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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

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

 

 

For the Quarterly Period Ended June 30, 2009

 

 

Or

 

 

o

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

 

 

For the transition period from                       to                       

 

Commission file number 001-33761

 

PZENA INVESTMENT MANAGEMENT, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware

(State or Other Jurisdiction of
Incorporation or Organization)

 

20-8999751

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

 

120 West 45th Street
New York, New York 10036

(Address of Principal Executive Offices)

 

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

 

Not Applicable

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

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

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

 

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

 

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

 

 

 



Table of Contents

 

PZENA INVESTMENT MANAGEMENT, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

 

Page

 

 

PART I — FINANCIAL INFORMATION

 

 

Item 1.

 

Consolidated Statements of Financial Condition of Pzena Investment Management, Inc. as of June 30, 2009 (unaudited) and December 31, 2008

 

1

 

 

Consolidated Statements of Operations (unaudited) of Pzena Investment Management, Inc. for the Three and Six Months Ended June 30, 2009 and June 30, 2008

 

2

 

 

Consolidated Statements of Cash Flows (unaudited) of Pzena Investment Management, Inc. for the Three and Six Months Ended June 30, 2009 and June 30, 2008

 

3

 

 

Consolidated Statements of Changes in Equity (unaudited) of Pzena Investment Management, Inc. for the Six Months Ended June 30, 2009 and June 30, 2008

 

4

 

 

Notes to the Consolidated Financial Statements (unaudited)

 

5

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

24

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

36

Item 4

 

Controls and Procedures

 

36

 

 

 

 

 

 

 

PART II — OTHER INFORMATION

 

 

Item 1.

 

Legal Proceedings

 

38

Item 1A

 

Risk Factors

 

38

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

38

Item 3.

 

Defaults Upon Senior Securities

 

38

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

38

Item 5.

 

Other Information

 

39

Item 6

 

Exhibits

 

39

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements.  Forward-looking statements provide our current expectations, or forecasts, of future events.  Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts.  Words or phrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words or phrases, or the negatives of 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.

 

Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements.  Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in Item 1A, “Risk Factors” in Part I of our Annual Report on Form 10-K for our fiscal year ended December 31, 2008.  Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q.  We undertake no obligation to publicly revise any forward-looking statements to reflect circumstances or events after the date of this Quarterly Report on Form 10-Q, 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.

 

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

 

·                  our anticipated future results of operations and operating cash flows;

 

·                  our business strategies and investment policies;

 

·                  our financing plans and the availability of short- or long-term borrowing, or equity financing;

 

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

 

·                  potential growth opportunities available to us;

 

·                  the recruitment and retention of our employees;

 

·                  our expected levels of compensation for our employees;

 

·                  our potential operating performance, achievements, efficiency and cost reduction efforts;

 

·                  our expected tax rate;

 

·                  changes in interest rates;

 

·                  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.

 

The reports that we file with the SEC, accessible on the SEC’s website at www.sec.gov, identify additional factors that can affect forward-looking statements.

 

ii



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

PZENA INVESTMENT MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

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

 

 

 

As of

 

 

 

June 30,
2009

 

December 31,
2008

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Cash and Cash Equivalents

 

$

25,892

 

$

27,421

 

Due from Broker

 

35

 

41

 

Advisory Fees Receivable

 

10,612

 

13,606

 

Investments in Equity Securities, at Fair Value

 

15,199

 

14,045

 

Receivable from Related Parties

 

127

 

191

 

Other Receivables

 

59

 

74

 

Prepaid Expenses and Other Assets

 

677

 

949

 

Deferred Tax Asset

 

4,678

 

3,444

 

Property and Equipment, Net of Accumulated Depreciation of $2,154 and $1,913, respectively

 

2,513

 

2,748

 

TOTAL ASSETS

 

$

59,792

 

$

62,519

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts Payable and Accrued Expenses

 

$

7,474

 

$

4,338

 

Due to Broker

 

31

 

47

 

Due to Principals

 

653

 

 

Term Loan

 

10,000

 

22,000

 

Senior Subordinated Debt to Related Parties

 

16,000

 

16,000

 

Liability to Selling and Converting Shareholders

 

3,121

 

1,787

 

Other Liabilities

 

1,270

 

2,007

 

TOTAL LIABILITIES

 

38,549

 

46,179

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

Preferred Stock (Par Value $0.01; 200,000,000 Shares Authorized; None Outstanding)

 

 

 

Class A Common Stock (Par Value $0.01; 750,000,000 Shares Authorized; 8,633,041and 6,187,068 Shares Issued and Outstanding in 2009 and 2008, respectively)

 

86

 

61

 

Class B Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 55,529,751 and 57,975,724 Shares Issued and Outstanding in 2009 and 2008, respectively)

 

 

 

Additional Paid-In Capital

 

9,813

 

9,749

 

Accumulated Deficit

 

(3,986

)

(5,289

)

Total Pzena Investment Management, Inc.’s Equity

 

5,913

 

4,521

 

Non-Controlling Interests

 

15,330

 

11,819

 

TOTAL EQUITY

 

21,243

 

16,340

 

TOTAL LIABILITIES AND EQUITY

 

$

59,792

 

$

62,519

 

 

See accompanying notes to consolidated financial statements

 

1



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PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

 

 

For the Three Months Ended
June 30,

 

For the Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

REVENUE

 

$

14,232

 

$

28,305

 

$

27,904

 

$

58,317

 

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

Compensation and Benefits Expense

 

5,983

 

8,662

 

12,023

 

17,613

 

General and Administrative Expenses

 

1,973

 

2,652

 

4,426

 

5,695

 

TOTAL OPERATING EXPENSES

 

7,956

 

11,314

 

16,449

 

23,308

 

Operating Income

 

6,276

 

16,991

 

11,455

 

35,009

 

 

 

 

 

 

 

 

 

 

 

OTHER INCOME/(EXPENSE)

 

 

 

 

 

 

 

 

 

Interest and Dividend Income

 

127

 

541

 

247

 

1,037

 

Interest Expense

 

(405

)

(1,056

)

(855

)

(2,037

)

Realized and Unrealized Gain/(Loss), Net on Equity Securities and Securities Sold Short

 

3,729

 

(3,300

)

1,909

 

(6,880

)

Other Income/(Expense)

 

(515

)

26

 

(1,096

)

12

 

Total Other Income/(Expense)

 

2,936

 

(3,789

)

205

 

(7,868

)

Income Before Income Taxes

 

9,212

 

13,202

 

11,660

 

27,141

 

Income Tax Provision/(Benefit)

 

(64

)

1,456

 

(338

)

2,998

 

Consolidated Net Income

 

9,276

 

11,746

 

11,998

 

24,143

 

Less: Net Income Attributable to Non-Controlling Interests

 

8,455

 

10,966

 

10,695

 

22,543

 

Net Income Attributable to Pzena Investment Management, Inc.

 

$

821

 

$

780

 

$

1,303

 

$

1,600

 

 

Earnings Per Share — Basic and Diluted Attributable to Pzena Investment Management, Inc. Common Stockholders:

 

Net Income for Basic Earnings per Share

 

$

821

 

$

780

 

$

1,303

 

$

1,600

 

Basic Earnings per Share

 

$

0.10

 

$

0.13

 

$

0.17

 

$

0.26

 

Basic Weighted Average Shares Outstanding

 

8,633,041

 

6,123,494

 

7,795,194

 

6,121,590

 

 

 

 

 

 

 

 

 

 

 

Net Income for Diluted Earnings per Share

 

$

4,330

 

$

8,124

 

$

6,860

 

$

16,722

 

Diluted Earnings per Share

 

$

0.07

 

$

0.13

 

$

0.11

 

$

0.26

 

Diluted Weighted Average Shares Outstanding

 

64,778,860

 

64,080,857

 

64,566,604

 

64,079,122

 

 

See accompanying notes to consolidated financial statements

 

2



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PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

For the Three Months Ended
June 30,

 

For the Six Months Ended
June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

 

Consolidated Net Income

 

$

9,276

 

$

11,746

 

$

11,998

 

$

24,143

 

Adjustments to Reconcile Net Income to Cash Provided by Operating Activities:

 

 

 

 

 

 

 

 

 

Depreciation

 

120

 

118

 

241

 

233

 

Non-Cash Compensation

 

310

 

389

 

561

 

633

 

Director Share Grant

 

 

 

280

 

140

 

Realized and Unrealized (Gain)/Loss, Net on Equity Securities and Securities Sold Short

 

(3,729

)

3,300

 

(1,909

)

6,880

 

Increase in Liability to Selling and Converting Shareholders

 

602

 

 

1,204

 

 

Deferred Income Taxes

 

(526

)

517

 

(1,193

)

1,064

 

Changes in Operating Assets and Liabilities:

 

 

 

 

 

 

 

 

 

Advisory Fees Receivable

 

(296

)

1,128

 

2,994

 

5,564

 

Due from Broker

 

2

 

(12

)

6

 

179

 

Prepaid Expenses and Other Assets

 

153

 

46

 

6

 

1,157

 

Due to Broker

 

(10

)

3,330

 

(16

)

(645

)

Due to Principals

 

57

 

 

653

 

 

Accounts Payable, Accrued Expenses and Other Liabilities

 

2,194

 

1,776

 

2,325

 

3,284

 

Purchases of Equity Securities and Securities Sold Short

 

(2,285

)

(5,309

)

(4,857

)

(22,145

)

Proceeds from Sale of Equity Securities and Securities Sold Short

 

2,184

 

5,190

 

5,615

 

11,857

 

Net Cash Provided by Operating Activities

 

8,052

 

22,219

 

17,908

 

32,344

 

 

 

 

 

 

 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

 

Receivable from Related Parties

 

47

 

(1

)

49

 

31

 

Purchases of Property and Equipment

 

(6

)

(33

)

(6

)

(82

)

Net Cash Provided by/(Used in) Investing Activities

 

41

 

(34

)

43

 

(51

)

 

 

 

 

 

 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

 

Contributions from Non-Controlling Interests

 

 

100

 

 

6,933

 

Distributions to Non-Controlling Interests

 

 

(15

)

 

(1,095

)

Capital Distribution

 

 

 

(9

)

 

Term Loan Repayment

 

(4,000

)

(3,000

)

(12,000

)

(3,000

)

Dividends

 

 

(672

)

 

(1,344

)

Distributions to Members

 

(4,906

)

(17,391

)

(7,471

)

(23,764

)

Net Cash Used in Financing Activities

 

(8,906

)

(20,978

)

(19,480

)

(22,270

)

NET CHANGE IN CASH

 

$

(813

)

$

1,207

 

$

(1,529

)

$

10,023

 

 

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS—Beginning of Period

 

$

26,705

 

$

36,000

 

$

27,421

 

$

27,184

 

Net Change in Cash

 

(813

)

1,207

 

(1,529

)

10,023

 

CASH AND CASH EQUIVALENTS—End of Period

 

$

25,892

 

$

37,207

 

$

25,892

 

$

37,207

 

 

 

 

 

 

 

 

 

 

 

Supplementary Cash Flow Information:

 

 

 

 

 

 

 

 

 

 Interest Paid

 

$

392

 

$

1,032

 

$

859

 

$

2,014

 

 Income Taxes Paid

 

$

753

 

$

1,650

 

$

1,372

 

$

3,042

 

 

See accompanying notes to consolidated financial statements

 

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Table of Contents

 

PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

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

 

 

 

Shares of
Class A
Common
Stock

 

Shares of
Class B
Common
Stock

 

Class A
Common
Stock

 

Additional
Paid-In
Capital

 

Accumulated
Other
Comprehensive
Income

 

Retained
Earnings/

(Accumulated
Deficit)

 

Non-
Controlling
Interests

 

Total

 

Balance at December 31, 2008

 

6,187,068

 

57,975,724

 

$

61

 

$

9,749

 

$

 

$

(5,289

)

$

11,819

 

$

16,340

 

Unit Conversion

 

2,445,973

 

(2,445,973

)

25

 

107

 

 

 

(108

)

24

 

Amortization of Non-Cash Compensation

 

 

 

 

43

 

 

 

318

 

361

 

Net Income

 

 

 

 

 

 

1,303

 

10,695

 

11,998

 

Capital Distribution

 

 

 

(86

)

(9

)

 

 

(7,394

)

(7,480

)

Balance at June 30, 2009

 

8,633,041

 

55,529,751

 

$

86

 

$

9,813

 

$

 

$

(3,986

)

$

15,330

 

$

21,243

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2007

 

6,111,118

 

57,937,910

 

$

61

 

$

(2,043

)

$

 

$

61

 

$

16,355

 

$

14,434

 

Issuance of Class A Common Stock

 

12,376

 

 

 

11

 

 

 

118

 

129

 

Issuance of Class B Common Stock and Amortization of Non-Cash Compensation

 

 

13,000

 

 

28

 

 

 

266

 

294

 

Net Income

 

 

 

 

 

 

1,600

 

22,543

 

24,143

 

Capital Contributions

 

 

 

 

172

 

 

 

5,838

 

6,010

 

Accumulated Other Comprehensive Income

 

 

 

 

 

67

 

 

635

 

702

 

Equity Effect of Operating Company Net Deficit on Non-Controlling Interests

 

 

 

 

3,467

 

 

 

(3,467

)

 

Capital Distribution

 

 

 

 

 

 

 

(23,764

)

(23,764

)

Class A Cash Dividends Declared ($0.11 per share)

 

 

 

 

 

 

(1,347

)

 

(1,347

)

Balance at June 30, 2008

 

6,123,494

 

57,950,910

 

$

61

 

$

1,635

 

$

67

 

$

314

 

$

18,524

 

$

20,601

 

 

See accompanying notes to consolidated financial statements

 

4



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements

 

Note 1—Organization

 

Pzena Investment Management, Inc. (the “Company”) functions as the holding company through which the business of its operating company, Pzena Investment Management, LLC, is conducted. The Company was incorporated in the State of Delaware on May 8, 2007.  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”) 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 pursuant to the guidance set forth in Financial Accounting Standards Board (“FASB”), Technical Bulletin No. 85-5, Issues Relating to Accounting for Business Combinations (“FTB 85-5”).  As a result of these transactions, as of and subsequent to October 30, 2007, (i) the Company has consolidated the financial results of Pzena Investment Management, LLC 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 Pzena Investment Management, LLC’s net income.

 

Pzena Investment Management, LLC is an investment adviser which is registered under the Investment Advisers Act of 1940 and is headquartered in New York, New York.  As of June 30, 2009, the Company managed assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and international capital markets.

 

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

 

Entity

 

Type of Entity (Date of Formation)

 

Ownership at
June 30,
2009

 

Pzena Large Cap Value Fund

 

Massachusetts Trust (11/01/2002)

 

99.6%

 

Pzena International Value Service

 

Delaware Limited Liability Company (12/22/2003)

 

17.5%

 

Pzena Global Value Service

 

Delaware Limited Liability Company (12/22/2003)

 

0.6%

 

Pzena Emerging Markets Country Value Service

 

Delaware Limited Liability Company (12/28/2007)

 

99.9%

 

Pzena Emerging Markets Focused Value Service

 

Delaware Limited Liability Company (12/28/2007)

 

99.9%

 

 

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

 

Note 2—Significant Accounting Policies

 

Basis of Presentation:

 

The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles and related Securities and Exchange Commission rules and regulations.  The Company’s policy is to consolidate all majority-owned subsidiaries in which it has a controlling financial interest and variable interest entities where the Company is deemed to be the primary beneficiary (“Consolidated Subsidiaries”).  Pursuant to the guidance of Emerging Issues Task Force Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”), the Company also consolidates non-variable-interest entities in which it acts as the general partner or managing member.  All of these entities represent 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.

 

The Pzena International Value Service and the Pzena Global Value Service are limited liability companies whose managing members are or were members of the executive committee of the operating company or the operating company itself.  Neither of these entities are considered variable-interest entities, as the managing members have substantive interests in the partnerships.  Each of these limited liability companies are considered entities “similar” to limited partnerships and thus subject to the guidance of EITF 04-5.  Under each of their respective operating agreements, none of these entities’ non-managing members have the ability to remove the managing member under any circumstance, nor do they have any participating rights.  As a result, nothing substantive exists to overcome the presumption of control by the managing member laid out by EITF 04-5.  As the managing members of these entities are,

 

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Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

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

 

During 2008, the decision was made to close the Pzena Large Cap Value Fund II, the Pzena Emerging Markets Value Service, the Pzena Mega Cap Value Fund, and Pzena Value Partners.  The results of operations and financial position of each of these entities were consolidated until the dates of their respective liquidations.

 

All of the consolidated 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 partnerships pursuant to Emerging Issues Task Force Issue No. 85-12, Retention of Specialized Accounting for Investments in Consolidation (“EITF 85-12”).  Thus, the Company reports the investment partnerships’ investments in equity securities and securities sold short at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.

 

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

 

The Company acts as the investment manager for four trusts and one offshore investment company, each of which are considered variable-interest entities.  All of these entities are vehicles through which the Company offers its Global Value and/or International Value strategies.  The Company is not considered the primary beneficiary of any of these entities.  Correspondingly, their results of operations and financial condition are not consolidated by the Company.  The total net assets of these variable-interest entities were approximately $412.7 million and $446.0 million at June 30, 2009 and December 31, 2008, respectively.  The Company is not exposed to losses as a result of its involvement with these entities because it has no direct investment in them.

 

Management’s Use of Estimates:

 

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

 

Fair Values of Financial Instruments:

 

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

 

Revenue Recognition:

 

Revenue, comprised of advisory fee income, is recognized over the period in which investment management services are provided.  Advisory fee income includes management fees that are calculated based on percentages of assets under management (“AUM”), generally billed quarterly, either in arrears or advance, depending on their contractual terms.  Advisory fee income also includes incentive fees that may be earned by the Company depending on the investment return of the 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’s participation percentage in such return differentials is then multiplied by assets under management to determine the incentive fees earned.  Returns are calculated on an annualized basis over the contract’s measurement period, which may extend up to three years.  Incentive fees are generally payable annually.  Pursuant to the preferred accounting method under Emerging Issues Task Force Issue D-96, Accounting for Management Fees Based on a Formula (“EITF D-96”), such incentive fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.  The Company recognized no such incentive fees for the three and six months ended June 30, 2009 and 2008.

 

6



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

Earnings per Share:

 

Basic earnings per share is computed by dividing the Company’s net income or loss attributable to the Company’s 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 membership units, as well as outstanding operating company options and phantom units, to the extent they would have a dilutive effect on net income per share for the reporting period.  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 Company net income associated with its increased interest in the operating company is taxed at the Company’s effective tax rate.

 

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

 

 

 

For the Three Months

 

 

 

Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Non-Controlling Interests of Pzena Investment Management, LLC

 

$

6,119

 

$

12,735

 

Less: Assumed Corporate Income Taxes

 

(2,610

)

(5,391

)

Assumed After-Tax Income of Pzena Investment Management, LLC

 

$

3,509

 

$

7,344

 

 

 

 

 

 

 

Assumed After-Tax Income of Pzena Investment Management, LLC

 

$

3,509

 

$

7,344

 

Net Income of Pzena Investment Management, Inc.

 

821

 

780

 

Diluted Net Income.

 

$

4,330

 

$

8,124

 

 

 

 

For the Six Months

 

 

 

Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Non-Controlling Interests of Pzena Investment Management, LLC

 

$

9,685

 

$

26,212

 

Less: Assumed Corporate Income Taxes

 

(4,128

)

(11,090

)

Assumed After-Tax Income of Pzena Investment Management, LLC

 

$

5,557

 

$

15,122

 

 

 

 

 

 

 

Assumed After-Tax Income of Pzena Investment Management, LLC

 

$

5,557

 

$

15,122

 

Net Income of Pzena Investment Management, Inc.

 

1,303

 

1,600

 

Diluted Net Income.

 

$

6,860

 

$

16,722

 

 

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

 

7



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

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

 

 

 

For the Three Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Net Income for Basic Earnings per Share

 

$

821

 

$

780

 

Basic Weighted Average Shares Outstanding

 

8,633,041

 

6,123,494

 

Basic Earnings per Share

 

$

0.10

 

$

0.13

 

 

 

 

 

 

 

Net Income for Diluted Earnings per Share

 

$

4,330

 

$

8,124

 

Basic Weighted Average Shares Outstanding

 

8,633,041

 

6,123,494

 

Dilutive Effect of Operating Company Units

 

55,559,751

 

57,950,910

 

Dilutive Effect of Phantom Units

 

586,068

 

6,453

 

Diluted Weighted Average Shares Outstanding

 

64,778,860

 

64,080,857

 

Diluted Earnings per Share

 

$

0.07

 

$

0.13

 

 

 

 

For the Six Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Net Income for Basic Earnings per Share

 

$

1,303

 

$

1,600

 

Basic Weighted Average Shares Outstanding

 

7,795,194

 

6,121,590

 

Basic Earnings per Share

 

$

0.17

 

$

0.26

 

Net Income for Diluted Earnings per Share

 

$

6,860

 

$

16,722

 

Basic Weighted Average Shares Outstanding

 

7,795,194

 

6,121,590

 

Dilutive Effect of Operating Company Units

 

56,397,598

 

57,950,910

 

Dilutive Effect of Phantom Units

 

373,812

 

6,622

 

Diluted Weighted Average Shares Outstanding

 

64,566,604

 

64,079,122

 

Diluted Earnings per Share

 

$

0.11

 

$

0.26

 

 

Cash and Cash Equivalents:

 

The Company considers all 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 deposits and other accounts, the majority of which are held at two financial institutions.  These balances, at times, exceed federally insured limits.

 

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

 

Due to/from Broker:

 

Due to/from broker consists primarily of cash balances and amounts receivable/payable for unsettled securities transactions held/initiated at the clearing brokers of the Company’s consolidated investment partnerships.

 

Investments in Equity Securities, at Fair Value:

 

Investments in equity securities represent primarily the securities held by the Company’s consolidated investment partnerships.  All such securities are recorded at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.

 

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

 

8



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

measuring fair value and a valuation hierarchy based upon the transparency of inputs used in the valuation of an asset or liability.  Classification within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement.  The valuation hierarchy contains three levels: (i) valuation inputs are unadjusted quoted market prices for identical assets or liabilities in active markets (Level 1); (ii) valuation inputs are quoted prices for identical assets or liabilities in markets that are not active, quoted market prices for similar assets and liabilities in active markets and other observable inputs directly or indirectly related to the asset or liability being measured (Level 2); and (iii) valuation inputs are unobservable and significant to the fair value measurement (Level 3).

 

In April 2009, the FASB issued FASB Staff Position Statement of Financial Accounting Standard (“SFAS”) No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP”), effective for fiscal years and interim periods ending after June 15, 2009.  This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have significantly decreased in relation to normal market activity.  Additionally, entities are required to disclose in interim and annual periods the inputs and valuation techniques used to measure fair value and define assets and liabilities measured at fair value by major category.

 

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

 

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

 

 

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

Equity Securities

 

$

15,199

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

Interest Rate Swap

 

 

(230

)

 

Total Fair Value

 

$

15,199

 

$

(230

)

$

 

 

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

 

 

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

Equity Securities

 

$

14,045

 

$

 

$

 

Liabilities:

 

 

 

 

 

 

 

Interest Rate Swap

 

 

(628

)

 

Total Fair Value

 

$

14,045

 

$

(628

)

$

 

 

Securities Valuation:

 

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

 

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

 

Concentrations of Credit Risk:

 

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

 

The concentration of credit risk with respect to advisory fees receivable is generally limited due to the short payment terms extended to clients by the Company.  On a periodic basis, the Company evaluates its advisory fees receivable and establishes an allowance for doubtful accounts, if necessary, based on a history of past write-offs and collections and current credit conditions.

 

9



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

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

 

Financial Instruments:

 

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

 

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

 

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

 

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

 

Derivatives Not Accounted For As Hedging

 

Statement of

 

Amount of Loss Recognized
In Income on Derivative

 

Instruments Under SFAS 133

 

Operations Account

 

2009

 

2008

 

 

 

 

 

 

 

 

 

Interest Rate Contracts

 

Other Expense

 

$

43

 

$

 

Total

 

 

 

$

43

 

$

 

 

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

 

Derivatives Not Accounted For As Hedging

 

Statement of

 

Amount of Loss Recognized
In Income on Derivative

 

Instruments Under SFAS 133

 

Operations Account

 

2009

 

2008

 

 

 

 

 

 

 

 

 

Interest Rate Contracts

 

Other Expense

 

$

68

 

$

 

Total

 

 

 

$

68

 

$

 

 

10



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

Derivatives Not Accounted For As Hedging
Instruments Under SFAS 133

 

Statement of
Financial
Condition Account

 

Fair Value

 

Statement of
Financial
Condition Account

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Contracts

 

 

$

 

Other Liabilities

 

$

230

 

Total

 

 

 

$

 

 

 

$

230

 

 

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

 

 

 

Asset Derivatives

 

Liability Derivatives

 

Derivatives Not Accounted For As Hedging
Instruments Under SFAS 133

 

Statement of
Financial
Condition Account

 

Fair Value

 

Statement of
Financial
Condition Account

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Contracts

 

 

$

 

Other Liabilities

 

$

628

 

Total

 

 

 

$

 

 

 

$

628

 

 

Property and Equipment:

 

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

 

Business Segments:

 

The Company views its operations as comprising one operating segment.

 

Income Taxes:

 

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

 

The Company and its consolidated subsidiaries account for all state, local and federal taxation pursuant to the asset and liability method, which requires deferred income tax assets and liabilities to be recorded for temporary differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income.  Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more likely than not to be realized.  At June 30, 2009 and December 31, 2008, the Company had a $63.4 million and a $62.7 million valuation allowance, respectively, against the deferred tax asset recorded as part of the Company’s acquisitions of operating company membership units.  The income tax provision, or credit, 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 on the consolidated statements of financial condition.

 

Foreign Currency:

 

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

 

11



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 2—Significant Accounting Policies (continued)

 

The Company does not isolate that portion of the results of its operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held.  Such fluctuations are included in the net realized and unrealized loss, net on equity securities and securities sold short in the consolidated statements of operations.

 

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

 

New Accounting Pronouncements:

 

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 167 amends FASB Interpretation No. 46(R), “Variable Interest Entities” for determining whether an entity is a  SFAS 167 variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE.  Under SFAS 167, 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.  SFAS 167 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance.  SFAS 167 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities.  SFAS 167 is effective for interim and annual periods beginning after November 15, 2009.  Earlier application is prohibited.  The Company is currently evaluating the impact the adoption of SFAS 167 will have on its consolidated financial statements.

 

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

 

Note 3—Property and Equipment

 

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

 

 

 

As of

 

 

 

June 30,
2009

 

December 31,
2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Computer Hardware

 

$

927

 

$

921

 

Computer Software

 

191

 

191

 

Furniture and Fixtures

 

1,161

 

1,161

 

Office Equipment

 

243

 

243

 

Leasehold Improvements

 

2,145

 

2,145

 

Total

 

4,667

 

4,661

 

Less: Accumulated Depreciation and Amortization

 

(2,154

)

(1,913

)

Total

 

$

2,513

 

$

2,748

 

 

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

 

12



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 4—Related Party Transactions

 

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

 

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

 

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

 

Certain qualified employees of the Company have the ability to open separately-managed accounts, or invest in certain of the Company’s consolidated investment partnerships, without being assessed advisory fees.  Investments by employees in separately-managed accounts are permitted only at the discretion of the Executive Committee of the Company, but are generally not subject to the same minimum investment levels that are required of outside investors.

 

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

 

As discussed in Note 9, on October 28, 2008, the operating company issued an aggregate of $16.0 million principal amount of Senior Subordinated Notes to 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.

 

Note 5—Commitments and Contingencies

 

In the normal course of business, the Company enters into agreements that include indemnities in favor of third parties, such as engagement letters with advisors and consultants.  In certain cases, the Company may have recourse against third parties with respect to these indemnities.  The Company maintains insurance policies that may provide coverage against certain claims under these indemnities.  FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), providing accounting and disclosure requirements for certain guarantees.  The Company has had no claims or payments pursuant to these agreements, and it believes the likelihood of a claim being made is remote.  Utilizing the methodology in FIN 45, the Company’s estimate of the value of such guarantees is de minimis, and, therefore, an accrual has not been made in the consolidated financial statements.

 

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

 

13



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 5—Commitments and Contingencies (continued)

 

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

 

Note 6—Retirement Plan

 

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

 

Note 7—Compensation and Benefits

 

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

 

 

 

For the Three Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Cash Compensation and Other Benefits

 

$

5,673

 

$

8,373

 

Other Non-Cash Compensation

 

310

 

289

 

Total Compensation and Benefits Expense

 

$

5,983

 

$

8,662

 

 

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

 

 

 

For the Six Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Cash Compensation and Other Benefits

 

$

11,462

 

$

16,980

 

Other Non-Cash Compensation

 

561

 

633

 

Total Compensation and Benefits Expense

 

$

12,023

 

$

17,613

 

 

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

 

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

 

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

 

14



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 7—Compensation and Benefits (continued)

 

months ended June 30, 2009.  All outstanding phantom units vest ratably over a four-year period that commenced January 1, 2008.  At June 30, 2009 and December 31, 2008, the liability associated with deferred compensation investment accounts was approximately $0.2 million and $0.3 million, respectively, and has been included as a component of other liabilities on the consolidated statements of financial condition.  For the three and six months ended June 30, 2009, the Company recognized approximately $0.2 million and $0.4 million, respectively, in compensation and benefits expense associated with the amortization of all deferred compensation awards.

 

Note 8—Short Term Borrowings

 

Simultaneously with the Credit Agreement described below, on July 23, 2007, the operating company obtained a $20.0 million revolving credit facility, expiring on July 23, 2010, in order to finance its short term working capital needs.  This facility carries a commitment fee of 0.2% on any unused amounts, and the Company’s approximately $1.8 million letter of credit reduces the amounts otherwise available to be used.  On February 11, 2008, the operating company entered into Amendment No. 1 to its Credit Agreement.  The amendment changed a number of Credit Agreement provisions, including reducing the capacity of the revolving credit facility from $20.0 million to $5.0 million.  On September 19, 2008, the operating company entered into Amendment No. 2 to its Credit Agreement.  The amendment reduced the capacity of the revolving credit facility from $5.0 million to $3.0 million and extended its maturity to July 23, 2011.  On October 28, 2008, the operating company entered into Amendment No. 3 to its Credit Agreement, which reduced the capacity of the revolving credit facility to the value of its letter of credit, approximately $1.8 million.  As of and for the periods ended June 30, 2009 and December 31, 2008, no balance was outstanding against the facility.

 

Note 9—Debt

 

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

 

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

 

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

 

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

 

(i)                                     the minimum assets under management financial covenant was eliminated;

 

(ii)                                  the excess cash flow mandatory repayment was eliminated;

 

15



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 9—Debt (continued)

 

(iii)                               the commitments under the revolving credit facility were reduced from $3.0 million to approximately $1.8 million;

 

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

 

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

 

(vi)                          amendments were made to certain covenants in order to permit the incurrence of subordinated debt by the operating company.

 

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

 

In order to fund the $25.0 million repayment by the operating company, the Company used $9.0 million in cash reserves and the proceeds from the issuance by the operating company of an aggregate of $16.0 million principal amount of Senior Subordinated Notes (collectively, the “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.  The issuance of these Notes was approved by the three independent members of the Company’s Board of Directors.

 

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

 

As discussed above, subsequent to Amendment No. 2 and Amendment No. 3 to the Company’s Credit Agreement in 2008, the minimum EBITDA and minimum AUM covenants were eliminated.  The Company was in compliance with these covenants as of and for all 2008 periods in which they were in effect.

 

Pursuant to the Credit Agreement and the Senior Subordinated Notes, the operating company would be in default if it ever failed to pay required interest and amortization payments in a timely fashion.  Further, the Credit Agreement stipulates that the operating company would be in default thereunder if it defaults on its Senior Subordinated Notes.  Such events of default would permit the lender under the applicable debt agreement to accelerate the debt thereunder.  No such occurrence of acceleration occurred during the three and six months ended June 30, 2009 and 2008.

 

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

 

Note 10—Interest Rate Swap

 

The Company manages its exposure to changes in market rates of interest.  The Company’s use of derivative instruments is limited to an interest rate swap used to manage the interest rate exposure related to its Credit Agreement.  The Company monitors its position and the credit rating of the counterparty and does not anticipate non-performance by such counterparty.

 

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

 

During the three months ended September 30, 2008, the Company changed the designation of its swap agreement from a cash flow hedge to a trading derivative, as a significant portion of the cash flows associated with the original forecasted transaction were probable to not occur due to the amortization payments required to be made pursuant to the terms of its amended Credit Agreement.

 

16



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 10—Interest Rate Swap (continued)

 

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

 

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

 

Note 11—Income Taxes

 

The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes.  Neither it nor the Company’s other consolidated subsidiaries has made a provision for federal or state income taxes because it is the individual responsibility of each of these entities’ members (including the Company) to separately report their proportionate share of the respective entity’s taxable income or loss.  The operating company has made a provision for New York City UBT.  Subsequent to the offering and reorganization on October 30, 2007, the 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 June 30, 2009 and 2008, the Company’s taxable income was determined as follows:

 

 

 

For the Three Months

 

 

 

Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Income Before Taxes

 

$

9,212

 

$

13,202

 

Unincorporated Business Taxes

 

(406

)

(885

)

Non-Controlling Interests

 

(8,455

)

(10,966

)

Income Before Corporate Income Taxes

 

$

351

 

$

1,351

 

 

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

 

 

 

For the Six Months

 

 

 

Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Income Before Taxes

 

$

11,660

 

$

27,141

 

Unincorporated Business Taxes

 

(744

)

(1,825

)

Non-Controlling Interests

 

(10,695

)

(22,543

)

Income Before Corporate Income Taxes

 

$

221

 

$

2,773

 

 

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

 

17



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 11—Income Taxes (continued)

 

The Company and the operating company are generally no longer subject to U.S. federal, or state and local income tax examinations by tax authorities for any year prior to 2005.  All tax years subsequent to and including 2005 are considered open and subject to examination by tax authorities.

 

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

 

 

 

For the Three Months
Ended June 30,

 

 

 

2009

 

2008

 

Current Provision:

 

 

 

 

 

Unincorporated Business Taxes

 

$

462

 

$

939

 

Local Corporate Tax

 

 

 

State Corporate Tax

 

 

 

Federal Corporate Tax

 

 

 

Total Current Provision

 

$

462

 

$

939

 

Deferred Provision:

 

 

 

 

 

Unincorporated Business Taxes

 

$

(56

)

$

(54

)

Local Corporate Tax

 

43

 

62

 

State Corporate Tax

 

82

 

107

 

Federal Corporate Tax

 

281

 

402

 

Total Deferred Provision

 

$

350

 

$

517

 

Deferred Income Tax Valuation Allowance

 

(876

)

 

Total Provision/(Benefit) for Income Taxes

 

$

(64

)

$

1,456

 

 

 

 

For the Six Months
Ended June 30,

 

 

 

2009

 

2008

 

Current Provision:

 

 

 

 

 

Unincorporated Business Taxes

 

$

855

 

$

1,934

 

Local Corporate Tax

 

 

 

State Corporate Tax

 

 

 

Federal Corporate Tax

 

 

 

Total Current Provision

 

$

855

 

$

1,934

 

Deferred Provision:

 

 

 

 

 

Unincorporated Business Taxes

 

$

(111

)

$

(109

)

Local Corporate Tax

 

63

 

126

 

State Corporate Tax

 

123

 

222

 

Federal Corporate Tax

 

422

 

825

 

Total Deferred Provision

 

$

497

 

$

1,064

 

Deferred Income Tax Valuation Allowance

 

(1,690

)

 

Total Provision/(Benefit) for Income Taxes

 

$

(338

)

$

2,998

 

 

Prior to October 30, 2007, the operating company was a cash basis taxpayer.  As the result of the Company’s acquisition of membership 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 $0.4 million in deferred tax liabilities as of June 30, 2009 and December 31, 2008.  Such amounts are recorded in other liabilities in the consolidated statements of financial condition.

 

The acquisition of the operating company membership units noted above 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 offering and tax basis of the operating company as of October 30, 2007, this election gave rise to a deferred tax asset of approximately $68.1 million and $66.1 million at June 30, 2009 and December 31, 2008, respectively.

 

18



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 11—Income Taxes (continued)

 

Pursuant to a Tax 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.

 

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

 

The Company determined that, after weighing both the positive and negative evidence discussed above, a portion of the benefits associated with this deferred tax asset were more likely than not to go unrealized due to estimates of future taxable income.  As a result, on September 30, 2008, the Company established a $62.7 million valuation allowance to reduce the net deferred tax asset to an amount more likely than not to be realized.  This deferred tax asset remains 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 to reflect this change in the estimated realization of the asset.  On September 30, 2008, the Company recorded an approximate $53.3 million increase to other income associated with this reduction in the liability to selling and converting shareholders.

 

In October 2008, the selling unitholders agreed to waive any payments that the Company is or will be required to make to them for the 2008 and 2009 tax years pursuant to the Tax Receivable Agreement.  During the quarter ended December 31, 2008, the Company recognized approximately $2.9 million in other income associated with this waiver.

 

As discussed further in Note 15 below, on March 3, 2009, certain of the operating company’s members exchanged an aggregate of 2,445,973 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 value of the Company’s common stock and the tax basis of the operating company, this election gave rise to a $2.5 million deferred tax asset and a corresponding $2.2 million liability to selling and converting shareholders under the Tax Receivable Agreement.  Using the methodology described above, the Company assessed the realizability of the deferred tax asset associated with this exchange and determined that a portion of its benefits would go unutilized.  Consequently, the Company established a $2.4 million valuation allowance to reduce the deferred tax asset to an amount more likely than not to be realized.  This deferred tax asset remains 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 to reflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging Issues Task Force Issue No. 94-10, Accounting by a Company for the Income Tax Effects of Transactions among or with Its Shareholders under FASB Statement No.109 (“EITF 94-10”), the Company recorded the effects of these transactions in equity.

 

During the three and six months ended June 30, 2009, the Company reduced its valuation allowance by approximately $0.9 million and $1.7 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 $0.6 million for the three months ended June 30, 2009, and by $1.2 million for the six months ended June 30, 2009.  The effects of these changes to the deferred tax asset and liability to selling and converting shareholders were recorded as a component of the provision for income taxes and other expense, respectively, on the consolidated statements of operations.  As of June 30, 2009 and December 31, 2008, the net values of this deferred tax asset were approximately $4.7 million and $3.4 million, respectively.

 

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

 

19



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 11—Income Taxes (continued)

 

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

 

 

 

Section 754

 

Other

 

Valuation
Allowance

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2009

 

$

67,186

 

$

1,297

 

$

(64,275

)

$

4,208

 

Deferred Tax Expense

 

(726

)

320

 

 

(406

)

Change in Valuation Allowance

 

 

 

876

 

876

 

Balance at June 30, 2009

 

$

66,460

 

$

1,617

 

$

(63,399

)

$

4,678

 

 

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

 

 

 

Section 754

 

Other

 

Valuation
Allowance

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008

 

$

65,368

 

$

785

 

$

(62,709

)

$

3,444

 

Deferred Tax Expense

 

(1,440

)

832

 

 

(608

)

Unit Conversion

 

2,532

 

 

(2,380

)

152

 

Change in Valuation Allowance

 

 

 

1,690

 

1,690

 

Balance at June 30, 2009

 

$

66,460

 

$

1,617

 

$

(63,399

)

$

4,678

 

 

Note 12—Investments in Equity Securities, at Fair value

 

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

 

 

 

Cost

 

Unrealized
Gain/(Loss)

 

Fair Value

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Equities

 

$

20,098

 

$

(4,899

)

$

15,199

 

 

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

 

 

 

Cost

 

Unrealized
Gain/(Loss)

 

Fair Value

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Equities

 

$

24,097

 

$

(10,052

)

$

14,045

 

 

Note 13—Non-Controlling Interests

 

The Company did not initially record a non-controlling interest associated with the acquisition of its operating company, as the post-offering net equity of the operating company was less than zero.  Pursuant to the guidance in Emerging Issues Task Force Issue No. 95-7, Implementation Issues Related to the Treatment of Minority Interest in Certain Real Estate Trusts (“EITF 95-7”), a non-controlling interest in the equity of the operating company was recorded after the initial deficit that existed at acquisition was extinguished in 2008.

 

20



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 13—Non-Controlling Interests (continued)

 

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

 

 

 

For the Three Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Non-Controlling Interest of Pzena Investment Management, LLC

 

$

6,119

 

$

12,735

 

Non-Controlling Interest in Consolidated Subsidiaries

 

2,336

 

(1,769

)

Non-Controlling Interests

 

$

8,455

 

$

10,966

 

 

 

 

For the Six Months
Ended June 30,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Non-Controlling Interest of Pzena Investment Management, LLC

 

$

9,685

 

$

26,212

 

Non-Controlling Interest in Consolidated Subsidiaries

 

1,010

 

(3,669

)

Non-Controlling Interests

 

$

10,695

 

$

22,543

 

 

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

 

 

 

As of

 

 

 

June 30,
2009

 

December 31, 2008

 

 

 

(in thousands)

 

 

 

 

 

 

 

Non-Controlling Interest of Pzena Investment Management, LLC

 

$

5,900

 

$

3,397

 

Non-Controlling Interest in Consolidated Subsidiaries

 

9,430

 

8,422

 

Non-Controlling Interests

 

$

15,330

 

$

11,819

 

 

Note 14—Members’ Equity Interests of Operating Company

 

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

 

On January 1, 2009 and 2008, the operating company granted 30,000 and 13,000, respectively, restricted Class B units to certain members pursuant to the Pzena Investment Management, LLC 2006 Equity Incentive Plan.  On January 1, 2008, the operating company also issued 86,458 phantom Class B units as part of its Bonus Plan.  In December 2008, participants in the Company’s deferred compensation program converted a portion of their holdings in investment accounts into an aggregate of 89,826 phantom Class B units.  No such phantom units were granted for the three and six months ended June 30, 2009.  All outstanding phantom units vest ratably over a four-year period that commenced January 1, 2008.

 

Except as otherwise provided by law, the liability of a member of the operating company is limited to the amount of its capital account.  A member may transfer or assign all, or any part of, its membership interest to any other party (a “Transferee”).  A Transferee of such membership interest shall not become a member unless its membership in the operating company is unanimously approved by the then existing member(s) in writing.  Any Transferee 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.

 

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Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 15—Shareholders’ Equity

 

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

 

On October 30, 2007, the Company consummated an initial public offering of 6,100,000 shares of its Class A common stock, par value $0.01 per share, for net proceeds of approximately $98.9 million, after payment of underwriting discounts and offering expenses.  These net proceeds were used to purchase 6,100,000 membership units of the operating company, representing 9.5% of its then outstanding membership units, from its two outside investors and one former employee.  Concurrently with the consummation of the Company’s initial public offering, 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, (ii) the 6,100,000 membership units of the operating company that the Company acquired were reclassified as Class A units of the operating company, (iii) an additional 11,118 Class A units were issued to the Company in respect of its issuance of 11,112 shares of Class A common stock to certain directors of the Company on October 30, 2007, and contribution of the $100 initial investment the Company received in exchange for issuance of six shares of Class A common stock on May 10, 2007, and (iv) the holders of the remaining 90.5% of the outstanding membership 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.  Accordingly, immediately following the consummation of the offering and reorganization, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 9.5% and 90.5%, respectively, of the economic interests in the operations of the business.  As of June 30, 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.

 

For each membership unit of the operating company that was reclassified as a Class B unit in the reorganization, the Company issued the holder one share of its Class B common stock, par value $0.000001 per share, in exchange for the payment of this par value.  Each share of the Company’s Class 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 our 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 Pzena Investment Management, LLC 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).

 

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

 

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

 

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

 

The acquisition of the operating company’s membership interests by the Company has been treated as a reorganization of entities under common control pursuant to the guidance set forth in FTB 85-5.  Accordingly, the net assets assumed by the Company through the offering have been reported at the operating company’s historical cost basis.  As a result of these transactions, as of and subsequent to October 30, 2007, (i) the Company has consolidated the financial results of 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’s income will be generated by its economic interest in the operating company’s net income.

 

22



Table of Contents

 

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

 

Note 15—Shareholders’ Equity (continued)

 

This acquisition of membership units in the operating company has allowed the Company to make an election to step up its tax basis in the net assets acquired.  This step up is deductible for tax purposes over a 15-year period.  Pursuant to a tax receivable agreement between the Company and the operating company, 85% of the benefits of this election, less amounts waived, will be returned to the selling and converting unitholders of the operating company as they are realized.

 

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

 

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

 

The Company elected to step up its tax basis in the incremental assets acquired.  Based on the exchange-date fair value of the Company’s common stock and the tax basis of the operating company, this election gave rise to a $2.5 million deferred tax asset and a corresponding $2.2 million liability to selling and converting shareholders under the Tax Receivable Agreement.  The Company assessed the realizability of the deferred tax asset associated with this exchange and determined that a portion of its benefits would go unutilized.  Consequently, the Company established a $2.4 million valuation allowance to reduce the deferred tax asset to an amount more likely than not to be realized.  This deferred tax asset remains 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 to reflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging Issues Task Force Issue No. 94-10, Accounting by a Company for the Income Tax Effects of Transactions among or with Its Shareholders under FASB Statement No.109 (“EITF 94-10”), the Company recorded the effects of these transactions in equity.

 

The incremental assets and liabilities assumed in the exchange were recorded on March 3, 2009 as follows:

 

 

 

(in thousands)

 

 

 

 

 

Pzena Investment Management, LLC Members’ Capital

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