class B units to employees pursuant to its equity incentive plan, these additional holders of Class B units would be entitled to receive a corresponding number of shares of the Company’s Class B common stock (including if the Class B units awarded are subject to vesting).31, 2010,28, 2011, and March 3, 2009,31, 2010, certain of the operating company’s members exchanged an aggregate of 734,618536,528 and 2,445,973,734,618, respectively, of their Class B units for an equivalent number of shares of Company Class A common stock. These acquisitions of additional operating company membership interests were treated as reorganizations of entities under common control as required by the Business Combinations Topic of the FASB ASC.and March 3, 2009 as follows: March 28, March 31, 2011 2010 (in thousands) Pzena Investment Management, LLC Members' Capital $ 7,425 $ 10,140 Pzena Investment Management, LLC Accumulated Deficit (7,167 ) (9,824 ) Realizable Deferred Tax Asset 306 391 Net Tax Receivable Liability to Converting Unitholders (260 ) (332 ) Total $ 304 $ 375 Common Stock, at Par $ 5 $ 7 Additional Paid-in Capital 299 368 Total $ 304 $ 375 15—12—Subsequent EventsAs required bySubsequent Events Topic of the FASB ASC, the Company evaluatedneed for disclosures and/or adjustments resulting from subsequent events through the issuance date of its consolidatedthe financial statements.On October 26, 2010, the Company’s Board of Directors declared a quarterly dividend of $0.03 per share of Class A common stock, payable on December 2, 2010 to shareholders of record as of November 18, 2010.ana public-equity investment management firm that utilizes a classic value investment approach in eachacross all of our investment strategies. We currently manage assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and non-U.S. capital markets. At September 30, 2010,March 31, 2011, our assets under management, or AUM, was $14.3$16.3 billion. We manage separate accounts on behalf of institutions and high net worth individuals, and act as a sub-investment adviser for a variety of SEC-registered mutual funds and offshore funds.FollowingConcurrently with the consummation of our initial public offering and reorganization on October 30, 2007, we became the sole managing member of Pzena Investment Management, LLC.the operating company. As such, we now control its business and affairs and, therefore, consolidate its financial results with ours. In light of our employees’ and other investors’ collective membership interest in our operating company, we reflect their ownership as a non-controlling interest in our consolidated financial statements. As a result, subsequent to October 30, 2007,we have consolidated the financial results of the operating company with our own and reflected the membership interest in it that we do not own as a non-controlling interest in our consolidated financial statements and we recognize income is generated byfrom our economic interest in ourthe operating company’s net income. As of September 30, 2010,March 31, 2011, the holders of Class A common stock (through the Company) and the holders of Class B units of theour operating company held approximately 14.6%15.4% and 85.4%84.6%, respectively, of the economic interests in the operations of our business. For the Three Months Ended March 31, 2011 2010 (in thousands, except share and per-share amounts) GAAP Net Income $ 1,657 $ 984 Net Effect of Tax Receivable Agreement (748 ) (240 ) Non-GAAP Net Income $ 909 $ 744 GAAP Non-Controlling Interest of Pzena Investment Management, LLC $ 9,290 $ 8,291 Less: Assumed Corporate Income Taxes 3,979 3,553 Assumed After-Tax Income of Pzena Investment Management, LLC $ 5,311 $ 4,738 Non-GAAP Net Income of Pzena Investment Management, Inc. 909 744 Non-GAAP Diluted Net Income $ 6,220 $ 5,482 Non-GAAP Diluted Earnings Per Share Attributable to Pzena Investment Management, Inc. Common Stockholders: Non-GAAP Net Income for Diluted Earnings per Share $ 6,220 $ 5,482 Non-GAAP Diluted Earnings per Share $ 0 $ 0 65,199,988 65,005,989 clients.investors. Our advisory fee income is recognized over the period in which investment management services are provided. Following the preferred method identified in the Revenue Recognition Topic of the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), income from incentive fees is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.······ Certain of these clients pay us fees according to the performance of their accounts relative to certain agreed-upon benchmarks, which results in a slightly lower base fee, but allows us to earn higher fees if the relevant investment strategy outperforms the agreed-upon benchmark.fixed ratefixed-rate management fees. Due to the substantially larger account size of certain of these accounts, the average advisory fees we earn on them, as a percentage of AUM, are lower than the advisory fees we earn on our institutional accounts.areis based on the value of our AUM at a specific date on a quarterly basis, either in arrears or advance. Generally, advisoryAdvisory fees on certain of our institutional accounts, and with respect to most of our retail accounts, are calculated based on the average of the monthly or daily market values.value. Advisory fees are also generally adjusted for any cash flows into or out of a portfolio, where the cash flow represents greater than 10% of the value of the portfolio. While a specific group of accounts may use the same fee rate, the method used to calculate the fee according to the fee rate schedule may differ as described above.··differentdiffering fee schedules;···· The table included in the section below describes the components of our compensation expense for the three and nine months ended September 30, 2010 and 2009:“2006 Plan”) and the Pzena Investment Management, Inc. 2007“PIM LLC 2006 Equity Incentive Plan (“the 2007 Plan,” together the “2006 and 2007 Plans”Plan”), we have issued restricted Class B units and options to acquire Class Bpurchase units in ourthe operating company, and options to acquire shares of our Class A common stock, all of which vest ratably over the respective award’s vesting period.company. We useduse a fair-value method in recording the compensation expense associated with the granting of these stock-based compensation awards.restricted units, and options to purchase units, to new and existing members under the PIM LLC 2006 Equity Incentive Plan. Under this method, compensation expense is measured at the grant date based on the estimated fair value of the award and is recognized over the award’s vesting period. The fair value of the units is determined by reference to the market price of our Class A common stock on the date of grant, since these units are exchangeable for shares of our Class A common stock on a one-for-one basis. The fair value of the options to acquire Class Bpurchase units and options to acquire shares of our Class A common stock is determined by using an appropriate option pricing model on the grant date.On January 1, 2007, we instituted a deferredPursuant to the Pzena Investment Management, LLC Amended and Restated Bonus Plan (the “Bonus Plan”), eligible employees whose cash compensation plan, in which employees who earnis in excess of $600,000 per year are required to defercertain thresholds have a portion of their compensation inthat excess of this amount.mandatorily deferred. These deferred amounts may take the form of phantom Class B units, or be invested, in a variety of third-party mutual funds at the employee’s discretion, and vest ratably over four years.in certain third-party mutual funds, restricted phantom units of our operating company, or money market funds. Amounts deferred in any periodcalendar year reduce that period’syear’s cash compensation expense and vest ratably over a four-year period beginning on January 1st of the next year. At March 31, 2011 and December 31, 2010, the liability associated with deferred compensation investment accounts was approximately $0.3 million and $0.9 million, respectively, which is recorded in the deferred compensation liability on the consolidated statement of financial condition. For the three months ended March 31, 2011 and 2010, we recognized approximately $0.5 million and $0.3 million, respectively, in compensation and benefits expense associated with the amortization of all prior deferred compensation awards. Should additional amounts be deferred in future periods,years, we would expect the non-cash portion of our compensation expense to increase as the existingpreviously and subsequently deferred amounts are amortized through income.September 30, 2010,March 31, 2011, we had approximately $3.4$3.7 million in total unrecorded compensation expense related to unvested operating company phantom units issued pursuant to our deferred compensation plan,Bonus Plan, operating company Class B unit and option grants issued under ourthe PIM LLC 2006 Equity Incentive Plan, and Class A stock and option grants issued under our Pzena Investment Management, Inc. 2007 Plan.Equity Incentive Plan (the “2007 Equity Incentive Plan”). We expect that the amortization of these amounts will be approximately $0.7$2.5 million forin the remainder of 2010, $2.62011, $0.9 million for 2011,in 2012, $0.2 million in 2013, and $0.1 million for 2012, with a negligible amount amortized thereafter. office expenses, depreciation, and the costs associated with operating and maintaining our research, trading, and portfolio accounting systems. Our occupancy-related costs and professional services expenses, in particular, generally increase or decrease in relative proportion to the overall size and scale of our business operations.As a result of our offering on October 30, 2007, we have incurred, and expect to continue tothe Company’sour acquisitions of our operating companycompany’s units from itsour selling and converting shareholders. Amounts waived by our selling and converting shareholders have, and would, reduce this liability. Other income/(expense) is also affected by the investment income or loss which arose from our investments in various private investment vehicles that we employed to incubate new strategies prior to their redemption during the three months ended September 30, 2010, the non-controlling interest allocation of the income or loss of our consolidated investment partnerships to their outside investors, interest expense on our outstanding debt prior to its extinguishment, mark-to-market movements on our swap agreement prior to its termination, net realized and unrealized gains and losses from our investments in mutual funds, and interest income generated on our excess cash balances. We expect the interest and investment components if any, of other income/(expense), in the aggregate, to fluctuate based on market conditions.September 30, 2010,March 31, 2011, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 14.6%15.4% and 85.4%84.6%, respectively, of the economic interests in the operations of the business.Provision/Expense/(Benefit) As such, our effective tax rate has increased as a result of our reorganization. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more likely than not to be realized. As of September 30, 2010March 31, 2011 and December 31, 2009, the Company’s2010, our valuation allowance against the deferred tax asset associated with our acquisition of operating company units in conjunction with the offering and subsequent exchanges was $61.4$60.6 million and $60.3$59.4 million, respectively.ContentsOperating ResultsGeneralBeginningsecond halfthree months ended March 31, 2011 and 2010, and for the twelve months ended March 31, 2011, is described below. Inflows are composed solely of 2007the investment of new or additional assets by new or existing clients. Outflows consist solely of redemptions of assets by existing clients. For the For the Three Months Twelve Months Ended March 31, Ended March 31, Assets Under Management 2011 2010 2011 (in billions) Institutional Accounts Beginning of Period Assets $ 12.5 $ 10.7 $ 11.7 Inflows 0.4 0.4 1.8 Outflows (0.6 ) (0.3 ) (2.0 ) Net Flows (0.2 ) 0.1 (0.2 ) Market Appreciation 0.7 0.9 1.5 End of Period Assets $ 13.0 $ 11.7 $ 13.0 Retail Accounts Beginning of Period Assets $ 3.1 $ 3.6 $ 3.7 Inflows 0.3 0.3 1.3 Outflows (0.3 ) (0.5 ) (2.0 ) Net Flows - (0.2 ) (0.7 ) Market Appreciation 0.2 0.3 0.3 End of Period Assets $ 3.3 $ 3.7 $ 3.3 Total Beginning of Period Assets $ 15.6 $ 14.3 $ 15.4 Inflows 0.7 0.7 3.1 Outflows (0.9 ) (0.8 ) (4.0 ) Net Flows (0.2 ) (0.1 ) (0.9 ) Market Appreciation 0.9 1.2 1.8 End of Period Assets $ 16.3 $ 15.4 $ 16.3 AUM at March 31, Investment Strategy 2011 2010 (in billions) U.S. Value Strategies $ 10.6 $ 10.5 Global Value Strategies 3.6 2.9 Europe, Australasia, and Far East ("EAFE") Value Strategies 2.1 2.0 Total $ 16.3 $ 15.4 quarterthree months ended March 31, 2009,2011, the performance of our investment strategies was negatively impacted byimproved alongside the significant volatilityimprovement in the equity markets. Performance prior to March 31, 2009 was influenced by our overweight investment exposure toAs a result of the financial services sectorcontinued improvements in particular. Subsequent to March 31, 2009, allthe performance of our investment strategies experienced improvementand the equity markets, our AUM increased by $0.9 billion, or 5.8%, from $15.4 billion at March 31, 2010, to $16.3 billion at March 31, 2011.their performance,institutional accounts and outperformed their respective benchmarks. As$3.3 billion in retail accounts, for a result, ourtotal of $16.3 billion in assets under management increased by $0.4 billion, or 2.9%, from $13.9 billion at September 30, 2009, to $14.3 billion at September 30, 2010, due to positive performance of $0.9 billion, offset by net outflows of $0.5 billion.September 30, 2010,March 31, 2011, we experienced net outflows of $0.3 billion, consisting oftotal gross outflows of $1.2$0.9 billion, which were offset by total gross inflows of $0.9$0.7 billion. For the nine months ended September 30, 2010, we experienced net outflows of $0.7 billion, consisting of gross outflows of $3.0 billion, offset by gross inflows of $2.3 billion.September 30, 2010, ourMarch 31, 2011, assets in institutional accounts experiencedincreased by $0.5 billion, or 4.0%, due to $0.7 billion in market appreciation and $0.4 billion in gross inflows, of $0.6 billion, which were offset by $0.5$0.6 billion in gross outflows. For the nine months ended September 30, 2010, our institutional accounts experienced gross inflows of $1.3 billion, which were offset by $1.3 billion in gross outflows.For the three months ended September 30, 2010, ourMarch 31, 2011, assets in retail accounts experienced $0.7increased by $0.2 billion, or 6.5%, as a result of $0.2 billion in gross outflowsmarket appreciation and $0.3 billion in gross inflows. For the nine months ended September 30, 2010, our retail accounts experienced $1.7inflows, offset by $0.3 billion in gross outflowsoutflows.$1.0 billion in gross inflows.Accordingly, givenSince we are long-term fundamental investors, we believe that our investment strategies yield the most benefits, and are best evaluated, over a long-term timeframe. We believe that our investment strategies are generally evaluated by our clients and our potential future clients based on their relative performance since inception, and the previous one-year, three-year, and five-year periods. There has typically been a correlation between our strategies’ investment performance and the size and direction of asset flows over the long term. To the extent that our returns for these periods outperform client benchmarks, we would generally anticipate increased asset flows over the long term. Correspondingly, negative returns relative to client benchmarks could cause existing clients to reduce their exposure to our products, and hinder new client acquisition.levels,for the three months ended March 31, 2011 compared to that of the three months ended March 31, 2010, our revenues for the three and nine months ended September 30, 2010March 31, 2011 increased compared tofrom our revenues for the three and nine months ended September 30, 2009.March 31, 2010. An increase in revenueweighted average AUM and in revenues typically results in higher operating income and net income.Assets Under Management We would expect pressure on our operating margins in the future if average AUM and FlowsThe change in AUM in our institutional accounts and our retail accounts for the three and nine months ended September 30, 2010 and 2009 and the twelve months ended September 30, 2010 is described below:
Months EndedAt September 30, 2010, our $14.3 billion of AUM was invested in various value-oriented investment strategies representing distinct geographical segments. The following table describes the allocation of our AUM, as of September 30, 2010 and 2009, among our investment strategies:Three Months Ended September 30, 2010 versus September 30, 2009At September 30, 2010, we managed $14.3 billion in total assets, an increase of $0.4 billion, or 2.9%, from $13.9 billion at September 30, 2009. The year-over-year increase in AUM was primarily duerevenues were to $0.9 billion in market appreciation and $3.7 million in gross inflows, offset by $4.2 billion in gross outflows. Improving overall economic conditions contributed to the performance-related increase in our AUM.At September 30, 2010, we managed $11.3 billion in institutional accounts and $3.0 billion in retail accounts, for a total of $14.3 billion in assets.decline. For the three months ended September 30, 2010, assets in institutional accountsMarch 31, 2011, our operating expenses increased by $1.3 billion,$1.0 million, or 13.0%10.8%, due to $1.2 billion in market appreciation and $0.6 billion in gross inflows, offset by $0.5 billion in gross outflows. Forfrom $9.3 million for the three months ended September 30,March 31, 2010, assetsto $10.3 million for the three months ended March 31, 2011, due to an increase in retail accounts decreased by $0.1 billion, or 3.2%, as a result of $0.7 billioncompensation and benefits expenses, resulting from increases in gross outflows, offset by $0.3 billion in gross inflowsdiscretionary bonus accruals and $0.3 billion in market appreciation.TableThe following table indicates the annualized returns, gross and net (which represents annualized returns prior to and after payment of Contentsadvisory fees, respectively), of our five largest investment strategies from their inception to March 31, 2011, and in the five-year, three-year, and one-year periods ended March 31, 2011, relative to the performance of: (i) the market index which is most Nine Months Ended Septembercommonly used by our clients to compare the performance of the relevant investment strategy, and (ii) the S&P 500® Index, which is provided for the limited purpose of providing a comparison to the broader equity market. Investment Strategy (Inception Date) Large Cap Value (October 2000) Annualized Gross Returns 5.1 % (1.2 )% 1.8 % 11.8 % Annualized Net Returns 4.6 % (1.7 )% 1.3 % 11.3 % 4.1 % 1.4 % 0.6 % 15.2 % 1.1 % 2.6 % 2.4 % 15.6 % Global Value (January 2004) Annualized Gross Returns 3.7 % (3.0 )% (2.1 )% 11.7 % Annualized Net Returns 2.9 % (3.7 )% (2.8 )% 10.9 % 5.6 % 2.1 % (0.2 )% 13.4 % 4.5 % 2.6 % 2.4 % 15.6 % Value Service (January 1996) Annualized Gross Returns 10.5 % (0.7 )% 1.8 % 12.3 % Annualized Net Returns 9.7 % (1.3 )% 1.1 % 11.6 % 7.9 % 1.4 % 0.6 % 15.2 % 7.1 % 2.6 % 2.4 % 15.6 % EAFE Diversified Value (November 2008) Annualized Gross Returns 25.5 % — — 13.3 % Annualized Net Returns 25.2 % — — 13.0 % 17.3 % — — 10.4 % 16.5 % — — 15.6 % Small Cap Value (January 1996) Annualized Gross Returns 14.6 % 6.6 % 14.2 % 19.3 % Annualized Net Returns 13.3 % 5.5 % 13.0 % 18.1 % 10.1 % 2.2 % 6.8 % 20.6 % 7.1 % 2.6 % 2.4 % 15.6 % (1) The historical returns of these investment strategies are not necessarily indicative of their future performance, or the future performance of any of our other current or future investment strategies. (2) Net of applicable withholding taxes. 2010 versus September 30, 2009At September 30, 2010, we managed $14.3 billionto 40 stocks. We launched this strategy in total assets, an increaseOctober 2000. As of $0.4 billion, or 2.9%, from $13.9 billion at September 30, 2009.March 31, 2011, the Large Cap Value strategy generated a one-year annualized gross return of 11.8%. Our consumer discretionary exposure was the largest contributor to performance, while holdings in the financial services, energy, and materials and processing sectors also made a significant contribution.year-over-year increase in AUM wasconsumer discretionary and industrials sectors primarily due to $0.9 billion in market appreciation and $3.7 million in gross inflows, offset by $4.2 billion in gross outflows. Improving overall economic conditions contributed to this performance, with contributions from the performance-related increaseenergy and financials sectors as well.AUM.At September 30, 2010, we managed $11.3 billionexposure to the consumer discretionary, financial services, technology, energy, and materials and processing sectors.institutional accountsNovember 2008. As of March 31, 2011, the EAFE Diversified Value strategy generated a one-year annualized gross return of 13.3%. The industrials, consumer discretionary, telecommunication services, and $3.0 billionfinancials sectors made significant contributions to this performance.retail accounts, forJanuary 1996. As of March 31, 2011, the Small Cap Value strategy generated a totalone-year annualized gross return of $14.3 billion in assets. For19.3%. This performance was driven primarily by our exposure to the nine months ended September 30, 2010, assets in institutional accounts increased by $0.6 billion, or 5.6%, due to $0.6 billion in market appreciationfinancial services, producer durables, technology, and $1.3 billion in gross inflows, offset by $1.3 billion in gross outflows. For the nine months ended September 30, 2010, assets in retail accounts decreased by $0.6 billion, or 16.7%, as a result of $1.7 billion in gross outflows, offset by $1.0 billion in gross inflowsmaterials and $0.1 billion in market appreciation.At September 30, 2010, institutional accounts represented 79.0% of our total AUM, compared to 73.4% at September 30, 2009. At September 30, 2010, our Global Value and EAFE Value investment strategies accounted for 35.7% of our AUM, compared to 28.8% at September 30, 2009.revenuesrevenue from advisory fees earned on our institutional and retail accounts for the three and nine months ended September 30,March 31, 2011 and 2010 and 2009 is described below: For the Three Months Ended March 31, Revenue 2011 2010 (in thousands) Institutional Accounts $ 18,659 $ 16,132 Retail Accounts 3,129 3,018 Total $ 21,788 $ 19,150 September 30,March 31, 2011 versus March 31, 2010 versus September 30, 2009$1.7$2.6 million, or 10.1%13.5%, to $18.5$21.8 million for the three months ended September 30, 2010,March 31, 2011, from $16.8$19.2 million for the three months ended September 30, 2009.March 31, 2010. This change was driven primarily by an increaseincreases in weighted average AUM, which increased $1.4$1.8 billion, or 11.5%12.5%, to $13.6$16.2 billion for the three months ended September 30, 2010,March 31, 2011, from $12.2$14.4 billion for the three months ended September 30, 2009.fee rate was 0.544%fees were 0.539% and 0.550%0.532% for the three months ended September 30,March 31, 2011 and 2010, and 2009, respectively. The decreaseThis increase was primarily due to a shift in asset mix towards our institutional accounts. Institutional accounts comprised 79.6% of average assets for the three months ended March 31, 2011, increasing from 75.7% for the three months ended March 31, 2010. In addition, the expiration of the temporary, voluntary partial fee waiver on the John Hancock Classic Value Fund, which ended in May 2010, contributed to an increase in the weighted average fee rate was due in part to large institutional inflows in our newly launched Europe, Australasia, and Far East (“EAFE”) Diversified Value and Global Diversified Value strategies infrom the fourthfirst quarter of 2009. We typically offer reduced2010. For the three months ended March 31, 2010 our share of this fee rateswaiver was $0.2 million. initial clients in our new product offerings.$12.9 billion for the three months ended March 31, 2011, from $10.9 billion for the three months ended March 31, 2010, and had weighted average fees of 0.578% and 0.594% for the three months ended March 31, 2011 and 2010, respectively. The decrease in the weighted average fee rate was alsoprimarily due to an increase in the average size of our institutional accounts. Our tieredaccounts, as well as the shift, for certain of our clients, to a performance-based fee. These performance-based fees pay incentive fees according to the performance relative to certain agreed-upon benchmarks, which results in a lower base fee, schedules typically charge lower rates as account size increases. Weighted average assetsbut allows for us to earn higher fees if the relevant investment strategy out-performs the agreed-upon benchmark. This decrease was offset to an extent by a shift in asset mix amongst our institutional accounts increased $1.7 billion, or 19.3%, to $10.5 billion for the three months ended September 30, 2010, from $8.8 billion for the three months ended September 30, 2009,products and had a weighted average fee rate of 0.589% and 0.630% for the three months ended September 30, 2010 and 2009, respectively. This decline was primarily due to institutional inflowsan increase in our EAFE Diversified Value and Global Diversified Value strategies, and a higher average institutional account size. performance fees recognized.$0.3$0.2 billion, or 8.8%5.7%, to $3.1$3.3 billion for the three months ended September 30, 2010,March 31, 2011, from $3.4$3.5 billion for the three months ended September 30, 2009,March 31, 2010, and had a weighted average fee ratefees of 0.389%0.385% and 0.346%0.341% for the three months ended September 30,March 31, 2011 and 2010, and 2009, respectively. The year-over-year increase in weighted average fees in retail accounts was due to the timing of asset flows in our retail accounts andpart to the expiration of the voluntary partial fee waiver in May 2010 on the John Hancock Classic Value Fund, for which we act as sub-investment advisor, which ended in May 2010.Nine Months Ended September 30, 2010 versus September 30, 2009Our total revenue increased $12.3 million, or 27.5%, to $57.0 million for the nine months ended September 30, 2010, from $44.7 million for the nine months ended September 30, 2009. This change was driven primarilypartially offset by an increase in weighted average AUM, which increased $3.5 billion, or 32.7%, to $14.2 billion for the nine months ended September 30, 2010, from $10.7 billion for the nine months ended September 30, 2009.Our weighted average fee rate was 0.537% and 0.559% for the nine months ended September 30, 2010 and 2009, respectively. The decrease in the weighted average fee rate was due primarily to an increase in the average size of our institutional accounts. Our tiered fee schedules typically charge lower rates as account size increases. Weighted average assets in institutional accounts increased $3.2 billion, or 42.1%, to $10.8 billion for the nine months ended September 30, 2010, from $7.6 billion for the nine months ended September 30, 2009, and had a weighted average fee rate of 0.590% and 0.642% for the nine months ended September 30, 2010 and 2009, respectively. Weighted average assets in retail accounts increased $0.3 billion, or 9.7%, to $3.4 billion for the nine months ended September 30, 2010, from $3.1 billion for the nine months ended September 30, 2009, and had a weighted average fee rate of 0.367% and 0.355% for the nine months ended September 30, 2010 and 2009, respectively. The year-over-year increase in weighted average fee rate for retail assets was due to the timing of asset flows inflows. For the three months ended March 31, 2010 our retail accounts and the effectsshare of the voluntary partialthis fee waiver on the John Hancock Classic Value Fund, for which we act as sub-investment advisor, which commenced in May 2009 and expired in May 2010.and nine months ended September 30, 2010March 31, 2011 and 2009: For the Three Months Ended March 31, 2011 2010 (in thousands) Cash Compensation and Other Benefits $ 7,205 $ 6,546 Other Non-Cash Compensation 1,183 842 Total Compensation and Benefits Expense $ 8,388 $ 7,388 September 30,March 31, 2011 versus March 31, 2010 versus September 30, 2009$1.1$1.0 million, or 13.6%10.8%, to $9.2$10.3 million for the three months ended September 30, 2010,March 31, 2011, from $8.1$9.3 million for the three months ended September 30, 2009.March 31, 2010. This increase was primarily attributable to increasesan increase in discretionary bonus accrualscompensation and employee headcount, which increased from 65 at September 30, 2009 to 71 at September 30, 2010.$1.2$1.0 million, or 19.4%13.5%, to $8.4 million for the three months ended March 31, 2011, from $7.4 million for the three months ended September 30, 2010, from $6.2 million for the three months ended September 30, 2009.March 31, 2010. This increase was primarily a result of increases in discretionary bonus accruals and employee headcount, which increased from 65 at September 30, 2009 to 71 at September 30, 2010, as discussed above.decreased byremained consistent, at $1.9 million, for each of the three months ended March 31, 2011 and 2010. million, or 5.3%, to $1.8 million for the three months ended September 30, 2010,March 31, 2011, and consisted primarily of $0.3 million of net realized and unrealized gains from $1.9investments, offset by $0.1 million forin other expense, and expenses of $0.1 million related to adjustments to our liability to our selling and converting shareholders. As discussed further below, under “Tax Receivable Agreement,” this liability represents 85% of the three months ended September 30, 2009. This decrease was mainly attributable to decreasesamount of cash savings, if any, in insurance fees.Nine Months Ended September 30, 2010 versus September 30, 2009Total operating expenses increased by $3.4 million, or 13.8%, to $28.0 million for the nine months ended September 30, 2010, from $24.6 million for the nine months ended September 30, 2009. This increase was primarily attributable to increases in discretionary bonus accrualsU.S. federal, state and employee headcount, which increased from 65 at September 30, 2009 to 71 at September 30, 2010.Compensation and benefits expense increased by $3.7 million, or 20.2%, to $22.0 million for the nine months ended September 30, 2010, from $18.3 million for the nine months ended September 30, 2009. This increase was primarilylocal income tax that we realize as a result of the amortization of the increases in discretionary bonus accruals and employee headcount, which increasedtax basis generated from 65 at September 30, 2009 to 71 at September 30, 2010, as discussed above.General and administrative expenses decreasedour purchase of operating company units from our selling shareholders. Amounts waived by $0.4 million, or 6.3%, to $5.9 million for the nine months ended September 30, 2010, from $6.3 million for the nine months ended September 30, 2009. This decrease was mainly attributable to decreases in professional fees and insurance fees.Other Income/(Expense)Three Months Ended September 30, 2010 versus September 30, 2009$1.1$0.7 million for the three months ended September 30, 2010. ExclusiveMarch 31, 2010, and consisted primarily of $1.7expenses of $1.0 million in other expense associated with a decrease inrelated to adjustments to our liability to our selling and converting shareholders and $0.2 million of interest expense associated with changes in the realizability of our related deferred tax asset, other income/(expense) was income of $0.6 million. This income consisted primarily ofoperating company’s subordinated note agreements, offset by $0.5 million in unrealized and realized gains and losses from investments. Net realized and unrealized gain/(loss) from investments represents both the Company’s and external investors’ allocation of the gain/(loss) from the Company’s consolidated investments. At September 30, 2010, the Company had total assets of $0.8 million in such investments. Of the net realized and unrealized gain/(loss)gains from investments and $0.1 million of interest and dividend income. The decline in interest expense was a result of the full repayment of our outstanding debt in 2010. The decline in net realized and unrealized gains from investments was primarily a result of having less firm assets invested in our products.September 30,March 31, 2011 and 2010 $0.3 millionincluded adjustments related to our tax receivable agreement and the associated liability to selling and converting shareholders. Our effective corporate tax rate, exclusive of adjustments related to our tax receivable agreement and the associated liability to selling and converting shareholders, was attributable to the outside interests of our investment partnerships. The external investors’ allocation of net realized42.8% and unrealized gain/(loss) is also included as a component of net income from non-controlling interests. Interest and dividend income was income of $0.1 million.Other income/(expense) was income of $1.6 million42.6% for the three months ended September 30, 2009. Exclusive of $2.4 million in other expense associated with an increase inMarch 31, 2011 and 2010, respectively.liability to our selling and converting shareholders associated with changes in the realizability of our related deferred tax asset, other income/(expense) was income of $4.0 million. Thisbefore income consisted primarily of $4.2 million in income related to the positive performance of investments in our own products, offset by $0.2 million in net interest expense. Net realized and unrealized gain/(loss) from investments represents both the Company’s and external investors’ allocation of the gain/(loss) from the Company’s consolidated investments. At September 30, 2009, the Company had total assets of $18.4 million in such investments. Of the $4.2 million in income related to the positive performance of our investments in our own products, $2.8 million was attributable to the outside interests of our investment partnerships. The external investors’ allocation of net realized and unrealized gain/(loss) is also included as a component of net income from non-controlling interests.Nine Months Ended September 30, 2010 versus September 30, 2009Other income/(expense) was an expense of $1.4 million for the nine months ended September 30, 2010. Exclusive of $1.6 million in other expense associated with an increase in our liability to our selling and converting shareholders associated with changes in the realizability of our related deferred tax asset, other income/(expense) was income of $0.2 million. This income consisted primarily of $0.1 million in miscellaneous income and $0.1 million in income related to the positive performance of our investments in our own products, all of which was attributable to the outside interests of our investment partnerships. At September 30, 2010, the Company had total assets of $0.8 million in such investments. The external investors’ allocation of net realized and unrealized gain/(loss) is also included as a component of net income from non-controlling interests.Other income/(expense) was income of $1.8 million for the nine months ended September 30, 2009. Exclusive of $3.6 million in other expense associated with an increase in our liability to our selling and converting shareholders associated with changes in the realizability of our related deferred tax, other income/(expense) was income of $5.4 million. This income consisted primarily of $6.1 million in income related to the positive performance of our investments in our own products and $0.2 million in miscellaneous income, offset by $0.9 million in net interest expense. Net realized and unrealized gain/(loss) from investments represents both the Company’s and external investors’ allocation of the gain/(loss) from the Company’s consolidated investments. At September 30, 2009, the Company had total assets of $18.4 million in such investments. Of the $6.1 million in income related to the positive performance of our investments in our own products, $3.8 million was attributable to the outside interests of our investment partnerships. The external investors’ allocation of net realized and unrealized gain/(loss) is also included as a component of net income from non-controlling interests.Income Tax Provision/(Benefit)Three Months Ended September 30, 2010 versus September 30, 2009The income tax provision/(benefit) was a benefit of $1.1 milliontaxes for the three months ended September 30,March 31, 2011 and 2010 are as follows: For the Three Months Ended March 31, 2011 2010 (in thousands) Income Before Income Taxes $ 11,580 $ 9,176 Change in Liability to Selling and Converting Shareholders 117 1,026 Unincorporated Business Taxes (767 ) (615 ) Non-Controlling Interests (9,340 ) (8,291 ) Non-GAAP Income Before Corporate Taxes $ 1,590 $ 1,296 For the Three Months Ended March 31, 2011 2010 % of Non-GAAP % of Non-GAAP Tax Pre-tax Income Tax Pre-tax Income (in thousands) (in thousands) Federal Rate Applied to Non-GAAP Pre-tax Income $ 541 34.0 % $ 441 34.0 % State and Local Taxes, Net of Federal Benefit 140 8.8 % 111 8.6 % Non-GAAP Effective Tax Rate $ 681 42.8 % $ 552 42.6 % ThisThe income tax expense/(benefit) for the three months ended March 31, 2011 and 2010 included $0.9 million and $1.3 million, respectively, of benefit was generated primarily dueassociated with adjustments to a $2.2 million reduction of the valuation allowance recorded against our deferred tax asset associated withrelated to our tax receivable agreement. Exclusive of this adjustment,these adjustments, the remaining income tax provisionexpense/(benefit) for the three months ended September 30, 2010March 31, 2011 consisted of $0.5income tax expenses of $0.8 million in operating company unincorporated business taxes and $0.6$0.7 million inof corporate income taxes. The income tax provision/(benefit) forFor the three months ended September 30, 2009 was a benefit of $2.0 million and was generated primarily due to a reduction of $3.1 million to the valuation allowance against our deferred tax asset associated with our tax receivable agreement. Exclusive of this adjustment,March 31, 2010, the remaining income tax provision for the three months ended September 30, 2009expense/(benefit) consisted of $0.5income tax expenses of $0.6 million infor operating company unincorporated business taxes and $0.5$0.6 million inof corporate income taxes. The increase in these taxes is attributable primarily to an increase in taxable income. As noted above, the non-GAAP effective tax rate increased slightly, from 42.6% for the three months ended March 31, 2010 to 42.8% for the three months ended March 31, 2011. A comparison of the GAAP effective tax rate for the three months ended September 30,March 31, 2011 and 2010 to that of the three months ended September 30, 2009 is not meaningful due to the valuation allowance adjustments.Nine Months Ended September 30, 2010 versus September 30, 2009The income tax provision/(benefit) was a provision of $1.4 million for the nine months ended September 30, 2010. Exclusive of a reduction of $2.1 million to the income tax provision related to an increase to the valuation allowance against our deferred tax asset associated with our tax receivable agreement, the remaining income tax provision for the nine months ended September 30, 2010 consisted of $1.8 million in operating company unincorporated business taxes and $1.7 million in corporate income taxes. The income tax provision/(benefit) for the nine months ended September 30, 2009 was a benefit of $2.4 million and was generated primarily due to a reduction of $4.8 million to the valuation allowance against our deferred tax asset associated with our tax receivable agreement. Exclusive of this adjustment, the remaining income tax provision for the nine months ended September 30, 2009 consisted of $1.3 million in operating company unincorporated business taxes and $1.1 million in corporate income taxes. A comparison of the effective tax rate for the nine months ended September 30, 2010 to that of the nine months ended September 30, 2009 is not meaningful due to the valuation allowance adjustments.September 30,March 31, 2011 versus March 31, 2010 versus September 30, 2009$8.0$9.3 million and $8.3 million for the three months ended September 30,March 31, 2011 and 2010, respectively, and consisted almost entirely of $7.7 million associated with our employees’ and outside investors’ interest in the income of the operating company and $0.3 million of income from our consolidated subsidiaries’ interestcompany. The change in the earnings of our consolidated investment partnerships. Netnet income attributable to non-controlling interests was $10.8 million for the three months ended September 30, 2009, and consisted of $8.1 million associated with our employees’ and outside investors’ interest in the income of the operating company and $2.8 million of income from our consolidated subsidiaries’ interest in the earnings of our consolidated investment partnerships. The increase in the interest in the earnings of the operating company isreflects primarily a result of the increase in our weighted average AUM, which had a corresponding positive impact on operating company revenues and income. The decrease in our consolidated subsidiaries’ interest in the earnings of our consolidated investment partnerships is primarily a result of the deconsolidation of the Pzena Global Value Service and the Pzena EAFE Value Service on December 31, 2009, and the deconsolidation of the Pzena Emerging Market Countries Value Service and the Pzena Emerging Markets Focused Value Service during the three months ended September 30, 2010.Nine Months Ended September 30, 2010 versus September 30, 2009Net income attributable to non-controlling interests was $23.6 million for the nine months ended September 30, 2010, and consisted of $23.5 million associated with our employees’ and outside investors’ interest in the income of the operating company and $0.1 million of income from our consolidated subsidiaries’ interest in the earnings of our consolidated investment partnerships. Net income attributable to non-controlling interests was $21.5 million for the nine months ended September 30, 2009, and consisted of approximately of $17.7 million associated with our employees’ and outside investors’ interest in the income of the operating company and $3.8 million of income from our consolidated subsidiaries’ interest in the earnings of our consolidated investment partnerships. The increase in the interest in the earnings of the operating company is primarily a result of the increase in our weighted average AUM, which had a corresponding positive impact on revenues and income. The decrease in our consolidated subsidiaries’ interest in the earnings of our consolidated investment partnerships is primarily a result of the deconsolidation of the Pzena Global Value Service and the Pzena EAFE Value Service on December 31, 2009, and the deconsolidation of the Pzena Emerging Market Countries Value Service and the Pzena Emerging Markets Focused Value Service during the three months ended September 30, 2010.Non-GAAP Net IncomeOur results for the three and nine months ended September 30, 2010 and 2009 included adjustments related to our tax receivable agreement and the associated liability to our selling and converting shareholders. Excluding these adjustments, diluted net income and diluted net income per share was $5.2 million and $0.08, respectively, for the three months ended September 30, 2010, and $5.3 million and $0.08, respectively, for the three months ended September 30, 2009. On a similar basis, diluted net income and diluted net income per share was $15.7 million and $0.24, respectively, for the nine months ended September 30, 2010, and $11.7 million and $0.18, respectively, for the nine months ended September 30, 2009. We believe that excluding these adjustments provides information to better analyze our operations between periods and over time. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, financial measures prepared in accordance with GAAP.A reconciliation of the non-GAAP measures to the most comparable GAAP measures is included below:At September 30, 2010,$26.8 million.$22.1 million, inclusive of $2.1 million in cash held by our consolidated investment partnership. Advisory fees receivable were $14.2was $16.1 million.long term,long-term, primarily through cash generated from operations. As an investment management firm, our business has been materially affected by conditions in the global financial markets and economic conditions throughout the world. Our liquidity is highly dependent on the revenue and income from our operations, which is directly related to our levels of AUM. As of and forFor the three months ended September 30, 2010,March 31, 2011, our weighted average AUM and revenues increased by 11.5%12.5% and 10.1%13.5%, respectively, compared to our weighted average AUM and revenues for the three months ended September 30, 2009.March 31, 2010. These increases contributed to a 28.6%26.5% increase in our cash provided by operating activities forduring the comparable period. As of and for the nine months ended September 30, 2010, our weighted average AUM and revenues increased by 32.7% and 27.5%, respectively, compared to the nine months ended September 30, 2009. These increases contributed to a 35.2% increase in our cash provided by operating activities for the comparable period.Further,Compensation is our largest expense. To the extent we consider cash compensation, onedeem necessary and appropriate to run our business, recognizing the need to retain our key personnel, we have the ability to change the absolute levels of our largest expenses,compensation packages, as sufficiently variable such thatwell as change the mix of their cash and non-cash components. Historically, the Company has not tied its levels of compensation directly to revenue, as many Wall Street firms do. Correspondingly, there is not a linear relationship between the Company’s compensation and the revenues it generates. This generally has the effect of increasing operating margins in periods of increased revenues, but can be adjusted to mitigate any potential decline inreduce operating margins when revenue we may experience in the next twelve months. declines.distributionstax allocations to the members of our operating company, which consisted of 3435 of our employees, certain unaffiliated persons, two former employees, and us, will continue to be a material financing activity.During Cash distributions to operating company members for partnership tax allocations would increase should the nine months ended September 30, 2010, we repaid the remaining $10.0 million principal amount outstandingtaxable income of the Senior Subordinated Notes held by the entities established by Richard S. Pzena.operating company increase.if required, would be available on acceptable terms.the repaymentour lack of our term loanlong-term debt, and Senior Subordinated Notes, and our ability to vary cash compensation levels, have provided us with an appropriate degree of flexibility in providing for our liquidity needs. 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 in amounts that have been paid to them in the past, or at all, if, among other things, we do not have the cash necessary to pay our intended dividends. To the extent we do not have cash on hand sufficient to pay dividends in the future, we may decide not to pay dividends. By paying cash dividends rather than investing that cash in our future growth, we risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations or unanticipated capital expenditures, should the need arise.Term LoanSenior Subordinated NotesDuring the year ended December 31, 2009, we used cash generated from operations to repay the remaining $22.0 millionmay be limited by our holding company structure and applicable provisions of the principal amount outstanding under our term loan. Concurrently with the termination of this term loan, a security interest in our accounts receivable and one of our subsidiaries was released by the lender in September 2009.During the nine months ended September 30, 2010, we used cash on hand to repay the remaining $10.0 million principal amount outstanding of the Senior Subordinated Notes held by the entities established by Richard S. Pzena.Class Bmembership units of our operating company concurrentlyconcurrent with our initial public offering, and the subsequent and future exchanges by holders of Class B units of our operating company for shares of our Class A common stock (pursuant to the exchange rights provided for in the operating company’s operating agreement), has resulted in, and is expected to continue to result in, increases in our share of the tax basis of the tangible and intangible assets of our operating company at the time of our acquisitionsacquisition and these subsequent and future exchanges, which will increase the tax depreciation and amortization deductions that otherwise would not have been available to us. These increases in tax basis and tax depreciation and amortization deductions have reduced, and are expected to continue to reduce, the amount of tax that we would otherwise be required to pay in the future. We have entered into a tax receivable agreement with the current members of our operating company, the one member of our operating company immediately prior to our initial public offering who sold all of its Class Bmembership units to us in connection with our initial public offering, and any future holders of Class B units, that requires us to pay them 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize (or are deemed to realize in the case of an early termination payment by us, or a change in control, as described in the tax receivable agreement) as a result of the increases in tax basis described above and certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.In October 2008, the selling unitholders agreed to waive any payments that we were required to make to them for the 2008 and 2009 tax years pursuant to the tax receivable agreement.Cash FlowsOperating activities provided cash of $9.9 million and $7.7 million for the three months ended September 30, 2010 and 2009, respectively. Operating activities provided $37.5 million and $25.6 million for the nine months ended September 30, 2010 and 2009, respectively. The year-over-year increase in cash flows from operating activities was driven primarily by an increase in weighted average AUM from $12.2 billion for the three months ended September 30, 2009, to $13.6 billion for the three months ended September 30, 2010, and an increase in weighted average AUM from $10.7 billion for the nine months ended September 30, 2009, to $14.2 billion for the nine months ended September 30, 2010, which had a corresponding positive impact on total revenues.Investing activities consist primarily of investments in affiliates and other investment partnerships, as well as capital expenditures. Investing activities used less than $0.1 million for each of the three months ended September 30, 2010 and 2009. Investing activities provided less than $0.1 million for the nine months ended September 30, 2010, and had no net effect for the nine months ended September 30, 2009.Financing activities consist primarily of borrowing arrangements and distributions to and contributions from non-controlling interests. Financing activities used $6.6 million and $14.4 million of cash for the three months ended September 30, 2010 and 2009, respectively. The $7.8 million decrease in financing activities is primarily attributable to a $10.0 million decrease in principal repayments associated with our debt obligations, offset by a $1.6 million increase in distributions to non-controlling interests, a $0.3 million decrease in contributions from non-controlling interests, and a $0.3 million increase in dividends paid.Financing activities used $26.5 million and $33.9 million for the nine months ended September 30, 2010 and 2009, respectively. The $7.4 million decrease in financing activities is primarily attributable to a $12.0 million decrease in principal repayments associated with our debt obligations and a $4.0 million increase in contributions from non-controlling interests, offset by a $8.0 million increase in distributions to non-controlling interests and a $0.6 million increase in dividends paid.Off-Balance Sheet ArrangementsWe did not have any off-balance sheet arrangements as of September 30, 2010.(“GAAP”)(GAAP), requires management to make estimates and judgments that affect our reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. We evaluate our estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.ConsolidationOurOr policy is to consolidate all majority-owned subsidiaries in which we have a controlling financial interest and VIEsvariable-interest entities of which we are deemed to be the primary beneficiary. We also consolidate non-VIEsnon-variable-interest entities which we control as the general partner or managing member. We assess our consolidation practices regularly, as circumstances dictate. All significant inter-company transactions and balances have been eliminated.C-corporation“C” corporation under the Internal Revenue Code, and thus liable for federal, state and local taxes on the income derived from our economic interest in our operating company. The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes. Our operating company has not made a provision for federal or state income taxes because it is the responsibility of each of the operating company’s members (including us) to separately report their proportionate share of the operating company’s taxable income or loss. Similarly, the income of our consolidated investment partnerships is not subject to income taxes, as such income is allocated to each partnership’s individual partners. The operating company has made a provision for New York City Unincorporated Business Tax (“UBT”)(UBT). management judgments and assumptions. In determining the valuation allowance, we use historical and forecasted future operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations. Each quarter, we re-evaluate our estimate related to the valuation allowance, including our assumptions about future profitability.$61.4$60.6 million valuation allowance, assessed as of September 30, 2010recorded against the deferred tax asset associated with our acquisitionsacquisition of operating company Class Bmembership units, is a critical accounting estimate because the underlying assumptions can change from period to period. For example, tax law changes, or variances in future projected operating performance, could result in a change in the valuation allowance. If we were not able to realize all or part of our net deferred tax assets in the future, an adjustment to our deferred tax assetsasset valuation allowance would be charged to income tax expense in the period such determination was made.Recent Accounting PronouncementsIn September 2009, the FASB issued a new standard that requires an enterprise to perform a qualitative analysis to determine whether its variable-interests give it a controlling financial interest in a VIE. Under the standard, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. An enterprise that holds a substantive interest and a controlling financial interest in a VIE is deemed to be the primary beneficiary of the VIE and is required to consolidate the VIE. The standard also requires an ongoing assessment of whether an enterprise is the primary beneficiary of a VIE, and additional disclosures about an enterprise’s involvement in VIEs, and any significant changes in risk exposure due to that involvement. The standard is effective for fiscal years beginning after November 15, 2009. In November 2009, the FASB issued a proposed standard update, which defers the consolidation criteria requirements of this new standard for assets managers’ interests in entities that apply the specialized accounting guidance for investment companies, or that have the attributes of investment companies. In February 2010, the FASB issued further guidance which provided a limited scope deferral for a reporting entity’s interest in an entity that meets all of the following conditions: (a) the entity has all the attributes of an investment company as defined under AICPA Audit and Accounting Guide, Investment Companies, or does not have all the attributes of an investment company but is an entity for which it is acceptable based on industry practice to apply measurement principles that are consistent with the AICPA Audit and Accounting Guide, Investment Companies, (b) the reporting entity does not have explicit or implicit obligations to fund any losses of the entity that could potentially be significant to the entity, and (c) the entity is not a securitization entity, asset-backed financing entity or an entity that was formerly considered a qualifying special-purpose entity. The reporting entity is required to perform a consolidation analysis for entities that qualify for the deferral in accordance with previously issued guidance on VIEs. We have evaluated the deferral guidelines and determined that the standard is applicable for our investment in our operating company, but that we meet the criteria for deferral provided in this standard for our VIEs. We adopted the updated guidance on January 1, 2010, and it had no impact on our consolidated financial statements. We are monitoring future guidance for updates on the treatment of our interests in our VIEs.a sub-investment adviser. Global markets haveAs noted in Item 1A, “Risk Factors,” of our 2010 Form 10-K filed with the SEC on March 15, 2011, we experienced unprecedenteddeclines in AUM from the quarter ended September 30, 2007, through the quarter ended March 31, 2009, largely due to the volatility and the current economic environment is challenging. Market conditions have,disruption in the recent past, resultedcapital and credit markets. During those periods, we experienced declines in a significant reductionrevenue and profitability, and there can be no assurance that there will not be declines in our AUM, whichrevenue and profitability should volatility and disruption in turn directly impacted our revenuesthe capital and net income. A resumption ofcredit markets occur again in the future. An economic downturn, and volatility in the global financial markets, could also significantly affect the estimates, judgments, and assumptions used in the valuation of our financial instruments.All of ourand nine months ended September 30,March 31, 2011 and 2010 and 2009 was generally derived from advisory fees, which are typically based on the market value of our AUM, which can be affected by adverse changes in interest rates, foreign currency exchange and equity prices. Accordingly, a decline in the prices of securities would cause our revenue and earningsincome to decline, due to a decrease in the value of the assets we manage. In addition, such a decline could cause our clients to withdraw their funds in favor of investments offering higher returns or lower risk, which would cause our revenue and earningsincome to decline further.September 30, 2010,March 31, 2011, the fair value of these assets was $2.3$6.9 million. Assuming a 10% increase or decrease, the fair value would have increased or decreased by $0.2$0.7 million at September 30, 2010.Wenoany debt that bears interest at a variable rate, it does not have any direct exposure to interest rate risk at September 30, 2010. 2011.September 30, 2010,March 31, 2011, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2010,March 31, 2011, our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). were effective to ensure that information we are required to disclose 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 and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.and nine months ended September 30, 2010March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.32reporting.Proceedings.Proceedings.Factors.Factors.20092010 Annual Report on Form 10-K.Securities.Securities.Table of ContentsSIGNATURESNovemberMay 4, 20102011Principal Accounting Officeraccounting officer)