PZN-2013.06.30-10Q
Table of Contents

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, 2013
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.)
120 West 45th Street
New York, New York 10036
(Address of Principal Executive Offices) (Zip Code)

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

Not Applicable
 
(Former name, former address, and former fiscal year if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 1, 2013, there were 12,202,294 outstanding shares of the registrant’s Class A common stock, par value $0.01 per share.
As of August 1, 2013, there were 52,347,732 outstanding shares of the registrant’s Class B common stock, par value $0.000001 per share.


Table of Contents

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

 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i

Table of Contents

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, 2012.  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

Table of Contents

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
PZENA INVESTMENT MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share and per-share amounts)
 
As of
 
June 30, 2013
 
December 31, 2012
 
(unaudited)
 
 
ASSETS
 
 
 
Cash and Cash Equivalents
$
25,675

 
$
32,645

Restricted Cash
1,031

 
1,030

Due from Broker
85

 
22

Advisory Fees Receivable
18,374

 
14,626

Investments, at Fair Value
8,323

 
5,170

Receivable from Related Parties
131

 
83

Other Receivables
536

 
51

Prepaid Expenses and Other Assets
666

 
585

Deferred Tax Asset, Net of Valuation Allowance of $58,185 and $59,917 in 2013 and 2012, respectively
10,372

 
9,688

Property and Equipment, Net of Accumulated Depreciation of $2,772 and $2,695 in 2013 and 2012, respectively
707

 
779

TOTAL ASSETS
$
65,900

 
$
64,679

LIABILITIES AND EQUITY
 

 
 

Liabilities:
 

 
 

Accounts Payable and Accrued Expenses
$
10,059

 
$
4,305

Due to Broker
68

 
23

Liability to Selling and Converting Shareholders
9,602

 
9,656

Lease Liability
991

 
1,203

Deferred Compensation Liability
1,039

 
1,327

Other Liabilities
146

 
199

TOTAL LIABILITIES
21,905

 
16,713

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; 12,210,592  and 11,149,941 Shares Issued and Outstanding in 2013 and 2012, respectively)
121

 
111

Class B Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 52,190,656 and 53,482,324 Shares Issued and Outstanding in 2013 and 2012, respectively)

 

Additional Paid-In Capital
10,935

 
11,765

Retained Earnings
2,988

 
2,693

Total Pzena Investment Mangement, Inc.'s Equity
14,044

 
14,569

Non-Controlling Interests
29,951

 
33,397

TOTAL EQUITY
43,995

 
47,966

TOTAL LIABILITIES AND EQUITY
$
65,900

 
$
64,679

 
See accompanying notes to consolidated financial statements.

1

Table of Contents

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,
 
2013
 
2012
 
2013
 
2012
REVENUE
$
22,132

 
$
18,339

 
$
42,974

 
$
38,107

EXPENSES


 


 
 

 
 

Compensation and Benefits Expense
8,914

 
8,012

 
18,522

 
16,185

General and Administrative Expense
1,943

 
1,916

 
3,752

 
3,619

Total Operating Expenses
10,857

 
9,928

 
22,274

 
19,804

Operating Income
11,275

 
8,411

 
20,700

 
18,303

OTHER INCOME/(EXPENSE)


 


 
 

 
 

Interest Income
27

 
41

 
54

 
95

Interest Expense

 

 

 
(26
)
Dividend Income
87

 
34

 
116

 
58

Net Realized and Unrealized Gain/ (Loss) from Investments
414

 
(189
)
 
1,265

 
666

Change in Liability to Selling and Converting Shareholders
(229
)
 
315

 
(1,268
)
 
(658
)
Other (Expense)/ Income
(48
)
 
(72
)
 
(88
)
 
33

Total Other Income
251

 
129

 
79

 
168

Income Before Income Taxes
11,526

 
8,540

 
20,779

 
18,471

Income Tax Expense
1,234

 
1,534

 
796

 
1,780

Net Income
10,292

 
7,006

 
19,983

 
16,691

Less: Net Income Attributable to Non-Controlling Interests
9,026

 
6,392

 
17,548

 
15,070

Net Income Attributable to Pzena Investment Management, Inc.
$
1,266

 
$
614

 
$
2,435

 
$
1,621

 
 
 
 
 
 
 
 
Net Income for Basic Earnings per Share
$
1,266

 
$
614

 
$
2,435

 
$
1,621

Basic Earnings per Share
$
0.10

 
$
0.06

 
$
0.21

 
$
0.15

Basic Weighted Average Shares Outstanding
12,315,065

 
10,565,406

 
11,793,938

 
10,570,247

 
 
 
 
 
 
 
 
Net Income for Diluted Earnings per Share
$
6,358

 
$
614

 
$
12,268

 
$
10,032

Diluted Earnings per Share
$
0.10

 
$
0.06

 
$
0.18

 
$
0.15

Diluted Weighted Average Shares Outstanding1
66,562,823

 
10,565,406

 
66,550,266

 
65,395,327

 
 
 
 
 
 
 
 
Cash Dividends per Share of Class A Common Stock
$
0.03

 
$
0.03

 
$
0.19

 
$
0.22

1 Under the "two-class method," restricted Class B units that are considered participating securities are required to be included in the computation of diluted earnings per share. 

See accompanying notes to consolidated financial statements.

2

Table of Contents

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, 2012
11,149,941

 
53,482,324

 
$
111

 
$
11,765

 
$
2,693

 
$
33,397

 
$
47,966

Unit Conversion
1,328,334

 
(1,328,334
)
 
13

 
746

 

 
(640
)
 
119

Amortization of Non-Cash Compensation
7,414

 
36,666

 

 
270

 

 
1,211

 
1,481

Directors' Shares

 

 

 
27

 

 
123

 
150

Net Income

 

 

 

 
2,435

 
17,548

 
19,983

Repurchase and Retirement of Class A Common Stock
(275,097
)
 

 
(3
)
 
(1,681
)
 

 

 
(1,684
)
Repurchase and Retirement of Class B Unit Options

 

 

 
(14
)
 
 
 
(57
)
 
(71
)
Class A Cash Dividends Declared and Paid ($0.19 per share)

 

 

 

 
(2,140
)
 

 
(2,140
)
Distributions to Non-Controlling Interests

 

 

 

 

 
(21,809
)
 
(21,809
)
Other

 

 

 
(178
)
 
 
 
178

 

Balance at June 30, 2013
12,210,592

 
52,190,656

 
$
121

 
$
10,935

 
$
2,988

 
$
29,951

 
$
43,995

  
See accompanying notes to consolidated financial statements.

3

Table of Contents

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,
 
2013
 
2012
 
2013
 
2012
OPERATING ACTIVITIES
 
 
 
 
 
 
 
Net Income
$
10,292

 
$
7,006

 
$
19,983

 
$
16,691

Adjustments to Reconcile Net Income to Cash
 
 
 
 
 

 
 

Provided by Operating Activities:
 
 
 
 
 

 
 

Depreciation
38

 
57

 
77

 
115

Disposal of Fixed Assets

 

 

 
(93
)
Non-Cash Compensation
1,225

 
665

 
2,519

 
1,351

Director Share Grant
75

 
70

 
150

 
140

Net Realized and Unrealized (Gain)/Loss from Investments
(414
)
 
189

 
(1,265
)
 
(666
)
Change in Liability to Selling and Converting Shareholders
229

 
(315
)
 
1,268

 
658

Deferred Income Taxes
527

 
956

 
93

 
611

Changes in Operating Assets and Liabilities:
 
 
 
 
 

 
 

Advisory Fees Receivable
(1,573
)
 
1,734

 
(3,748
)
 
287

Due from Broker
1,554

 
1,010

 
(63
)
 
(1,518
)
Restricted Cash

 

 
(1
)
 

Prepaid Expenses and Other Assets
227

 
(13
)
 
(566
)
 
56

Due to Broker
(1,581
)
 
(1,532
)
 
45

 
1,415

Accounts Payable, Accrued Expenses, and Other Liabilities
3,313

 
3,616

 
4,392

 
4,257

Tax Receivable Agreement Payments

 

 
(2,000
)
 
(2,093
)
Change in Lease Liability
(106
)
 
(153
)
 
(212
)
 
(307
)
Purchases of Investments
(19,906
)
 
(10,588
)
 
(53,206
)
 
(31,423
)
Proceeds from Sale of Investments
19,004

 
10,742

 
52,702

 
31,955

Net Cash Provided by Operating Activities
12,904

 
13,444

 
20,168

 
21,436

INVESTING ACTIVITIES
 
 
 
 
 

 
 

Purchases of Investments in Deferred Compensation Plan
(40
)
 
(10
)
 
(1,459
)
 
(462
)
Proceeds from Investments in Deferred Compensation Plan

 

 
78

 
544

Payments to Related Parties
(1
)
 
(14
)
 
(48
)
 
(34
)
Purchase of Property and Equipment
(5
)
 
(1
)
 
(5
)
 
(1
)
Net Cash (Used in)/Provided by Investing Activities
(46
)
 
(25
)
 
(1,434
)
 
47

FINANCING ACTIVITIES
 
 
 
 
 

 
 

Repurchase and Retirement of Class A Common Stock
(1,017
)
 
(125
)
 
(1,684
)
 
(125
)
Repurchase and Retirement of Class B Unit Options
(71
)
 

 
(71
)
 

Distributions to Non-Controlling Interests
(10,186
)
 
(8,933
)
 
(21,809
)
 
(22,270
)
Contributions from Non-Controlling Interests

 
45

 

 
45

Dividends
(368
)
 
(317
)
 
(2,140
)
 
(2,326
)
Net Cash Used in Financing Activities
(11,642
)
 
(9,330
)
 
(25,704
)
 
(24,676
)
NET CHANGE IN CASH
$
1,216

 
$
4,089

 
$
(6,970
)
 
$
(3,193
)
CASH AND CASH EQUIVALENTS - Beginning of Period
$
24,459

 
$
27,801

 
$
32,645

 
$
35,083

Net Change in Cash
1,216

 
4,089

 
(6,970
)
 
(3,193
)
CASH AND CASH EQUIVALENTS - End of Period
$
25,675

 
$
31,890

 
$
25,675

 
$
31,890

Supplementary Cash Flow Information:
 
 
 
 
 

 
 

In-Kind Distribution to Non-Controlling Interests of Equity Securities, at Fair Value
$

 
$

 
$

 
$
371

Interest Paid
$

 
$

 
$

 
$
26

Income Taxes Paid
$
964

 
$
993

 
$
1,833

 
$
1,733


See accompanying notes to consolidated financial statements.

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Table of Contents
Pzena Investment Management, Inc.
Unaudited Notes to 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 which is registered under the Investment Advisers Act of 1940 and is headquartered in New York, New York.  As of June 30, 2013, 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 investment in its operating company, has consolidated the results of operations and financial condition of the following entities as of June 30, 2013:
 
 
 
 
Operating Company's Ownership at
Legal Entity
Type of Entity (Date of Formation)
 
June 30, 2013
Pzena Investment Management, Pty
Australian Proprietary Limited Company (12/16/2009)
 
100.0
%
Pzena Investment Management Special Situations, LLC
Delaware Limited Liability Company (12/01/2010)
 
99.9
%
Pzena Investment Funds Trust, Pzena Large Cap Value Fund
Massachusetts Trust (11/01/2002)
 
0.0
%
Pzena International Value Service, a series of Pzena Investment Management International, LLC
Delaware Limited Liability Company (12/22/2003)
 
0.0
%
 
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, which includes Pzena Investment Management, Pty and Pzena Investment Management Special Situations, LLC.  The Company also consolidates variable-interest entities (“VIEs”) where the Company is deemed to be the primary beneficiary, which includes Pzena Investment Funds Trust, Pzena Large Cap Value Fund (“Pzena Large Cap Value Fund”) and Pzena International Value Service, a series of Pzena Investment Management International, LLC (“Pzena International Value Fund”).  These majority-owned subsidiaries in which the Company has a controlling financial interest and the VIEs where the Company is deemed to be the primary beneficiary are collectively referred to as “consolidated subsidiaries.”  As required by the Consolidation Topic of the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”), the Company also consolidates non-variable-interest entities in which it acts or acted as the general partner or managing member.  All of these entities represent or represented private investment partnerships over which the Company exercises or exercised control.  Non-controlling interests recorded on the consolidated financial statements of the Company include the non-controlling interests of the outside investors in each of these entities, as well as those of the operating company.  All significant inter-company transactions and balances have been eliminated.
 
The operating company is the managing member of Pzena International Value Fund.  As of February 1, 2011, as a result of a shift in the equity ownership of that series on that date, the operating company was considered the primary beneficiary of this series and, as a result, the series was consolidated with the Company as of that date.  At June 30, 2013, Pzena International Value Fund’s $1.2 million in net assets were included in the Company’s consolidated statements of financial condition.


5

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


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, 2013, the Pzena Large Cap Value Fund’s $1.2 million in net assets were included in the Company’s consolidated statements of financial condition.
 
All of the consolidated investment partnerships are investment companies under the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies.  The Company has retained the specialized accounting for these partnerships pursuant to the Consolidation of Partnerships and Similar Entities Subtopic of the FASB ASC.  Thus, the Company reports these investment partnerships’ investments in Investments, at Fair Value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.
 
VIEs that are not consolidated continue to receive investment management services from the Company, and are vehicles through which the Company offers its global value and/or international (ex-U.S.) value strategies.  The total net assets of these VIEs was approximately $148.0 million and $150.9 million at June 30, 2013 and December 31, 2012, respectively.  Neither the Company nor the operating company were exposed to losses as a result of its involvement with these entities because they had no 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 are recorded as adjustments 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.
 
Fair Values of Financial Instruments:
 
The carrying amounts of all financial instruments in the consolidated statements of financial condition are presented at their fair value.
 
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 their contractual terms.  Advisory fee income also includes performance fees that may be earned by the Company depending on the investment return of the assets under management.  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 FASB ASC, such performance fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.  For each of the three and six months ended June 30, 2013, the Company recognized approximately $0.1 million in performance fee income.  The Company did not recognize any performance fee income for the three months ended June 30, 2012. Approximately $0.3 million in such fees were recognized for the six months ended June 30, 2012.
 
Cash and Cash Equivalents:
 
At June 30, 2013 and December 31, 2012, Cash and Cash Equivalents was $25.7 million and $32.6 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.
 

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


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 $1.0 million at June 30, 2013 and December 31, 2012 as collateral for a letter of credit issued by a third party in lieu of a cash security deposit, as required by the Company’s lease for its New York office space.  Such amounts are recorded in Restricted Cash 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, at Fair Value:
 
Investments, at Fair Value represents the securities held by the Company and its consolidated subsidiaries, as well as investments in mutual funds.  The Company’s investments in third-party mutual funds are held to satisfy the Company’s obligations under its deferred compensation program.  Dividends associated with the investments of the Company’s consolidated subsidiaries are recorded as dividend income on an ex-dividend basis in the consolidated statement of operations.
 
All such investments are recorded at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.
 
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).
 
The Company’s fair value measurements relate to its consolidated investments in equity securities, which are exchange-traded securities with quoted prices in active markets, and its investments in mutual funds.  The fair value measurements of the equity securities and investments in mutual funds have been classified as Level 1.
 
The following table presents these instruments’ fair value at June 30, 2013:
 
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Assets:
 
 
 
 
 
Equity Securities
$
3,765

 
$

 
$

Investments in Mutual Funds
4,558

 

 

Total Fair Value
$
8,323

 
$

 
$


    







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



The following table presents these instruments’ fair value at December 31, 2012:

 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Assets:
 
 
 
 
 
Equity Securities
$
2,225

 
$

 
$

Investments in Mutual Funds
2,945

 

 

Total Fair Value
$
5,170

 
$

 
$


Securities Valuation:
 
Investments in equity securities 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 mutual funds 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 and investments in mutual funds is determined on a specific identification basis and is included in Net Realized and Unrealized Gain/(Loss) from Investments 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 and collections and current credit conditions.  At June 30, 2013 and December 31, 2012, 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”).
 
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

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


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, 2013, the Company had a $58.2 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, 2012, the Company had a $59.9 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.
 
Foreign Currency:
 
Investment securities and other assets and liabilities denominated in foreign currencies are remeasured into U.S. dollar amounts at the date of valuation.  Purchases and sales of investment securities, and income and expense items denominated in foreign currencies, are remeasured into U.S. dollar amounts on the respective dates of such transactions.
 
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 Net Realized and Unrealized Gain/(Loss) from Investments 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.
 
The functional currency of the Company is the United States Dollar.  The functional currency of the Company’s representative office in Australia is the Australian Dollar.  Assets and liabilities of this office are translated at the spot 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, 2013 and 2012, the Company did not record any accumulated other comprehensive income.
 
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,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Cash Compensation and Other Benefits
$
7,689

 
$
7,347

 
$
16,077

 
$
14,834

Non-Cash Compensation
1,225

 
665

 
2,445

 
1,351

Total Compensation and Benefits Expense
$
8,914

 
$
8,012

 
$
18,522

 
$
16,185

   
        











    

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Table of Contents
Pzena Investment Management, Inc.
Unaudited Notes to 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.  For the three months ended June 30, 2013 and 2012, the operating company did not grant any non-cash compensation awards. Details of restricted Class B units and restricted shares of Class A common stock awarded during the six months ended June 30, 2013 and 2012 are as follows:

 
For the Six Months Ended June 30,
 
For the Six Months Ended June 30,
 
2013
 
2012
 
Amount
 
Fair Value1
 
Amount
 
Fair
Value1
Restricted Class B Units
18,517

 
$
5.40

 
53,116

 
$
4.33

Restricted Shares of Class A Common Stock
100,000

 
$
4.41

 

 
$

1 Represents the grant date estimated fair value per share or unit.


Pursuant to the Pzena Investment Management, LLC Amended and Restated 2006 Equity Incentive Plan (“the 2006 Equity Incentive Plan”), the operating company issues restricted units, phantom Class B units and options to purchase units in our operating company.  Under the Pzena Investment Management, Inc. 2007 Equity Incentive Plan (“the 2007 Equity Incentive Plan”), the Company issued shares of restricted Class A common stock and options to acquire shares of Class A common stock.

Under the Pzena Investment Management, LLC Amended and Restated Bonus Plan (the “Bonus Plan”), eligible employees whose cash 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 third-party mutual funds, phantom operating company Class B units, or money market funds.  Amounts deferred in any calendar year reduce that year’s cash compensation expense and are both amortized and vest ratably over a four-year period commencing the following year.  As of June 30, 2013 and December 31, 2012, the liability associated with deferred compensation investment accounts was $1.0 million and $1.3 million, respectively.
 
For the three months ended June 30, 2013 and 2012, the Company recognized approximately $1.2 million and $0.7 million, respectively, in compensation and benefits expense associated with the amortization of all unvested operating company Class B units, option grants, and operating company phantom Class B units issued under the 2006 Equity Incentive Plan; restricted Class A common stock issued under the 2007 Equity Incentive Plan; and all unvested deferred compensation awards associated with the Bonus Plan. For the six months ended June 30, 2013 and 2012, the Company recognized approximately $2.4 million and $1.4 million, respectively, in such compensation and benefits expense.

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 the compensation otherwise payable to the director 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 shall be 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, 2013 and December 31, 2012, there were 203,052 and 147,500 phantom shares of Class A common stock outstanding, respectively.  There have been no distributions made under the Director Plan to date.

The Company issues to certain of its employees delayed-vesting cash awards.  For the three and six months ended June 30, 2013 and 2012 no such awards were granted.  Delayed-vesting cash awards have varying vesting schedules with $1.0 million to be paid at the end of 2013 and the remaining $0.5 million to be paid at the end of 2014.

As of June 30, 2013 and December 31, 2012, the Company had approximately $17.0 million and $17.9 million, respectively, in unrecorded compensation expense related to unvested operating company phantom Class B units issued pursuant to its Bonus Plan; operating company Class B units, option grants, and operating company phantom Class B units issued under the 2006 Equity Incentive Plan; and restricted Class A common stock issued under the 2007 Equity Incentive Plan.

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


Note 4 – Employee Benefit Plans
 
During 2011, the operating company implemented 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 each of the three months ended June 30, 2013 and 2012, the expense recognized in connection with this plan was $0.2 million. For each of the six months ended June 30, 2013 and 2012, the expense recognized in connection with this plan was $0.4 million.

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.  For the three and six months ended June 30, 2013 and 2012,  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,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and per share amounts)
Net Income for Basic Earnings per Share
$
1,266

 
$
614

 
$
2,435

 
$
1,621

Basic Weighted-Average Shares Outstanding
12,315,065

 
10,565,406

 
11,793,938

 
10,570,247

Basic Earnings per Share
$
0.10

 
$
0.06

 
$
0.21

 
$
0.15


Diluted earnings per share adjusts this calculation to reflect the impact of all outstanding operating company membership units, phantom operating company Class B units, phantom Class A common stock, outstanding operating company 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 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.
 
For the three and six months ended June 30, 2013 and 2012, the Company’s diluted net income was determined as follows: 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Net Income Attributable to Non-Controlling Interests of
Pzena Investment Management, LLC
$
8,715

 
$
6,508

 
$
16,829

 
$
14,717

Less: Assumed Corporate Income Taxes
3,623

 
2,789

 
6,996

 
6,306

Assumed After-Tax Income of Pzena Investment Management, LLC
5,092

 
3,719

 
9,833

 
8,411

Net Income of Pzena Investment Management, Inc.
1,266

 
614

 
2,435

 
1,621

Diluted Net Income 1
$
6,358

 
$
4,333

 
$
12,268

 
$
10,032

 
 
 
 
 
 
 
 

1 Since the assumed incremental income results in an increase in per share income for the three months ended June 30, 2012, the assumed effects of the conversion of operating company Class B units, options to purchase operating company units, options to purchase Class A common stock, and phantom operating company units are excluded from the the calculation of diluted income per share. 
 

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


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.

For the three and six months ended June 30, 2013 and 2012, 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,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and
per share amounts)
Diluted Net Income Allocated to:
 
 
 
 
 
 
 
Class A Common Stock
$
6,343

 
$
614

 
$
12,239

 
$
9,994

Participating Class B Restricted Units
15

 

 
29

 
38

Total Diluted Net Income Attributable to Shareholders
$
6,358

 
$
614

 
$
12,268

 
$
10,032

Basic Weighted-Average Shares Outstanding
12,315,065

 
10,565,406

 
11,793,938

 
10,570,247

Dilutive Effect of Operating Company B Units
52,190,656

 

 
52,770,426

 
54,010,518

Dilutive Effect of Options 1
637,208

 

 
630,821

 
463,088

Dilutive Effect of Phantom Operating Company Class B Units & Phantom Shares of Class A Common Stock
1,232,905

 

 
1,174,261

 
105,987

Dilutive Effect of Restricted Shares of Class A Common Stock 2
29,663

 

 
23,494

 

Dilutive Weighted-Average Shares Outstanding
66,405,497

 
10,565,406

 
66,392,940

 
65,149,840

Add: Participating Restricted Operating Company Class B Units 3
157,326

 

 
157,326

 
245,487

Total Dilutive Weighted-Average Shares Outstanding
66,562,823

 
10,565,406

 
66,550,266

 
65,395,327

Diluted Earnings per Share
$
0.10

 
$
0.06

 
$
0.18

 
$
0.15


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 Restricted 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 1.2 million options to purchase Class B units and 1.0 million options to purchase Company Class A common stock were excluded from the calculation of diluted net income per share for each of the three and six months ended June 30, 2013, as their inclusion would have had an antidilutive effect based on current market prices. Approximately 1.7 million options to purchase Class B units and 1.0 million options to purchased Company Class A common stock were excluded from the calculation of diluted net income for each of the three and six months ended June 30, 2012, as their inclusion would have had an antidilutive effect for the respective periods based on 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

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


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, 2013, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 18.9% and 81.1%, respectively, of the economic interests in the operations of the business. As of December 31, 2012, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 17.2% and 82.8%, 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 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.
 
On March 20, 2013, and August 31, 2012, certain of the operating company’s members exchanged an aggregate of 1,328,334 and 722,521, respectively, of their Class B units for an equivalent number of shares of Company Class A common stock.  These acquisitions of additional operating company membership interests were treated as reorganizations of entities under common control as required by the Business Combinations Topic of the FASB ASC.

On April 30, 2013, the Company repurchased and retired 55,000 options to purchase Class B units.
 
The Company’s current 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.  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 three months ended June 30, 2013 and 2012, the Company purchased and retired 165,562 and 28,454 shares of Class A common stock, respectively, under the current repurchase authorization at an average price per share of $6.14 and $4.39, respectively.   During the six months ended June 30, 2013 and 2012, the Company purchased and retired 275,097 and 28,454 shares of Class A common stock, respectively, under the current repurchase authorization at an average price per share of $6.12 and $4.39, respectively.   The Company records the repurchase of shares and units at cost based on the trade date of the transaction.


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


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,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Non-Controlling Interests of Pzena Investment Management, LLC
$
8,715

 
$
6,508

 
$
16,829

 
$
14,717

Non-Controlling Interests of Consolidated Investment Partnerships
311

 
(116
)
 
719

 
353

Net Income Attributable to Non-Controlling Interests
$
9,026

 
$
6,392

 
$
17,548

 
$
15,070

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


Note 8—Investments, at Fair Value
 
Investments, at Fair Value consisted of the following at June 30, 2013:
 
 
Cost
 
Unrealized
Gain/(Loss)
 
Fair Value
 
(in thousands)
Equity Securities
$
3,397

 
$
368

 
$
3,765

Investments in Mutual Funds
3,983

 
575

 
4,558

Total
$
7,380

 
$
943

 
$
8,323


Investments, at Fair Value consisted of the following at December 31, 2012:
 
 
Cost
 
Unrealized
Gain/(Loss)
 
Fair Value
 
(in thousands)
Equity Securities
$
1,988

 
$
237

 
$
2,225

Investments in Mutual Funds
2,561

 
384

 
2,945

Total
$
4,549

 
$
621

 
$
5,170



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



Note 9—Property and Equipment
 
Property and Equipment, Net of Accumulated Depreciation is comprised of the following:
 
 
As of
 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Leasehold Improvements
$
1,219

 
$
1,219

Computer Hardware
987

 
982

Furniture and Fixtures
788

 
788

Office Equipment
271

 
271

Computer Software
214

 
214

Total
3,479

 
3,474

Less: Accumulated Depreciation and Amortization
(2,772
)
 
(2,695
)
Total
$
707

 
$
779


Depreciation is included in general and administrative expense and totaled approximately $0.1 million for each of the three and six months ended June 30, 2013 and 2012.

Note 10—Related Party Transactions
 
For the three months ended June 30, 2013 and 2012, the Company earned $0.3 million and $0.4 million, respectively, in investment advisory fees from unconsolidated VIEs which receive investment management services from the Company.  For the six months ended June 30, 2013 and 2012, the Company earned $0.7 million and $0.8 million, respectively, in such fees. The Company is not the primary beneficiary of these VIEs.
 
At both June 30, 2013 and December 31, 2012, 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 Company is the sponsor and investment manager of this entity.
 
At June 30, 2013 and December 31, 2012, Receivable from Related Parties included approximately $0.1 million of loans to employees.

The operating company manages the personal funds of certain of the Company’s employees, including the CEO, its two Presidents, and its two Executive Vice Presidents.  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 $0.1 million for each of the three months ended June 30, 2013 and 2012.  For each of the six months ended June 30, 2013 and 2012, the Company waived $0.2 million of 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 months ended June 30, 2013 and 2012. The Company paid approximately $0.1 million of such fees for the six months ended June 30, 2013 and 2012.
 
Note 11—Commitments and Contingencies
 

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


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.
 
The Company leases office space under a non-cancelable operating lease agreement which expires on October 31, 2015.  The Company reflects minimum lease expense for its headquarters on a straight-line basis over the lease term.  During the year ended December 31, 2011, the Company entered into a noncancelable sublease agreement for certain excess office space associated with its operating lease agreement.  The sublease agreement also expires on October 31, 2015.
 
Lease expenses were $0.3 million for each of the three months ended June 30, 2013 and 2012 and are included in general and administrative expense. Such expenses totaled $0.7 million for each of the six months ended June 30, 2013 and 2012.
 
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,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Current Provision:
 
 
 
 
 
 
 
Unincorporated Business Taxes 1
$
706

 
$
578

 
$
702

 
$
1,169

Local Corporate Tax

 

 

 

State Corporate Tax

 

 

 

Federal Corporate Tax

 

 

 

Total Current Provision
$
706

 
$
578

 
$
702

 
$
1,169

Deferred Provision:
 
 
 
 
 
 
 
Unincorporated Business Taxes 1
$
(36
)
 
$
(27
)
 
$
22

 
$
15

Local Corporate Tax
74

 
62

 
157

 
139

State Corporate Tax
129

 
110

 
276

 
246

Federal Corporate Tax
631

 
365

 
1,134

 
834

Total Deferred Provision
$
798

 
$
510

 
$
1,589

 
$
1,234

Change in Valuation Allowance
(556
)
 
446

 
(1,781
)
 
(623
)
Net Adjustment Related to Change in Effective Tax Rate
$
286

 
$

 
$
286

 
$

Total Income Tax Expense
$
1,234

 
$
1,534

 
$
796

 
$
1,780


1 During March 2013, the operating company recognized a $0.6 million tax benefit associated with the amendment of prior year tax returns to change the methodology for state and local receipts. 

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



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.  It is 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, 2013 and 2012, no such expenses were recognized.  As of June 30, 2013 and December 31, 2012, no such accruals were recorded.
 
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 2009.  All tax years subsequent to, and including, 2009 are considered open and subject to examination by tax authorities.
 
The acquisition of the 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 signed between the members of the operating company and the Company, 85% of the cash savings generated by this election will be distributed to the selling and converting shareholders upon the realization of this benefit.
 
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.
 
As discussed in Note 6, Shareholders’ Equity, on March 20, 2013 and August 31, 2012, certain of the operating company’s members exchanged an aggregate of 1,328,334 and 722,521, respectively, of their Class B units for an equivalent number of shares of Company Class A common stock.  The Company elected to step up its tax basis in the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair values of the Company’s common stock and the tax basis of the operating company, this election gave rise to a $5.9 million deferred tax asset and corresponding $5.0 million liability on March 20, 2013 and a $2.2 million deferred tax asset and a corresponding $1.9 million liability on August 31, 2012.   The Company assessed the realizability of the deferred tax asset associated with each of these exchanges and determined that a portion of each of their benefits would go unutilized.  Consequently, the Company established a $5.1 million and $1.9 million valuation allowance on March 20, 2013 and August 31, 2012, respectively, to reduce the deferred tax asset to an amount more likely than not to be realized.  These deferred tax assets remain available to the Company and can be used to reduce taxable income in future years.  The Company similarly reduced the associated liability to selling and converting shareholders by $4.4 million and $1.6 million at March 20, 2013 and August 31, 2012, respectively, to reflect this change in the estimated realization of these assets.  As required by the Income Taxes Topic of the FASB ASC, the Company recorded the effects of these transactions in equity.   

During the three and six months ended June 30, 2013, after giving effect to the exchanges discussed earlier, the Company’s valuation allowance was reduced by approximately $0.6 million and $1.8 million, respectively, due to revised estimates of future taxable income.   Results for the three and six months ended June 30, 2013 also reflects a decrease in the Company's effective tax rate due to a decrease in state and local rates associated with a change in methodology for state and local receipts during 2013. 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 $0.2 million and $1.3 million for the three and six months ended June 30, 2013, 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 months ended June 30, 2012, the Company’s valuation allowance was increased by approximately $0.4 million, due to revised estimates of future taxable income.  To reflect this change in the estimated realization of the asset and its liability for future payments, the Company decreased its liability to selling and converting shareholders by $0.3 million for the three months ended June 30, 2012.   During the six months ended June 30, 2012, after giving effect to the exchanges discussed earlier, the Company’s valuation allowance was decreased by approximately $0.6 million, due to revised estimates of future taxable income.  To reflect this change in the estimated realization of the asset and its liability for future payments, the Company increased

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


its liability to selling and converting shareholders by $0.7 million for the six months ended June 30, 2012. 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, 2013 and December 31, 2012, the net values of all deferred tax assets were approximately $10.4 million and $9.7 million, respectively.
 
The change in the Company’s deferred tax assets, net of valuation allowance, for the three and six months ended June 30, 2013 is summarized as follows:
 
 
Section 754
 
Other
 
Valuation
Allowance
 
Total
 
(in thousands)
Balance at December 31, 2012
$
65,069

 
$
4,536

 
$
(59,917
)
 
$
9,688

Deferred Tax (Expense)/Benefit
(907
)
 
103

 

 
(804
)
Unit Exchange
5,935

 

 
(5,140
)
 
795

Change in Valuation Allowance

 

 
1,225

 
1,225

Balance at March 31, 2013
$
70,097

 
$
4,639

 
$
(63,832
)
 
$
10,904

Deferred Tax (Expense)/Benefit
(905
)
 
103

 

 
(802
)
Change in Effective Rate
(5,272
)
 
(105
)
 
5,091

 
(286
)
Change in Valuation Allowance

 

 
556

 
556

Balance at June 30, 2013
$
63,920

 
$
4,637

 
$
(58,185
)
 
$
10,372


The change in the Company’s deferred tax liabilities, which is included in other liabilities on the Company’s consolidated statements of financial condition, for the three and six months ended June 30, 2013, is summarized as follows:

 
Total
 
(in thousands)
 
 
Balance at December 31, 2012
$
(59
)
Deferred Tax Expense
14

Balance at March 31, 2013
$
(45
)
Deferred Tax Expense
5

Balance at June 30, 2013
$
(40
)
 
The change in the Company’s deferred tax assets, net of valuation allowance, for the three and six months ended June 30, 2012 is summarized as follows:

 
Section 754
 
Other
 
Valuation
Allowance
 
Total
 
(in thousands)
Balance at December 31, 2011
$
66,224

 
$
3,661

 
$
(61,050
)
 
$
8,835

Deferred Tax (Expense)/Benefit
(823
)
 
158

 

 
(665
)
Change in Valuation Allowance

 

 
1,069

 
1,069

Balance at March 31, 2012
$
65,401

 
$
3,819

 
$
(59,981
)
 
$
9,239

Deferred Tax (Expense)/Benefit
(835
)
 
320

 

 
(515
)
Change in Valuation Allowance

 

 
(446
)
 
(446
)
Balance at June 30, 2012
$
64,566

 
$
4,139

 
$
(60,427
)
 
$
8,278




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




The change in the Company’s deferred tax liabilities for the three and six months ended June 30, 2012 is summarized as follows:
 
 
Total
 
(in thousands)
 
 
Balance at December 31, 2011
$
(13
)
Deferred Tax Benefit
(59
)
Balance at March 31, 2012
$
(72
)
Deferred Tax Expense
5

Balance at June 30, 2012
$
(67
)

Note 13—Subsequent Events
 
The Company evaluated the need for disclosures and/or adjustments resulting from subsequent events through the date the financial statements were issued.  This evaluation did not result in any subsequent events that necessitated disclosures and/or adjustments.

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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, 2013, our assets under management, or AUM, was $20.3 billion.  We manage separate accounts on behalf of institutions and high net worth individuals, and act as sub-investment adviser for a variety of SEC-registered mutual 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, 2013, the holders of Class A common stock (through the Company) and the holders of Class B units of our operating company held approximately 18.9% and 81.1%, respectively, of the economic interests in the operations of our business.
 
Non-GAAP Net Income
 
Our results for the three and six months ended June 30, 2013 and 2012 included recurring adjustments related to the Company’s tax receivable agreement and the associated liability to its selling and converting shareholders.  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 $6.3 million and $0.09, respectively, for the three months ended June 30, 2013 and $4.5 million and $0.07, respectively, for three months ended June 30, 2012.  Excluding these adjustments, non-GAAP diluted net income and non-GAAP diluted earnings per share were $12.0 million and $0.18, respectively, for the six months ended June 30, 2013 and $10.1 million and $0.15, respectively, for six months ended June 30, 2012. 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 other adjustments, and the adjustments related to our tax receivable agreement and the associated liability to selling and converting shareholders.  Our effective tax rate, exclusive of these adjustments, was approximately 41.6% for each of the three and six months ended June 30, 2013 and 42.8% for each of the three and six months ended June 30, 2012.  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.

















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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,
 
2013
 
2012
 
2013
 
2012
 
(In thousands, except share and per share data)
GAAP Net Income
$
1,266

 
$
614

 
$
2,435

 
$
1,621

Net Effect of Tax Receivable Agreement
(41
)
 
131

 
(227
)
 
35

Non-GAAP Net Income
$
1,225

 
$
745

 
$
2,208

 
$
1,656

GAAP Net Income Attributable to Non-Controlling Interest of Pzena Investment Management, LLC
$
8,715

 
$
6,508

 
$
16,829

 
$
14,717

Less: Assumed Corporate Income Taxes
3,623

 
2,789

 
6,996

 
6,306

Assumed After-Tax Income of Pzena Investment Management, LLC
5,092

 
3,719

 
9,833

 
8,411

Non-GAAP Net Income of Pzena Investment Management, Inc.
1,225

 
745

 
2,208

 
1,656

Non-GAAP Diluted Net Income
$
6,317

 
$
4,464

 
$
12,041

 
$
10,067

Non-GAAP Diluted Earnings Per Share Attributable to
Pzena Investment Management, Inc. Common Stockholders:
 
 
 
 
 
 
 
Non-GAAP Net Income for Diluted Earnings per Share
$
6,317

 
$
4,464

 
$
12,041

 
$
10,067

Non-GAAP Diluted Earnings Per Share
$
0.09

 
$
0.07

 
$
0.18

 
$
0.15

Non-GAAP Diluted Weighted-Average Shares Outstanding
66,562,823

 
65,426,774

 
66,550,266

 
65,395,327


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


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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, 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 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.  General and Administrative Expense includes office rent and other expenses, professional and outside services fees, depreciation, and the costs associated with operating and maintaining our research, trading, and portfolio accounting systems.  Our occupancy-related costs and professional services expenses, in particular, generally increase or decrease in relative proportion to the overall size and scale of our business operations.

We incur additional expenses associated with being a public company for, among other things, director and officer insurance, director fees, SEC reporting and compliance (including Sarbanes-Oxley and Dodd-Frank compliance), professional fees, transfer agent fees, and other similar expenses.  These additional expenses have and will continue to reduce our net income.
 
Our expenses may fluctuate due to a number of factors, including the following:
 
variations in the level of total compensation expense due to, among other things, bonuses, awards of equity to our employees and employee members of our operating company, changes in our employee count and mix, and competitive factors; and
general and administrative expenses, such as rent, professional service fees and data-related costs, incurred, as necessary, to run our business.

Other Income/(Expense)
 

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Other Income/(Expense) is derived primarily from investment income or loss arising from our consolidated subsidiaries, income or loss generated by our investments in third-party mutual funds, and interest income generated on our cash balances.  Other Income/(Expense) is also affected by changes in our estimates of the liability due to our selling and converting shareholders associated with payments owed to them under the tax receivable agreement which was executed in connection with our reorganization and initial public offering on October 30, 2007.  As discussed further below under “Tax Receivable Agreement,” this liability represents 85% of the amount of cash savings, if any, in U.S. federal, state, and local income tax that we realize as a result of the amortization of the increases in tax basis generated from our acquisitions of our operating company’s units from our selling and converting shareholders.  We expect the interest and investment components of Other Income/(Expense), in the aggregate, to fluctuate based on market conditions and the performance of our consolidated investment partnerships and other investments.
 Non-Controlling Interests

Our operating company has historically consolidated the results of operations of the private investment partnerships over which we exercise a controlling influence.  We are the sole managing member of our operating company and control its business and affairs and, therefore, consolidate its financial results with ours.  In light of our employees’ and outside investors’ interest in our operating company, we have reflected their membership interests as a non-controlling interest in our consolidated financial statements.  As a result, our income is generated by our economic interest in our operating company’s net income.  As of June 30, 2013, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 18.9% and 81.1%, respectively, of the economic interests in the operations of the business.

Operating Results
 
Assets Under Management and Flows
 
As of June 30, 2013, our approximately $20.3 billion of AUM was invested in a variety of value-oriented investment strategies, representing distinct capitalization segments of U.S. and non-U.S. equity markets.  The performance of our largest investment strategies as of June 30, 2013 is further described below.  We follow the same investment process for each of these strategies.  Our investment strategies are distinguished by the market capitalization ranges from which we select securities for their portfolios, which we refer to as each strategy’s investment universe, as well as the regions in which we invest and the degree to which we concentrate on a limited number of holdings.  While our investment process includes ongoing review of companies in the investment universes described below, our actual investments may include companies outside of the relevant market capitalization range at the time of our investment.  In addition, the number of holdings typically found in the portfolios of each of our investment strategies may vary, as described below.

The following table indicates the annualized returns, gross and net (which represents annualized returns prior to, and after, payment of advisory fees, respectively), of our six largest investment strategies from their inception to June 30, 2013, and in the five-year, three-year, and one-year periods ended June 30, 2013, as well as the performance of the market index which is most commonly used by our clients to compare the performance of the relevant investment strategy over those time periods.
 

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Table of Contents

 
 
Period Ended June 30, 20131
Investment Strategy (Inception Date)
 
Since Inception
 
5 Years
 
3 Years
 
1 Year
Large Cap Focused Value (October 2000)
 
 
 
 
 
 
 
 
Annualized Gross Returns
 
6.2
%
 
8.6
%
 
18.0
%
 
32.7
%
Annualized Net Returns
 
5.7
%
 
8.1
%
 
17.5
%
 
32.1
%
Russell 1000® Value Index
 
5.4
%
 
6.7
%
 
18.5
%
 
25.3
%
Global Focused Value (January 2004)
 
 

 
 

 
 

 
 

Annualized Gross Returns
 
4.2
%
 
3.5
%
 
13.8
%
 
31.0
%
Annualized Net Returns
 
3.4
%
 
2.8
%
 
13.1
%
 
30.2
%
MSCI(SM) World Index—Net/U.S.$2
 
5.6
%
 
2.7
%
 
13.7
%
 
18.6
%
Large Cap Expanded Value (July 2012)
 
 

 
 

 
 

 
 

Annualized Gross Returns
 
33.6
%
 

 

 
33.6
%
Annualized Net Returns
 
33.4
%
 

 

 
33.4
%
Russell 1000® Value Index
 
25.3
%
 

 

 
25.3
%
International (ex-U.S) Expanded Value (November 2008)
 
 

 
 

 
 

 
 

Annualized Gross Returns
 
14.5
%
 

 
12.3
%
 
28.3
%
Annualized Net Returns
 
14.2
%
 

 
12.0
%
 
27.9
%
MSCI® EAFE Index—Net/U.S.$2
 
9.5
%
 

 
10.1
%
 
18.6
%
Focused Value (January 1996)
 
 

 
 

 
 

 
 

Annualized Gross Returns
 
10.8
%
 
9.7
%
 
19.3
%
 
33.1
%
Annualized Net Returns
 
9.9
%
 
9.0
%
 
18.6
%
 
32.4
%
Russell 1000® Value Index
 
8.4
%
 
6.7
%
 
18.5
%
 
25.3
%
Small Cap Focused Value (January 1996)
 
 

 
 

 
 

 
 

Annualized Gross Returns
 
14.1
%
 
15.5
%
 
19.0
%
 
28.4
%
Annualized Net Returns
 
12.8
%
 
14.3
%
 
17.8
%
 
27.2
%
Russell 2000® Value Index
 
9.9
%
 
8.6
%
 
17.3
%
 
24.8
%
 
1 The historical returns of these investment strategies are not necessarily indicative of their future performance, or the future performance of any of our other current or future investment strategies.

2 Net of applicable withholding taxes and presented in U.S. $.

Large Cap Focused Value.  We screen a universe of the 500 largest U.S. listed companies, based on market capitalization, to build a portfolio generally consisting of 30 to 40 stocks. We launched this strategy in October 2000. At June 30, 2013, the Large Cap Focused Value strategy generated a one-year gross return of 32.7%, outperforming its benchmark. The main drivers of this outperformance were our exposure to the financial services and technology sectors, an underweight position in the utilities sector, and the portfolio's housing-related holdings, partially offset by certain holdings in the consumer discretionary and energy sectors.
 
Global Focused Value.  We screen a universe of the 1,500 largest non U.S. listed companies, based on market capitalization, and the 500 largest U.S. listed companies, based on market capitalization, to build a portfolio generally consisting of 40 to 60 stocks. We launched this strategy in January 2004. At June 30, 2013, the Global Focused Value strategy generated a one-year gross return of 31.0%, outperforming its benchmark.  The portfolio’s top contributors to relative performance were the financial services, industrials, information technology, and materials sectors. This outperformance was partially offset by certain stocks in the energy sector.
 
Large Cap Expanded Value.  We screen a universe of the 500 largest U.S. listed companies, based on market capitalization, to build a portfolio generally consisting of 50 to 80 stocks. We launched this strategy in July 2012. At June 30,

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Table of Contents

2013, the Large Cap Expanded Value strategy generated a one-year gross return of 33.6%, outperforming its benchmark.  This outperformance was driven primarily by the financial services sector, our underweight exposure to the utilities sector and the portfolio’s housing-related holdings, partially offset by certain holdings in the consumer discretionary and energy sectors.
 
International (ex-U.S.) Expanded Value.  We screen a universe of the 1,500 largest non-U.S. listed companies, based on market capitalization, to build a portfolio generally consisting of 60 to 80 stocks. We launched this strategy in November 2008. At June 30, 2013, the International (ex-U.S.) Expanded Value strategy generated a one-year gross return of 28.3%, outperforming its benchmark. The largest contributors to this outperformance was our stock selection in the industrials, materials, consumer discretionary and financial services sectors, partially offset by our overweight investment exposure to the energy sector.

Focused Value.  We screen a universe of the 1,000 largest U.S. listed companies, based on market capitalization, to build a portfolio generally consisting of 30 to 40 stocks. We launched this strategy in January 1996. At June 30, 2013, the Focused Value strategy generated a one-year gross return of 33.1%, outperforming its benchmark. The main contributors to this outperformance were our exposure to the financial services sector, the portfolio's housing-related holdings, and underweight investment exposure to the utilities sector, partially offset by certain holdings in the consumer discretionary sector.
 
Small Cap Focused Value.  We screen a universe of U.S. listed companies ranked from the 1,001st to 3,000th largest, based on market capitalization, to build a portfolio generally consisting of 40 to 50 stocks. We launched this strategy in January 1996. At June 30, 2013, the Small Cap Focused Value strategy generated a one-year gross return of 28.4%, outperforming its benchmark. A broad number of holdings across a diverse range of industries contributed to this outperformance, specifically certain stocks in the financial services, healthcare, and materials and processing sectors. This outperformance was partially offset by certain stocks in the consumer discretionary sector.
 
Our earnings and cash flows are heavily dependent upon prevailing financial market conditions.  Significant increases or decreases in the various securities markets, particularly the equities markets, can have a material impact on our results of operations, financial condition, and cash flows.
 
The change in AUM in our institutional accounts and our retail accounts for the three, six and twelve months ended June 30, 2013 and 2012 is described below.  Inflows are composed solely of the investment of new or additional assets by new or existing clients.  Outflows consist solely of redemptions of assets by existing clients.


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Table of Contents

Assets Under Management
 
 
 
 
 
 
 
 
 
 
 
 
($ billions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
For the Twelve Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
Institutional Accounts
 
 
 
 
 
 
 
 
 
 
 
 
  Assets
 
 
 
 
 
 
 
 
 
 
 
 
     Beginning of Period
 
$
12.2

 
$
12.2

 
$
11.2

 
$
11.3

 
$
10.9

 
$
12.9

          Inflows
 
0.1

 
0.3

 
0.5

 
0.4

 
0.8

 
1.4

          Outflows
 
(0.4
)
 
(0.7
)
 
(0.9
)
 
(1.6
)
 
(2.2
)
 
(2.5
)
          Net Flows
 
(0.3
)
 
(0.4
)
 
(0.4
)
 
(1.2
)
 
(1.4
)
 
(1.1
)
          Market Appreciation/(Depreciation)
 
0.7

 
(0.9
)
 
1.8

 
0.8

 
3.1

 
(0.9
)
     End of Period
 
$
12.6

 
$
10.9

 
$
12.6

 
$
10.9

 
$
12.6

 
$
10.9

 
 
 
 
 
 
 
 
 
 
 
 
 
Retail Accounts
 
 
 
 
 
 
 
 
 
 
 
 
  Assets
 
 
 
 
 
 
 
 
 
 
 
 
     Beginning of Period Assets
 
$
7.3

 
$
2.5

 
$
5.9

 
$
2.2

 
$
2.2

 
$
3.0

          Inflows
 
0.3

 
0.1

 
1.1

 
0.3

 
4.8

 
0.7

          Outflows
 
(0.4
)
 
(0.2
)
 
(0.6
)
 
(0.4
)
 
(1.1
)
 
(1.3
)
          Net Flows
 
(0.1
)
 
(0.1
)
 
0.5

 
(0.1
)
 
3.7

 
(0.6
)
          Market Appreciation/(Depreciation)
 
0.5