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EX-31.1 - EXHIBIT 31.1 - Pzena Investment Management, Inc.pzn2015q2exhibit311.htm
EX-31.2 - EXHIBIT 31.2 - Pzena Investment Management, Inc.pzn2015q2exhibit312.htm
EX-32.1 - EXHIBIT 32.1 - Pzena Investment Management, Inc.pzn2015q2exhibit321.htm
EX-32.2 - EXHIBIT 32.2 - Pzena Investment Management, Inc.pzn2015q2exhibit322.htm
10-Q - 10-Q PDF - Pzena Investment Management, Inc.pzn2015063010q.pdf

 
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, 2015
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
 
20-8999751
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)
320 Park Avenue
New York, New York 10022
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code: (212) 355-1600

Not Applicable

(Former Address of Principal Executive Offices) (Zip Code)

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 Data 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 x 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
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 

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 3, 2015, there were 15,607,254 outstanding shares of the registrant’s Class A common stock, par value $0.01 per share.
As of August 3, 2015, there were 50,641,323 outstanding shares of the registrant’s Class B common stock, par value $0.000001 per share.
 



PZENA INVESTMENT MANAGEMENT, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i


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, 2014.  Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report.  We undertake no obligation to publicly revise any forward-looking statements to reflect circumstances or events after the date of this Quarterly Report, or to reflect the occurrence of unanticipated events.  You should, however, review the factors and risks we describe in the reports we will file from time to time with the Securities and Exchange Commission, or SEC, after the date of this Quarterly Report on Form 10-Q.

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


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, 2015
 
December 31, 2014
 
(unaudited)
 
 
ASSETS
 
 
 
Cash and Cash Equivalents
$
24,441

 
$
39,109

Restricted Cash
3,769

 
2,810

Due from Broker
529

 
94

Advisory Fees Receivable
23,790

 
22,939

Investments
33,143

 
27,945

Receivable from Related Parties
313

 
107

Other Receivables
606

 
647

Prepaid Expenses and Other Assets
798

 
845

Deferred Tax Asset, Net of Valuation Allowance of $42,900 and $44,239, respectively
13,967

 
14,618

Property and Equipment, Net of Accumulated Depreciation of $664 and $3,072, respectively
7,639

 
2,772

TOTAL ASSETS
$
108,995

 
$
111,886

LIABILITIES AND EQUITY
 

 
 

Liabilities:
 

 
 

Accounts Payable and Accrued Expenses
$
14,061

 
$
5,974

Due to Broker
1,248

 
698

Securities Sold Short, at Fair Value
2,406

 
1,572

Liability to Selling and Converting Shareholders
16,275

 
15,358

Deferred Compensation Liability
1,550

 
2,211

Lease Liability
743

 
354

Other Liabilities
819

 
686

TOTAL LIABILITIES
37,102

 
26,853

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; 12,805,161 and 13,044,719 Shares Issued and Outstanding in 2015 and 2014, respectively)
127

 
130

Class B Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 53,316,083 and 52,891,939 Shares Issued and Outstanding in 2015 and 2014, respectively)

 

Additional Paid-In Capital
5,749

 
8,007

Retained Earnings
9,243

 
10,264

Total Pzena Investment Management, Inc.'s Equity
15,119

 
18,401

Non-Controlling Interests
56,774

 
66,632

TOTAL EQUITY
71,893

 
85,033

TOTAL LIABILITIES AND EQUITY
$
108,995

 
$
111,886

 
See accompanying notes to unaudited consolidated financial statements.

1


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,
 
2015
 
2014
 
2015
 
2014
REVENUE
$
29,510

 
$
27,945

 
$
58,163

 
$
54,346

EXPENSES


 


 


 


Compensation and Benefits Expense
11,800

 
9,899

 
23,870

 
19,949

General and Administrative Expense
4,490

 
2,505

 
8,093

 
4,825

Total Operating Expenses
16,290

 
12,404

 
31,963

 
24,774

Operating Income
13,220

 
15,541

 
26,200

 
29,572

OTHER INCOME/ (EXPENSE)


 
 
 
 

 
 

Interest Income
7

 
10

 
21

 
25

Dividend Income
312

 
112

 
430

 
162

Gains/ (Losses) and Other Investment Income
460

 
410

 
475

 
514

Change in Liability to Selling and Converting Shareholders
(672
)
 
(1,996
)
 
(917
)
 
(2,123
)
Other Income/ (Expense)
54

 
56

 
(137
)
 
(33
)
Total Other Income/ (Expense)
161

 
(1,408
)
 
(128
)
 
(1,455
)
Income Before Income Taxes
13,381

 
14,133

 
26,072

 
28,117

Income Tax Expense/ (Benefit)
566

 
(274
)
 
1,654

 
1,409

Net Income
12,815

 
14,407

 
24,418

 
26,708

Less: Net Income Attributable to Non-Controlling Interests
10,893

 
12,283

 
20,874

 
23,136

Net Income Attributable to Pzena Investment Management, Inc.
$
1,922

 
$
2,124

 
$
3,544

 
$
3,572

 
 
 
 
 
 
 
 
Net Income for Basic Earnings per Share
$
1,922

 
$
2,124

 
$
3,544

 
$
3,572

Basic Earnings per Share
$
0.15

 
$
0.17

 
$
0.27

 
$
0.29

Basic Weighted Average Shares Outstanding1
12,946,168

 
12,180,192

 
13,001,633

 
12,178,402

 
 
 
 
 
 
 
 
Net Income for Diluted Earnings per Share
$
8,531

 
$
9,096

 
$
16,458

 
$
16,692

Diluted Earnings per Share
$
0.13

 
$
0.13

 
$
0.24

 
$
0.25

Diluted Weighted Average Shares Outstanding1
68,223,560

 
67,998,237

 
68,109,058

 
68,021,135

 
 
 
 
 
 
 
 
Cash Dividends per Share of Class A Common Stock
$
0.03

 
$
0.03

 
$
0.35

 
$
0.29

1 The Company issues restricted shares of Class A common stock and restricted Class B units that have non-forfeitable dividend rights. Under the "two-class method," these shares and units are considered participating securities and are required to be included in the computation of basic and diluted earnings per share. 

See accompanying notes to unaudited consolidated financial statements.


2


PZENA INVESTMENT MANAGEMENT, INC.
UNAUDITED CONSOLIDATED STATEMENT 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
 
Retained
Earnings
 
   Non-Controlling
Interests
 
Total
Balance at December 31, 2014
13,044,719

 
52,891,939

 
$
130

 
$
8,007

 
$
10,264

 
$
66,632

 
$
85,033

Amortization of Non-Cash Compensation
18,535

 
23,800

 

 
306

 

 
1,178

 
1,484

Non-Cash Compensation Modification

 
(142,315
)
 

 
(141
)
 

 
(572
)
 
(713
)
Directors' Share Grants

 

 

 
45

 

 
183

 
228

Net Income

 

 

 

 
3,544

 
20,874

 
24,418

Options Exercised

 
688,281

 

 
333

 

 
1,355

 
1,688

Repurchase and Retirement of Class A Common Stock
(258,093
)
 

 
(3
)
 
(2,340
)
 

 

 
(2,343
)
Repurchase and Retirement of Class B Units

 
(145,622
)
 

 
(309
)
 

 
(1,275
)
 
(1,584
)
Class A Cash Dividends Declared and Paid ($0.35 per share)

 

 

 

 
(4,565
)
 

 
(4,565
)
Contributions from Non-Controlling Interests

 

 

 

 

 
385

 
385

Distributions to Non-Controlling Interests

 

 

 

 

 
(32,138
)
 
(32,138
)
Other

 

 

 
(152
)
 

 
152

 

Balance at June 30, 2015
12,805,161

 
53,316,083

 
$
127

 
$
5,749

 
$
9,243

 
$
56,774

 
$
71,893

  
See accompanying notes to unaudited consolidated financial statements.

3


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,
 
2015
 
2014
 
2015
 
2014
OPERATING ACTIVITIES
 
 
 
 
 
 
 
Net Income
$
12,815

 
$
14,407

 
$
24,418

 
$
26,708

Adjustments to Reconcile Net Income to Cash
 
 
 
 
 
 
 
Provided by Operating Activities:
 
 
 
 
 
 
 
Depreciation
187

 
57

 
252

 
110

Disposal of Fixed Assets
428

 

 
428

 

Non-Cash Compensation
1,561

 
1,180

 
3,034

 
2,656

Directors' Share Grants
82

 
82

 
228

 
198

(Gains)/ Losses and Other Investment Income
(460
)
 
(410
)
 
(475
)
 
(514
)
Lease Liability
862

 

 
862

 

Change in Liability to Selling and Converting Shareholders
672

 
1,996

 
917

 
2,123

Deferred Income Taxes
14

 
(1,170
)
 
640

 
(200
)
Changes in Operating Assets and Liabilities:


 


 


 


Advisory Fees Receivable
(776
)
 
(503
)
 
(851
)
 
43

Due from Broker
170

 
(435
)
 
(437
)
 
(1,131
)
Restricted Cash
(284
)
 
(2,374
)
 
(959
)
 
(2,374
)
Prepaid Expenses and Other Assets
318

 
239

 
57

 
(80
)
Non-Cash Compensation Modification

 

 
(713
)
 

Due to Broker
496

 
(4,114
)
 
550

 
1,114

Accounts Payable, Accrued Expenses, and Other Liabilities
5,203

 
4,901

 
6,051

 
3,657

Tax Receivable Agreement Payments

 

 

 
(1,945
)
Change in Lease Liability
(367
)
 
(107
)
 
(473
)
 
(213
)
Purchases of Equity Securities and Securities Sold Short
(11,312
)
 
(15,911
)
 
(28,823
)
 
(31,266
)
Proceeds from Equity Securities and Securities Sold Short
11,825

 
14,910

 
24,649

 
24,973

Net Cash Provided by Operating Activities
21,434

 
12,748

 
29,355

 
23,859

INVESTING ACTIVITIES
 
 
 
 
 
 
 
Purchases of Investments
(2,238
)
 
(102
)
 
(6,773
)
 
(621
)
Proceeds from Sale of Investments
1,289

 

 
7,060

 
541

Payments to Related Parties
(8
)
 
87

 
(206
)
 
(5
)
Purchases of Property and Equipment
(2,257
)
 

 
(5,547
)
 
(81
)
Net Cash Used in Investing Activities
(3,214
)
 
(15
)
 
(5,466
)
 
(166
)
FINANCING ACTIVITIES
 
 
 
 
 
 
 
Repurchase and Retirement of Class A Common Stock
(1,518
)
 
(373
)
 
(2,343
)
 
(373
)
Repurchase and Retirement of Class B Units
(1,542
)
 
(500
)
 
(1,584
)
 
(541
)
Loan Proceeds

 
205

 

 
205

Option Exercise

 

 
1,688

 

Distributions to Non-Controlling Interests
(11,485
)
 
(12,029
)
 
(32,138
)
 
(28,854
)
Contributions from Non-Controlling Interests
49

 
630

 
385

 
1,578

Dividends
(388
)
 
(365
)
 
(4,565
)
 
(3,531
)
Net Cash Used in Financing Activities
(14,884
)
 
(12,432
)
 
(38,557
)
 
(31,516
)
NET CHANGE IN CASH
$
3,336

 
$
301

 
$
(14,668
)
 
$
(7,823
)
CASH AND CASH EQUIVALENTS - Beginning of Period
$
21,105

 
$
25,754

 
$
39,109

 
$
33,878

Net Change in Cash
3,336

 
301

 
(14,668
)
 
(7,823
)
CASH AND CASH EQUIVALENTS - End of Period
$
24,441

 
$
26,055

 
$
24,441

 
$
26,055

Supplementary Cash Flow Information:
 
 
 
 
 
 
 
Income Taxes Paid
$
360

 
$
1,213

 
$
769

 
$
1,544


See accompanying notes to unaudited consolidated financial statements.

4

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements


Note 1—Organization
 
Pzena Investment Management, Inc. (the “Company”) functions as the sole managing member of its operating company, Pzena Investment Management, LLC (the “operating company”).   As a result, the Company: (i) consolidates the financial results of the operating company and reflects the membership interests that it does not own as a non-controlling interest in its consolidated financial statements; and (ii) recognizes income generated from its economic interest in the operating company’s net income.
 
The operating company is an investment adviser registered under the Investment Advisers Act of 1940 and is headquartered in New York, New York. As of June 30, 2015, the operating company managed assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and non-U.S. capital markets.
 
The Company, through its own interests, and its interest in the operating company, has consolidated the results of operations and financial condition of the following entities as of June 30, 2015
 
 
 
 Ownership at
Legal Entity
Type of Entity (Date of Formation)
 
June 30, 2015
Pzena Investment Management, Pty
Australian Proprietary Limited Company (12/16/2009)
 
100.0
%
Pzena Financial Services, LLC
Delaware Limited Liability Company (10/15/2013)
 
100.0
%
Pzena Investment Management, LTD
England and Wales Private Limited Company (01/08/2015)
 
100.0
%
Pzena Investment Management Special Situations, LLC
Delaware Limited Liability Company (12/01/2010)
 
99.9
%
Pzena Mid Cap Focused Value Fund, a series of Advisors Series Trust
Open-end Management Investment Company, series of Delaware Statutory Trust (3/31/2014)
 
92.0
%
Pzena Long/Short Value Fund, a series of Advisors Series Trust
Open-end Management Investment Company, series of Delaware Statutory Trust (3/31/2014)
 
83.7
%
Pzena International Value Service, a series of Pzena Investment Management International, LLC
Delaware Limited Liability Company (12/22/2003)
 
43.3
%
Pzena Emerging Markets Focused Value Fund, a series of Advisors Series Trust
Open-end Management Investment Company, series of Delaware Statutory Trust (3/31/2014)
 
15.6
%
Pzena Investment Funds Trust, Pzena Large Cap Value Fund
Massachusetts Trust (11/01/2002)
 
3.0
%
 
Note 2—Significant Accounting Policies
 
Basis of Presentation:
 
The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and related Securities and Exchange Commission (“SEC”) rules and regulations.  The Company’s policy is to consolidate all majority-owned subsidiaries in which it has a controlling financial interest.  Certain investment vehicles the operating company sponsors for which it is the investment advisor are considered to be variable-interest entities (“VIEs”). The Company consolidates VIEs where the Company is deemed to be the primary beneficiary. The majority-owned subsidiaries in which the Company has a controlling financial interest and the VIEs for which the Company is deemed to be the primary beneficiary are collectively referred to as “consolidated subsidiaries.”  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 through consolidation.

On March 31, 2014, the operating company launched the Pzena Emerging Markets Focused Value Fund, Pzena Mid Cap Focused Value Fund, and Pzena Long/Short Value Fund, for each of which it acts as the investment advisor. These funds each meet the definition of VIE due to their series trust structure, as the shareholders of the individual funds lack the ability to make decisions regarding the trustees and the key activities of the fund, because those abilities reside at the trust level. For purposes of consolidation, the Company believes it is the primary beneficiary when it, along with its related parties and de-facto agents, owns

5

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


a majority of the fund shares because the majority of the variability of the funds accrues to the Company. On March 31, 2014, the Company provided the initial cash investment for each fund in an effort to generate an investment performance track record to attract third-party investors and had an initial investment representing 100% of the ownership in each entity. As a result, the entities were consolidated with the Company as of March 31, 2014. On August 5, 2014, due to additional subscriptions into the Pzena Emerging Markets Focused Value Fund, the Company's ownership decreased to 42.9% and the entity was deconsolidated. However, as of December 19, 2014, as a result of a shift in equity ownership on that date, the Company was considered the primary beneficiary of the fund and the entity was reconsolidated. During the period when the Company was not considered the primary beneficiary of the Pzena Emerging Markets Focused Value Fund, it removed the related assets, liabilities and non-controlling interest from its consolidated statement of financial condition, the related net investment income from its consolidated statement of operations and classified the remaining investment as an equity method investment. The Pzena Emerging Markets Focused Value Fund, Pzena Mid Cap Focused Value Fund, and Pzena Long/Short Value Fund will continue to be consolidated to the extent the Company is deemed to be the primary beneficiary of them. At June 30, 2015, the aggregate of these funds' $22.3 million in net assets was included in the Company's consolidated statement of financial condition.

The operating company is the managing member of Pzena International Value Service, a series of Pzena Investment Management International, LLC.  The operating company is considered the primary beneficiary of this entity. At June 30, 2015, Pzena International Value Fund’s $3.9 million in net assets were included in the Company’s consolidated statement of financial condition.

Pzena Investment Funds Trust, Pzena Large Cap Value Fund is a Massachusetts Trust in which a majority of the trustees are members of the executive committee of the operating company.  A majority of the trustees do not hold equity investments in this trust.  Since the holders of the equity investments in this partnership lack a controlling financial interest in it, this entity is deemed to be a VIE.  The Company is considered the primary beneficiary of this VIE.  At June 30, 2015, the fund’s $1.2 million in net assets were included in the Company’s consolidated statement of financial condition.

Effective January 1, 2015, substantially all of the Company's investments in third party mutual funds, held to satisfy the Company's obligations under its deferred compensation program, were reallocated to the Pzena Emerging Markets Focused Value Fund, Pzena Mid Cap Focused Value Fund, Pzena Long/Short Value Fund, Pzena Large Cap Value Fund, Pzena International Value Service, a private investment partnership and certain other investments.     

VIEs that are not consolidated continue to receive investment management services from the operating company and are private investment partnerships the operating company sponsors, through which it offers its Global Value and/or Non-U.S. Value Strategies.  The total net assets of these VIEs was approximately $442.4 million and $408.9 million at June 30, 2015 and December 31, 2014, respectively.  As of June 30, 2015, the operating company had a $1.9 million investment in one of these firm-sponsored vehicles held to satisfy the Company's obligations under its deferred compensation program but was not deemed to be primary beneficiary of the entity. As of December 31, 2014, neither the Company nor the operating company was exposed to losses as a result of its involvement with these entities because neither had a direct investment in them.

The Company records in its own equity its pro-rata share of transactions that impact the operating company’s net equity, including unit and option issuances, repurchases, and retirements.  The operating company’s pro-rata share of such transactions is recorded as an adjustment to additional paid-in capital or non-controlling interests, as applicable, on the consolidated statements of financial position.
 
Management’s Use of Estimates:
 
The preparation of financial statements in conformity with GAAP 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.
 

 

6

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


Revenue Recognition:
 
Revenue, comprised of advisory fee income, is recognized over the period in which advisory 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 the applicable contractual terms.  Advisory fee income also includes performance fees that may be earned by the Company depending on the investment return of the AUM.  Performance 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 AUM to determine the performance fees earned.   In general, returns are calculated on an annualized basis over the contract’s measurement period, which usually extends to three years.  Performance fees are generally payable annually.  Following the preferred method identified in the Revenue Recognition Topic of the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), such performance fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.  For the three and six months ended June 30, 2015, the Company recognized approximately $0.3 million and $0.8 million in performance fee income, respectively. For the three and six months ended June 30, 2014, the Company recognized approximately $0.2 million and $0.5 million in performance fee income, respectively.

Cash and Cash Equivalents:
 
At June 30, 2015 and December 31, 2014, Cash and Cash Equivalents was $24.4 million and $39.1 million, respectively.  The Company considers all money market funds and highly-liquid debt instruments with an original maturity of three months or less at the time of purchase to be cash equivalents.  The Company maintains its cash in bank deposits and other accounts whose balances often exceed federally insured limits.
 
Interest on cash and cash equivalents is recorded as interest income on an accrual basis in the consolidated statements of operations.
 
Restricted Cash:
 
The Company maintained compensating balances of Restricted Cash of $3.8 million and $2.8 million at June 30, 2015 and December 31, 2014, respectively. The Company holds letters of credit issued by a third party in lieu of cash security deposits, as required by the Company’s leases for its new corporate headquarters and former office space.  

The Pzena Long/Short Value Fund is required to maintain cash collateral for margin accounts established to support securities sold short, not yet purchased. To satisfy this requirement, cash of $2.5 million and $1.5 million as of June 30, 2015 and December 31, 2014, respectively, was set aside and recorded in Restricted Cash in the consolidated statements of financial condition.

Due to/from Broker:
 
Due to/from Broker consists primarily of amounts payable/receivable for unsettled securities transactions held/initiated at the clearing brokers of the Company’s consolidated subsidiaries.
 
Investments:
 
Investment Securities, trading
Investments classified as trading securities consist of equity securities held by the Company and its consolidated subsidiaries.  Certain of the Company’s investments are held to satisfy the Company’s obligations under its deferred compensation program.  Prior to 2015, the Company held investments in third-party mutual funds to satisfy the Company's obligations under its deferred compensation program. Dividends associated with the Company's investments and the investments of the Company’s consolidated subsidiaries are recorded as dividend income on an ex-dividend basis in the consolidated statement of operations.

Securities Sold Short represents securities sold short, not yet purchased by the Pzena Long/Short Value Fund, which is consolidated with the Company's financial statements. Dividend expense associated with these investments is reflected in Other Expense on an ex-dividend basis in the consolidated statements of operations.
 

7

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


All such investments are recorded at fair value, with net realized and unrealized gains and losses reported in earnings. Net realized and unrealized gains and losses are a component of Gains/ (Losses) and Other Investment Income in the consolidated statements of operations.

Investments in equity method investees
During the three and six months ended June 30, 2015, the Company accounted for its investment in a private investment partnership in which the Company has a non-controlling interest and exercises significant influence using the equity method. This investment is included in Investments in the Company's consolidated statement of financial condition. The carrying value of this investment is recorded at the amount of capital reported by the private investment partnership. The capital account reflects any contributions paid to, distributions received from, and equity earnings of, the private investment partnership. The earnings of this investment are recorded as equity in the earnings of affiliates and reflected as a component of Gains/ (Losses) and Other Investment Income in the consolidated statement of operations.

Investments in equity method investees are evaluated for impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the carrying amounts of the assets exceed their respective fair values, additional impairment tests are performed to measure the amounts of impairment losses, if any. During the three and six months ended June 30, 2015, no impairment losses were recognized.

Fair Value Measurements:
 
The Fair Value Measurements and Disclosures Topic of the FASB ASC 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.  The Fair Value Measurements and Disclosures Topic of the FASB ASC also establishes a framework for 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).
 
Included in the Company’s consolidated assets and liabilities are investments in equity securities and securities sold short, both of which are exchange-traded securities with quoted prices in active markets. Also included in the Company's investments during 2014 were third-party mutual funds which have a readily available net asset value per share.  The fair value measurements of the equity securities, securities sold short, and investments in third-party mutual funds during 2014 have been classified as Level 1. The investments in equity method investees are held at their carrying value.
 
The following table presents these instruments’ fair value at June 30, 2015:
 
 
Level 1
 
Level 2
 
Level 3
 
Other Assets Not Held at Fair Value
 
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
 
 
Equity Securities
$
31,246

 
$

 
$

 
$

 
$
31,246

Investments in Equity Method Investees

 

 

 
1,897

 
1,897

Total
$
31,246

 
$

 
$

 
$
1,897

 
$
33,143



8

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


 
Level 1

Level 2

Level 3

Other Liabilities Not Held at Fair Value

Total
 
(in thousands)
Liabilities:
 

 

 




Securities Sold Short
$
2,406


$

 
$


$


$
2,406


The following table presents these instruments’ fair value at December 31, 2014:

 
Level 1
 
Level 2
 
Level 3
 
Other Assets Not Held at Fair Value
 
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
 
 
Equity Securities
$
23,036

 
$

 
$

 
$

 
$
23,036

Investments in Mutual Funds
4,909

 

 

 

 
4,909

Total
$
27,945

 
$

 
$

 
$

 
$
27,945


 
Level 1
 
Level 2
 
Level 3
 
Other Liabilities Not Held at Fair Value
 
Total
 
(in thousands)
Liabilities:
 
 
 
 
 
 
 
 
 
Securities Sold Short
$
1,572

 
$

 
$

 
$

 
$
1,572

    
For the three and six months ended June 30, 2015 and 2014, there were no transfers between levels. In addition, the Company did not hold any Level 2 or 3 securities during these periods.

Securities Valuation:
 
Investments in equity securities and securities sold short for which market quotations are available are valued at the last reported price or closing price on the primary market or exchange on which they trade.  If no reported equity sales occurred on the valuation date, equity investments are valued at the bid price.  Investments in firm-sponsored investment vehicles and third-party mutual funds during 2014, are valued at the closing net asset value per share of the fund on the day of valuation.  Transactions are recorded on a trade date basis.

The net realized gain or loss on sales of securities, securities sold short, and investments in third-party mutual funds is determined on a specific identification basis and is included in Gains/ (Losses) and Other Investment Income 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 cash equivalents in bank deposits and other accounts whose balances often 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, collections, and current credit conditions.  For each of the three and six months ended June 30, 2015, approximately 10.8% of the Company's advisory fees were generated from advisory agreements with one client relationship. The Company had no client relationships that were

9

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


greater than 10% of total revenue during 2014. At June 30, 2015 and December 31, 2014, no allowance for doubtful accounts was deemed necessary.
 
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 subsidiaries is not subject to income taxes, since it is allocated to each partnership’s individual partners.  The operating company has made a provision for New York City Unincorporated Business Tax (“UBT”).

Judgment is required in evaluating the Company's uncertain tax positions and determining its provision for income taxes. The Company establishes reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when the Company believes that certain positions might be challenged despite its belief that its tax return positions are in accordance with applicable tax laws. The Company adjusts these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate. It is also the Company’s policy to recognize accrued interest, and penalties associated with uncertain tax positions in Income Tax Expense on the consolidated statement of operations. For the three and six months ended June 30, 2015 and 2014, no such expenses were recognized. As of June 30, 2015 and December 31, 2014, no such accruals were recorded. 
The Company and its consolidated subsidiaries account for all federal, state, and local taxation pursuant to the asset and liability method, which requires deferred income tax assets and liabilities to be recorded for temporary differences between the carrying amount 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, 2015, the Company had a $42.9 million valuation allowance against deferred tax assets recorded as part of the Company’s initial public offering and the subsequent exchanges of Class B units for shares of its Class A common stock.  At December 31, 2014, the Company had a $44.2 million valuation allowance against these deferred tax assets.  The income tax expense, or benefit, is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities. The Company records its deferred tax liabilities as a component of other liabilities in the consolidated statements of financial condition.

Excess tax benefits related to stock- and unit-transactions are not recognized until they result in a reduction of cash taxes payable. The benefit of these excess tax benefits will be recorded in equity when they reduce cash taxes payable. The Company will only recognize a tax benefit from stock- and unit-based awards in Additional Paid-In Capital if an incremental tax benefit is realized after all other tax benefits currently available have been utilized. For the three and six months ended June 30, 2015, the Company had approximately $0.2 million and $0.3 million, respectively, in tax benefits associated with stock- and unit-based awards that it was not able to recognize. There were less than $0.1 million in such unrecognized tax benefits for each of the three and six months ended June 30, 2014.
 

10

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


Foreign Currency:
 
The functional currency of the Company is the U.S. Dollar.  Assets and liabilities of foreign operations whose functional currency is not the U.S. Dollar are translated at the exchange rate in effect at the applicable reporting date, and the consolidated statements of operations are translated at the average exchange rates in effect during the applicable period.  For the three and six months ended June 30, 2015 and 2014, the Company did not record any accumulated other comprehensive income.

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.
 
The Company does not isolate the portion of the results of its operations resulting from the impact of fluctuations in foreign exchange rates on its non-U.S. investments.  Such fluctuations are included in Gains/ (Losses) and Other Investment Income 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 unrealized foreign exchange gains and losses arise from changes in the fair values of assets and liabilities resulting from changes in exchange rates.
 
Recently Issued Accounting Pronouncements Not Yet Adopted:

In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis". This standard modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for fiscal years and interim periods within those years beginning after December 15, 2015, and requires either a retrospective approach to adoption or modified retrospective approach, by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. Early adoption is permitted. The company is currently assessing the impact of this standard on its consolidated financial statements, as well as the available transition method.

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. In July 2015, the FASB postponed the effective date of this new guidance from January 1, 2017 to January 1, 2018. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the potential impact on the consolidated statements and related disclosures, as well as the available transition methods.


Note 3—Compensation and Benefits
 
Compensation and benefits expense to employees and members is comprised of the following:
 

For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Cash Compensation and Other Benefits
$
10,239

 
$
8,719

 
$
20,836

 
$
17,293

Non-Cash Compensation
1,561

 
1,180

 
3,034

 
2,656

Total Compensation and Benefits Expense
$
11,800

 
$
9,899

 
$
23,870

 
$
19,949

   

11

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


All non-cash compensation awards granted have varying vesting schedules and are issued at prices equal to the assessed fair market value at the time of issuance, as discussed below.  No new non-cash compensation awards were issued during the three months ended June 30, 2015 and 2014. Details of non-cash compensation awards granted during the six months ended June 30, 2015 and 2014 are as follows:
 
For the Six Months Ended June 30,
 
2015
 
2014

Amount
 
Fair
Value
1
 
Amount
 
Fair
Value
1
Restricted Class B Units
23,782

 
$
9.46

 
32,479

 
$
11.76

Options to Purchase Shares of Class A Common Stock2
1,000,000

 
$
1.07

 

 
$

Deferred Compensation Phantom Class B Units

 
$

 
22,959

 
$
11.76

Participating Shares of Restricted Class A Common Stock3
29,868

 
$
8.37

 

 
$

Restricted Shares of Class A Common Stock
100,000

 
$
6.08

 

 
$

1 Represents the grant date fair value per share or unit.
2 Represents options to purchase shares of Class A common stock issued whose vesting is contingent on meeting various departmental and company-wide performance goals, including revenue growth in excess of certain expenses. These share options contingently vest over a period of 7 years.
3 Represents restricted shares of Class A common stock that receive nonforfeitable rights to dividends.

Pursuant to the Pzena Investment Management, LLC Amended and Restated 2006 Equity Incentive Plan (“the 2006 Equity Incentive Plan”), the operating company issues Class B units, phantom Class B units and options to purchase Class B units.  The Company also issues Delayed Exchange Class B units pursuant to the 2006 Equity Incentive Plan. These Class B units vested immediately upon grant, but may not be exchanged pursuant to the Amended and Restated Operating Agreement of the operating company until at least the seventh anniversary of the date of grant. These units are also not entitled to any benefit under the Tax Receivable Agreement between the Company and members of the operating company. Under the Pzena Investment Management, Inc. 2007 Equity Incentive Plan (“the 2007 Equity Incentive Plan”), the Company issues shares of restricted Class A common stock and contingently vesting options to acquire shares of Class A common stock. No restricted Class B units were forfeited during the three months ended June 30, 2015. During the six months ended June 30, 2015, 5,775 restricted Class B units were forfeited in connection with employee departures. During the three and six months ended June 30, 2015, no contingently vesting options vested. During the six months ended June 30, 2015, 142,315 Delayed Exchange Class B units issued to one employee during 2014 were canceled and replaced with cash compensation. Additional compensation expense of less than $0.1 million was recognized upon cancellation and replacement of the award. No units were canceled during the three months ended June 30, 2015. During the three months ended June 30, 2014, 701,299 phantom Class B units were forfeited in connection with employee departures.

Under the Pzena Investment Management, LLC Amended and Restated Bonus Plan (the “Bonus Plan”), eligible employees whose compensation is in excess of certain thresholds have a portion of that excess mandatorily deferred.  These deferred amounts may be invested, at the employee’s discretion, in certain investment options as designated by the Compensation Committee of the Company's Board of Directors.  Amounts deferred in any calendar year reduce that year’s compensation expense and are amortized and vest ratably over a four-year period commencing the following year.  The Company also issued to certain of its employees deferred compensation with certain investment options that also vest ratably over a four-year period. As of June 30, 2015 and December 31, 2014, the liability associated with all deferred compensation investment accounts was $1.6 million and $2.2 million, respectively. During the three months ended June 30, 2014, 5,953 phantom Class B units issued under the plan and approximately $1.0 million in deferred compensation investments were forfeited in connection with employee departures. No deferred compensation was forfeited during the three or six months ended June 30, 2015
 
Pursuant to the Pzena Investment Management, Inc. Non-Employee Director Deferred Compensation Plan (the “Director Plan”), non-employee directors may elect to have all or part of their compensation otherwise payable in cash deferred in the form of phantom shares of Class A common stock of the Company.  Elections to defer compensation under the Director Plan are made on a year-to-year basis.  Distributions under the Director Plan are made in a single distribution of shares of Class A common stock at such time as elected by the participant when the deferral was made.  Since inception of the Director Plan in 2009, the Company’s directors have elected to defer 100% of their compensation in the form of phantom shares of Class A common stock.  Amounts deferred in any calendar year are amortized over the calendar year and reflected as General and Administrative Expense.  As of June 30, 2015 and December 31, 2014, there were 231,179 and 190,389 phantom shares of

12

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


Class A common stock outstanding, respectively. For the three and six months ended June 30, 2015 and 2014, no distributions were made under the Director Plan.

The Company has issued to certain of its employees delayed-vesting cash awards.  For the three and six months ended June 30, 2015 and 2014 no such awards were granted.  Previously awarded delayed-vesting cash awards have varying vesting schedules with $0.4 million to be paid at the end of 2015.

As of June 30, 2015 and December 31, 2014, the Company had approximately $26.7 million and $26.8 million, respectively, in unrecorded compensation expense related to unvested awards issued pursuant to its Bonus Plan and certain agreements; Class B units, Delayed Exchange Class B units, contingently vesting option grants, and phantom Class B units issued under the 2006 Equity Incentive Plan; and restricted Class A common stock and option grants issued under the 2007 Equity Incentive Plan. The Company anticipates that this unrecorded cost will amortize over the respective vesting periods of the awards.

Note 4 – Employee Benefit Plans
 
The operating company has a Profit Sharing and Savings Plan for the benefit of substantially all employees.  The Profit Sharing and Savings Plan is a defined contribution profit sharing plan with a 401(k) deferral component.  All full-time employees and certain part-time employees who have met the age and length of service requirements are eligible to participate in the plan.  The plan allows participating employees to make elective deferrals of compensation up to the annual limits which are set by law.  The plan provides for a discretionary annual contribution by the operating company which is determined by a formula based on the salaries of eligible employees as defined by the plan.  For the three and six months ended June 30, 2015, the expense recognized in connection with this plan was $0.2 million and $0.5 million, respectively.  For the three and six months ended June 30, 2014, the expense recognized in connection with this plan was $0.2 million and $0.5 million, respectively.  

Note 5—Earnings per Share
 
Basic earnings per share is computed by dividing the Company’s net income attributable to its common stockholders by the weighted average number of shares outstanding during the reporting period.  

Under the two-class method of computing basic earnings per share, basic earnings per share is calculated by dividing net income for basic earnings per share by the weighted average number of common shares outstanding during the period.  The two-class method includes an earnings allocation formula that determines earnings per share for each participating security according to dividends declared and undistributed earnings for the period.  The Company’s net income for basic earnings per share is reduced by the amount allocated to participating restricted shares of Class A common stock which participate for purposes of calculating earnings per share.  

For the three and six months ended June 30, 2015 and 2014,  the Company’s basic earnings per share was determined as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands, except share and per share amounts)
Net Income for Basic Earnings per Share Allocated to:
 
 
 
 
 
 

Class A Common Stock
$
1,918

 
$
2,124

 
$
3,539

 
$
3,572

Participating Shares of Restricted Class A Common Stock
4

 

 
5

 

Total Net Income for Basic Earnings per Share
$
1,922

 
$
2,124

 
$
3,544

 
$
3,572

Basic Weighted-Average Shares Outstanding
12,916,300

 
12,180,192

 
12,982,326

 
12,178,402

Add: Participating Shares of Restricted Class A Common Stock 1
29,868

 

 
19,307

 

Total Basic Weighted-Average Shares Outstanding
12,946,168

 
12,180,192

 
13,001,633

 
12,178,402

Basic Earnings per Share
$
0.15

 
$
0.17

 
$
0.27

 
$
0.29



13

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


1 Certain unvested shares of Class A common stock granted to employees have nonforfeitable rights to dividends and therefore participate fully in the results of the Company from the date they are granted. They are included in the computation of basic earnings per share using the two-class method for participating securities.

Diluted earnings per share adjusts this calculation to reflect the impact of all outstanding operating company membership units, phantom Class B units, phantom Class A common stock, outstanding Class B unit options, options to purchase Class A common stock, and restricted Class A common stock, 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 that all outstanding 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, exclusive of adjustments associated with both the valuation allowance and the liability to selling and converting shareholders and other one-time charges.
 
For the three and six months ended June 30, 2015 and 2014, the Company’s diluted net income was determined as follows: 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net Income Attributable to Non-Controlling Interests of Pzena Investment Management, LLC
$
10,523

 
$
12,226

 
$
20,564

 
$
23,006

Less: Assumed Corporate Income Taxes
3,914

 
5,254

 
7,650

 
9,886

Assumed After-Tax Income of Pzena Investment Management, LLC
6,609

 
6,972

 
12,914

 
13,120

Net Income of Pzena Investment Management, Inc.
1,922

 
2,124

 
3,544

 
3,572

Diluted Net Income
$
8,531

 
$
9,096

 
$
16,458

 
$
16,692

 
Under the two-class method of computing diluted earnings per share, diluted earnings per share is calculated by dividing net income for diluted earnings per share by the weighted average number of common shares outstanding during the period, plus the dilutive effect of any potential common shares outstanding during the period using the more dilutive of the treasury method or two-class method.  The two-class method includes an earnings allocation formula that determines earnings per share for each participating security according to dividends declared and undistributed earnings for the period.  The Company’s net income for diluted earnings per share is reduced by the amount allocated to participating restricted Class B units for purposes of calculating earnings per share.  Dividend equivalent distributions paid per share on the operating company’s unvested restricted Class B units are equal to the dividends paid per Company Class A common stock.


14

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


For the three and six months ended June 30, 2015 and 2014, the Company’s diluted earnings per share were determined as follows:
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands, except share and
per share amounts)
Diluted Net Income Allocated to:
 
 
 
 
 
 
 
Class A Common Stock
$
8,516

 
$
9,076

 
$
16,432

 
$
16,655

Participating Shares of Restricted Class A Common Stock
4

 

 
5

 

Participating Class B Units
11

 
20

 
21

 
37

Total Diluted Net Income Attributable to Shareholders
$
8,531

 
$
9,096

 
$
16,458

 
$
16,692

 
 
 
 
 
 
 
 
Total Basic Weighted-Average Shares Outstanding
12,946,168

 
12,180,192

 
13,001,633

 
12,178,402

Dilutive Effect of B Units
53,173,112

 
52,858,880

 
53,062,035

 
52,846,847

Dilutive Effect of Options 1
629,944

 
957,348

 
660,981

 
997,984

Dilutive Effect of Phantom Class B Units & Phantom Shares of Class A Common Stock
1,338,667

 
1,815,251

 
1,253,211

 
1,812,256

Dilutive Effect of Restricted Shares of Class A Common Stock 2
52,589

 
40,671

 
45,247

 
39,727

Dilutive Weighted-Average Shares Outstanding
68,140,480

 
67,852,342

 
68,023,107

 
67,875,216

Add: Participating Class B Units3
83,080

 
145,895

 
85,951

 
145,919

Total Dilutive Weighted-Average Shares Outstanding
68,223,560

 
67,998,237

 
68,109,058

 
68,021,135

Diluted Earnings per Share
$
0.13

 
$
0.13

 
$
0.24

 
$
0.25


1 Represents the dilutive effect of options to purchase operating company Class B units and Company Class A common stock.
2 Certain restricted shares of Class A common stock granted to employees are not entitled to dividend or dividend equivalent payments until they are vested and are therefore non-participating securities and are not included in the computation of basic earnings per share. They are included in the computation of diluted earnings per share when the effect is dilutive using the treasury stock method.
3 Unvested Class B Units granted to employees have nonforfeitable rights to dividend equivalent distributions and therefore participate fully in the results of the operating company's operations from the date they are granted. They are included in the computation of diluted earnings per share using the two-class method for participating securities.

Approximately 0.6 million and 0.8 million options to purchase Class B units were excluded from the calculation of diluted net income per share for each of the three and six months ended June 30, 2015 and 2014, respectively, as their inclusion would have had an antidilutive effect based on current market prices.

Note 6—Shareholders’ Equity
 
The Company functions as the sole managing member of the operating company.  As a result, the Company: (i) consolidates the financial results of the operating company and reflects the membership interest in it that it does not own as a non-controlling interest in its consolidated financial statements; and (ii) recognizes income generated from its economic interest in the operating company’s net income.  Class A and Class B units of the operating company have the same economic rights per unit.  As of June 30, 2015, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 19.4% and 80.6%, respectively, of the economic interests in the operations of the business. As of December 31, 2014, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 19.8% and 80.2%, respectively, of the economic interests in the operations of the business.

Each Class B unit of the operating company has a corresponding share of the Company’s Class B common stock, par value $0.000001 per share.  Each share of the Company’s Class B common stock entitles its holder to five votes, until the first time that the number of shares of Class B common stock outstanding constitutes less than 20% of the number of all shares of the Company’s common stock outstanding.  From this time and thereafter, each share of the Company’s Class B common stock entitles its holder to one vote.  When a Class B unit is exchanged for a share of the Company’s Class A common stock or forfeited, a corresponding share of the Company’s Class B common stock will automatically be redeemed and

15

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


cancelled.  Conversely, to the extent that the Company causes the operating company to issue additional Class B units to employees pursuant to its equity incentive plan, these additional holders of Class B units would be entitled to receive a corresponding number of shares of the Company’s Class B common stock (including if the Class B units awarded are subject to vesting).
 
All holders of the Company’s Class B common stock have 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 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. No Class B units were exchanged during the three or six months ended June 30, 2015 and 2014.
 
The Company’s share repurchase program was announced on April 24, 2012.  The Board of Directors authorized the Company to repurchase an aggregate of $10 million of the Company’s outstanding Class A common stock and the operating company’s Class B units on the open market and in private transactions in accordance with applicable securities laws.  On February 11, 2014, the Company announced that its Board of Directors approved an increase of $20 million in the aggregate amount authorized under the program. The timing, number and value of common shares and units repurchased are subject to the Company’s discretion.  The Company’s share repurchase program is not subject to an expiration date and may be suspended, discontinued, or modified at any time, for any reason.

During the six months ended June 30, 2015, the Company purchased and retired 258,093 shares of Class A common stock and 145,622 Class B units under the current repurchase authorization at a weighted average price per share of $9.07 and $10.87, respectively.  During the six months ended June 30, 2014, the Company purchased and retired 34,572 shares of Class A common stock and 51,139 Class B units under the repurchase authorization at a weighted average price per unit of $10.79 and $10.58, respectively. The Company records the repurchase of shares and units at cost based on the trade date of the transaction.

During the six months ended June 30, 2015, 896,855 Class B unit options exercised resulted in the issuance of 688,281 net Class B units issued as a result of the redemption of 208,574 Class B units for the cashless exercise of the options and $1.7 million in cash. During the six months ended June 30, 2014, 159,602 Class B unit options and 250,000 Class A common stock options were exercised and resulted in the issuance of 95,199 Class B units and 68,346 shares of Class A common stock, respectively, as a result of the redemption of 64,403 Class B units and 181,654 shares of Class A common stock for the cashless exercise of the options.

Note 7—Non-Controlling Interests
 
Net Income Attributable to Non-Controlling Interests in the operations of the Company’s operating company and consolidated subsidiaries is comprised of the following:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Non-Controlling Interests of Pzena Investment Management, LLC
$
10,523

 
$
12,226

 
$
20,564

 
$
23,006

Non-Controlling Interests of Consolidated Subsidiaries
370

 
57

 
310

 
130

Net Income Attributable to Non-Controlling Interests
$
10,893

 
$
12,283

 
$
20,874

 
$
23,136

 
Distributions to non-controlling interests represent tax allocations and dividend equivalents paid to the members of the operating company, as well as withdrawals from the Company’s consolidated subsidiaries. Contributions from non-controlling interests represent contributions to the Company's consolidated subsidiaries.


16

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


Note 8—Investments

The following is a summary of Investments:

 
As of
 
June 30, 2015
 
December 31, 2014
 
(in thousands)
Investment Securities, Trading
 

 
 

Equity Securities
$
31,246

 
$
23,036

Investments in Mutual Funds

 
4,909

Total Investment Securities, Trading
31,246

 
27,945

Investments in Equity Method Investees
1,897

 

Total
$
33,143

 
$
27,945


Investment Securities, Trading
 
Investments, at Fair Value consisted of the following at June 30, 2015:
 
 
Cost
 
Unrealized
Gain/(Loss)
 
Fair Value
 
(in thousands)
Equity Securities
$
31,975

 
$
(729
)
 
$
31,246

Total
$
31,975

 
$
(729
)
 
$
31,246


    Securities Sold Short, at Fair Value consisted of the following at June 30, 2015:
 
Proceeds
 
Unrealized
(Gain)/ Loss
 
Fair Value
 
(in thousands)
Securities Sold Short
$
2,462

 
$
(56
)
 
$
2,406

Total
$
2,462

 
$
(56
)
 
$
2,406


    
Investments, at Fair Value consisted of the following at December 31, 2014:
 
 
Cost
 
Unrealized
Gain/(Loss)
 
Fair Value
 
(in thousands)
Equity Securities
$
23,789

 
$
(753
)
 
$
23,036

Investments in Mutual Funds
3,820

 
1,089

 
4,909

Total
$
27,609

 
$
336

 
$
27,945



17

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


Securities Sold Short, at Fair Value consisted of the following at December 31, 2014:

 
Proceeds
 
Unrealized
(Gain)/ Loss
 
Fair Value
 
(in thousands)
Securities Sold Short
$
1,496

 
$
76

 
$
1,572

Total
$
1,496

 
$
76

 
$
1,572


Investments in Equity Method Investees

The operating company sponsors and provides investment management services to certain private investment partnerships through which it offers its investment strategies. As of January 1, 2015, the Company made an investment in one of these private investment partnerships to satisfy its obligations under the Company's deferred compensation program. The Company holds a non-controlling interest and exercises significant influence in this entity, and accounts for its investment as an equity method investment. As of June 30, 2015, the Company owned approximately 4.5% of the private investment partnership with a carrying value of $1.9 million.

Note 9—Property and Equipment
 
Property and Equipment, Net of Accumulated Depreciation is comprised of the following:
 
 
As of
 
June 30,
2015
 
December 31,
2014
 
(in thousands)
Leasehold Improvements
$
6,151

 
$
3,206

Computer Hardware
632

 
1,228

Furniture and Fixtures
1,158

 
786

Computer Software
182

 
345

Office Equipment
180

 
279

Total
8,303

 
5,844

Less: Accumulated Depreciation and Amortization
(664
)
 
(3,072
)
Total
$
7,639

 
$
2,772


During the three months ended June 30, 2015, the Company moved to its new corporate headquarters, as discussed further in Note 11—Commitments and Contingencies, and began depreciating approximately $6.2 million in leasehold improvements and $1.2 million in furniture and fixtures related to its new office space. The Company recognized a $0.4 million loss on the disposal of fixed assets associated with the retirement of assets in our former corporate headquarters, which is included in general and administrative expense. No such losses were recognized during the three or six months ended June 30, 2014.

Depreciation is included in general and administrative expense and totaled approximately $0.2 million and $0.3 million for the three and six months ended June 30, 2015, respectively, and $0.1 million for each of the three and six months ended June 30, 2014, respectively.

Note 10—Related Party Transactions
 
For the three months ended June 30, 2015 and 2014, the Company earned $0.9 million and $0.6 million, respectively, in investment advisory fees from unconsolidated VIEs that receive investment management services from the Company.  For the six months ended June 30, 2015 and 2014, the Company earned $1.7 million and $1.2 million, respectively, in such fees.
 

18

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


At both June 30, 2015 and December 31, 2014, the Company had approximately $0.1 million remaining of advances 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 operating company is the sponsor and investment manager of this entity.
 
At June 30, 2015, Receivable from Related Parties included approximately $0.2 million of a forgivable loan associated with an initial employment agreement. The loan becomes forgivable in installments over a period of approximately 18 months. No loans to employees were recorded at December 31, 2014.

The operating company, as investment manager of the three mutual funds, Pzena Emerging Markets Focused Value Fund, Pzena Long/Short Value Fund, and Pzena Mid Cap Focused Value Fund, has contractually agreed to waive a portion or all of its management fees and pay fund expenses to ensure that the annual operating expenses of the funds stay below certain established total expense ratio thresholds. For the three and six months ended June 30, 2015, the Company recognized $0.2 million and $0.4 million of such expenses, respectively. For each of the three and six months ended June 30, 2014, the Company recognized $0.2 million of such expenses.

The operating company manages the personal funds of certain of the Company’s employees, including its CEO, its two Presidents, and its Executive Vice President.  The operating company also manages accounts beneficially owned by a private fund in which certain of the Company’s executive officers invest.  Investments by employees in individual accounts are permitted only at the discretion of the executive committee of the operating company, but are generally not subject to the same minimum investment levels that are required of outside investors.  The operating company also manages the personal funds of some of its employees’ family members.  Pursuant to the respective investment management agreements, the operating company waives or reduces its regular advisory fees for these accounts and personal funds.   In addition, the operating company pays custody and administrative fees for certain of these accounts and personal funds in order to incubate products or preserve performance history.  The aggregate value of the fees that the Company waived related to the Company’s executive officers, other employees, and family members, was approximately $0.2 million for each of the three months ended June 30, 2015 and 2014, respectively. For each of the six months ended June 30, 2015 and 2014, the company waived $0.3 million in such fees. The aggregate value of the custody and administrative fees paid related to the Company’s executive offers, other employees, and family members was less than $0.1 million for each of the three and six months ended June 30, 2015 and 2014.
 
Note 11—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. 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 the Guarantees Topic of the FASB ASC, the Company’s estimate of the value of such guarantees is de minimis, therefore, no accrual has been made in the consolidated financial statements.
 
During the three months ended June 30, 2015, the Company moved to its new corporate headquarters. The new office space is leased under a non-cancelable operating lease agreement that expires on December 31, 2025. The Company reflects minimum lease expense for its headquarters on a straight-line basis over the lease term. During the three months ended June 30, 2015, the Company entered into a five year sublease agreement commencing on May 1, 2015 and cancelable by either the Company or sublessee given appropriate notice after the third anniversary of the commencement of the sublease agreement. The sublease agreement is for certain office space associated with the Company's operating lease agreement in its new corporate headquarters. The sublease income associated with this agreement will be recognized as it is received and will decrease lease expense.

The Company's former headquarters are leased under a non-cancelable operating lease agreement that expires on October 31, 2015.  During the year ended December 31, 2011, the Company entered into a non-cancelable sublease agreement for certain excess office space associated with its operating lease agreement.  The sublease agreement also expires on October 31, 2015. During the three months ended June 30, 2015, $1.0 million in losses were recognized in general and administrative expense for the remaining rent and expected disposal costs associated with exiting the Company's former headquarters. No such losses were recognized for the three and six months ended June 30, 2014.

Lease expenses, including the losses and expenses recorded during the three months ended June 30, 2015 which we do not expect to recur, were $1.4 million and $1.8 million for the three and six months ended June 30, 2015, respectively, and are

19

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


included in general and administrative expense. Such expenses were $2.3 million and $0.7 million for the six months ended June 30, 2015 and 2014, respectively. Lease expenses for the three and six months ended June 30, 2015 were net of $0.1 million of sublease income. No such income was recognized during the three or six months ended June 30, 2014.

As of June 30, 2015 and December 31, 2014, the Company's liability for losses and contingencies was $0.7 million and $0.4 million, respectively.
 
Note 12—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 have 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.  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.

The components of the income tax expense are as follows:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Current Provision:
 
 
 
 
 
 
 
Unincorporated Business Taxes
$
552

 
$
896

 
$
1,014

 
$
1,609

Local Corporate Tax

 

 

 

State Corporate Tax

 

 

 

Federal Corporate Tax

 

 

 

Total Current Provision
$
552

 
$
896

 
$
1,014

 
$
1,609

Deferred Provision:
 
 
 
 
 
 
 
Unincorporated Business Taxes
$
(13
)
 
$
(61
)
 
$
49

 
$
8

Local Corporate Tax
78

 
137

 
150

 
248

State Corporate Tax
48

 
266

 
94

 
498

Federal Corporate Tax
874

 
887

 
1,686

 
1,610

Total Deferred Provision
$
987

 
$
1,229

 
$
1,979

 
$
2,364

Change in Valuation Allowance
(973
)
 
(2,399
)
 
(1,339
)
 
(3,166
)
Net Adjustment Related to Change in Effective Tax Rate1

 

 

 
602

Total Income Tax Expense
$
566

 
$
(274
)
 
$
1,654

 
$
1,409


1 During the three months ended March 31, 2014, the Company recognized adjustments to the deferred tax asset and valuation allowance assessed against the deferred tax asset associated with changes in the effective tax rate.

The Income Taxes Topic of the FASB ASC establishes the minimum threshold for recognizing, and a system for measuring, the benefits of tax return positions in financial statements.  

As of June 30, 2015 and December 31, 2014, the Company had available for U.S. federal income tax reporting purposes, a net operating loss carryforward of $10.0 million and $9.5 million, respectively, which expires in varying amounts during the tax years 2027 through 2035.

20

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


As of June 30, 2015 and December 31, 2014, approximately $2.3 million and $1.6 million, respectively, of deductions for excess stock- and unit- based transactions were included in net operating losses. The $0.9 million of tax benefit associated with these deductions will be credited to Additional Paid In Capital when such deductions reduce taxes payable. Although these net operating losses are included in the total carryforward amount, they are not reflected in the table of deferred tax assets as the excess tax benefits are not yet realized.
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 2010.  All tax years subsequent to, and including, 2010 are considered open and subject to examination by tax authorities. In 2013, the statue of limitations in New York City for the Company's 2009 tax year was extended association with the amendment of prior year tax returns to change the methodology for state and local receipts.
 
The acquisition of operating company Class B units, noted below, has allowed the Company to make an election under Section 754 of the Internal Revenue Code (“Section 754”) to step up its tax basis in the net assets acquired.  This step up is deductible for tax purposes over a 15-year period.  Based on the net proceeds of the initial public offering and tax basis of the operating company, this election gave rise to an initial deferred tax asset of approximately $68.7 million.

Pursuant to a tax receivable agreement 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.
 
If the Company exercises its right to terminate the tax receivable agreement early, the Company will be obligated to make an early termination payment to the selling and converting shareholders, based upon the net present value (based upon certain assumptions and deemed events set forth in the tax receivable agreement) of all payments that would be required to be paid by the Company under the tax receivable agreement.  If certain change of control events were to occur, the Company would be obligated to make an early termination payment.
 
During the three and six months ended June 30, 2015, the Company’s valuation allowance was reduced by approximately $1.0 million and $1.3 million, respectively, due to revised estimates of future taxable income. These changes are reflected as a net adjustment to the Company's Section 754 deferred tax asset, valuation allowance, and other deferred tax assets. To reflect these changes in the estimated realization of the asset and its liability for future payments, the Company increased its liability to selling and converting shareholders by $0.7 million and $0.9 million for the three and six months ended June 30, 2015, respectively. The effects of these changes to the deferred tax asset and liability to selling and converting shareholders were recorded as a component of the income tax expense and other expense, respectively, on the consolidated statements of operations.  

During the three and six months ended June 30, 2014, the Company’s valuation allowance was reduced by approximately $2.4 million and $3.2 million, respectively, due to revised estimates of future taxable income. Results for the six months ended June 30, 2014 also reflects changes in the Company's expected future tax benefits due to a decrease in its effective rate. This decrease is reflected as an adjustment to the Company's Section 754 deferred tax asset, valuation allowance, and other deferred tax assets. To reflect these changes in the estimated realization of the asset and its liability for future payments, the Company increased its liability to selling and converting shareholders by $2.0 million and $2.1 million for the three and six months ended June 30, 2014, respectively. The effects of these changes to the deferred tax asset and liability to selling and converting shareholders were recorded as a component of the income tax expense and other expense, respectively, on the consolidated statements of operations.

As of June 30, 2015 and December 31, 2014, the net values of all deferred tax assets were approximately $14.0 million and $14.6 million, respectively.
 

21

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


The change in the Company’s deferred tax asset, net of valuation allowance, for the three and six months ended June 30, 2015 is summarized as follows:
 
 
Section 754
 
Other
 
Valuation
Allowance
 
Total
 
(in thousands)
Balance at December 31, 2014
$
54,783

 
$
4,074

 
$
(44,239
)
 
$
14,618

Deferred Tax (Expense)/Benefit
(923
)
 
(80
)
 

 
(1,003
)
Change in Valuation Allowance

 

 
366

 
366

Balance at March 31, 2015
$
53,860

 
$
3,994

 
$
(43,873
)
 
$
13,981

Deferred Tax (Expense)/Benefit
(923
)
 
(64
)
 

 
(987
)
Change in Valuation Allowance

 

 
973

 
973

Balance at June 30, 2015
$
52,937

 
$
3,930

 
$
(42,900
)
 
$
13,967


The change in the Company’s deferred tax liability, which is included in other liabilities on the Company’s consolidated statements of financial condition, for the three and six months ended June 30, 2015, is summarized as follows:

 
Total
 
(in thousands)
Balance at December 31, 2014
$
(18
)
Deferred Tax Expense
11

Balance at March 31, 2015
$
(7
)
Deferred Tax Expense

Balance at June 30, 2015
$
(7
)
 
The change in the Company’s deferred tax asset, net of valuation allowance, for the three and six months ended June 30, 2014 is summarized as follows:

 
Section 754
 
Other
 
Valuation
Allowance
 
Total
 
(in thousands)
Balance at December 31, 2013
$
61,628

 
$
4,657

 
$
(53,973
)
 
$
12,312

Deferred Tax (Expense)/Benefit
(1,104
)
 
(36
)
 

 
(1,140
)
Change in Valuation Allowance

 

 
767

 
767

   Net Adjustment to Deferred Tax Asset
(6,608
)
 
(351
)
 
6,357

 
(602
)
Balance at March 31, 2014
$
53,916

 
$
4,270

 
$
(46,849
)
 
$
11,337

Deferred Tax (Expense)/Benefit
(965
)
 
(266
)
 

 
(1,231
)
Change in Effective Rate

 

 

 

Change in Valuation Allowance

 

 
2,399

 
2,399

Balance at June 30, 2014
$
52,951

 
$
4,004

 
$
(44,450
)
 
$
12,505



22

Pzena Investment Management, Inc.
Notes to Unaudited Consolidated Financial Statements (Continued)


The change in the Company’s deferred tax liability for the three and six months ended June 30, 2014 is summarized as follows:
 
 
Total
 
(in thousands)
 
 
Balance at December 31, 2013
$
(39
)
Deferred Tax Expense
5

Balance at March 31, 2014
$
(34
)
Deferred Tax Expense
2

Balance at June 30, 2014
$
(32
)

Note 13—Subsequent Events

On July 21, 2015, the Company declared a quarterly dividend of $0.03 per share of its Class A common stock that will be paid on August 27, 2015 to holders of record on August 13, 2015.

On July 27, 2015, certain of the operating company's members exchanged an aggregate of 2,772,171 of their Class B units for an equivalent number of shares of Class A common stock.

No other subsequent events necessitated disclosures and/or adjustments.




23


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

Overview
 
We are a public-equity investment management firm that utilizes a classic value investment approach across all of our investment strategies.  We currently manage assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and non-U.S. capital markets.  At June 30, 2015, our assets under management, or AUM, was $28.0 billion.  We manage separate accounts on behalf of institutions, act as sub-investment adviser for a variety of SEC-registered mutual funds and non-U.S. funds, and act as investment adviser to certain Pzena SEC-registered mutual funds, private placement funds and non-U.S. funds.
 
We function as the sole managing member of our operating company, Pzena Investment Management, LLC (the “operating company”).  As a result, we: (i) consolidate the financial results of our operating company with our own, and reflect the membership interest in it that we do not own as a non-controlling interest in our consolidated financial statements; and (ii) recognize income generated from our economic interest in our operating company’s net income.  As of June 30, 2015, the holders of Class A common stock (through the Company) and the holders of Class B units of our operating company held approximately 19.4% and 80.6%, respectively, of the economic interests in the operations of our business.

As of June 30, 2015, holders of Class B units of our operating company included our five named executive officers and their estate planning vehicles, who collectively held approximately 55.3% of the economic interest in our operating company. As of June 30, 2015, 33 other employee members held approximately 4.2%, and certain other members of our operating company, including one of our directors and his related entities, and certain former employees, collectively held 21.1% of the economic interests in our operating company through ownership of Class B units.
 
Non-GAAP Net Income
 
Our results for the three and six months ended June 30, 2015 and 2014 included recurring adjustments related to our deferred tax asset generated by the Company's initial public offering and subsequent unit conversions as well as our tax receivable agreement and the associated liability to our selling and converting shareholders, in addition to adjustments related to certain non-recurring charges recognized in operating expenses during the three and six months ended June 30, 2015.  We believe that these accounting adjustments add a measure of non-operational complexity, which partially obscures the underlying performance of our business.  In evaluating our financial condition and results of operations, we also review certain non-GAAP measures of earnings, which exclude these items.  Excluding these adjustments, non-GAAP diluted net income and non-GAAP diluted earnings per share were $9.3 million and $0.14, respectively, for the three months ended June 30, 2015, and $8.7 million and $0.13, respectively, for the three months ended June 30, 2014. Excluding these adjustments, non-GAAP diluted net income and non-GAAP diluted earnings per share were $17.4 million and $0.26, respectively, for the six months ended June 30, 2015, and $16.3 million and $0.24, respectively, for the six months ended June 30, 2014.  GAAP and non-GAAP net income for diluted earnings per share generally assumes all operating company membership units are converted into Company stock at the beginning of the reporting period, and the resulting change to our net income associated with our increased interest in the operating company is taxed at our effective tax rate, exclusive of the adjustments related to our tax receivable agreement and the associated liability to selling and converting shareholders, the adjustments related to the non-recurring charges recognized in operating expenses, and other adjustments.  Our effective tax rate, exclusive of these adjustments, was 37.2% for the three and six months ended June 30, 2015, respectively, and 43.0% for the three and six months ended June 30, 2014.  See “Operating Results - Income Tax Expense” below.
 
We use these non-GAAP measures to assess the strength of the underlying operations of the business. We believe that these adjustments, and the non-GAAP measures derived from them, provide information to better analyze our operations between periods and over time. We also use non-GAAP net income as one factor in determining the amount of dividends we pay.  See “Dividend Policy” below.  Investors should consider these non-GAAP measures in addition to, and not as a substitute for, financial measures prepared in accordance with GAAP.






24



A reconciliation of the non-GAAP measures to the most comparable GAAP measures is included below:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands, except share and per share data)
GAAP Net Income
$
1,922

 
$
2,124

 
$
3,544

 
$
3,572

Net Effect of Tax Receivable Agreement
(118
)
 
(357
)
 
(170
)
 
(419
)
Net Effect of Non-Recurring Lease Expenses
147

 

 
183

 

Non-GAAP Net Income
$
1,951

 
$
1,767

 
$
3,557

 
$
3,153

 
 
 
 
 
 
 
 
GAAP Net Income Attributable to Non-Controlling Interest of Pzena Investment Management, LLC
$
10,523

 
$
12,226

 
$
20,564

 
$
23,006

Effect of Non-Recurring Lease Expenses
1,197

 

 
1,475

 

Non-GAAP Net Income Attributable to Non-Controlling Interest of Pzena Investment Management, LLC
11,720

 
12,226

 
22,039

 
23,006

Less: Assumed Corporate Income Taxes
4,359

 
5,254

 
8,199

 
9,886

Assumed After-Tax Income of Pzena Investment Management, LLC
7,361

 
6,972

 
13,840

 
13,120

Non-GAAP Net Income of Pzena Investment Management, Inc.
1,951

 
1,767

 
3,557

 
3,153

Non-GAAP Diluted Net Income
$
9,312

 
$
8,739

 
$
17,397

 
$
16,273

Non-GAAP Diluted Earnings Per Share Attributable to
Pzena Investment Management, Inc. Common Stockholders:
 
 
 
 
 
 
 
Non-GAAP Net Income for Diluted Earnings per Share
$
9,312

 
$
8,739

 
$
17,397

 
$
16,273

Non-GAAP Diluted Earnings Per Share
$
0.14

 
$
0.13

 
$
0.26

 
$
0.24

Non-GAAP Diluted Weighted-Average Shares Outstanding
68,223,560

 
67,998,237

 
68,109,058

 
68,021,135


Revenue
 
We generate revenue primarily from management fees and performance fees, which we collectively refer to as our advisory fees, by managing assets on behalf of institutional accounts and for retail clients, which are generally open-end mutual funds catering primarily to retail investors.  Our advisory fee income is recognized over the period in which investment management services are provided.  Following the preferred method identified in the Revenue Recognition Topic of the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), income from performance fees is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.
 
Our advisory fees are primarily driven by the level of our AUM.  Our AUM increases or decreases with the net inflows or outflows of funds into our various investment strategies and with the investment performance thereof.  In order to increase our AUM and expand our business, we must develop and market investment strategies that suit the investment needs of our target clients, and provide attractive returns over the long term.  The value and composition of our AUM, and our ability to continue to attract clients, will depend on a variety of factors including, among other things:
 
our ability to educate our target clients about our classic value investment strategies and provide them with exceptional client service;
the relative investment performance of our investment strategies, as compared to competing products and market indices;
competitive conditions in the investment management and broader financial services sectors;
general economic conditions;
investor sentiment and confidence; and

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

For our institutional accounts, we are paid fees according to a schedule, which varies by investment strategy.  The substantial majority of these accounts pay us management fees pursuant to a schedule in which the rate we earn on the AUM declines as the amount of AUM increases.
 
Pursuant to our sub-investment advisory agreements with our retail clients and Pzena-branded mutual funds, we are generally paid a management fee according to a schedule in which the rate we earn on the AUM declines as the amount of AUM increases.  Certain of these funds pay us fixed-rate management fees.  Due to the substantially larger account size of certain of these accounts, the average advisory fees we earn on them, as a percentage of AUM, are lower than the advisory fees we earn on our institutional accounts.
 
Certain of our clients pay us fees according to the performance of their accounts relative to certain agreed-upon benchmarks, which results in a lower base fee but allows us to earn higher fees if the relevant investment strategy outperforms the agreed-upon benchmark.
 
The majority of advisory fees we earn on institutional accounts is based on the value of our AUM at a specific date on a quarterly basis, either in arrears or in advance.  Advisory fees on certain of our institutional accounts, and with respect to all of our retail accounts, are calculated based on the average of the monthly or daily market value.  Advisory fees are also generally adjusted for any cash flows into or out of a portfolio, where the cash flow represents greater than 10% of the value of the portfolio.  While a specific group of accounts may use the same fee rate, the method used to calculate the fee according to the fee rate schedule may differ as described above.
 
Our advisory fees may fluctuate based on a number of factors, including the following:
 
changes in AUM due to appreciation or depreciation of our investment portfolios, and the levels of the contribution and withdrawal of assets by new and existing clients;
distribution of AUM among our investment strategies, which have differing fee schedules;
distribution of AUM between institutional accounts and retail accounts, for which we generally earn lower overall advisory fees; and
the level of our performance with respect to accounts on which we are paid performance fees.

Expenses
 
Our expenses consist primarily of Compensation and Benefits Expense, as well as General and Administrative Expense.  Our largest expense is Compensation and Benefits, which includes the salaries, bonuses, equity-based compensation, and related benefits and payroll costs attributable to our employee members and employees.  Compensation and benefits packages are benchmarked against relevant industry and geographic peer groups in order to attract and retain qualified personnel.