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, 2012, our assets under management, or AUM, was $13.1 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 offshore 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, 2012, the holders of Class A common stock (through the Company) and the holders of Class B units of our operating company held approximately 16.3% and 83.7%, 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, 2012, and 2011 include the 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 net income per share were $4.5 million and $0.07, respectively, for the three months ended June 30, 2012, and $6.6 million and $0.10, respectively, for the three months ended June 30, 2011. Excluding these adjustments, non-GAAP diluted net income and non-GAAP diluted net income per share were $10.1 million and $0.15, respectively for the six months ended June 30, 2012, and $12.8 million and $0.20, respectively, for the six months ended June 30, 2011. 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 historical effective tax rate, exclusive of one-time prior period 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 42.8% for each of the three and six months ended June 30, 2012 and 42.9% for each of the three and six months ended June 30, 2011, as noted in the section "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. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, financial measures prepared in accordance with GAAP.

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

                                           For the Three                      For the Six
                                       Months Ended June 30,             Months Ended June 30,
                                       2012             2011             2012             2011
                                         (In thousands, except share and per share amounts)


 GAAP Net Income                   $        614     $        859     $      1,621     $      2,516
Net Effect of Tax Receivable
Agreement                                   131              160               35             (588 )
 Non-GAAP Net Income               $        745     $      1,019     $      1,656     $      1,928

 GAAP Income Attributable to
Non-Controlling Interest
 of Pzena Investment Management,
LLC                                $      6,508     $      9,740     $     14,717     $     19,030
 Less: Assumed Corporate Income
Taxes                                     2,789            4,177            6,306            8,156
 Assumed After-Tax Income of
Pzena Investment Management, LLC   $      3,719     $      5,563     $      8,411     $     10,874
 Non-GAAP Net Income of Pzena
Investment Management, Inc.                 745            1,019            1,656            1,928
 Non-GAAP Diluted Net Income       $      4,464     $      6,582     $     10,067     $     12,802

Non-GAAP Diluted Earnings Per
Share Attributable to
Pzena Investment Management,
Inc. Common Stockholders:
 Non-GAAP Net Income for Diluted
Earnings per Share                 $      4,464     $      6,582     $     10,067     $     12,802
 Non-GAAP Diluted Earnings Per
Share                              $       0.07     $       0.10     $       0.15     $       0.20
 Non-GAAP Diluted
Weighted-Average Shares
Outstanding                          65,426,774       65,054,033       65,395,327       65,070,712

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.

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. These 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 members of our operating company, changes in our employee count and mix, and competitive factors; and

• expenses, such as rent, professional service fees and data-related costs, incurred, as necessary, to run our business.

Compensation and Benefits Expense

Our largest expense is compensation and benefits, which includes the salaries, bonuses, equity-based compensation, and related benefits and payroll costs attributable to our members and employees. Compensation and benefits packages are benchmarked against relevant industry and geographic peer groups in order to attract and retain qualified personnel.

Pursuant to the Pzena Investment Management, LLC Amended and Restated 2006 Equity Incentive Plan (the "2006 Equity Incentive Plan"), we have issued restricted 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"), we have issued options to acquire shares of our Class A common stock.

We use a fair-value method in recording the compensation expense associated with the granting of restricted units, and options to purchase units and common stock, to new and existing members of our operating company under the 2006 and 2007 Equity Incentive Plans. Under this method, compensation expense is measured at the grant-date based on the estimated fair value of the award and is recognized over the award's vesting period.

The fair value of awarded units is determined by reference to the market price of our Class A common stock on the date of grant, since these units are exchangeable for shares of our Class A common stock on a one-for-one basis. For each of the three months ended June 30, 2012 and 2011, there were no restricted operating company Class B units granted. For the six months ended June 30, 2012 and 2011, we granted 53,116 and 6,000, respectively, restricted operating company Class B units, and the related shares of Class B common stock, under the 2006 Equity Incentive Plan. For each of the three months ended June 30, 2012 and 2011, we recognized approximately $0.2 million in compensation and benefits expense associated with the amortization of all unvested restricted operating company Class B units. For the six months ended June 30, 2012 and 2011, we recognized approximately $0.4 million and $0.3 million, respectively, in such compensation and benefits expense.

The fair value of the options to purchase Class B units and Class A common stock is determined by using an appropriate option pricing model on the grant-date. For the three and six months ended June 30, 2012 and 2011, there were no options granted to purchase units or shares of common stock under the 2006 and 2007 Equity Incentive Plans. For the three months ended June 30, 2012 and 2011, we recognized approximately $0.1 million and $0.5 million, respectively, in compensation and benefits expense associated with the amortization of all unvested options to acquire operating company Class B units and unvested options to acquire Class A common stock issued under the 2006 and 2007 Equity Incentive Plans. For the six months ended June 30, 2012 and 2011, we recognized approximately $0.1 million and $1.1 million, respectively, in such expense.

Pursuant to 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, restricted phantom units of our operating company, or money market funds. Amounts deferred in any calendar year reduce that year's cash compensation expense and are amortized ratably over a four-year period commencing the following year. At June 30, 2012 and December 31, 2011, the liability associated with deferred compensation investment accounts was approximately $0.6 million and $1.2 million, respectively, and is recorded as deferred compensation liability on the consolidated statements of financial condition. For the three months ended June 30, 2012 and 2011, we recognized approximately $0.4 million and $0.5 million, respectively, in compensation and benefits expense associated with the amortization of all deferred compensation awards. For the six months ended June 30, 2012 and 2011, we recognized approximately $0.8 million and $1.0 million, respectively, in such expense.

As of June 30, 2012, we had approximately $2.0 million in total unrecorded compensation expense related to unvested operating company phantom units issued pursuant to our Bonus Plan, operating company unit and option grants issued under the 2006 Equity Incentive Plan. We expect that the amortization of these amounts will be approximately $1.5 million in 2012, $0.8 million in 2013, $0.3 million in 2014 and $0.1 million in 2015.

We have historically granted delayed-vesting cash awards to certain of our members. These delayed-vesting cash awards have varying vesting schedules, with $0.8 million to be paid in 2012 and the remaining $0.4 million to be paid in 2013.

General and Administrative Expense

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.

Other Income/(Expense)

Other income/(expense) is derived primarily from investment income or loss arising from our consolidated subsidiaries, our investments in various private investment vehicles that we employ to incubate new strategies, 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 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. Amounts waived by our selling and converting shareholders, if any, reduce this liability. 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, 2012, the holders of Class A common stock (through the Company) and the holders of Class B units of the operating company held approximately 16.3% and 83.7%, respectively, of the economic interests in the operations of the business.

Income Tax Expense/(Benefit)

As a "C" corporation under the Internal Revenue Code, we are liable for federal, state and local taxes on the income derived from our economic interest in the operating company, which is net of its provision for New York City Unincorporated Business Taxes, or UBT. Correspondingly, in our consolidated financial statements, we report both the operating company's provision for UBT, as well as our provision for federal, state and local corporate taxes.

Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more likely than not to be realized. As of June 30, 2012 and December 31, 2011, our valuation allowance against the deferred tax asset associated with our acquisition of operating company units in conjunction with the offering and subsequent exchanges was $60.4 million and $61.1 million, respectively.

Operating Results

Assets Under Management and Flows

As of June 30, 2012, our approximately $13.1 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 five largest investment strategies as of June 30, 2012 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. 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 five largest investment strategies from their inception to June 30, 2012, and in the five-year, three-year, and one-year periods ended June 30, 2012, relative to the performance of: (i) the market index which is most commonly used by our clients to compare the performance of the relevant investment strategy, and (ii) the S&P 500® Index, which is provided for the limited purpose of providing a comparison to the broader equity market.

                                                    Period Ended June 30, 2012(1)
Investment Strategy (Inception
Date)                                  Since
                                     Inception         5 Years           3 Years          1 Year
Large Cap Value (October 2000)
Annualized Gross Returns                     4.2 %           (5.6 )%           14.4 %          (4.7 )%
Annualized Net Returns                       3.7 %           (6.1 )%           13.8 %          (5.1 )%
Russell 1000® Value Index                    3.8 %           (2.2 )%           15.8 %           3.0 %
S&P 500® Index                               1.5 %            0.2 %            16.4 %           5.5 %
Global Value (January 2004)
Annualized Gross Returns                     1.4 %           (8.7 )%            9.6 %         (13.4 )%
Annualized Net Returns                       0.7 %           (9.4 )%            8.8 %         (14.0 )%
MSCI World(SM)
Index-Net/U.S.$(2)                           4.2 %           (3.0 )%           11.0 %          (5.0 )%
S&P 500® Index                               4.5 %            0.2 %            16.4 %           5.5 %
International Diversified Value
(November 2008)(3)
Annualized Gross Returns                    11.0 %              -               8.2 %         (15.0 )%
Annualized Net Returns                      10.7 %              -               7.9 %         (15.2 )%
MSCI EAFE® Index-Net/U.S.$(2)                7.2 %              -               6.0 %         (13.9 )%
S&P 500® Index                              12.2 %              -              16.4 %           5.5 %
Value Service (January 1996)
Annualized Gross Returns                     9.5 %           (5.0 )%           16.2 %          (2.1 )%
Annualized Net Returns                       8.7 %           (5.6 )%           15.4 %          (2.8 )%
Russell 1000® Value Index                    7.5 %           (2.2 )%           15.8 %           3.0 %
S&P 500® Index                               6.9 %            0.2 %            16.4 %           5.5 %
Small Cap Value (January 1996)
Annualized Gross Returns                    13.3 %            1.7 %            23.5 %           5.3 %
Annualized Net Returns                      12.0 %            0.7 %            22.3 %           4.2 %
Russell 2000® Value Index                    9.0 %           (1.1 )%           17.4 %          (1.4 )%
S&P 500® Index                               6.9 %            0.2 %            16.4 %           5.5 %

(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.
(3) Formerly known as EAFE Diversified Value.

Large Cap 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, 2012, the Large Cap Value strategy generated a one-year annualized gross return of -4.7%, underperforming both its benchmark and the broader equity market in general. This underperformance relative to the benchmark was due primarily to our investment exposure to the technology sector, partially offset by our stock selection within the materials and energy sectors.

Global 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, 2012, the Global Value strategy generated a one-year annualized gross return of -13.4%, underperforming both its benchmark and the broader equity market in general. This underperformance relative to the benchmark was due primarily to our overweight investment exposure to the technology and financial services sectors, and our stock selection within the consumer staples sector.

International Diversified Value (formerly known as EAFE Diversified 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 100 stocks. We launched this strategy in November 2008. At June 30, 2012, the International Diversified Value strategy generated a one-year annualized gross return of -15.0%, underperforming both its benchmark and the broader equity market in general. This underperformance relative to the benchmark was due primarily to our overweight investment exposure to the technology and financial services sectors, partially offset by our stock selection within the consumer staples and materials sectors.

Value Service. 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, 2012, the Value strategy generated a one-year annualized gross return of -2.1%, underperforming both its benchmark and the broader equity market in general. This underperformance relative to the benchmark was due primarily to our investment exposure to the technology and financial services sectors, partially offset by our stock selection within the energy and materials sectors.

Small Cap 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, 2012, the Small Cap Value strategy generated a one-year annualized gross return of 5.3%, outperforming its benchmark and relatively even with the broader equity market in general. This outperformance relative to the benchmark was due primarily to our stock selection within the health care and materials sectors, and our overweight investment exposure to the consumer discretionary and producer durables sectors.

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 and six months ended June 30, 2012 and 2011, and the twelve months ended June 30, 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.

                                                                                                         For the Twelve
                                        For the Three                         For the Six                 Months Ended
                                    Months Ended June 30,                Months Ended June 30,              June 30,
 Assets Under Management           2012                2011             2012               2011               2012
                                                                    (in billions)
Institutional Accounts
 Assets
   Beginning of Period        $         12.2       $       13.0     $       11.3       $       12.5     $           12.9
     Inflows                             0.3                0.7              0.4                1.0                  1.4
. . .