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Section 1: 10-Q (FORM 10-Q)

10-Q
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
 
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended September 30, 2008
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: 001-33294
 
Fortress Investment Group LLC
(Exact name of registrant as specified in its charter)
 
 
     
Delaware
  20-5837959
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
1345 Avenue of the Americas,
New York, NY
(Address of principal executive offices)
  10105
(Zip Code)
 
(212) 798-6100
(Registrant’s telephone number, including area code)
 
 
 
(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 þ     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. (Check one):
 
             
Large accelerated filer o
  Accelerated filer o   Non-accelerated filer þ
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.
 
Class A Shares: 94,609,525 outstanding as of November 12, 2008.
 
Class B Shares: 312,071,550 outstanding as of November 12, 2008.
 


 

 
FORTRESS INVESTMENT GROUP LLC
 
FORM 10-Q
 
INDEX
 
                 
        Page
 
      Financial Statements        
        Consolidated Balance Sheets as of September 30, 2008 (unaudited) and December 31, 2007     1  
        The following statements are presented on a combined basis prior to the date of Fortress’s reorganization (Note 1) on January 17, 2007 and consolidated thereafter:        
        Statements of Operations (unaudited) for the three and nine months ended September 30, 2008 and 2007     2  
        Statement of Shareholders’ Equity (unaudited) for the nine months ended September 30, 2008     3  
        Statements of Cash Flows (unaudited) for the nine months ended September 30, 2008 and 2007     4  
        Notes to Consolidated and Combined Financial Statements (unaudited)     5  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     48  
      Quantitative and Qualitative Disclosures About Market Risk     80  
      Controls and Procedures     83  
 
      Legal Proceedings     84  
      Risk Factors     85  
      Unregistered Sales of Equity Securities and Use of Proceeds     119  
      Defaults upon Senior Securities     119  
      Submission of Matters to a Vote of Security Holders     119  
      Other Information     119  
      Exhibits     120  
    121  
 EX-10.3: FIRST AMENDMENT TO THE THIRD AMENDED AND RESTATED CREDIT AGREEMENT
 EX-31.1: CERTIFICATION
 EX-31.2: CERTIFICATION
 EX-32.1: CERTIFICATION
 EX-32.2: CERTIFICATION


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DEFINED TERMS
 
As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires:
 
“Management Fee Paying Assets Under Management,” or “AUM,” refers to the management fee paying assets we manage, including, as applicable, capital we have the right to call from our investors pursuant to their capital commitments to various funds. Our AUM equals the sum of:
 
(i) the capital commitments or invested capital (or NAV, if lower) of our private equity funds, depending on which measure management fees are being calculated upon at a given point in time, which in connection with funds raised after March 2006 includes the mark-to-market value of public securities held within the funds;
 
(ii) the contributed capital of our publicly traded alternative investment vehicles, which we refer to as our “Castles”;
 
(iii) the net asset value, or “NAV,” of our hedge funds; and
 
(iv) the NAV of our managed accounts, to the extent management fees are charged.
 
For each of the above, the amounts exclude assets under management for which we charge either no or nominal fees, generally related to our principal investments in funds as well as investments in funds by our principals, directors and employees.
 
Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. Our definition of AUM is not based on any definition of assets under management contained in our operating agreement or in any of our Fortress Fund management agreements.
 
“Fortress,” “we,” “us,” “our,” and the “company” refer, (i) following the consummation of the reorganization and the Nomura transaction on January 17, 2007, collectively, to Fortress Investment Group LLC and its subsidiaries, including the Fortress Operating Group and all of its subsidiaries, and, (ii) prior to the consummation of the reorganization and the Nomura transaction on January 17, 2007, to the Fortress Operating Group and all of its subsidiaries, in each case not including funds that, prior to March 31, 2007, were consolidated funds, except with respect to our historical financial statements and discussion thereof unless otherwise specified. Effective March 31, 2007, all of our previously consolidated funds were deconsolidated. The financial statements contained herein represent consolidated financial statements of Fortress Investment Group LLC subsequent to the reorganization and combined financial statements of Fortress Operating Group, considered the predecessor, prior to the reorganization. See Part I, Item 1, “Financial Statements.”
 
“Fortress Funds” and “our funds” refers to the private investment funds and alternative asset companies that are managed by the Fortress Operating Group.
 
“Fortress Operating Group” refers to the combined entities, which were wholly-owned by the principals prior to the Nomura transaction and in each of which Fortress Investment Group LLC acquired an indirect controlling interest upon completion of the Nomura transaction.
 
“principals” or “Principals” refers to Peter Briger, Wesley Edens, Robert Kauffman, Randal Nardone and Michael Novogratz, collectively, who prior to the completion of our initial public offering and the Nomura transaction directly owned 100% of the Fortress Operating Group units and following completion of our initial public offering and the Nomura transaction own a majority of the Fortress Operating Group units and all of the Class B shares, representing a majority of the total combined voting power of all of our outstanding Class A and Class B shares. The principals’ ownership percentage is subject to change based on, among other things, equity offerings by Fortress and dispositions by the principals.
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
Some of the statements under Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk,” Part II, Item 1A, “Risk Factors,” and elsewhere in this Quarterly Report on Form 10-Q may contain forward-looking statements which reflect our current views with respect to, among other things, future events and financial


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performance. Readers can identify these forward-looking statements by the use of forward-looking words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of those words or other comparable words. Any forward-looking statements contained in this report are based upon the historical performance of us and our subsidiaries and on our current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business prospects, growth strategy and liquidity. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from those indicated in these statements. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.


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PART I. FINANCIAL INFORMATION
 
ITEM 1.   FINANCIAL STATEMENTS
 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands, except share data)
 
                 
    September 30,
    December 31,
 
    2008     2007  
 
ASSETS
Cash and cash equivalents
  $ 259,252     $ 100,409  
Due from affiliates
    49,429       198,669  
Investments
               
Equity method investees
    949,709       1,091,918  
Options in affiliates
    137       16,001  
Deferred tax asset
    517,578       511,204  
Other assets
    78,772       71,580  
                 
    $ 1,854,877     $ 1,989,781  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
               
Accrued compensation and benefits
  $ 146,702     $ 269,324  
Due to affiliates
    395,508       455,734  
Dividends payable
          21,285  
Deferred incentive income
    163,635       173,561  
Debt obligations payable
    750,000       535,000  
Other liabilities
    57,726       36,729  
                 
      1,513,571       1,491,633  
                 
Commitments and Contingencies
               
Principals’ and Others’ Interests in Equity of Consolidated Subsidiaries
    174,854       308,023  
Shareholders’ Equity
               
Class A shares, no par value, 1,000,000,000 shares authorized, 94,609,525 and 94,597,646 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively
           
Class B shares, no par value, 750,000,000 shares authorized, 312,071,550 shares issued and outstanding
           
Paid-in capital
    538,619       384,700  
Retained earnings (accumulated deficit)
    (373,004 )     (193,200 )
Accumulated other comprehensive income (loss)
    837       (1,375 )
                 
      166,452       190,125  
                 
    $ 1,854,877     $ 1,989,781  
                 
 
See notes to consolidated and combined financial statements


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except share data)
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Revenues
                               
Management fees from affiliates
  $ 154,266     $ 124,991     $ 447,928     $ 286,956  
Incentive income from affiliates
    718       106,690       56,162       283,879  
Other revenues (affiliate portion disclosed in Note 6)
    30,152       15,601       70,022       51,866  
Interest and dividend income — investment company holdings
                               
Interest income
                      243,713  
Interest income from controlled affiliate investments
                      4,707  
Dividend income
                      7,436  
Dividend income from controlled affiliate investments
                      53,174  
                                 
      185,136       247,282       574,112       931,731  
                                 
Expenses
                               
Interest expense
                               
Investment company holdings
                      132,620  
Other
    9,481       7,285       29,705       26,016  
Compensation and benefits
    134,774       101,703       399,253       507,003  
Principals agreement compensation
    239,976       232,048       714,710       612,981  
General, administrative and other
    23,536       17,412       59,852       80,320  
Depreciation and amortization
    2,437       2,230       7,309       6,423  
                                 
      410,204       360,678       1,210,829       1,365,363  
                                 
Other Income (Loss)
                               
Gains (losses) from investments
                               
Investment company holdings
                               
Net realized gains (losses)
                      86,264  
Net realized gains (losses) from controlled affiliate investments
                      715,024  
Net unrealized gains (losses)
                      (19,928 )
Net unrealized gains (losses) from controlled affiliate investments
                      (1,428,837 )
Other investments
                               
Net realized gains (losses)
    (2,477 )     777       (803 )     831  
Net realized gains (losses) from affiliate investments
    (671 )     (2,475 )     (516 )     143,017  
Net unrealized gains (losses)
          (1,921 )           (2,597 )
Net unrealized gains (losses) from affiliate investments
    (6,951 )     (54,579 )     (43,352 )     (221,745 )
Earnings (losses) from equity method investees
    (37,921 )     (30,716 )     (113,550 )     (23,289 )
                                 
      (48,020 )     (88,914 )     (158,221 )     (751,260 )
                                 
Income (Loss) Before Deferred Incentive Income, Principals’ and Others’ Interests in Income of Consolidated Subsidiaries and Income Taxes
    (273,088 )     (202,310 )     (794,938 )     (1,184,892 )
Deferred incentive income
                      307,034  
Principals’ and others’ interests in (income) loss of consolidated subsidiaries
    210,012       152,534       612,692       854,550  
                                 
Income (Loss) Before Income Taxes
    (63,076 )     (49,776 )     (182,246 )     (23,308 )
Income tax benefit (expense)
    5,636       12,219       333       (7,237 )
                                 
Net Income (Loss)
  $ (57,440 )   $ (37,557 )   $ (181,913 )   $ (30,545 )
                                 
Dividends declared per Class A share
  $     $ 0.2250     $ 0.4500     $ 0.6174  
                                 
Earnings Per Unit — Fortress Operating Group
                            January 1 through January 16  
                                 
Net income per Fortress Operating Group unit
                          $ 0.36  
                                 
Weighted average number of Fortress Operating Group units outstanding
                            367,143,000  
                                 
Earnings Per Class A share — Fortress Investment Group
                            January 17 through September 30  
                                 
Net income (loss) per Class A share, basic
  $ (0.61 )   $ (0.41 )   $ (1.96 )   $ (1.83 )
                                 
Net income (loss) per Class A share, diluted
  $ (0.66 )   $ (0.52 )   $ (1.97 )   $ (1.83 )
                                 
Weighted average number of Class A shares outstanding, basic
    94,938,434       94,894,636       94,915,666       91,255,519  
                                 
Weighted average number of Class A shares outstanding, diluted
    407,009,984       406,966,186       406,987,216       91,255,519  
                                 
 
See notes to consolidated and combined financial statements


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

CONSOLIDATED AND COMBINED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008
(Dollars in thousands)
 
                                                 
                      Retained
    Accumulated
       
                      Earnings
    Other
    Total
 
    Class A
    Class B
    Paid-In
    (Accumulated
    Comprehensive
    Shareholders’
 
    Shares     Shares     Capital     Deficit)     Income (Loss)     Equity  
 
Shareholders’ Equity — December 31, 2007
    94,597,646       312,071,550     $ 384,700     $ (193,200 )   $ (1,375 )   $ 190,125  
Director restricted share grant
    11,879             244                   244  
Dividends declared
                (42,572 )                 (42,572 )
Capital increase related to equity-based compensation
                198,503                   198,503  
Dividend and distribution equivalents accrued in connection with equity-based compensation (net of tax)
                (2,256 )                 (2,256 )
Cumulative effect adjustment — adoption of SFAS 159 (Note 3)
                      2,109       1,212       3,321  
Comprehensive income (loss) (net of tax)
                                               
Net income (loss)
                      (181,913 )           (181,913 )
Foreign currency translation
                            (787 )     (787 )
Comprehensive income (loss) from equity method investees
                            333       333  
Allocation to Principals’ and others’ interests in equity of consolidated subsidiaries
                            1,454       1,454  
                                                 
Total comprehensive income (loss)
                                            (180,913 )
                                                 
Shareholders’ Equity — September 30, 2008
    94,609,525       312,071,550     $ 538,619     $ (373,004 )   $ 837     $ 166,452  
                                                 
 
See notes to consolidated and combined financial statements


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

CONSOLIDATED AND COMBINED STATEMENT OF CASH FLOWS (Unaudited)
(Dollars in thousands)
 
                 
    Nine Months Ended September 30,  
    2008     2007  
 
Cash Flows From Operating Activities
               
Net income (loss)
  $ (181,913 )     (30,545 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
               
Depreciation and amortization
    7,309       6,423  
Other amortization and accretion
    3,401       1,876  
(Earnings) losses from equity method investees
    113,550       23,289  
Distributions of earnings from equity method investees
    9,386       9,765  
(Gains) losses from investments
    44,671       727,971  
Deferred incentive income
    (36,003 )     (355,381 )
Principals’ and others’ interests in income (loss) of consolidated subsidiaries
    (612,692 )     (854,550 )
Deferred tax (benefit) expense
    (8,297 )     (16,775 )
Options received from affiliates
          (2,006 )
Assignments of options to employees
          4,627  
Equity-based compensation
    853,861       713,850  
Cash flows due to changes in
               
Cash held at consolidated subsidiaries and restricted cash
          (166,199 )
Due from affiliates
    90,724       214,558  
Receivables from brokers and counterparties and other assets
    (13,052 )     (23,024 )
Accrued compensation and benefits
    (93,466 )     92,475  
Due to affiliates
    (50 )     (6,392 )
Deferred incentive income
    26,077        
Due to brokers and counterparties and other liabilities
    30,076       118,098  
Investment company holdings
               
Purchases of investments
          (5,105,865 )
Proceeds from sale of investments
          3,398,739  
                 
Net cash provided by (used in) operating activities
    233,582       (1,249,066 )
                 
Cash Flows From Investing Activities
               
Purchase of other loan and security investments
          (10,578 )
Proceeds from sale of other loan and security investments
          317  
Contributions to equity method investees
    (135,036 )     (410,447 )
Distributions of capital from equity method investees
    211,162       115,190  
Proceeds from sale of equity method investments
          29,071  
Cash received on settlement of derivatives
          132  
Purchase of fixed assets
    (9,120 )     (8,907 )
Proceeds from disposal of fixed assets
    53       2,532  
                 
Net cash provided by (used in) investing activities
    67,059       (282,690 )
                 
Cash Flows From Financing Activities
               
Borrowings under debt obligations
    450,000       1,999,070  
Repayments of debt obligations
    (235,000 )     (2,010,025 )
Payment of deferred financing costs
    (5,020 )     (6,813 )
Issuance of Class A shares to Nomura
          888,000  
Issuance of Class A shares in initial public offering
          729,435  
Costs related to initial public offering
          (76,766 )
Dividends and dividend equivalents paid
    (81,026 )     (43,237 )
Fortress Operating Group capital distributions to Principals
          (219,112 )
Purchase of Fortress Operating Group units from Principals
          (888,000 )
Principals’ and others’ interests in equity of consolidated subsidiaries — contributions
    145       3,183,792  
Principals’ and others’ interests in equity of consolidated subsidiaries — distributions
    (270,897 )     (1,916,216 )
                 
Net cash provided by (used in) financing activities
    (141,798 )     1,640,128  
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    158,843       108,372  
Cash and Cash Equivalents, Beginning of Period
    100,409       61,120  
                 
Cash and Cash Equivalents, End of Period
  $ 259,252     $ 169,492  
                 
Supplemental Disclosure of Cash Flow Information
               
Cash paid during the period for interest (excluding interest paid by master funds while such funds were consolidated of $85.1 million in 2007)
  $ 26,084       70,003  
                 
Cash paid during the period for income taxes
  $ 7,184       30,158  
                 
Supplemental Schedule of Non-cash Investing and Financing Activities
               
Employee compensation invested directly in subsidiaries
  $ 22,861       59,403  
                 
Investments of receivable amounts into Fortress Funds
  $ 59,133       149,825  
                 
Dividends, dividend equivalents and Fortress Operating Group unit distributions declared but not yet paid
  $       43,009  
                 
Fortress Operating Group pre-IPO distributions of investments to Principals
  $       196,764  
                 
Fortress Operating Group pre-IPO distributions of investments to employees
  $       23,338  
                 
See Note 1 regarding the non-cash deconsolidation transaction in 2007
               
 
See notes to consolidated and combined financial statements


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
1.   ORGANIZATION AND BASIS OF PRESENTATION
 
Fortress Investment Group LLC (the “Registrant,” or, together with its subsidiaries, “Fortress”) is a global alternative asset management firm whose predecessor was founded in 1998. Its primary business is to sponsor the formation of, and provide investment management services for, various investment funds and companies (the “Fortress Funds”). Fortress generally makes principal investments in these funds.
 
Fortress has three primary sources of income from the Fortress Funds: management fees, incentive income, and investment income on its principal investments in the funds. The Fortress Funds fall into the following business segments in which Fortress operates:
 
1) Private equity funds:
 
a) Funds which make significant, control-oriented investments in debt and equity securities of public or privately held entities; and
 
b) Publicly traded alternative investment vehicles that Fortress refers to as the “Castles,” which are companies that invest primarily in real estate and real estate related debt investments.
 
2) Hedge funds:
 
a) Liquid hedge funds, which invest globally in fixed income, currency, equity and commodity markets, and their related derivatives; and
 
b) Hybrid hedge funds, which invest globally in diversified assets, opportunistic lending situations and securities through the capital structure, as well as investment funds managed by external managers.
 
3) Principal investments in the above described funds.
 
2007 Reorganization of Fortress Operating Group
 
Fortress Investment Group LLC was formed on November 6, 2006 for the purpose of becoming the general partner of Fortress Operating Group, completing the Nomura Transaction (described below), and effecting a public offering of shares and related transactions (the “Transactions”) in order to carry on the business of its predecessor, Fortress Operating Group, as a publicly traded entity. The Registrant is a limited liability company and its members are not responsible for any of its liabilities beyond the equity they have invested. Fortress’s formation documents allow for an indefinite life.
 
In December 2006, the Principals entered into a securities purchase agreement with Nomura Investment Managers U.S.A., Inc., or Nomura (whose ultimate parent is Nomura Holdings, Inc., a Japanese corporation). On January 17, 2007, Nomura completed the transaction (the “Nomura Transaction”) by purchasing 55,071,450 Class A shares of the Registrant for $888 million and the Registrant, in turn, purchased 55,071,450 Fortress Operating Group units, which then represented 15% of Fortress Operating Group’s economic interests, from the Principals for $888 million.
 
On February 8, 2007, the Registrant completed an initial public offering (“IPO”) of 39,428,900 of its Class A shares for net proceeds of approximately $652.7 million.
 
The accompanying consolidated and combined financial statements include the following:
 
  •  subsequent to Fortress’s reorganization and the inception of operations of Fortress Investment Group LLC on January 17, 2007, the accounts of Fortress Investment Group LLC and its consolidated subsidiaries, and


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
  •  prior to such reorganization and the inception of operations of Fortress Investment Group LLC, the accounts of eight affiliated entities under common control and management (“Fortress Operating Group” or the “predecessor”) and their respective consolidated subsidiaries. Each of the eight entities was owned either directly or indirectly by its members, Peter Briger, Wesley Edens, Robert Kauffman, Randal Nardone, and Michael Novogratz (the “Principals”).
 
2007 Consolidation and Deconsolidation of Fortress Funds
 
Certain of the Fortress Funds were consolidated into Fortress prior to the Transactions, notwithstanding the fact that Fortress has only a minority economic interest in these funds. Consequently, Fortress’s financial statements reflected the assets, liabilities, revenues, expenses and cash flows of the consolidated Fortress Funds on a gross basis through the date of their deconsolidation. The majority ownership interests in these funds, which are not owned by Fortress, were reflected as Principals’ and others’ interests in equity of consolidated subsidiaries in the accompanying financial statements during periods in which such funds were consolidated. The management fees and incentive income earned by Fortress from the consolidated Fortress Funds were eliminated in consolidation; however, Fortress’s allocated share of the net income from these funds was increased by the amount of these eliminated fees. Accordingly, the consolidation of these Fortress Funds had no net effect on Fortress’s earnings from the Fortress Funds.
 
Following the IPO, each Fortress subsidiary that acts as a general partner of a consolidated Fortress Fund granted rights, effective March 31, 2007, to the investors in the fund to provide that a simple majority of the fund’s unrelated investors are able to liquidate the fund, without cause, in accordance with certain procedures, or to otherwise have the ability to exert control over the fund. The granting of these rights has led to the deconsolidation of the Fortress Funds from Fortress’s financial statements as of March 31, 2007. The deconsolidation of the Fortress Funds has had significant effects on many of the items within these financial statements but has had no net effect on net income or equity. Since the deconsolidation did not occur until March 31, 2007, the statement of operations and the statement of cash flows for the nine months ended September 30, 2007 are presented with these funds on a consolidated basis for the period prior to the deconsolidation. The unaudited pro forma effects of the deconsolidation on these financial statements are described in Note 12 in order to provide more comparable information to 2008.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Financial Statement Guide
 
             
    Note
     
Selected Financial Statement Captions
  Reference    
Explanation
 
Balance Sheet
           
Due from Affiliates
    6     Generally, management fees and incentive income earned from Fortress Funds which are expected to be received in the short term.
Investments in Equity Method Investees
    3     The carrying value of Fortress’s principal investments in the Fortress Funds.
Options in Affiliates
    3     The fair value of common stock options received from the Castles.
Deferred Tax Asset
    5     Relates to tax benefits expected to be realized in the future.
Due to Affiliates
    6     Generally, amounts due to the Principals related to their interests in Fortress Operating Group and the tax receivable agreement.
Deferred Incentive Income
    2     Incentive income already received from certain Fortress Funds based on past performance, which is subject to contingent repayment based on future performance.
Debt Obligations Payable
    4     The balance outstanding on the credit agreement.
Principals’ and Others’ Interests in Equity of Consolidated Subsidiaries
    6     The GAAP basis of the Principals’ ownership interests in Fortress Operating Group as well as employees’ ownership interests in certain subsidiaries.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
             
    Note
     
Selected Financial Statement Captions
  Reference    
Explanation
 
Income Statement
           
             
Management Fees from Affiliates
    2     Fees earned for managing Fortress Funds, generally determined based on the size of such funds.
Incentive Income from Affiliates
    2     Income earned from Fortress Funds, based on the performance of such funds.
Compensation and Benefits
    7     Includes equity-based, profit-sharing and other compensation to employees.
Principals Agreement Compensation
    N/A     As a result of the principals agreement, the value of a significant portion of the Principals’ equity in Fortress prior to the Nomura Transaction is being recorded as an expense over a five year period. Fortress is not a party to this agreement. It is an agreement between the Principals to further incentivize them to remain with Fortress. This GAAP expense has no economic effect on Fortress or its shareholders.
Gains (Losses) from Other Investments
    N/A     Subsequent to the IPO, the result of asset dispositions or changes in the fair value of assets which are marked to market (primarily the Castles).
Earnings (Losses) from Equity Method Investees
    3     Fortress’s share of the net earnings (losses) of Fortress Funds resulting from its principal investments.
Principals’ and Others’ Interests in (Income) Loss of Consolidated Subsidiaries
    6     Primarily the Principals’ and employees’ share of Fortress’s earnings based on their ownership interests in subsidiaries, including Fortress Operating Group. This amount is recorded in order to provide a net income (loss) which relates only to Fortress’s Class A shareholders.
Income Tax Benefit (Expense)
    5     The net tax result related to the current period. Certain of Fortress’s revenues are not subject to taxes because they do not flow through taxable entities. Furthermore, Fortress has significant permanent differences between its GAAP and tax basis earnings.
Earnings Per Share
    8     GAAP earnings per share based on Fortress’s capital structure, which is comprised of outstanding and unvested equity interests, including interests which participate in Fortress’s earnings, at both the Fortress and subsidiary levels.

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
             
    Note
     
Selected Financial Statement Captions
  Reference    
Explanation
 
Other
           
Distributions
    8     A summary of dividends and distributions, and the related outstanding shares and units, is provided.
Distributable Earnings
    10     A presentation of our financial performance by segment (fund type) is provided, on the basis of the operating performance measure used by Fortress’s management committee.
 
The accompanying consolidated and combined financial statements and related notes of Fortress have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Fortress’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Fortress’s consolidated and combined financial statements for the year ended December 31, 2007 and notes thereto included in Fortress’s annual report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated and combined financial statements for the year ended December 31, 2007.
 
Certain prior period amounts have been reclassified to conform to the current period’s presentation.

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
2.   MANAGEMENT AGREEMENTS AND FORTRESS FUNDS
 
Management Fees and Incentive Income
 
Fortress recognized management fees and incentive income as follows:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007(A)  
 
Private Equity
                               
Funds
                               
Management fees — affil. 
  $ 44,221     $ 35,064     $ 128,626     $ 97,358  
Incentive income — affil. 
    509       105,632       38,684       317,574  
Castles
                               
Management fees — affil. 
    12,755       12,256       38,828       35,251  
Management fees, options — affil. 
                      2,006  
Incentive income — affil. 
          691       12       18,596  
Hedge Funds
                               
Liquid Hedge Funds
                               
Management fees — affil. 
    59,530       44,319       169,721       112,381  
Incentive income — affil. 
    47       (640 )     16,885       157,559  
Management fees — non-affil.(B)
    110       32       246       311  
Incentive income — non-affil.(B)
    36       431       240       431  
Hybrid Hedge Funds
                               
Management fees — affil. 
    37,760       33,352       110,753       93,032  
Incentive income — affil. 
    162       1,007       581       1,832  
Management fees — non-affil.(B)
    270       24       730       83  
Incentive income — non-affil.(B)
    13,094             13,094        
Total
                               
Management fees — affil. 
  $ 154,266     $ 124,991     $ 447,928     $ 340,028  
Incentive income — affil.(C)
  $ 718     $ 106,690     $ 56,162     $ 495,561  
Management fees — non-affil.(B)
  $ 380     $ 56     $ 976     $ 394  
Incentive income — non-affil.(B)
  $ 13,130     $ 431     $ 13,334     $ 431  
 
 
(A) Presented on a pro forma basis (Note 12), as adjusted for the deconsolidation of the Fortress Funds as if it had occurred on January 1, 2007.
 
(B) Included in Other Revenues on the statement of operations.
 
(C) See “Deferred Incentive Income” below.
 
Deferred Incentive Income
 
Incentive income from certain Fortress Funds, primarily private equity funds, is received when such funds realize profits, based on the related agreements. However, this incentive income is subject to contingent repayment by Fortress to the funds until certain overall fund performance criteria are met. Accordingly, Fortress does not


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
recognize this incentive income as revenue until the related contingencies are resolved. Until such time, this incentive income is recorded on the balance sheet as deferred incentive income and is included as “distributed-unrecognized” deferred incentive income in the table below. Incentive income from such funds, based on their net asset value, which has not yet been received is not recorded on the balance sheet and is included as “undistributed” deferred incentive income in the table below.
 
Incentive income from certain Fortress Funds, primarily hybrid hedge funds, is earned based on achieving annual performance criteria. Accordingly, this incentive income is recorded as revenue at year end (in the fourth quarter of each year), is generally received subsequent to year end, and has not been recognized for these funds during the nine months ended September 30, 2008 and 2007. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $0.0 million and $92.0 million of additional incentive income from affiliates would have been recognized during the nine months ended September 30, 2008 and 2007, respectively. Incentive income based on achieving annual performance criteria that has not yet been recognized is not recorded on the balance sheet and is included as “undistributed” deferred incentive income in the table below.
 
Deferred incentive income from the Fortress Funds, subject to contingent repayment, was comprised of the following, on an inception to date basis:
 
                                 
    Distributed-
    Distributed-
    Distributed-
    Undistributed, net
 
    Gross     Recognized(A)     Unrecognized(B)     (C)(D)  
 
Deferred incentive income as of December 31, 2007
  $ 444,721     $ (271,160 )   $ 173,561     $ 384,520  
Share of income (loss) of Fortress Funds
    26,077             26,077       (313,058 )
Recognition of previously deferred incentive income
          (36,003 )     (36,003 )      
                                 
Deferred incentive income as of September 30, 2008
  $ 470,798     $ (307,163 )   $ 163,635     $ 71,462  
                                 
 
 
(A) All related contingencies have been resolved.
 
(B) Reflected on the balance sheet.
 
(C) On a deconsolidated basis, subsequent to March 31, 2007, undistributed incentive income is no longer recorded and is not reflected on the balance sheet. At September 30, 2008, the undistributed incentive income is comprised of $155.0 million of gross undistributed incentive income, net of $83.5 million of previously distributed incentive income that would be returned by Fortress to the related funds if such funds were liquidated on September 30, 2008 at their net asset values.
 
(D) From inception to September 30, 2008, Fortress has recognized and paid compensation expense under its employee profit sharing arrangements (Note 7) in connection with the $470.8 million of distributed incentive income. If the $71.5 million of undistributed incentive income were realized, Fortress would recognize and pay an additional $30.4 million of compensation expense.
 
Private Equity Funds
 
In 2008, Fortress made an additional $100 million commitment to Fund V. Fortress’s affiliates, including employees and the Principals, made additional commitments to this fund of $67.3 million at the same time.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
During the nine months ended September 30, 2008, Fortress formed new private equity funds which had capital commitments as follows:
 
         
Fortress’s commitments
  $ 48,328  
Fortress’s affiliates’ commitments
    87,963  
Third party investors’ commitments
    3,966,006  
         
Total capital commitments
  $ 4,102,297  
         
 
Unrealized losses in a significant portion of Fortress’s private equity funds have resulted in higher future returns being required before Fortress earns incentive income from such funds.
 
Liquid Hedge Funds and Hybrid Hedge Funds
 
During the nine months ended September 30, 2008, Fortress formed new hedge funds with net asset values as follows:
 
                 
    September 30, 2008 NAV  
    Liquid     Hybrid  
 
Fortress(A)
  $ 1,265     $  
Fortress’s affiliates
    497,654        
Third party investors
    1,369,993        
                 
Total NAV
  $ 1,868,912     $  
                 
 
 
(A) Includes a third quarter incentive income allocation of $159,000.
 
As of September 30, 2008, the liquid hedge funds had received redemption notices totaling $0.9 billion which were paid in October 2008 (subject to certain holdbacks).
 
As a result of not meeting the incentive income thresholds with respect to current investors, the incentive income from a significant portion of the capital invested in Fortress’s hybrid and liquid hedge funds has been discontinued for an indeterminate period of time. Returns earned on capital from new investors continue to be incentive income eligible.
 
3.   INVESTMENTS IN EQUITY METHOD INVESTEES AND OTHER EQUITY INVESTMENTS
 
Fortress elected to record its investments in and options from Newcastle and Eurocastle at fair value pursuant to SFAS 159 (“The Fair Value Option For Financial Assets and Financial Liabilities”) beginning January 1, 2008. Fortress made this election to simplify its accounting for these publicly traded equity securities (and related options), which were previously recorded based on the equity method of accounting. As a result, Fortress recorded an aggregate increase to the carrying amounts of these assets of $22.9 million, which was recorded as a cumulative effect adjustment to retained earnings ($2.1 million) and also impacted the Principals’ interests in the equity of consolidated subsidiaries (Fortress Operating Group) ($17.6 million), deferred tax assets ($1.9 million), and accumulated other comprehensive income ($1.2 million). Fortress accounts for dividends received from these investments as dividend income, a component of Other Revenues.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Investments in Equity Method Investees
 
Fortress holds investments in certain unconsolidated Fortress Funds which are recorded based on the equity method of accounting. Upon the deconsolidation of the consolidated Fortress Funds on March 31, 2007 (Note 1), these funds also became equity method investees. Fortress’s maximum exposure to loss with respect to these entities is generally equal to its investment plus its basis in any options received from such entities as described below, plus any receivables from such entities as described in Note 6. In addition, unconsolidated affiliates also hold ownership interests in certain of these entities. Summary financial information related to these investments is as follows:
 
                                                 
                Fortress’s Equity in Net Income (Loss)  
    Fortress’s Investment     Three Months Ended September 30,     Nine Months Ended September 30,  
    September 30,
    December 31,
                         
    2008     2007     2008     2007     2008     2007  
 
Private equity funds, excluding NIH(A)
  $ 667,180     $ 623,830     $ (6,309 )   $ (33,658 )   $ (74,606 )   $ (41,682 )
NIH
    4,523       5,770       (9 )     4,019       872       2,995  
Newcastle(B)
    6,513       3,184       N/A       (412 )     N/A       777  
Eurocastle(B)
    4,150       11,799       N/A       1,487       N/A       1,398  
                                                 
Total private equity
    682,366       644,583       (6,318 )     (28,564 )     (73,734 )     (36,512 )
Liquid hedge funds(A)
    32,535       73,748       (3,668 )     (3,801 )     (3,117 )     192  
Hybrid hedge funds(A)
    232,166       371,310       (27,940 )     1,649       (36,715 )     12,984  
Other
    2,642       2,277       5             16       47  
                                                 
    $ 949,709     $ 1,091,918     $ (37,921 )   $ (30,716 )   $ (113,550 )   $ (23,289 )
                                                 
 
 
(A) These entities were consolidated prior to March 31, 2007.
 
(B) Fortress elected to record these investments at fair value pursuant to SFAS 159 beginning on January 1, 2008.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
A summary of the changes in Fortress’s investments in equity method investees is as follows:
 
                                                                 
    Nine Months Ended September 30, 2008  
    Private Equity Funds     Castles(A)     Liquid
    Hybrid
             
    NIH     Other     Newcastle     Eurocastle     Hedge Funds     Hedge Funds     Other     Total  
 
Investment, beginning
  $ 5,770     $ 623,830     $ 3,184     $ 11,799     $ 73,748     $ 371,310     $ 2,277     $ 1,091,918  
Earnings from equity method investees
    872       (74,606 )     N/A       N/A       (3,117 )     (36,715 )     16       (113,550 )
Other comprehensive income from equity method investees
    (17 )     3,309       N/A       N/A                         3,292  
Contributions to equity method investees
          134,511       N/A       N/A       59,037       262       359       194,169  
Distributions of earnings from equity method investees
    (2,102 )     (7,021 )     N/A       N/A       (253 )           (10 )     (9,386 )
Distributions of capital from equity method investees
          (11,706 )     N/A       N/A       (96,880 )     (102,691 )           (211,277 )
                                                                 
Total distributions from equity method investees
    (2,102 )     (18,727 )     N/A       N/A       (97,133 )     (102,691 )     (10 )     (220,663 )
                                                                 
Sale of investments
          (1,137 )                                   (1,137 )
Mark to fair value — January 1, 2008(B)
    N/A       N/A       10,110       12,762       N/A       N/A       N/A       22,872  
Mark to fair value — during period(C)
    N/A       N/A       (6,781 )     (21,524 )     N/A       N/A       N/A       (28,305 )
Translation adjustment
                      1,113                         1,113  
                                                                 
Investment, ending
  $ 4,523     $ 667,180     $ 6,513     $ 4,150     $ 32,535     $ 232,166     $ 2,642     $ 949,709  
                                                                 
Ending balance of undistributed earnings
  $     $       N/A       N/A     $ 75     $ 1,066     $ 6     $ 1,147  
                                                                 
 
 
(A) Fortress elected to record these investments at fair value pursuant to SFAS 159 beginning on January 1, 2008.
 
(B) Recorded as a cumulative effect adjustment as described above.
 
(C) Recorded to Other Investments — Net Unrealized Gains (Losses) from Affiliate Investments.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
The ownership percentages presented in the following tables are reflective of the ownership interests held as of the end of the respective periods. For tables which include more than one Fortress Fund, the ownership percentages are based on a weighted average by total equity of the funds as of period end.
 
                                 
    Private Equity Funds Excluding NIH(C)     Newcastle Investment Holdings LLC (“NIH”)  
    September 30,
    December 31,
    September 30,
    December 31,
 
    2008     2007     2008     2007  
 
Assets
  $ 17,091,841     $ 16,982,495     $ 299,219     $ 336,176  
Liabilities
    (2,711,408 )     (3,445,658 )     (218,648 )     (230,457 )
                                 
Equity
  $ 14,380,433     $ 13,536,837     $ 80,571     $ 105,719  
                                 
Fortress’s Investment
  $ 667,180     $ 623,830     $ 4,523     $ 5,770  
                                 
Ownership(A)
    4.6 %     4.6 %     4.8 %     4.8 %
                                 
 
                                 
    Nine Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Revenues and gains (losses) on investments
  $ (3,325,753 )   $ (3,329,819 )   $ 35,773     $ 93,918  
Expenses
    (345,364 )     (194,551 )     (16,808 )     (22,962 )
                                 
Net Income (Loss)
  $ (3,671,117 )   $ (3,524,370 )   $ 18,965     $ 70,956  
                                 
Fortress’s equity in net income (loss)
  $ (74,606 )   $ (41,682 )   $ 872     $ 2,995  
                                 
              (B )                
 
 
(A) Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates.
 
(B) The revenues and expenses of these entities were consolidated through March 31, 2007, the effective date of the deconsolidation (Note 1). As a result, the amounts shown for Fortress’s equity in net income of these entities relate to the period subsequent to March 31, 2007.
 
(C) Includes one entity which is recorded on a one quarter lag (i.e. the balances reflected for this entity are for June 30, 2008 and the period then ended). It is recorded on a lag because it is a German entity and does not provide financial reports under U.S. GAAP within the reporting timeframe necessary for U.S. public entities. During the quarter ended September 30, 2008, this entity had a significant revenue realization event. Fortress’s share of this revenue was $11.9 million, which will be recorded by Fortress in the fourth quarter of 2008.
 


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                                 
    Newcastle Investment Corp.     Eurocastle Investment Ltd.  
    September 30,
    December 31,
    September 30,
    December 31,
 
    2008     2007     2008     2007  
 
Assets
  $ 5,785,226     $ 8,037,770     $ 9,302,638     $ 10,713,687  
Liabilities
    (6,125,327 )     (7,590,145 )     (8,036,326 )     (8,865,921 )
Minority interest
                (8 )     (8 )
                                 
Equity
  $ (340,101 )   $ 447,625     $ 1,266,304     $ 1,847,758  
                                 
Ownership, basic(A)
    1.9 %     1.9 %     1.7 %     1.6 %
                                 
Ownership, diluted(A)(B)
    4.8 %     4.7 %     10.3 %     9.8 %
                                 
Ownership by Fortress and affiliates, diluted(B)
    15.1 %     15.5 %     31.3 %     29.3 %
                                 
Market value of shares owned(A)(C)
  $ 6,513     $ 13,293     $ 4,150     $ 24,561  
                                 
 
                                 
    Nine Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Revenues and gains (losses) on investments
  $ 361,461     $ 543,369     $ 589,854     $ 552,586  
Expenses
    (268,053 )     (505,690 )     (656,097 )     (542,100 )
Other income (loss)
    (355,968 )           47,911       65,846  
Discontinued operations
    (8,724 )     (2 )            
Preferred dividends
    (10,126 )     (9,265 )            
                                 
Net Income (Loss)
  $ (281,410 )   $ 28,412     $ (18,332 )   $ 76,332  
                                 
Fortress’s equity in net income (loss)
    N/A     $ 777       N/A     $ 1,398  
                                 
 
 
(A) Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates.
 
(B) Fully diluted ownership represents the percentage of outstanding common shares assuming that all options are exercised. Currently, all of the options are out of the money (that is, their strike price is below the current market price per share).
 
(C) Based on the closing price of the related shares and, if applicable, the foreign currency exchange rate on the last day of trading in the applicable period.
 
                                 
    Liquid Hedge Funds     Hybrid Hedge Funds  
    September 30,
    December 31,
    September 30,
    December 31,
 
    2008     2007     2008     2007  
 
Assets
  $ 9,761,791     $ 8,358,378     $ 12,674,623     $ 12,098,175  
Liabilities
    (1,012,898 )     (67,483 )     (4,606,119 )     (4,493,901 )
Minority Interest
                (30,299 )     (26,834 )
                                 
Equity
  $ 8,748,893     $ 8,290,895     $ 8,038,205     $ 7,577,440  
                                 
Fortress’s Investment
  $ 32,535     $ 73,748     $ 232,165     $ 371,310  
                                 
Ownership(A)
    0.4 %     0.9 %     2.9 %     4.9 %
                                 
 

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                                 
    Nine Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Revenues and gains (losses) on investments
  $ (716,901 )   $ 1,092,573     $ (485,557 )   $ 720,455  
Expenses
    (490,442 )     (710,854 )     (312,522 )     (255,716 )
                                 
Net Income
  $ (1,207,343 )   $ 381,719     $ (798,079 )   $ 464,739  
                                 
Fortress’s equity in net income (loss)
  $ (3,117 )   $ 192     $ (36,715 )   $ 12,984  
                                 
              (B )             (B )
 
 
(A) Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates.
 
(B) The revenues and expenses of these entities were consolidated through March 31, 2007, the effective date of the deconsolidation (Note 1). As a result, the amounts shown for Fortress’s equity in net income of these entities relate to the period subsequent to March 31, 2007.
 
Options in Affiliates
 
Fortress holds options to purchase additional shares of its equity method investees with carrying values as follows:
 
                         
    September 30,
    December 31,
       
    2008     2007    
Accounting Treatment
 
 
Newcastle options
  $ 33     $ 5       Recorded at fair value  
Eurocastle options
    104       15,996       Recorded at fair value  
                         
    $ 137     $ 16,001          
                         
 
Investments in Variable Interest Entities
 
As part of the deconsolidation of the consolidated Fortress Funds (Note 1), Fortress caused reconsideration events to occur in each of the variable interest entities in which it was deemed to be the primary beneficiary. As a result of these reconsideration events, Fortress is no longer considered the primary beneficiary of, and therefore does not consolidate, any of the variable interest entities in which it holds an interest. No reconsideration events occurred during the nine months ended September 30, 2008 which caused a change in Fortress’s accounting.
 
The following table presents information as of September 30, 2008 regarding entities formed during the nine months ended September 30, 2008 that were determined to be VIEs in which Fortress holds a variable interest. The amounts presented below are included in, and not in addition to, the equity method investment tables above.
 
                         
    Fortress is not Primary Beneficiary        
Business Segment
  Gross Assets     Fortress Investment(A)     Notes  
 
Private Equity Funds
  $ 1,154,601     $ 8,013       (B )
Liquid Hedge Funds
  $ 315,747     $ 85          
 
 
(A) Represents Fortress’s maximum exposure to loss with respect to these entities, which includes direct and indirect investments in the funds.
 
(B) Fortress’ investment includes $0.1 million of management fees receivable from the Private Equity Funds.

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
Fair Value of Financial Instruments
 
The following table presents information regarding Fortress’s financial instruments which are recorded at fair value:
 
             
    September 30,
     
    2008 Fair Value    
Valuation Method
 
Assets — Carried at Fair Value
           
Newcastle and Eurocastle common shares
  $ 10,663     Level 1 — Quoted prices in active markets for identical assets
Newcastle and Eurocastle options
  $ 137     Level 2 — Lattice-based option valuation models using significant observable inputs
 
4.   DEBT OBLIGATIONS
 
The following table presents information regarding Fortress’s debt obligations:
 
                                                         
                                  September 30, 2008  
          Face Amount and
                Weighted
    Weighted
 
          Carrying Value     Contractual
    Final
    Average
    Average
 
    Month
    September 30,
    December 31,
    Interest
    Stated
    Funding
    Maturity
 
Debt Obligation
  Issued     2008     2007     Rate     Maturity     Cost(A)     (Years)  
 
Credit agreement(B)
                                                       
Revolving debt(C)
    May 2007     $     $ 185,000       LIBOR + 0.85 %(D)     May 2012       0.00 %     N/A  
Term loan
    May 2007       350,000       350,000       LIBOR + 0.85 %     May 2012       4.52 %     3.61  
Delayed term loan
    May 2007       400,000             LIBOR + 0.85 %     May 2012       4.55 %     1.47  
                                                         
Total
          $ 750,000     $ 535,000                       4.54 %     2.47  
                                                         
 
 
(A) The weighted average funding cost is calculated based on the contractual interest rate (utilizing the most recently reset LIBOR rate) plus the amortization of deferred financing costs. The most recently reset LIBOR rate was 3.19%.
 
(B) Collateralized by substantially all of Fortress Operating Group’s assets as well as Fortress Operating Group’s rights to fees from the Fortress Funds and its equity interests therein.
 
(C) Approximately $189 million was undrawn under the revolving debt facility as of September 30, 2008, including a $25 million letter of credit subfacility of which $11 million was utilized. However, as a result of the amendments described in Note 11, the aggregate amount of revolving credit facility commitments has been reduced from $200 million to $125 million. In addition, Lehman Brothers Commercial Paper, Inc., which is committed to fund $11.9 million of the $125 million revolving credit facility, has filed for bankruptcy protection, and it is reasonably possible that it will not fund its portion of the commitments. As a result, approximately $102 million of the undrawn amount is currently available.
 
(D) Subject to unused commitment fees of 0.25% per annum.
 
In connection with the repayment of a portion of a prior term loan, $2.0 million of deferred loan costs were written off to interest expense in February 2007. In May 2007, Fortress entered into a new credit agreement to refinance its existing credit agreement, reduce the amount of interest and other fees payable under its credit facilities, and increase the amount of funds available for investments.


18


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
On April 17, 2008, Fortress entered into an amendment to its credit agreement. The amendment, among other things, (i) permits Fortress to issue an unlimited amount of subordinated indebtedness with specified terms so long as 40% of the net proceeds are used to repay amounts outstanding under the credit agreement, (ii) increased the applicable rate on Eurodollar loans and letters of credit by 20 basis points (making the current rate LIBOR plus 0.85%) and the undrawn commitment fee by 5 basis points (making the current fee 0.25%), (iii) added an amortization schedule requiring Fortress to repay $100 million of amounts outstanding under the agreement each year during the next three years (with the first payment due on January 15, 2009), (iv) modified the financial covenants by (a) replacing the EBITDA-based financial covenant with a Consolidated Leverage Ratio covenant, (b) increasing the minimum amount of management fee earning assets by $3 billion to $21.5 billion (which minimum amount increases annually by $500 million) and (c) eliminating the annual $50 million increase in required minimum investment assets, and (v) revised various definitions and clarified terms with respect to swap providers who are lenders under the agreement. In connection with this amendment, Fortress incurred $4.9 million of deferred loan costs which were recorded in Other Assets. In addition, on May 29, 2008, Fortress entered into an amendment to its credit agreement to change from a co-borrower structure to a single borrower structure.
 
On November 12, 2008, Fortress entered into an amendment to its credit agreement as described in Note 11.
 
Fortress was in compliance with all of its debt covenants as of September 30, 2008.
 
5.   INCOME TAXES AND TAX RELATED PAYMENTS
 
For the nine months ended September 30, 2008, an estimated annual effective tax rate of 0.18% was used to compute the tax provision. Fortress incurred a loss before income taxes for financial reporting purposes, after deducting the compensation expense arising from the Principals’ forfeiture agreement. However, this compensation expense is not deductible for income tax purposes. Also, a portion of Fortress’s income is not subject to U.S. federal income tax, but is allocated directly to Fortress’s shareholders.
 
The provision for income taxes consists of the following:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Current
                               
Federal income tax
  $ (3,310 )   $ 5,016     $ (1,316 )   $ 10,071  
Foreign income tax
    891       620       2,090       1,686  
State and local income tax
    1,646       1,688       7,190       11,794  
                                 
      (773 )     7,324       7,964       23,551  
                                 
Deferred
                               
Federal income tax expense (benefit)
    (2,506 )     (12,716 )     (2,526 )     (1,648 )
Foreign income tax expense (benefit)
    (281 )     (57 )     (101 )     (790 )
State and local income tax expense (benefit)
    (2,076 )     (6,770 )     (5,670 )     (13,876 )
                                 
      (4,863 )     (19,543 )     (8,297 )     (16,314 )
                                 
Total expense (benefit)
  $ (5,636 )   $ (12,219 )   $ (333 )   $ 7,237  
                                 


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
The tax effects of temporary differences have resulted in deferred income tax assets and liabilities as follows:
 
                 
    September 30,
    December 31,
 
    2008     2007  
 
Deferred tax assets
  $ 517,578     $ 511,204  
                 
Deferred tax liabilities(A)
  $ 644     $ 891  
                 
 
 
(A) Included in Other Liabilities
 
For the nine months ended September 30, 2008, a deferred income tax provision of $0.2 million was credited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $2.1 million was credited to additional paid in capital, related to (i) dividend equivalent payments on RSU’s (Note 7), and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 7), which are currently deductible for income tax purposes.
 
Tax Receivable Agreement
 
Although the tax receivable agreement payments are calculated based on annual tax savings, for the nine months ended September 30, 2008, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $12.7 million.
 
6.   RELATED PARTY TRANSACTIONS AND INTERESTS IN CONSOLIDATED SUBSIDIARIES
 
Due from affiliates was comprised of the following:
 
                                                 
    Private Equity
          Liquid Hedge
    Hybrid Hedge
             
    Funds     Castles     Funds     Funds     Other     Total  
 
September 30, 2008
                                               
Management fees and incentive income
  $ 15,794     $ 6,401     $ 418     $ 2,350     $     $ 24,963  
Expense reimbursements
    4,324       3,782       3,899       3,460             15,465  
Dividends and distributions
          257                         257  
Other
    6,583                   273       1,888       8,744  
                                                 
Total
  $ 26,701     $ 10,440     $ 4,317     $ 6,083     $ 1,888     $ 49,429  
                                                 
 
                                                 
    Private Equity
          Liquid Hedge
    Hybrid Hedge
             
    Funds     Castles     Funds     Funds     Other     Total  
 
December 31, 2007
                                               
Management fees and incentive income
  $ 1,733     $ 45,004     $ 40,751     $ 98,197     $     $ 185,685  
Expense reimbursements
    1,307       2,051       3,074       3,487             9,919  
Dividends and distributions
          739                         739  
Other
                      1       2,325       2,326  
                                                 
Total
  $ 3,040     $ 47,794     $ 43,825     $ 101,685     $ 2,325     $ 198,669  
                                                 


20


Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Due to affiliates was comprised of the following:
 
                 
    September 30,
    December 31,
 
    2008     2007  
 
Principals
               
— Tax receivable agreement — Note 5
  $ 393,595     $ 393,265  
— Distributions payable on Fortress Operating Group units
          60,176  
Other
    1,913       2,293  
                 
    $ 395,508     $ 455,734  
                 
 
For the nine months ended September 30, 2008 and 2007, Other Revenues included approximately $44.6 million and $32.3 million, respectively, of revenues from affiliates, primarily expense reimbursements. Dividend income from affiliates of approximately $1.7 million was recorded during the nine months ended September 30, 2008.
 
Fortress has entered into cost sharing arrangements with the Fortress Funds, including market data services and subleases of certain of its office space. Expenses borne by the Fortress Funds under these agreements are generally paid directly by those entities (i.e. they are generally not paid by Fortress and reimbursed). For the nine months ended September 30, 2008 and 2007, these expenses, mainly related to subscriptions to market data services, approximated $15.6 million and $14.9 million, respectively.
 
In July 2008, three of the Principals invested an aggregate of $14.4 million in preferred equity interests of a subsidiary of one of the private equity Fortress Funds. The preferred equity does not pay a dividend.
 
Principals’ and Others’ Interests in Consolidated Subsidiaries
 
These amounts relate to equity interests in Fortress’s consolidated, but not wholly owned, subsidiaries, which are held by the Principals, employees and others.
 
This balance sheet caption was comprised of the following:
 
                 
    September 30,
    December 31,
 
    2008     2007  
 
Principals’ Fortress Operating Group units
  $ 139,489     $ 232,826  
Employee interests in majority owned and controlled fund advisor and general partner entities
    35,189       75,062  
Other
    176       135  
                 
Total
  $ 174,854     $ 308,023  
                 


21


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
This statement of operations caption was comprised of shares of consolidated net income (loss) related to the following, on a pre-tax basis:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008 Actual     2007 Actual     2008 Actual     2007 Actual  
 
Principals’ Fortress Operating Group units
  $ (208,169 )   $ (154,893 )   $ (611,760 )   $ (402,294 )
Employee interests in majority owned and controlled fund advisor and general partner entities
    (1,843 )     2,359       (1,401 )     8,359  
Third party investors in Fortress Funds(A)
                      (460,615 )
Other
                469        
                                 
Total
  $ (210,012 )   $ (152,534 )   $ (612,692 )   $ (854,550 )
                                 
 
 
(A) Prior to the deconsolidation (Note 1) on March 31, 2007.
 
7.   EQUITY-BASED AND OTHER COMPENSATION
 
Fortress’s total compensation and benefits expense, excluding Principals Agreement compensation, is comprised of the following:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Equity-based compensation, per below
  $ 57,755     $ 36,570     $ 139,152     $ 100,870  
Profit-sharing expense, per below
    8,158       9,857       49,866       234,868  
Discretionary bonuses
    35,737       29,838       109,793       82,897  
Other payroll, taxes and benefits
    33,124       25,438       100,442       88,368  
                                 
    $ 134,774     $ 101,703     $ 399,253     $ 507,003  
                                 
 
Equity-Based Compensation
 
The following tables present information regarding equity-based compensation during the nine months ended September 30, 2008.
 
                                                                 
    RSUs     Restricted Shares
    RPUs  
    Employees     Non-Employees     Issued to Directors     Employees  
    Number     Value(A)     Number     Value(A)     Number     Value(A)     Number     Value(A)  
 
Outstanding as of December 31, 2007
    43,215,535     $ 16.74       9,318,968     $ 15.22       97,296     $ 18.50           $  
Issued
    2,175,184       10.57       394,404       9.38       11,878       11.72       31,000,000       13.75  
Forfeited
    (1,874,192 )     17.47       (753,412 )     14.54                          
                                                                 
Outstanding as of September 30, 2008(B)
    43,516,527     $ 16.40       8,959,960     $ 15.02       109,174     $ 17.76       31,000,000     $ 13.75  
                                                                 
 


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Expense incurred(B)
                               
Employee RSUs
  $ 29,088     $ 28,265     $ 82,997     $ 82,280  
Non-Employee RSUs
    3,970       5,300       9,381       13,778  
Restricted Shares
    151       152       450       385  
LTIP
    1,733       2,853       5,162       4,427  
RPUs
    22,813             41,162        
                                 
Total equity-based compensation expense
  $ 57,755     $ 36,570     $ 139,152     $ 100,870  
                                 
 
 
(A) Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of September 30, 2008 for RSU awards granted to non-employees was $9.78.
 
(B) In future periods, Fortress will recognize compensation expense on its non-vested equity based awards of $968.2 million, with a weighted average recognition period of 4.4 years. This does not include amounts related to the Principals Agreement.
 
In April 2008, Fortress granted 31 million Fortress Operating Group (“FOG”) restricted partnership units (“RPUs”) to a senior employee. In connection with the grant of these interests, the employee receives partnership distribution equivalent payments on such units with economic effect as from January 1, 2008. The interests will vest into full capital interests in FOG units in three equal portions on the first business day of 2011, 2012 and 2013, respectively, subject to continued employment with Fortress. In connection with this grant, Fortress has reduced the employee’s profit sharing interests in various Fortress Funds.
 
When Fortress records equity-based compensation expense, including that related to the Principals Agreement, it records a corresponding increase in capital. Of the total increase in capital during the nine months ended September 30, 2008 from equity-based compensation arrangements of $853.9 million, $198.5 million increased Fortress’s paid-in capital, as reflected in the Statement of Shareholders’ Equity, and $655.4 million increased Principals’ interests in equity of consolidated subsidiaries, corresponding to the Principals’ interest in the equity-based compensation expense.
 
Profit Sharing Expense
 
Recognized profit sharing compensation expense is summarized as follows:
 
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Private equity funds(A)
  $ (5,412 )   $ 1,556     $ (2,868 )   $ 94,001  
Castles
    1,248       1,155       3,589       8,029  
Liquid hedge funds
    5,455       1,629       38,572       89,075  
Hybrid hedge funds
    6,867       5,517       10,573       43,763  
                                 
Total
  $ 8,158     $ 9,857     $ 49,866     $ 234,868  
                                 
 
 
(A) Negative amounts reflect the reversal of previously accrued profit sharing expense resulting from the determination that this expense is no longer probable of being incurred.

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Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
8.   EARNINGS PER SHARE AND DISTRIBUTIONS
 
Our potentially dilutive equity instruments fall primarily into two general categories: (i) instruments that we have issued as part of our compensation plan, and (ii) ownership interests in our subsidiary, Fortress Operating Group, that are owned by the Principals and are convertible into Class A shares. Based on the rules for calculating earnings per share, there are two general ways to measure dilution for a given instrument: (a) calculate the net number of shares that would be issued assuming any related proceeds are used to buy back outstanding shares (the treasury stock method), or (b) assume the gross number of shares are issued and calculate any related effects on net income available for shareholders (the if-converted and two-class methods). Fortress has applied these methods as prescribed by the rules to each of its outstanding equity instruments as shown below.
 
As a result of Fortress’s reorganization in January 2007 (Note 1), Fortress has calculated its earnings per share for two different periods within the nine months ended September 30, 2007. For the first period, prior to the reorganization on January 17, 2007, the calculation is based on the income and outstanding units of Fortress Operating Group, which were owned by the Principals, as if such units had been outstanding from the beginning of the period. For the second period, subsequent to the reorganization and commencement of operations of the Registrant, the calculation is based on the consolidated income of Fortress from January 17, 2007 through September 30, 2007 and the Class A shares outstanding for such period.
 
The computations of net income per Fortress Operating Group unit, prior to the reorganization, are set forth below:
 
                 
    January 1 through January 16, 2007  
    Basic     Diluted  
 
Weighted average units outstanding
               
Fortress Operating Group units outstanding
    367,143,000       367,143,000  
                 
Total weighted average units outstanding
    367,143,000       367,143,000  
                 
Net income per unit is calculated as follows:
               
Net income
  $ 133,397     $ 133,397  
Dilution in earnings of certain equity method investees
           
                 
Net income available to Fortress Operating Group unitholders
  $ 133,397     $ 133,397  
                 
Weighted average units outstanding
    367,143,000       367,143,000  
                 
Net income per unit
  $ 0.36     $ 0.36  
                 


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Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
The computations of basic and diluted net income (loss) per Class A share, subsequent to the reorganization, are set forth below:
 
                                 
          January 17
 
    Three Months Ended September 30, 2007     through September 30, 2007  
    Basic     Diluted     Basic     Diluted  
 
Weighted average shares outstanding
                               
Class A shares outstanding
    94,500,350       94,500,350       90,971,694       90,971,694  
Fully vested restricted Class A share units with dividend equivalent rights
    394,286       394,286       283,825       283,825  
Fortress Operating Group units exchangeable into Fortress Investment Group LLC Class A shares(1)
          312,071,550              
Class A restricted shares and Class A restricted share units granted to employees and directors (eligible for dividend and dividend equivalent payments)(2)
                       
Class A restricted share units granted to employees (not eligible for dividend and dividend equivalent payments)(3)
                       
                                 
Total weighted average shares outstanding
    94,894,636       406,966,186       91,255,519       91,255,519  
                                 
Basic and diluted net income (loss) per Class A share
                               
Net income (loss)
  $ (37,557 )   $ (37,557 )   $ (163,942 )   $ (163,942 )
Dividend equivalents declared on non-vested restricted Class A share units
    (1,125 )     (1,125 )     (2,742 )     (2,742 )
Dilution in earnings of certain equity method investees
                       
Add back Principals’ and others’ interests in loss of Fortress Operating Group, net of assumed corporate income tax at enacted rates, attributable to Fortress Operating Group units exchangeable into Fortress Investment Group LLC Class A shares(1)
          (173,093 )            
                                 
Net income (loss) available to Class A shareholders
  $ (38,682 )   $ (211,775 )   $ (166,684 )   $ (166,684 )
                                 
Weighted average shares outstanding
    94,894,636       406,966,186       91,255,519       91,255,519  
                                 
Basic and diluted net income (loss) per Class A share
  $ (0.41 )   $ (0.52 )   $ (1.83 )   $ (1.83 )
                                 
 


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30, 2008     September 30, 2008  
    Basic     Diluted     Basic     Diluted  
 
Weighted average shares outstanding
                               
Class A shares outstanding
    94,500,351       94,500,351       94,500,351       94,500,351  
Fully vested restricted Class A share units with dividend equivalent rights
    394,286       394,286       394,286       394,286  
Fully vested restricted Class A shares
    43,797       43,797       21,029       21,029  
Fortress Operating Group units exchangeable into Fortress Investment Group LLC Class A shares(1)
          312,071,550             312,071,550  
Class A restricted shares and Class A restricted share units granted to employees and directors (eligible for dividend and dividend equivalent payments)(2)
                       
Class A restricted share units granted to employees (not eligible for dividend and dividend equivalent payments)(3)
                       
                                 
Total weighted average shares outstanding
    94,938,434       407,009,984       94,915,666       406,987,216  
                                 
Basic and diluted net income (loss) per Class A share
                               
Net income (loss)
  $ (57,440 )   $ (57,440 )   $ (181,913 )   $ (181,913 )
Dilution in earnings due to RPUs treated as a participating security of Fortress Operating Group and fully vested restricted Class A share units with dividend equivalent rights treated as outstanding Fortress Operating Group units(4)
    (298 )     (298 )     (2,071 )     (2,071 )
Dividend equivalents declared on non-vested restricted Class A shares and restricted Class A share units
                (2,276 )     (2,276 )
Add back Principals’ and others’ interests in loss of Fortress Operating Group, net of assumed corporate income taxes at enacted rates, attributable to Fortress Operating Group units exchangeable into Fortress Investment Group LLC Class A shares(1)
          (210,477 )           (613,553 )
                                 
Net income (loss) available to Class A shareholders
  $ (57,738 )   $ (268,215 )   $ (186,260 )   $ (799,813 )
                                 
Weighted average shares outstanding
    94,938,434       407,009,984       94,915,666       406,987,216  
                                 
Basic and diluted net income (loss) per Class A share
  $ (0.61 )   $ (0.66 )   $ (1.96 )   $ (1.97 )
                                 
 
 
(1) The Fortress Operating Group units not held by Fortress (that is, those held by the Principals) are exchangeable into Class A shares on a one-to-one basis. These units are not included in the computation of basic earnings per share. These units enter into the computation of diluted net income (loss) per Class A share when the effect is dilutive using the if-converted method.
 
(2) Restricted Class A shares granted to directors and certain restricted Class A share units granted to employees are eligible to receive dividend or dividend equivalent payments when dividends are declared and paid on our Class A shares and therefore participate fully in the results of our operations from the date they are granted. They are included in the computation of both basic and diluted earnings per Class A share using the two-class method for participating securities, except during periods of net losses.

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Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
(3) Certain restricted Class A share units granted to employees are not entitled to dividend or dividend equivalent payments until they are vested and are therefore non-participating securities. These units 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. As a result of the net loss incurred for the period, the effect of the units on the calculation is anti-dilutive for the periods. The weighted average restricted Class A share units which are not entitled to receive dividend or dividend equivalent payments outstanding were:
 
         
Period
  Share Units
 
Three months ended:
       
September 30, 2008
    28,063,543  
September 30, 2007
    26,087,366  
Nine months ended September 30, 2008
    27,841,459  
Period from January 17, 2007 to September 30, 2007
    23,462,014  
 
(4) Fortress Operating Group RPUs are eligible to receive partnership distribution equivalent payments when distributions are declared and paid on Fortress Operating Group units. The RPUs represent a participating security of Fortress Operating Group and the resulting dilution in Fortress Operating Group earnings available to Fortress is reflected in the computation of both basic and diluted earnings per Class A share using the method prescribed for securities issued by a subsidiary. For purposes of the computation of basic and diluted earnings per Class A share, the fully vested restricted Class A share units with dividend equivalent rights are treated as outstanding Class A shares of Fortress and as outstanding partnership units of Fortress Operating Group.
 
The Class B shares have no net income (loss) per share as they do not participate in Fortress’s earnings (losses) or distributions. The Class B shares have no dividend or liquidation rights. Each Class B share, along with one Fortress Operating Group unit, can be exchanged for one Class A share, subject to certain limitations. The Class B shares have voting rights on a pari passu basis with the Class A shares. The number of Class B shares outstanding did not change subsequent to the IPO.
 
Fortress’s dividend paying shares and units were as follows:
 
                                 
    Weighted Average  
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2008     2007     2008     2007  
 
Class A shares
    94,500,351       94,500,350       94,500,351       85,640,019  
Restricted Class A shares
    108,661       97,296       103,411       83,396  
Restricted Class A share units(A)
    394,286       394,286       394,286       267,190  
Restricted Class A share units(B)
    24,101,891       23,730,308       23,840,819       20,430,657  
Fortress Operating Group units
    312,071,550       312,071,550       312,071,550       315,299,181  
Fortress Operating Group RPUs
    31,000,000             18,781,022        
                                 
Total
    462,176,739       430,793,790       449,691,439       421,720,443  
                                 
 


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                 
    As of September 30,
    As of December 31,
 
    2008     2007  
 
Class A shares
    94,500,351       94,500,350  
Restricted Class A shares
    109,174       97,296  
Restricted Class A share units(A)
    394,286       394,286  
Restricted Class A share units(B)
    24,040,462       23,906,779  
Fortress Operating Group units
    312,071,550       312,071,550  
Fortress Operating Group RPUs
    31,000,000        
                 
Total
    462,115,823       430,970,261  
                 
 
 
(A) Represents fully vested restricted Class A share units which are entitled to dividend equivalent payments.
 
(B) Represents nonvested restricted Class A share units which are entitled to dividend equivalent payments.
 
Dividends and distributions during the nine months ended September 30, 2008 are summarized as follows:
 
                                 
    Declared in Prior
  Current Year
    Year, Paid
  Declared and
  Declared but
   
    Current Year   Paid   Not Yet Paid   Total
 
Dividends on Class A Shares
  $ 21,285     $ 42,572     $     $ 42,572  
Dividend equivalents on restricted Class A share units(A)
    5,428       10,914             10,914  
Distributions to Fortress Operating Group unit holders (Principals)
    60,176       143,462             143,462  
Distributions to Fortress Operating Group RPU holders (Note 7)
          6,975             6,975  
                                 
Total distributions
  $ 86,889     $ 203,923     $     $ 203,923  
                                 
 
(A) A portion of these dividend equivalents, related to RSUs expected to be forfeited, is included as compensation expense in the consolidated statement of operations and is therefore considered an operating cash flow.
 
9.   COMMITMENTS AND CONTINGENCIES
 
Other than as described below, Fortress’s commitments and contingencies remain materially unchanged from December 31, 2007.
 
Private Equity Fund Capital Commitments — Fortress has remaining capital commitments to certain of the Fortress Funds which aggregated $153.7 million as of September 30, 2008. These commitments can be drawn by the funds on demand.
 
Minimum Future Rentals — Fortress is a lessee under operating leases for office space located in New York, Atlanta, Bethesda, Charlotte, Chicago, Dallas, Dubai, Frankfurt, Geneva, Hong Kong, London, Los Angeles, New Canaan, Rome, San Diego, San Francisco, Shanghai, Sydney, Tokyo, and Toronto.

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Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Minimum future rent payments under these leases is as follows:
 
         
October 1 to December 31, 2008
  $ 4,606  
2009
    19,223  
2010
    21,890  
2011
    12,369  
2012
    11,785  
2013
    11,587  
Thereafter
    34,164  
         
Total
  $ 115,624  
         
 
Rent expense recognized on a straight-line basis during the nine months ended September 30, 2008 and 2007 was $14.7 million and $11.0 million, respectively, and during the three months ended September 30, 2008 and 2007 was $5.3 million and $3.6 million, respectively, and was included in General, Administrative and Other Expense.
 
Litigation — Fortress is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions that existed as of September 30, 2008, if any, will not materially affect Fortress’s results of operations, liquidity or financial position.
 
On September 15, 2005, a lawsuit captioned David T. Atkins et al. v. Apollo Real Estate Advisors, L.P. et al. was brought on behalf of current and former limited partners in certain investing partnerships related to the sale of certain facilities to Ventas Realty Limited Partnership (“Ventas”) against a number of defendants, including one of the Portfolio Companies and a subsidiary of Fortress (“FIG”). FIG was the investment manager of consolidated Fortress Funds that were controlling shareholders of the Portfolio Company during the relevant time periods. The suit alleges that the defendants improperly obtained certain rights with respect to such facilities from the investing partnerships. The plaintiffs have asked for damages in excess of $100 million on each of nine counts, as to which FIG is a defendant on seven counts, including treble damages with respect to certain counts. On April 18, 2006, Fortress filed a motion to dismiss the claims with prejudice. On April 30, 2008, the court entered a memorandum and order granting the motion and dismissing the plaintiff’s complaint in its entirety. The plaintiffs were granted a period of 30 days from April 30, 2008 in which to file an amended complaint, after which the parties entered into a settlement, which has been paid in its entirety by Brookdale.
 
In addition, in the ordinary course of business, the Fortress Funds are and can be both the defendant and the plaintiff in numerous actions with respect to bankruptcy, insolvency and other types of proceedings. Such lawsuits may involve claims that adversely affect the value of certain financial instruments owned by the Fortress Funds. Although the ultimate outcome of actions cannot be ascertained with certainty, Fortress believes that the resolution of any such actions will not have a material adverse effect on its financial condition, liquidity or results of operations.
 
10.   SEGMENT REPORTING
 
Fortress conducts its management and investment business through the following five primary segments: (i) private equity funds, (ii) Castles, (iii) liquid hedge funds, (iv) hybrid hedge funds, and (v) principal investments in these funds as well as cash that is available to be invested. These segments are differentiated based on their varying investment strategies. Due to the increased significance of the principal investments segment, it has been disaggregated from the other segments in this period and for all periods presented.


29


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
“Distributable earnings” is a measure of operating performance used by management in analyzing its segment and overall results. For the existing Fortress businesses it is equal to net income adjusted as follows:
 
Incentive Income
 
(i) a. for Fortress Funds which are private equity funds, adding (a) incentive income paid (or declared as a distribution) to Fortress, less an applicable reserve for potential future clawbacks if the likelihood of a clawback is deemed greater than remote by Fortress’s chief operating decision maker as discussed below (net of the reversal of any prior such reserves that are no longer deemed necessary), minus (b) incentive income recorded in accordance with GAAP,
 
b. for other Fortress Funds, at interim periods, adding (a) incentive income on an accrual basis as if the incentive income from these funds were payable on a quarterly basis, minus (b) incentive income recorded in accordance with GAAP,
 
Other Income
 
(ii) with respect to income from certain principal investments and certain other interests that cannot be readily transferred or redeemed:
 
a. for equity method investments in the Castles (prior to 2008) and private equity funds as well as indirect equity method investments in hedge fund special investment accounts (which generally have investment profiles similar to private equity funds), treating these investments as cost basis investments by adding (a) realizations of income, primarily dividends, from these funds, minus (b) impairment with respect to these funds, if necessary, minus (c) equity method earnings (or losses) recorded in accordance with GAAP,
 
b. subtracting gains (or adding losses) on stock options held in the Castles,
 
c. subtracting unrealized gains (or adding unrealized losses) from consolidated private equity funds,
 
d. subtracting unrealized gains (or adding unrealized losses) from the Castles subsequent to the election of the fair value option under SFAS 159,
 
(iii) adding (a) proceeds from the sale of shares received pursuant to the exercise of stock options in certain of the Castles, in excess of their strike price, minus (b) management fee income recorded in accordance with GAAP in connection with the receipt of these options,
 
Expenses
 
(iv) adding or subtracting, as necessary, the employee profit sharing in incentive income described in (i) above to match the timing of the expense with the revenue,
 
(v) adding back equity-based compensation expense (including Castle options assigned to employees, RSUs and RPUs (including the portion of related dividend and distribution equivalents recorded as compensation expense), restricted shares and the LTIP),
 
(vi) adding back compensation expense recorded in connection with the forfeiture arrangements entered into among the principals,
 
(vii) adding the income (or subtracting the loss) allocable to the interests in consolidated subsidiaries attributable to Fortress Operating Group units, and


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
(viii) adding back income tax expense and any expense recorded in connection with the tax receivable agreement (Note 5).
 
Total segment assets are equal to total GAAP assets adjusted for:
 
(i) the difference between the GAAP carrying amount of equity method investments and their carrying amount for segment reporting purposes, which is generally fair value for publicly traded investments and cost for nonpublic investments,
 
(ii) employee portions of investments, which are reported gross for GAAP purposes (as assets offset by Principals’ and others’ interests in equity of consolidated subsidiaries) but net for segment reporting purposes, and
 
(iii) the difference between the GAAP carrying amount for options owned in certain of the Castles and their carrying amount for segment reporting purposes, which is intrinsic value.
 
Distributable Earnings Impairment
 
For purposes of this discussion, the term “private equity funds” includes hedge fund special investment accounts, which have investment profiles that are generally similar to private equity funds, and Castles.
 
Pursuant to the definition of Distributable Earnings (“DE”) above, impairment is taken into account in the calculation in two ways: first, in section (i)(a) regarding private equity incentive income, and, second, in section (ii)(a) regarding equity method investments in private equity funds.
 
DE is Fortress’s segment measure of operating performance and is defined by Fortress’s “chief operating decision maker” (“CODM”), which is its management committee, as specified under SFAS 131, “Disclosures about Segments of an Enterprise and Related Information”. The CODM receives performance reports on our segments on a DE basis pursuant to their requirements for managing Fortress’s business.
 
Investments in Private Equity Funds
 
For DE purposes, investments in private equity funds are held at their cost basis, subject to potential impairment. An analysis for potential impairment is performed whenever the reported net asset value (“NAV”) of a fund attributable to our investment is less than our cost basis in such investment. The NAV of a fund is equal to the fair value of its assets less its liabilities. Fortress analyzes these investments for impairment using the “other than temporary” impairment criteria in a manner similar to the one specified by SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities.” As a result, a fund investment is considered impaired for DE purposes whenever it is determined by the CODM that Fortress does not have the intent and ability to hold the investment to an anticipated recovery in value, if any, to or above Fortress’s cost basis. Prior to September 30, 2008, Fortress had not recorded any impairment with respect to such investments other than $9.5 million of impairment recorded with respect to Newcastle at June 30, 2008.
 
Private Equity Incentive Income
 
For DE purposes, incentive income is recognized from private equity funds as it is realized, subject to a reserve for potential clawback if the likelihood of clawback is determined to be greater than remote by the CODM. Incentive income from our private equity funds is paid to Fortress as particular investments are realized. However, it is subject to contingent repayment (or clawback) if the fund as a whole does not meet certain performance criteria. Fortress’s CODM has defined “remote” in this context to mean that management does not believe there is reasonable likelihood of a clawback and therefore its base case expectations of a fund’s performance do not include


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
a promote clawback. This is an easier threshold to meet than the “other than temporary” threshold used for estimating investment impairment. Management’s base case expectations are generally not greatly impacted by short-term volatility in the value of a fund’s portfolio companies, including the market prices of the shares of publicly traded portfolio companies, unless either (a) the operating performance of the underlying company, or the value of its assets, are expected to be impacted on a long-term basis (long-term being defined in relation to the remaining life of a given fund), or (b) the value has been depressed below a breakeven point (as described below) for a period in excess of 6-9 months (as circumstances and other factors dictate). These criteria reflect the CODM’s belief that short term changes in the values of portfolio companies do not have a material impact on the likelihood of a clawback, absent deterioration in such companies’ operating performance or in the value of their underlying assets.
 
Fortress conducts an analysis at each quarter end to determine whether a clawback reserve is required. The factors that enter into this analysis include: the amount of intrinsic unrealized gains or losses within each fund, the period of time until expected final realization, the diversification of the fund’s investments, the expected future performance of the fund, the period of time the fund has been in an intrinsic clawback position (i.e. liquidation at NAV would indicate a clawback, if any), and others as determined by management and the CODM. The point at which a liquidation at NAV would indicate no clawback and no additional promote payment is referred to as the breakeven point.
 
For instance, with respect to Fund III as described below, management believes that with the fund only being in an intrinsic clawback position for two quarters it is too soon to determine that a reserve for promote clawback is necessary. Furthermore, Fund III’s life allows six years for potential recovery and its diversified nature allows for the recovery of a subset of the fund’s investments to drive the entire fund above the breakeven point. Management has updated its base case expectations for this fund to take into account developments through September 30, 2008. This “base case scenario” contemplates management’s expectations for each of the fund’s underlying investments (the “portfolio companies”), including its expectations regarding the net asset values of the portfolio companies. This base case scenario does not reflect a promote clawback as it projects significant additional incentive income being earned from Fund III over its life. Management believes that the assumptions underlying the base case scenario are reasonable. However, the ultimate outcome of Fund III is subject to significant uncertainties and may be materially different than management’s expectations at September 30, 2008.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Investment Impairment for DE purposes
 
The following investments in private equity funds had reported NAVs below their cost basis as of September 30, 2008:
 
                                                         
    Fortress
    Fortress
          % Below
          Sep 30, 2008
       
    Share of
    Cost
          Cost
    Periods in
    DE Impairment
       
Fund
  NAV     Basis     Deficit     Basis     Deficit     Recorded     Notes  
 
Main Funds
                                                       
Fund III
  $ 6,929     $ 9,150     $ (2,221 )     (24 )%     2 Quarters     $       (A )
Fund IV and Fund IV CO
    104,092       113,566       (9,474 )     (8 )%     4 Quarters             (A )
Fund V and Fund V CO
    49,119       101,363       (52,244 )     (52 )%     4 Quarters             (A )
Single Investment Funds (combined)
                                               
GAGFAH (XETRA: GFJ)
    45,289       66,315       (21,026 )     (32 )%     2 Quarters       (21,026 )     (B )
Brookdale (NYSE: BKD)
    31,067       46,603       (15,536 )     (33 )%     4 Quarters       (15,536 )     (B )
Private investment #1
    58,216       63,874       (5,658 )     (9 )%     2 Quarters             (C )
Private investment #2
    4,223       8,455       (4,232 )     (50 )%     3 Quarters       (4,232 )     (D )
Private investment #3
    270,220       273,449       (3,229 )     (1 )%     4 Quarters             (C )
Castles
                                                       
Eurocastle (EURONEXT: ECT)
    4,150       13,011       (8,861 )     (68 )%     2 Quarters       (8,861 )     (B )
Newcastle (NYSE: NCT)
    6,513       7,190       (677 )     (9 )%     1 Quarter             (C )
                                                         
Total
  $ 579,818     $ 702,976     $ (123,158 )                   $ (49,655 )        
                                                         
 
 
(A) These funds are diversified private equity “main” funds with multiple underlying investments and fund lives extending to between 2014 and 2017. The CODM anticipates a sufficient recovery in value of a number of the underlying investments to cause each of the funds as a whole to recover to at least Fortress’s cost basis within the period of the funds’ respective lives. Fortress has the intent and ability to hold these investments until such recovery and therefore has not recorded DE impairment with respect to them.
 
(B) These are single asset “coinvestment” funds which have investments in public equity securities (or, in the case of Eurocastle, a direct investment in a public equity security). These public equity securities have traded significantly below Fortress’s cost basis for a substantial period and Fortress’s CODM has determined that these declines in value meet the definition of other than temporary impairment for DE purposes at this time.
 
(C) These investments have reported NAVs less than 10% below Fortress’s cost basis. The CODM anticipates a recovery in value to at least Fortress’s cost basis. Fortress has the intent and ability to hold these investments until such recovery and therefore has not recorded DE impairment with respect to them.
 
(D) This is a single asset “coinvestment” fund which has an investment in a private operating company. This private operating company has experienced liquidity issues as a result of the recent credit crisis and the CODM has determined that the resulting decline in value meets the definition of other than temporary impairment for DE purposes at this time.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
 
Clawback Reserve on Incentive Income for DE Purposes
 
Fortress had recognized incentive income for DE purposes from the following private equity funds, which are subject to contingent clawback, as of September 30, 2008:
 
                                                                         
                                              Sep 30, 2008
       
    Incentive
    No Longer
          Intrinsic
    Employee
          Periods in
    Gross
       
    Income
    Subject to
    Subject to
    Clawback
    Portion
    Net
    Intrinsic
    DE Reserve
       
Fund
  Received     Clawback     Clawback     (A)     (B)     Clawback     Clawback     Recorded     Notes  
 
Fund I
  $ 308,633     $ 296,882     $ 11,751     $     $     $       N/A     $       (C )
Fund II
    254,688       178,286       76,402                         N/A             (C )
Fund III
    72,483             72,483       72,483       27,068       45,415       3 Quarters             (D )
Fortress Residential Inv. Deutschland
    16,447             16,447       16,447       6,406       10,041       5 Quarters       (16,447 )     (E )
                                                                         
Total
  $ 652,251     $ 475,168     $ 177,083     $ 88,930     $ 33,474     $ 55,456             $ (16,447 )        
                                                                         
 
 
(A) Intrinsic clawback is the maximum amount of clawback that would be required to be repaid to the fund if the fund were liquidated at its NAV as of the reporting date.
 
(B) Employees who have received profit sharing payments in connection with private equity incentive income are liable to repay Fortress for their share of any clawback. Fortress remains liable to the funds for these amounts even if it is unable to collect the amounts from employees (or former employees).
 
(C) These funds had significant unrealized gains at September 30, 2008. As a result, the CODM determined that no reserve for clawback was required.
 
(D) This fund is a diversified “main” fund with multiple underlying investments and a fund life extending to 2014. Management believes that the primary reason for its drop in unrealized gains and the incurrence of unrealized losses, which moved the fund into an intrinsic clawback position, is the current confidence and liquidity crisis. Based on the criteria determined by the CODM which are described above, the CODM expects that the likelihood of a clawback with respect to Fund III is remote and has not recorded a reserve for such clawback. If this fund continues to be in an intrinsic clawback position, management will consider this factor (length of time in an intrinsic clawback position), as well as its updated base case scenario, in relation to the criteria described above and may come to a different conclusion at a future reporting date.
 
(E) This is a single asset fund which is invested in a publicly traded equity security. As described above, Fortress’s investment in this fund has been deemed to be other than temporarily impaired as of September 30, 2008. This fund has been in an intrinsic clawback position for a period in excess of 6-9 months. As a result, the CODM has determined that the likelihood of clawback based on the criteria described above is greater than remote and has recorded a reserve for this potential clawback.
 
Impairment Determination
 
Fortress has recorded a total of approximately $69.2 million of impairment and reserves for DE purposes on certain private equity funds as described above for DE purposes as of September 30, 2008 (including approximately $60 million during the third quarter of 2008). Additionally, values have generally deteriorated further since September 30, 2008. Fortress expects aggregate returns on its other private equity funds that are in an unrealized investment loss or intrinsic clawback position to ultimately exceed their carrying amount or breakdown point, as applicable. If such funds were liquidated at their September 30, 2008 NAV (although Fortress has no current intention of doing so), the result would be additional impairment losses and reserves for DE purposes of approximately $118.9 million.


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Summary financial data on Fortress’s segments is presented on the following pages, together with a reconciliation to revenues, assets and net income for Fortress as a whole. Fortress’s investments in, and earnings from, its equity method investees by segment are presented in Note 3.
 
                                                         
    Private
          Liquid
    Hybrid
                   
    Equity
          Hedge
    Hedge
    Principal
          Fortress
 
September 30, 2008 and the Nine Months Then Ended   Funds     Castles     Funds     Funds     Investments     Unallocated     Subtotal  
 
Segment revenues
                                                       
Management fees
  $ 128,514     $ 41,320     $ 169,965     $ 111,483     $     $     $ 451,282  
Incentive income
    12,294       12       17,125       14,128                   43,559  
                                                         
Segment revenues — total
  $ 140,808     $ 41,332     $ 187,090     $ 125,611     $     $     $ 494,841  
                                                         
Pre-tax distributable earnings
  $ 100,461     $ 12,033     $ 70,662     $ 26,099     $ (113,506 )   $ 21     $ 95,770  
                                                         
Total segment assets
  $ 26,673     $ 11,986     $ 4,317     $ 5,809     $ 1,241,117     $ 596,826     $ 1,886,728  
                                                         
                                              (A )        
 
                         
    Fortress
    Reconciliation
    Fortress
 
    Subtotal     to GAAP     Consolidated  
 
Revenues
  $ 494,841     $ 79,271     $ 574,112  
                         
Pre-tax distributable earnings/net income
  $ 95,770     $ (277,683 )   $ (181,913 )
                         
Total assets
  $ 1,886,728     $ (31,851 )   $ 1,854,877  
                         
 
 
(A) Unallocated assets include deferred tax assets of $517.6 million.
 
                                                         
    Private
          Liquid
    Hybrid
                   
Three Months Ended
  Equity
          Hedge
    Hedge
    Principal
          Fortress
 
September 30, 2008   Funds     Castles     Funds     Funds     Investments     Unallocated     Subtotal  
 
Segment revenues
                                                       
Management fees
  $ 44,184     $ 13,665     $ 59,640     $ 38,028     $     $     $ 155,517  
Incentive income
    (16,447 )           85       13,256                   (3,106 )
                                                         
Segment revenues — total
  $ 27,737     $ 13,665     $ 59,725     $ 51,284     $     $     $ 152,411  
                                                         
Pre-tax distributable earnings
  $ 18,575     $ 3,829     $ 25,236     $ 14,820     $ (82,850 )   $ 14     $ (20,376 )
                                                         
 
                         
    Fortress
    Reconciliation
    Fortress
 
    Subtotal     to GAAP     Consolidated  
 
Revenues
  $ 152,411     $ 32,725     $ 185,136  
                         
Pre-tax distributable earnings/net income
  $ (20,376 )   $ (37,064 )   $ (57,440 )
                         


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Reconciling items between segment measures and GAAP measures:
 
                 
    September 30, 2008 and
    Three Months Ended
 
    the Nine Months Then Ended     September 30, 2008  
 
                 
Adjustments from segment revenues to GAAP revenues
               
Adjust management fees*
  $ 488     $ 163  
Adjust incentive income
    26,390       16,956  
Adjust income from the receipt of options
           
Other revenues*
               
Adjust management fees from non-affiliates
    (3,842 )     (1,414 )
Adjust incentive income from non-affiliates
    (13,787 )     (13,132 )
Adjust other revenues
    70,022       30,152  
                 
      52,393       15,606  
                 
Total adjustments
  $ 79,271     $ 32,725  
                 
                 
               
 
* Segment revenues do not include GAAP other revenues, except to the extent they represent management fees or incentive income; such revenues are included elsewhere in the calculation of distributable earnings.
                 
Adjustments from pre-tax distributable earnings to GAAP net income
               
Adjust incentive income
               
Incentive income received from private equity funds, subject to contingent repayment
  $ (26,077 )   $  
Incentive income accrued from private equity funds, no longer subject to contingent repayment
    36,003       509  
Incentive income received from private equity funds, not subject to contingent repayment
    17        
Incentive income received from hedge funds, subject to annual performance achievement
           
Reserve for clawback, gross (see discussion above)
    16,447       16,447  
                 
      26,390       16,956  
                 
Adjust other income
               
Distributions of earnings from equity method investees**
    (367 )      
Earnings (losses) from equity method investees**
    (80,297 )     (12,814 )
Gains (losses) on options in equity method investees
    (16,160 )     (734 )
Unrealized gains (losses) on Castles
    (27,192 )     (6,217 )
Impairment of investments (see discussion above)
    59,162       49,655  
Adjust income from the receipt of options
           
                 
      (64,854 )     29,890  


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                 
    September 30, 2008 and
    Three Months Ended
 
    the Nine Months Then Ended     September 30, 2008  
 
Adjust employee compensation
               
Adjust employee equity-based compensation expense (including Castle options assigned)
    (146,246 )     (57,739 )
Adjust employee portion of incentive income from private equity funds, accrued prior to the realization of incentive income
    9,648        
Adjust employee portion of incentive income from one private equity fund, not subject to contingent repayment
    (4 )      
                 
      (136,602 )     (57,739 )
Adjust Principals’ equity-based compensation expense
    (714,710 )     (239,976 )
Adjust Principals’ interests related to Fortress Operating Group units
    611,760       208,169  
Adjust income taxes
    333       5,636  
                 
Total adjustments
  $ (277,683 )   $ (37,064 )
                 
 
** This adjustment relates to all of the Castles, private equity Fortress Funds and hedge fund special investment accounts in which Fortress has an investment.
                 
Adjustments from total segment assets to GAAP assets
               
Adjust equity investments from fair value
  $          
Adjust equity investments from cost
    (64,890 )        
Adjust investments gross of employee portion
    32,902          
Adjust option investments from intrinsic value
    137          
Total adjustments
  $ (31,851 )        
                 
 
                                                         
    Private
          Liquid
    Hybrid
                Fortress
 
    Equity
          Hedge
    Hedge
    Principal
          Unconsolidated
 
Nine Months Ended September 30, 2007   Funds     Castles     Funds     Funds     Investments     Unallocated     Subtotal  
 
Segment revenues
                                                       
Management fees
  $ 97,749     $ 34,877     $ 113,692     $ 94,096     $     $     $ 340,414  
Incentive income
    273,890       18,596       157,989       93,832                   544,307  
                                                         
Segment revenues — total
  $ 371,639     $ 53,473     $ 271,681     $ 187,928     $     $     $ 884,721  
                                                         
Pre-tax distributable earnings
  $ 249,116     $ 24,101     $ 129,203     $ 55,882     $ 25,531     $ (10,244 )   $ 473,589  
                                                         
 
                                         
    Fortress
  Consolidation
           
    Unconsolidated
  of Fortress
      Reconciliation
  Fortress
    Subtotal   Funds   Eliminations   to GAAP   Consolidated
 
Revenues
  $ 884,721     $ 317,114     $ (269,607 )   $ (497 )   $ 931,731  
                                         
Pre-tax distributable earnings/net income
  $ 473,589     $ (326,375 )   $ 326,375     $ (504,134 )   $ (30,545 )
                                         
 

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Table of Contents

 
FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                                                         
    Private
          Liquid
    Hybrid
                Fortress
 
    Equity
          Hedge
    Hedge
    Principal
          Unconsolidated
 
Three Months Ended September 30, 2007   Funds     Castles     Funds     Funds     Investments     Unallocated     Subtotal  
 
Segment revenues
                                                       
Management fees
  $ 35,133     $ 12,131     $ 44,351     $ 33,376     $     $     $ 124,991  
Incentive income
    83,592       691       (210 )     9,463                   93,536  
                                                         
Segment revenues — total
  $ 118,725     $ 12,822     $ 44,141     $ 42,839     $     $     $ 218,527  
                                                         
Pre-tax distributable earnings
  $ 82,273     $ 5,163     $ 23,815     $ 6,569     $ (4,110 )   $ (2,958 )   $ 110,752  
                                                         
 
                         
    Fortress
             
    Unconsolidated
    Reconciliation
    Fortress
 
    Subtotal     to GAAP     Consolidated  
 
Revenues
  $ 218,527     $ 28,755     $ 247,282  
                         
Pre-tax distributable earnings/net income
  $ 110,752     $ (148,309 )   $ (37,557 )
                         
 
Reconciling items between segment measures and GAAP measures:
 
                 
    Nine Months Ended
    Three Months Ended
 
    September 30, 2007     September 30, 2007  
 
Adjustments from segment revenues to GAAP revenues
               
Adjust management fees*
  $ 488     $ 163  
Adjust incentive income
    (48,316 )     13,477  
Adjust income from the receipt of options
    2,006        
Other revenues*
               
Adjust management fees from non-affiliates
    (2,879 )     (163 )
Adjust incentive income from non-affiliates
    (431 )     (323 )
Adjust other revenues
    48,635       15,601  
                 
      45,325       15,115  
                 
Total adjustments
  $ (497 )   $ 28,755  
                 
                 
               
 
* Segment revenues do not include GAAP other revenues, except to the extent they represent management fees or incentive income; such revenues are included elsewhere in the calculation of distributable earnings.

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                 
    Nine Months Ended
    Three Months Ended
 
    September 30, 2007     September 30, 2007  
 
                 
Adjustments from pre-tax distributable earnings to GAAP net income
               
Adjust incentive income
               
Incentive income received from private equity funds, subject to contingent repayment
  $ (191,948 )   $ (53,126 )
Incentive income accrued from private equity funds, no longer subject to contingent repayment
    309,275       97,333  
Incentive income received from private equity funds, not subject to contingent repayment
    (73,644 )     (22,168 )
Incentive income received from hedge funds, subject to annual performance achievement
    (91,999 )     (8,562 )
Reserve for clawback
           
                 
      (48,316 )     13,477  
Adjust other income
               
Distributions of earnings from equity method investees**
    (13,741 )     (1,415 )
Earnings (losses) from equity method investees**
    (49,762 )     (30,514 )
Gains (losses) on options in equity method investees, treated as derivatives
    (82,810 )     (58,354 )
Adjust income from the receipt of options
    2,006        
                 
      (144,307 )     (90,283 )
                 
Adjust employee compensation
               
Adjust employee equity-based compensation expense (including Castle options assigned)
    (99,014 )     (31,651 )
Adjust employee portion of incentive income from private equity funds, accrued prior to the realization of incentive income
          19,657  
Adjust employee portion of incentive income from one private equity fund, not subject to contingent repayment
    5,427       5,427  
                 
                 
      (93,587 )     (6,567 )
                 
Adjust Principals’ equity-based compensation expense
    (612,981 )     (232,048 )
Adjust Principals’ interests related to Fortress Operating Group units
    402,294       154,893  
Adjust income taxes
    (7,237 )     12,219  
                 
Total adjustments
  $ (504,134 )   $ (148,309 )
                 
 
** This adjustment relates to all of the Castles, private equity Fortress Funds and hedge fund special investment accounts in which Fortress has an investment. On an unconsolidated basis, each of these funds is accounted for under the equity method.

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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
Fortress’s depreciation expense by segment was as follows:
 
                                                 
    Private Equity
          Liquid Hedge
    Hybrid Hedge
             
    Funds     Castles     Funds     Funds     Unallocated     Total  
 
Nine Months Ended September 30,
                                               
2008
  $ 841     $ 538     $ 2,302     $ 2,195     $ 1,433     $ 7,309  
2007
  $ 747     $ 633     $ 1,860     $ 1,926     $ 1,257     $ 6,423  
Three Months Ended September 30,
                                               
2008
  $ 294     $ 165     $ 808     $ 709     $ 461     $ 2,437  
2007
  $ 265     $ 207     $ 649     $ 697     $ 412     $ 2,230  
 
11.   SUBSEQUENT EVENTS
 
These financial statements include a discussion of material events which have occurred subsequent to September 30, 2008 (referred to as “subsequent events”) through November 12, 2008. Events subsequent to that date have not been considered in these financial statements.
 
In October 2008, one of the private equity Fortress Funds redeemed an aggregate of $76.8 million in preferred equity investments previously made by three of the Principals in such fund. In October and November 2008, three of the Principals made new preferred equity investments in the net aggregate amount of $72.2 million in another of the private equity Fortress Funds. As of November 12, 2008, the Principals had an aggregate of $90.4 million invested in preferred equity interests of the private equity Fortress Funds and their subsidiaries.
 
In October and November 2008, the liquid hedge funds received redemption notices totaling $1.7 billion, most of which are still subject to being rescinded, which would become payable on or before the end of January 2009 (and these funds may receive additional redemption requests). The hybrid funds received notices requesting the return of $1.9 billion of capital to investors, most of which are still subject to being rescinded, which would be paid over time as the underlying investments are liquidated, in accordance with the governing documents of the applicable funds. During this period, such amounts would continue to be subject to management fees and, as applicable, incentive income.
 
On November 12, 2008, Fortress entered into an additional amendment to its credit agreement (Note 4). The amendment, among other things: (i) modified the definition of EBITDA, which is used to calculate the Consolidated Leverage Ratio, to exclude any realized or unrealized gains and losses on investments and to reflect private equity incentive income clawbacks on a cash basis; (ii) modified the financial covenants by (a) reducing the amount of required investment assets to $975 million (less any future term loan repayments) and (b) changing the required Consolidated Leverage Ratios for the quarters ending June 30 and September 30, 2009 from 2.5 to 1.0 to 2.75 to 1.0; (iii) increased the rate on LIBOR loans to LIBOR + 2.00% (and Base Rate loans to the prime rate + 1.00%) — this rate is no longer subject to change pursuant to a ratings-based pricing grid; (iv) established the commitment fee for the unused portion of the revolving credit facility at 0.25% — this rate is also no longer subject to change pursuant to a ratings-based pricing grid; (v) reduced the revolving credit facility commitments to $125 million; (vi) established a requirement that outstanding term loans be prepaid with 25% of the amount by which EBITDA for any twelve-month period exceeds $370 million (unless and until the amount of outstanding term loans equals or is less than $250 million); (vii) required $50 million of additional term loan repayments ($25 million in July of 2009 and 2010); (viii) established a requirement that the borrower cash collateralize the letter of credit obligations of distressed lenders under certain circumstances, including lender non-funding or bankruptcy; and (ix) established an event of default under certain circumstances where the borrower, any guarantor or certain of their subsidiaries are required to make promote clawback payments in excess of $20 million during any calendar year. In connection with


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
the amendment, Fortress prepaid $75 million of the outstanding term loans. Fortress is currently evaluating the impact that recording this amendment will have on its fourth quarter 2008 financial statements.
 
12.   PRO FORMA FINANCIAL INFORMATION
 
The unaudited pro forma financial information is presented in order to provide data which is more comparable to the 2008 period as a result of the deconsolidation (Note 1).
 
The unaudited pro forma financial information presented below was derived from the application of pro forma adjustments to the combined and consolidated financial statements of Fortress, as applicable, to give effect to the deconsolidation of the consolidated Fortress Funds. The deconsolidation transaction occurred effective March 31, 2007 as described in Note 1. The unaudited pro forma statement of operations and statement of cash flows information for the nine months ended September 30, 2007 have been prepared as if this transaction had occurred on January 1, 2007.
 
The unaudited pro forma effects of the deconsolidation of the Fortress Funds on the statement of operations information are as follows:
 
                         
    Nine Months Ended September 30, 2007  
          Deconsolidation
    Pro Forma
 
    Consolidated     Adjustments     Deconsolidated  
 
Revenues
                       
Management fees from affiliates
  $ 286,956     $ 53,072     $ 340,028  
Incentive income from affiliates
    283,879       211,682       495,561  
Other revenues
    51,866       (3,232 )     48,634  
Interest and dividend income — investment company holdings
    309,030       (309,030 )      
                         
      931,731       (47,508 )     884,223  
                         
Expenses
                       
Interest expense
                       
Investment company holdings
    132,620       (132,620 )      
Other
    26,016             26,016  
Compensation and benefits
    507,003       (9,805 )     497,198  
Principals agreement compensation
    612,981             612,981  
General, administrative and other
    80,320       (22,024 )     58,296  
Depreciation and amortization
    6,423             6,423  
                         
      1,365,363       (164,449 )     1,200,914  
                         


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FORTRESS INVESTMENT GROUP LLC
(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP — NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited) — (Continued)
SEPTEMBER 30, 2008
(dollars in tables in thousands, except share data)
 
                         
    Nine Months Ended September 30, 2007  
          Deconsolidation
    Pro Forma