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

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

or

 

¨ 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   10105
(Address of principal executive offices)   (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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    No  ¨

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  ¨

  Accelerated filer  x  

Non-accelerated filer  ¨

(Do not check if a smaller reporting company)

  Smaller reporting company   ¨

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

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: 165,036,886 outstanding as of August 3, 2010.

Class B Shares: 300,273,852 outstanding as of August 3, 2010.

 

 

 


Table of Contents

FORTRESS INVESTMENT GROUP LLC

FORM 10-Q

INDEX

 

          PAGE
     PART I. FINANCIAL INFORMATION     
Item 1.    Financial Statements   
   Consolidated Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009    1
   Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2010 and 2009    2
   Consolidated Statement of Equity (unaudited) for the six months ended June 30, 2010    3
   Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2010 and 2009    4
   Notes to Consolidated Financial Statements (unaudited)    5
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    38
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    68
Item 4.    Controls and Procedures    71
   PART II. OTHER INFORMATION   
Item 1.    Legal Proceedings    72
Item 1A.    Risk Factors    72
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    103
Item 3.    Defaults upon Senior Securities    103
Item 4.    Reserved    103
Item 5.    Other Information    103
Item 6.    Exhibits    104

SIGNATURES

   105


Table of Contents

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 and credit PE funds, depending on which measure management fees are being calculated upon at a given point in time, which in connection with private equity 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, including the Value Recovery Funds which pay fees based on realizations (and on certain managed assets); 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, collectively, to Fortress Investment Group LLC and its subsidiaries, including the Fortress Operating Group and all of its subsidiaries.

“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 January 2007, and in each of which Fortress Investment Group LLC acquired an indirect controlling interest in January 2007.

“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 related transactions directly owned 100% of the Fortress Operating Group units and following completion of our initial public offering and related transactions own a majority of the Fortress Operating Group units and 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 and grants by Fortress and dispositions by the principals.


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under Part II, Item 1A, “Risk Factors,” 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” 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 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. Accordingly, you should not place undue reliance on any forward-looking 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.

SPECIAL NOTE REGARDING EXHIBITS

In reviewing the agreements included as exhibits to this Quarterly Report on Form 10-Q, please remember they are included to provide you with information regarding their terms and are not intended to provide any other factual or disclosure information about the Company or the other parties to the agreements. The agreements contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties to the applicable agreement and:

 

   

should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate;

 

   

have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which disclosures are not necessarily reflected in the agreement;

 

   

may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors; and

 

   

were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement and are subject to more recent developments.

Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about the Company may be found elsewhere in this Quarterly Report on Form 10-Q and the Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

     June 30,
2010
(Unaudited)
    December 31,
2009
 

Assets

    

Cash and cash equivalents

   $ 167,527      $ 197,099   

Due from affiliates

     132,243        64,511   

Investments

     869,432        867,215   

Deferred tax asset

     454,806        440,639   

Other assets

     114,831        90,803   
                
   $ 1,738,839      $ 1,660,267   
                

Liabilities and Equity

    

Liabilities

    

Accrued compensation and benefits

   $ 101,413      $ 131,134   

Due to affiliates

     351,979        345,976   

Deferred incentive income

     244,966        160,097   

Debt obligations payable

     355,900        397,825   

Other liabilities

     35,543        25,921   
                
     1,089,801        1,060,953   
                

Commitments and Contingencies

    

Equity

    

Class A shares, no par value, 1,000,000,000 shares authorized, 165,036,886 and 145,701,622 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively

     —          —     

Class B shares, no par value, 750,000,000 shares authorized, 300,273,852 and 307,773,852 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively

     —          —     

Paid-in capital

     1,252,148        1,029,536   

Retained earnings (accumulated deficit)

     (944,529     (767,994

Accumulated other comprehensive income (loss)

     (1,075     (325
                

Total Fortress shareholders’ equity

     306,544        261,217   

Principals’ and others’ interests in equity of consolidated subsidiaries

     342,494        338,097   
                

Total equity

     649,038        599,314   
                
   $ 1,738,839      $ 1,660,267   
                

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Revenues

        

Management fees from affiliates

   $ 112,894      $ 108,425      $ 219,430      $ 214,077   

Incentive income from affiliates

     28,849        6,958        46,405        6,958   

Expense reimbursements from affiliates

     40,794        20,661        63,861        33,708   

Other revenues (affiliate portion disclosed in Note 6)

     8,793        3,043        21,822        6,640   
                                
     191,330        139,087        351,518        261,383   
                                

Expenses

        

Interest expense

     3,698        7,605        7,494        15,791   

Compensation and benefits

     159,529        113,456        338,922        222,692   

Principals agreement compensation

     237,367        237,367        472,126        472,126   

General, administrative and other

     24,242        21,034        45,350        38,219   

Depreciation and amortization

     3,294        2,761        5,976        5,402   
                                
     428,130        382,223        869,868        754,230   
                                

Other Income (Loss)

        

Gains (losses) from investments

     (12,957     19,441        (12,385     16,968   

Tax receivable agreement liability adjustment

     —          —          1,317        (55

Earnings (losses) from equity method investees

     6,150        51,057        26,031        16,208   
                                
     (6,807     70,498        14,963        33,121   
                                

Income (Loss) Before Income Taxes

     (243,607     (172,638     (503,387     (459,726

Income tax benefit (expense)

     (7,634     1,308        (9,186     1,715   
                                

Net Income (Loss)

   $ (251,241   $ (171,330   $ (512,573   $ (458,011
                                

Principals’ and Others’ Interests in Income (Loss) of Consolidated Subsidiaries

   $ (158,857   $ (126,738   $ (336,038   $ (346,260
                                

Net Income (Loss) Attributable to Class A Shareholders

   $ (92,384   $ (44,592   $ (176,535   $ (111,751
                                

Dividends declared per Class A share

   $ —        $ —        $ —        $ —     
                                

Earnings Per Class A share - Fortress Investment Group

        

Net income (loss) per Class A share, basic

   $ (0.57   $ (0.40   $ (1.14   $ (1.10
                                

Net income (loss) per Class A share, diluted

   $ (0.57   $ (0.41   $ (1.16   $ (1.10
                                

Weighted average number of Class A shares outstanding, basic

     165,246,781        115,547,744        161,385,135        105,447,324   
                                

Weighted average number of Class A shares outstanding, diluted

     165,246,781        427,619,294        465,388,269        417,518,874   
                                

 

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENT OF EQUITY (Unaudited)

FOR THE SIX MONTHS ENDED JUNE 30, 2010

(dollars in thousands)

 

     Class A Shares    Class B Shares     Paid-In
Capital
    Retained
Earnings
(Accumulated
Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Fortress
Shareholders’
Equity
    Principals’ and
Others’ Interests in
Equity of
Consolidated
Subsidiaries
    Total
Equity
 

Equity - December 31, 2009

   145,701,622    307,773,852      $ 1,029,536      $ (767,994   $ (325   $ 261,217      $ 338,097      $ 599,314   

Contributions from principals’ and others’ interests in equity

   —      —          —          —          —          —          63,815        63,815   

Distributions to principals’ and others’ interests in equity

   —      —          (661     —          —          (661     (95,525     (96,186

Conversion of Class B to Class A shares

   7,500,000    (7,500,000     7,188        —          —          7,188        (7,188     —     

Net deferred tax effects resulting from acquisition of Fortress Operating Group units

   —      —          4,559        —          —          4,559        —          4,559   

Net deferred tax effects resulting from exchange of Fortress Operating Group units

   —      —          7,262        —          —          7,262        —          7,262   

Director restricted share grant

   210,302    —          135        —          —          135        262        397   

Capital increase related to equity-based compensation, net

   11,624,962    —          196,596        —          —          196,596        388,996        585,592   

Dilution impact of Class A share issuance

   —      —          7,533        —          —          7,533        (7,533     —     

Comprehensive income (loss) (net of tax)

                 

Net income (loss)

   —      —          —          (176,535     —          (176,535     (336,038     (512,573

Foreign currency translation

   —      —          —          —          (177     (177     (663     (840

Comprehensive income (loss) from equity method investees

   —      —          —          —          (573     (573     (1,729     (2,302
                       

Total comprehensive income (loss)

                    (515,715
                                                           

Equity - June 30, 2010

   165,036,886    300,273,852      $ 1,252,148      $ (944,529   $ (1,075   $ 306,544      $ 342,494      $ 649,038   
                                                           

 

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

JUNE 30, 2010

(dollars in thousands)

 

     Six Months Ended June 30,  
     2010     2009  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (512,573   $ (458,011

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities

    

Depreciation and amortization

     5,976        5,402   

Other amortization and accretion

     1,678        6,887   

(Earnings) losses from equity method investees

     (26,031     (16,208

Distributions of earnings from equity method investees

     4,076        771   

(Gains) losses from investments

     12,385        (16,968

Deferred incentive income

     (46,677     —     

Deferred tax (benefit) expense

     2,440        (7,160

Tax receivable agreement liability adjustment

     (1,317     55   

Equity-based compensation

     584,155        577,949   

Allowance for doubtful accounts

     (2,447     —     

Other

     1,005        —     

Cash flows due to changes in

    

Due from affiliates

     (67,975     (32,219

Other assets

     838        1,551   

Accrued compensation and benefits

     21,640        (92,918

Due to affiliates

     (9,346     (16,126

Deferred incentive income

     131,546        —     

Other liabilities

     (1,397     (3,166
                

Net cash provided by (used in) operating activities

     97,976        (50,161
                

Cash Flows From Investing Activities

    

Contributions to equity method investees

     (31,694     (39,261

Distributions of capital from equity method investees

     46,124        27,548   

Purchase of fixed assets

     (1,522     (1,664

Acquisitions, net of cash received

     (13,474     —     
                

Net cash provided by (used in) investing activities

     (566     (13,377
                

Cash Flows From Financing Activities

    

Repayments of debt obligations

     (41,925     (289,291

Payment of deferred financing costs

     —          (4,162

Proceeds from public offering

     —          230,000   

Costs related to public offering

     —          (10,500

Principals’ and others’ interests in equity of consolidated subsidiaries - contributions

     56        67   

Principals’ and others’ interests in equity of consolidated subsidiaries - distributions

     (85,113     (35,407
                

Net cash provided by (used in) financing activities

     (126,982     (109,293
                

Net Increase (Decrease) in Cash and Cash Equivalents

     (29,572     (172,831

Cash and Cash Equivalents, Beginning of Period

     197,099        263,337   
                

Cash and Cash Equivalents, End of Period

   $ 167,527      $ 90,506   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest

   $ 6,583      $ 8,095   
                

Cash paid during the period for income taxes

   $ 6,006      $ 5,952   
                

Supplemental Schedule of Non-cash Investing and Financing Activities

    

Employee compensation invested directly in subsidiaries

   $ 64,021      $ 1,847   
                

Investments of receivable amounts into Fortress Funds

   $ 8,092      $ —     
                

Dividends, dividend equivalents and Fortress Operating Group unit distributions declared but not yet paid

   $ 4,337      $ —     
                

Distributions declared but not yet paid on other non-controlling interests

   $ 23,614      $ —     
                

Contingent consideration in purchase of Logan Circle Partners L.P.

   $ 4,000      $ —     
                

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(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:

 

  a) Private equity funds, which make significant, control-oriented investments in debt and equity securities of public or privately held entities in North America and Western Europe, with a focus on acquiring and building assets-based businesses with significant cash flows; and

 

  b) Publicly traded alternative investment vehicles, which Fortress refers to as “Castles,” which are companies that invest primarily in real estate and real estate related debt investments.

 

  2) Liquid hedge funds, which invest globally in fixed income, currency, equity and commodity markets, and related derivatives to capitalize on imbalances in the financial markets.

 

  3) Credit funds:

 

  a) Credit hedge funds, which make highly diversified investments globally in assets, opportunistic lending situations and securities throughout the capital structure with a value orientation, as well as in investment funds managed by external managers, and which include non-Fortress originated funds for which Fortress has been retained as manager as part of an advisory business; and

 

  b) Credit private equity (“PE”) funds which are comprised of a family of “credit opportunities” funds focused on investing in distressed and undervalued assets, a family of “long dated value” funds focused on investing in undervalued assets with limited current cash flows and long investment horizons, a family of “real assets” funds focused on investing in tangible and intangible assets in four principal categories (real estate, capital assets, natural resources and intellectual property), and an Asian fund.

 

  4) Principal investments in the above described funds.

Financial Statement Guide

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

Balance Sheet      
Due from Affiliates    6    Generally, management fees, expense reimbursements and incentive income due from Fortress Funds.
Investments    3    Primarily the carrying value of Fortress’s principal investments in the Fortress Funds.
Deferred Tax Asset    5    Relates to potential future tax benefits.
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.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

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.

Statement of Operations

     

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 Investments

   N/A    The result of asset dispositions or changes in the fair value of assets which are marked to market (primarily the Castles and GAGFAH).

Tax Receivable Agreement Liability Adjustment

   5    Represents a change in the amount due to the Principals under the tax receivable agreement.

Earnings (Losses) from Equity Method Investees

   3    Fortress’s share of the net earnings (losses) of the Fortress Funds resulting from its principal investments.

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.

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.

Earnings Per Share

   8    GAAP earnings per Class A 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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Selected Financial Statement Captions

   Note
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 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, 2009 and notes thereto included in Fortress’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2010. Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated financial statements for the year ended December 31, 2009.

2. MANAGEMENT AGREEMENTS AND FORTRESS FUNDS

Fortress has two principal sources of income from its agreements with the Fortress Funds: contractual management fees, which are generally based on a percentage of fee paying assets under management, and related incentive income, which is generally based on a percentage of profits subject to the achievement of performance criteria. Substantially all of Fortress’s net assets, after deducting the portion attributable to principals’ and others’ interests, are a result of principal investments in, or receivables from, these funds.

The Fortress Funds are divided into segments and Fortress’s agreements with each are detailed below.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Management Fees, Incentive Income and Related Profit Sharing Expense

Fortress recognized management fees and incentive income as follows:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010    2009    2010     2009

Private Equity

          

Private Equity Funds

          

Management fees - affil.

   $ 33,507    $ 38,921    $ 66,972      $ 76,590

Incentive income - affil.

     27,426      —        27,426        —  

Castles

          

Management fees - affil.

     11,074      11,950      22,854        23,340

Incentive income - affil.

     —        —        —          —  

Management fees - non-affil. (A)

     490      694      1,374        1,340

Liquid Hedge Funds

          

Management fees - affil.

     17,815      19,893      35,281        42,497

Incentive income - affil.

     116      144      (143     144

Management fees - non-affil. (A)

     1,668      —        3,004        25

Incentive income - non-affil. (A)

     —        —        —          —  

Credit Funds

          

Credit Hedge Funds

          

Management fees - affil.

     39,341      29,307      73,009        57,215

Incentive income - affil.

     —        —        (129     —  

Management fees - non-affil. (A)

     431      195      812        409

Incentive income - non-affil. (A)

     380      163      8,308        985

Credit PE Funds

          

Management fees - affil.

     11,157      8,354      21,314        14,435

Incentive income - affil.

     1,307      6,814      19,251        6,814

Management fees - non-affil. (A)

     —        —        —          —  

Other

          

Management fees - non-affil. (A) (C)

     3,695      —        3,695        —  

Total

          

Management fees - affil.

   $ 112,894    $ 108,425    $ 219,430      $ 214,077

Incentive income - affil. (B)

   $ 28,849    $ 6,958    $ 46,405      $ 6,958

Management fees - non-affil. (A)

   $ 6,284    $ 889    $ 8,885      $ 1,774

Incentive income - non-affil. (A)

   $ 380    $ 163    $ 8,308      $ 985

 

(A) Included in Other Revenues on the statement of operations.

 

(B) See “Deferred Incentive Income” below.

 

(C) Related to Logan Circle.

Deferred Incentive Income

Incentive income from certain Fortress Funds, primarily private equity funds and credit PE 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 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 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 six months ended June 30, 2010 and 2009. If the amount

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $9.7 million and $0.1 million of additional incentive income from affiliates would have been recognized during the six months ended June 30, 2010 and 2009, respectively. Incentive income based on achieving annual performance criteria that has not yet been recognized, if any, is not recorded on the balance sheet and is included as “undistributed” deferred incentive income in the table below.

During the six months ended June 30, 2010 and 2009, Fortress recognized $19.3 million and $6.8 million, respectively, of incentive income distributions from its credit PE funds which represented “tax distributions.” These tax distributions are not subject to clawback and reflect a cash amount equal to the amount expected to be paid out by Fortress for taxes or tax-related distributions on the allocated income from such funds.

Deferred incentive income from the Fortress Funds, subject to contingent repayment, was comprised of the following, on an inception to date basis:

 

     Distributed-
Gross
   Distributed-
Recognized (A)
    Distributed-
Unrecognized (B)
    Undistributed net of
intrinsic clawback

(C) (D)
 

Deferred incentive income as of December 31, 2009

   $ 503,415    $ (343,318   $ 160,097      $ 168,686   

Share of income (loss) of Fortress Funds

     —        —          —          83,311   

Distribution of incentive income

     131,546      —          131,546        (131,546

Recognition of previously deferred incentive income

     —        (46,677     (46,677     —     
                               

Deferred incentive income as of June 30, 2010

   $ 634,961    $ (389,995   $ 244,966      $ 120,451   
                               

 

(A) All related contingencies have been resolved.

 

(B) Reflected on the balance sheet.

 

(C) At June 30, 2010, the net undistributed incentive income is comprised of $203.8 million of gross undistributed incentive income, net of $83.3 million of intrinsic clawback (see next page). The net undistributed incentive income amount represents the amount that would be received by Fortress from the related funds if such funds were liquidated on June 30, 2010 at their net asset values.

 

(D) From inception to June 30, 2010, Fortress has paid $172.4 million of compensation expense under its employee profit sharing arrangements (Note 7) in connection with distributed incentive income, of which $27.9 million has not been expensed because management has determined that it is not probable of being incurred as an expense and will be recovered from the related employees. If the $203.8 million of gross undistributed incentive income were realized, Fortress would recognize and pay an additional $95.8 million of compensation expense.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

The following tables summarize information with respect to the Fortress Funds, other than the Castles, and their related incentive income thresholds as of June 30, 2010:

 

Fund

(Vintage)

(A)

   Maturity
Date (B)
   Inception to
Date
Capital Invested
   Inception to
Date
Distributions
    Net
Asset Value
(“NAV”)
   NAV
Surplus
(Deficit)
(C)
    Current
Preferred
Return
Threshold (D)
   Gain to
Cross Incentive
Income
Threshold (E)
   Undistributed
Incentive
Income (F)
   Distributed
Incentive
Income (G)
   Distributed
Incentive
Income
Subject to
Clawback (H)
   Gross
Intrinsic
Clawback (I)
   Net Intrinsic
Clawback (I)

Private Equity Funds

                                 

NIH (1998)

   Indefinite    $ 415,574    $ (782,065   $ 34,142      N/A      $ —        N/A    $ —      $ 94,513    $ —      $ —      $ —  

Fund I (1999) (J)

   Apr-10      1,062,177      (2,711,651     173,626      1,823,100        —        N/A      15,377      292,099      —        —        —  

Fund II (2002)

   Feb-13      1,974,296      (3,045,345     273,275      1,344,324        —        N/A      13,728      250,811      49,320      —        —  

Fund III (2004)

   Jan-15      2,762,993      (1,307,372     1,393,804      (61,817     843,006    $ 904,823      —        66,903      66,903    $ 66,903    $ 45,108

Fund III Coinvestment (2004)

   Jan-15      273,648      (90,925     168,203      (14,520     111,246      125,766      —        —        —        —        —  

Fund IV (2006)

   Jan-17      3,639,561      (119,640     2,662,599      (857,322     980,394      1,837,716      —        —        —        —        —  

Fund IV Coinvestment (2006)

   Jan-17      762,696      (12,676     542,622      (207,398     212,451      419,849      —        —        —        —        —  

GAGACQ Fund (2004)

   Nov-09      545,663      (595,401     N/A      N/A        N/A      N/A      N/A      51,476      N/A      N/A      N/A

FRID (2005)

   Apr-15      1,220,228      (505,605     358,010      (356,613     405,843      762,456      —        16,447      16,447      16,447      10,041

FRIC (2006)

   May-16      328,754      (17,460     136,088      (175,206     113,931      289,137      —        —        —        —        —  

FICO (2006)

   Jan-17      724,525      —          6,322      (718,203     229,867      948,070      —        —        —        —        —  

FHIF (2006)

   Jan-17      1,436,386      (63,154     1,251,047      (122,185     409,230      531,415      —        —        —        —        —  

Mortgage Opportunities Fund III (2008)

   Jun-13      193,861      (34,753     110,643      (48,465     —        48,465      —        —        —        —        —  
                                                     
                      $ 29,105    $ 772,249    $ 132,670    $ 83,350    $ 55,149
                                                     

PE Funds in Investment Period

                                 

Fund V (2007)

   Feb-18    $ 3,613,917    $ (2,570   $ 1,930,229    $ (1,681,118   $ 621,313    $ 2,302,431    $ —      $ —      $ —      $ —      $ —  

Fund V Coinvestment (2007)

   Feb-18      936,145      (126     452,080      (483,939     180,933      664,872      —        —        —        —        —  

FECI (2007)

   Feb-18      982,779      (144     749,371      (233,264     243,392      476,656      —        —        —        —        —  
                                                     
                      $ —      $ —      $ —      $ —      $ —  
                                                     

Credit PE Funds

                                 

Long Dated Value Fund I (2005)

   Apr-30    $ 267,325    $ (45,629   $ 244,637    $ 22,941      $ 63,196    $ 40,255    $ —      $ —      $ —      $ —      $ —  

Long Dated Value Fund II (2005)

   Nov-30      270,783      (50,548     241,339      21,104        50,314      29,210      —        412      —        —        —  

Long Dated Value Fund III (2007)

   Feb-32      334,665      (76,217     314,215      55,767        —        N/A      8,447      1,983      —        —        —  

LDVF Patent Fund (2007)

   Nov-27      35,268      (8,645     45,783      19,160        —        N/A      1,322      484      —        —        —  
                                                     
                      $ 9,769    $ 2,879    $ —      $ —      $ —  
                                                     

Credit PE Funds in Investment Period

                                 

Real Assets Fund (2007)

   Jun-17    $ 270,349    $ (89,992   $ 220,005    $ 39,648      $ —        N/A    $ 4,886    $ 1,316    $ —      $ —      $ —  

Assets Overflow Fund (2008)

   May-18      90,500      (57,070     50,128      16,698        —        N/A      1,004      662      29      —        —  

Credit Opportunities Fund (2008)

   Oct-20      3,411,136      (3,356,582     1,232,407      1,177,853        —        N/A      119,314      114,220      81,176      —        —  

FTS SIP L.P. (2008)

   Oct-18      662,642      (707,681     208,464      253,503        —        N/A      14,899      35,697      31,091      —        —  

Credit Opportunities Fund II (2009)

   Jul-22      328,646      (12,691     326,019      10,064        —        N/A      2,404      —        —        —        —  

Net Lease Fund I (2010)

   Jan-23      4,914      —          4,597      (317     78      395      —        —        —        —        —  

FCO MA LSS (2010)

   Jun-24      25,375      —          24,950      (425     143      568      —        —        —        —        —  

FCO MA II (2010)

   Jun-22      20,500      —          20,240      (260     4      264      —        —        —        —        —  

Japan Opportunity Fund (2009)

   Jun-19      374,161      (146,323     258,758      30,920        —        N/A      8,525      —        —        —        —  
                                                     
                      $ 151,032    $ 151,895    $ 112,296    $ —      $ —  
                                                     

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

     Incentive Income
Eligible NAV (K)
   Gain to Cross
Incentive Income
Threshold (L)
   Percentage of
Incentive Income
Eligible NAV Above
Incentive Income
Threshold (M)
    Undistributed
Incentive Income (N)
   Year to date
Incentive Income
Crystallized (O)

Liquid Hedge Funds

             

Macro Funds (P)

             

Main fund investments

   $ 2,178,065    $ 17,908    35.9   $ 3,108    $ 523

Sidepocket investments (Q)

     81,822      49,670    N/A        768      —  

Sidepocket investments - redeemers (R)

     230,712      134,054    N/A        511      —  

Fortress Commodities Funds (S)

             

Main fund investments

     975,835      13,519    11.9     569      1

Credit Hedge Funds

             

Special Opportunities Funds (S)

             

Main fund investments

   $ 2,595,930    $ —      100.0   $ 4,632    $ —  

Sidepocket investments (Q)

     183,844      66,459    N/A        1,864      —  

Sidepocket investments - redeemers (R)

     219,963      61,119    N/A        155      —  

Main fund investments (liquidating) (T)

     1,937,470      255,660    40.0     819      —  

Fortress Partners Funds (S)

             

Main fund investments

     224,898      69,557    33.5     755      —  

Sidepocket investments (Q)

     101,879      23,013    N/A        352      —  

Worden Fund

             

Main fund investments

     87,205      1,228    0.0     —        —  

 

(A) Vintage represents the year in which the fund was formed.

 

(B) Represents the contractual maturity date including the assumed exercise of all extension options, which in some cases may require the approval of the applicable fund advisory board. Private equity funds that have reached their maturity date are included in the table to the extent they have generated incentive income.

 

(C) Represents the gain needed to cross the incentive income threshold (as described in (E) below), excluding the impact of any relevant performance (i.e. preferred return) thresholds (as described in (D) below). The aggregate “NAV deficit,” net of surpluses, of the private equity funds was $1.8 billion as of period end.

 

(D) Represents the gain needed to achieve the current relevant performance thresholds, assuming the gain described in (C) above is already achieved.

 

(E) Represents the immediate increase in NAV needed for Fortress to begin earning incentive income, including the achievement of any relevant performance thresholds. It does not include the amount needed to earn back intrinsic clawback (see (I) below), if any. Incentive income is not recorded as revenue until it is received and any related contingencies are resolved (see (H) below).

 

(F) Represents the amount of additional incentive income Fortress would receive if the fund were liquidated at the end of the period at its NAV.

 

(G) Represents the amount of incentive income previously received from the fund since inception.

 

(H) Represents the amount of incentive income previously received from the fund which is still subject to contingencies and is therefore recorded on the consolidated balance sheet as Deferred Incentive Income. This amount will either be recorded as revenue when all related contingencies are resolved, or, if the fund does not meet certain performance thresholds, will be returned by Fortress to the fund (i.e., “clawed back”).

 

(I) Represents the amount of incentive income previously received from the fund that would be clawed back (i.e., returned by Fortress to the fund) if the fund were liquidated at the end of the period at its NAV, excluding the effect of any tax adjustments. Employees, former employees and affiliates of Fortress would be required to return a portion of this incentive income that was paid to them under profit sharing arrangements. “Gross” and “Net” refer to amounts that are gross and net, respectively, of this employee/affiliate portion of the intrinsic clawback. Fortress remains liable to the funds for these amounts even if it is unable to collect the amounts from employees/affiliates. Fortress withheld a portion of the amounts due to employees under these profit sharing arrangements as a reserve against future clawback; as of June 30, 2010, Fortress held $39.3 million of such amounts on behalf of employees related to all of the private equity funds.

 

(J) Fund I undistributed and distributed incentive income amounts are presented for the total fund, of which Fortress is entitled to approximately 50%. Distributed incentive income subject to clawback for Fund I is presented with respect to Fortress’s portion only.

 

(K) Represents the portion of a fund’s NAV that is eligible to earn incentive income.

 

(L) Represents, for those fund investors whose NAV is below the performance threshold Fortress needs to obtain before it can earn incentive income from such investors (their “incentive income threshold” or “high water mark”), the amount by which their aggregate incentive income thresholds exceed their aggregate NAVs. The amount by which the NAV of each investor within this category is below their respective incentive income threshold varies and, therefore, Fortress may begin earning incentive income from certain investors before this entire amount is earned back. Fortress earns incentive income whenever the assets of new investors, as well as of investors whose NAV exceeds their incentive income threshold, increase in value.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

(M) Represents the percentage which is computed by dividing (i) the aggregate NAV of all investors who are at or above their respective incentive income thresholds, by (ii) the total incentive income eligible NAV of the fund. The amount by which the NAV of each fund investor who is not in this category is below their respective incentive income threshold varies, and may vary significantly.

 

(N) Represents the amount of additional incentive income Fortress would earn from the fund if it were liquidated at the end of the period at its NAV. This amount is currently subject to performance contingencies generally until the end of the year or, in the case of sidepocket investments, until such investments are realized. Main Fund Investments (Liquidating) pay incentive income only after all capital is returned.

 

(O) Represents the amount of incentive income Fortress has earned in the current period from the fund which is no longer subject to contingencies.

 

(P) Represents the Drawbridge Global Macro Funds and Fortress Macro Funds. The Drawbridge Global Macro SPV (the “SPV”), which was established in February 2009 to liquidate illiquid investments and distribute the proceeds to then existing investors, is not subject to incentive income and is therefore not presented in the table. However, realized gains or losses within the SPV can decrease or increase, respectively, the gain needed to cross the incentive income threshold for investors with a corresponding investment in the main fund. The impact of the unrealized gains and losses within the SPV at June 30, 2010, as if they became realized, was immaterial to the amounts presented in the table for the Macro main fund.

 

(Q) Represents investments held in sidepockets (also known as special investment accounts), which generally have investment profiles similar to private equity funds. The performance of these investments may impact Fortress’s ability to earn incentive income from main fund investments. For the credit hedge funds, realized and unrealized losses from individual sidepockets below original cost may reduce the incentive income earned from main fund investments. For the Macro Funds, only realized losses from individual sidepockets reduce the incentive income earned from main fund investments. Based on current unrealized losses in Macro Fund sidepockets, if all of the Macro Fund sidepockets were liquidated at their NAV at June 30, 2010, the undistributed incentive income from the Macro main fund would not be materially impacted.

 

(R) Represents investments held in sidepockets for investors with no corresponding investment in the related main fund investments. In the case of the Macro Funds, such investors may have investments in the SPV (see (P) above).

 

(S) Includes onshore and offshore funds.

 

(T) Relates to accounts where investors have provided return of capital notices and are subject to payout as underlying fund investments are realized.

Private Equity Funds and Credit PE Funds

During the six months ended June 30, 2010, Fortress formed new private equity funds or credit PE funds which had capital commitments as follows as of June 30, 2010:

 

Fortress’s commitments

   $ 18,010

Fortress’s affiliates’ commitments

     23,700

Third party investors’ commitments

     592,255
      

Total capital commitments

   $ 633,965
      

Liquid Hedge Funds and Credit Hedge Funds

During the six months ended June 30, 2010, Fortress formed, or became the manager of, hedge funds with net asset values as follows as of June 30, 2010:

 

     Liquid    Credit

Fortress

   $ —      $ 102

Fortress’s affiliates

     —        —  

Third party investors

     —        87,205
             

Total NAV (A)

   $ —      $ 87,307
             

 

(A) Or other fee paying basis, as applicable.

Redemption notices received, and redemption payments which are made in periods after notices are received, including affiliates, have been as follows:

 

     Liquid Hedge Funds    Credit Hedge Funds

Six Months Ended June 30,

   Redemption Notices
Received
   Redemptions Paid
During the Period
   Redemption Notices
Received
   Redemptions Paid
During the Period

2010

   $ 436,732    $ 1,153,175    $ 270,250    $ 733,532

2009

   $ 1,017,045    $ 3,427,641    $ 142,586    $ 292,884

The differences between notices received and redemptions paid are a result of timing (notices received prior to quarter end, paid afterwards) and the contractual agreements regarding redemptions. In some cases, including all of the credit hedge funds, these agreements allow for delayed payment. In particular, the redemptions within the flagship credit hedge fund in 2008 and 2009, and the redemptions within the flagship liquid hedge fund in the fourth quarter of 2008 which related to illiquid investments, were subject to delayed payment.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Traditional Asset Management

In February 2010, Fortress announced that certain of its consolidated affiliates had agreed to acquire 100% of the equity of Logan Circle Partners, L.P. (“Logan Circle”) and its general partner, Logan Circle Partners GP, LLC, for approximately $19 million, with the potential for an additional payment at the end of 2011. The closing of the transaction occurred on April 16, 2010. The additional payment, or contingent consideration, is contingent on the growth and performance of Logan Circle’s business (but not contingent on the continued employment of any employees). The contingent consideration is payable in cash or Class A shares, at Fortress’s option, and had an estimated fair value of approximately $4 million at closing (maximum payment of $28 million). In addition, Fortress may make payments to the prior owners of Logan Circle, contingent upon the settlement of certain liabilities subject to pending litigation, of up to $2 million as of the date of acquisition. Fortress attributed a nominal fair value to these possible additional payments to the prior owners of Logan Circle. The total purchase price was approximately $23 million, which has been allocated approximately as follows: $14 million to goodwill (all expected to be tax deductible), $8 million to amortizable intangible assets, and $1 million to miscellaneous net assets.

The goodwill and other intangible assets have been recorded in Other Assets. The intangible assets are being amortized over their estimated useful lives, which range from 1 to 8 years. The contingent consideration is measured at fair value with changes in fair value being recorded as a gain (loss). This fair value is measured based on the expected performance of Logan Circle in 2011 and a discount rate, and therefore is considered a Level 3 valuation (Note 3). No material change in this valuation occurred between April 16, 2010 and June 30, 2010.

As of the date of acquisition, Logan Circle’s fair value was approximately equal to its carrying value. Fortress will test the Logan Circle goodwill and other intangible assets for impairment annually in the fourth quarter of each calendar year, or whenever events or circumstances indicate that it is more likely than not that Logan Circle’s fair value has declined below its carrying value. Logan Circle’ fair value will be estimated based on the following key assumptions: expected retention rate of existing investors, growth expectations, estimated future fee rates, and estimated operating margin. These assumptions are determined primarily based on Logan Circle’s past experience, Logan Circle’s historical and recent investment performance, current industry trends, and general economic expectations. These assumptions, particularly those relating to investor retention and growth expectations, are highly subjective and are subject to significant uncertainty with respect to future events. Continued challenging credit market conditions could adversely impact the value of Logan Circle.

In connection with the acquisition of Logan Circle, Fortress established a compensation plan for former Logan Circle employees who became employees of Fortress (the “Logan Circle Comp Plan”). The Logan Circle Comp Plan is further described in Note 7. From the date of acquisition through June 30, 2010, Logan Circle generated $3.7 million of revenues (primarily management fees from non-affiliates, recorded in Other Revenues) and $(4.1) million of net income (loss), including the impact of $0.1 million of equity-based compensation expense recorded in connection with the Logan Circle Comp Plan. This net income (loss) does not include any change in fair value of the contingent consideration.

Logan Circle is a fixed income asset manager with approximately $11.4 billion in assets under management as of the date of acquisition. With this acquisition, Fortress has expanded its investment management business to offer fixed income products to investors worldwide. Logan Circle is initially being reported in the “unallocated” section of Fortress’s segments until such time as it becomes material to Fortress’s operations.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

3. INVESTMENTS

Investments consist primarily of investments in equity method investees and options in these investees. The investees are primarily Fortress Funds.

Investments can be summarized as follows:

 

     June 30,
2010
   December 31,
2009

Equity method investees

   $ 822,885    $ 809,757

Equity method investees, held at fair value

     45,695      56,710
             

Total equity method investments

     868,580      866,467

Options in equity method investees

     852      748
             

Total investments

   $ 869,432    $ 867,215
             

Gains (losses) from investments can be summarized as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Net realized gains (losses)

   $ (55   $ (376   $ 345      $ (772

Net realized gains (losses) from affiliate investments

     (853     234        (1,182     (14

Net unrealized gains (losses)

     (637     —          (637     —     

Net unrealized gains (losses) from affiliate investments

     (11,412     19,583        (10,911     17,754   
                                

Total gains (losses) from investments

   $ (12,957   $ 19,441      $ (12,385   $ 16,968   
                                

Investments in Equity Method Investees

Fortress holds investments in certain Fortress Funds which are recorded based on the equity method of accounting. 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 Investment    Fortress’s Equity in Net Income (Loss)     Fortress’s Equity in Net Income (Loss)  
     June 30,    December 31,    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010    2009    2010     2009     2010     2009  

Private equity funds, excluding NIH (A)

   $ 529,584    $ 506,383    $ 7,444      $ 28,477      $ 16,686      $ (3,831

NIH

     2,292      2,486      (32     123        (181     (156

Newcastle (B)

     2,749      2,144      N/A        N/A        N/A        N/A   

Eurocastle (B)

     1,587      2,616      N/A        N/A        N/A        N/A   
                                              

Total private equity

     536,212      513,629      7,412        28,600        16,505        (3,987

Liquid hedge funds

     9,359      12,296      (245     957        21        1,969   

Credit hedge funds

     214,572      220,511      2,021        16,490        11,355        14,341   

Credit PE funds

     103,356      115,896      (3,888     5,027        (3,936     3,499   

Other

     5,081      4,135      850        (17     2,086        386   
                                              
   $ 868,580    $ 866,467    $ 6,150      $ 51,057      $ 26,031      $ 16,208   
                                              

 

(A) Includes Fortress’s direct investment in GAGFAH (XETRA:GFJ) common stock (a private equity portfolio company).

 

(B) Fortress elected to record these investments, as well as its direct investment in GAGFAH, at fair value pursuant to the fair value option for financial instruments.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

A summary of the changes in Fortress’s investments in equity method investees is as follows:

 

     Six Months Ended June 30, 2010  
     Private Equity     Liquid
Hedge Funds
    Credit              
     NIH     Other Funds (A)     Castles (B)       Hedge Funds     PE Funds     Other     Total  

Investment, beginning

   $ 2,486      $ 506,383      $ 4,760      $ 12,296      $ 220,511      $ 115,896      $ 4,135      $ 866,467   

Earnings from equity method investees

     (181     16,686        N/A        21        11,355        (3,936     2,086        26,031   

Other comprehensive income from equity method investees

     (13     —          N/A        —          —          (2,408     —          (2,421

Contributions to equity method investees

     —          19,427        —          7,260        934        18,039        50        45,710   

Distributions of earnings from equity method investees

     —          (55     N/A        (87     (10     (3,239     (685     (4,076

Distributions of capital from equity method investees

     —          (2,267     N/A        (10,131     (18,218     (20,996     (505     (52,117
                                                                

Total distributions from equity method investees

     —          (2,322     N/A        (10,218     (18,228     (24,235     (1,190     (56,193
                                                                

Mark to fair value - during period (C)

     N/A        (3,174     (64     N/A        N/A        N/A        N/A        (3,238

Translation adjustment

     —          (7,416     (360     —          —          —          —          (7,776
                                                                

Investment, ending

   $ 2,292      $ 529,584      $ 4,336      $ 9,359      $ 214,572      $ 103,356      $ 5,081      $ 868,580   
                                                                

Ending balance of undistributed earnings

   $ —        $ 1        N/A      $ 9      $ 4,523      $ 1,077      $ 1,690      $ 7,300   
                                                                

 

(A) Includes Fortress’s direct investment in GAGFAH (XETRA:GFJ) common stock (a private equity portfolio company).

 

(B) Fortress elected to record these investments, as well as its direct investment in GAGFAH, at fair value pursuant to the fair value option for financial instruments.

 

(C) Recorded to Other Investments – Net Unrealized Gains (Losses) from Affiliate Investments.

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. NIH, the Castles, GAGFAH and Other are not presented as they are insignificant to Fortress’s investments.

 

     Private Equity Funds excluding NIH  
     June 30,
2010
    December 31,
2009
 

Assets

   $ 11,115,058      $ 10,993,214   

Debt

     (25,432     (705,432

Other liabilities

     (479,426     (275,702
                

Equity

   $ 10,610,200      $ 10,012,080   
                

Fortress’s Investment (A)

   $ 529,584      $ 506,383   
                

Ownership (B)

     5.0     5.1
                
     Six Months Ended June 30,  
     2010     2009  

Revenues and gains (losses) on investments

   $ 281,058      $ 824,989   

Expenses

     (113,672     (130,114
                

Net Income (Loss)

   $ 167,386      $ 694,875   
                

Fortress’s equity in net income (loss)

   $ 16,686      $ (3,831
                

 

(A) Includes Fortress’s direct investment in GAGFAH (XETRA:GFJ) common stock (a private equity portfolio company). GAGFAH’s summary financial information is not included in this table.

 

(B) Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

     Liquid Hedge Funds     Credit Hedge Funds     Credit PE Funds (B)  
     June 30,
2010
    December 31,
2009
    June 30,
2010
    December 31,
2009
    June 30,
2010
    December 31,
2009
 

Assets

   $ 8,943,564      $ 9,641,111      $ 11,673,574      $ 11,048,076      $ 4,291,561      $ 6,243,776   

Debt

     —          —          (3,547,439     (2,938,213     (454,858     (1,767,331

Other liabilities

     (4,990,551     (6,187,965     (680,012     (667,604     (309,668     (95,807

Non-controlling interest

     —          —          (6,055     (16,600     (2,511     (153,016
                                                

Equity

   $ 3,953,013      $ 3,453,146      $ 7,440,068      $ 7,425,659      $ 3,524,524      $ 4,227,622   
                                                

Fortress’s Investment

   $ 9,359      $ 12,296      $ 214,572      $ 220,511      $ 103,356      $ 115,896   
                                                

Ownership (A)

     0.2     0.4     2.9     3.0     2.9     2.7
                                                
     Six Months Ended June 30,     Six Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009     2010     2009  

Revenues and gains (losses) on investments

   $ 144,857      $ 482,313      $ 672,716      $ 732,268      $ 529,609      $ 729,199   

Expenses

     (92,714     (91,392     (144,641     (143,270     (126,775     (65,007
                                                

Net Income (Loss)

   $ 52,143      $ 390,921      $ 528,075      $ 588,998      $ 402,834      $ 664,192   
                                                

Fortress’s equity in net income (loss)

   $ 21      $ 1,969      $ 11,355      $ 14,341      $ (3,936   $ 3,499   
                                                

 

(A) Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates.

 

(B) Includes one entity which is recorded on a one quarter lag (i.e., the balances reflected for this entity are for the periods ended March 31, 2010 and 2009, respectively) and two entities which are recorded on a one month lag. They are recorded on a lag because they are foreign entities and do not provide financial reports under U.S. GAAP within the reporting timeframe necessary for U.S. public entities.

Investments in Variable Interest Entities

Fortress is not 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 six months ended June 30, 2010 which caused a change in Fortress’s accounting, except as described below.

The following table sets forth certain information as of June 30, 2010 regarding entities formed during the six months ended June 30, 2010 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    Financial Obligations (A)    Fortress Investment (B)    Notes

Credit Hedge Funds

   $ 143,337    $ 49,887    $ 168    (C) (D)

Credit PE Funds

   $ 193,807    $ 46,449    $ 670    (C)

 

(A) Represents financial obligations at the fund level, which are not recourse to Fortress. Financial obligations include financial borrowings, derivative liabilities and short securities. In many cases, these funds have additional debt within unconsolidated subsidiaries. Of the financial obligations represented herein as of June 30, 2010, $47.4 million and $46.4 million represent financial borrowings which have weighted average maturities of 30.1 and 3.7 years for the credit hedge funds and credit PE funds, respectively.

 

(B) Represents Fortress’s maximum exposure to loss with respect to these entities, which includes direct and indirect investments in the funds. In addition to the table above, Fortress is exposed to potential changes in cash flow and revenues attributable to the management fees and/or incentive income Fortress earns from these entities.

 

(C) Fortress is not the primary beneficiary of these entities, which represent investing vehicles and a master fund, because the related funds and feeder fund (which are not consolidated) are more closely associated with these funds than Fortress based on both a quantitative and qualitative analysis. The investing vehicles and master fund were formed for the sole purpose of acting as investment vehicles for the related funds.

 

(D) Fortress’s investment includes $66,000 of other receivables from the credit hedge funds.

In June 2009, the FASB issued new guidance on consolidation which became effective for Fortress on January 1, 2010. This guidance changes the definition of a variable interest entity (“VIE”) and changes the methodology to determine who is the primary beneficiary of, or in other words who consolidates, a VIE. Generally, the changes are expected to cause more entities to be defined as VIE’s and to shift consolidation to those entities that exercise day-to-day control over the VIE’s, such as investment managers. In February 2010, the FASB updated this guidance to defer its application to certain managed entities, particularly investment companies and similar entities. As a result, this guidance had no material impact on Fortress’s financial position, results of operations or liquidity.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

The following table sets forth certain information regarding VIEs in which Fortress held a variable interest. The June 30, 2010 amounts presented below include VIEs formed during the period (as shown in the immediately preceding table) 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     
     June 30, 2010    December 31, 2009     

Business Segment

   Gross Assets    Financial
Obligations  (A)
   Fortress
Investment  (B)
   Gross Assets    Financial
Obligations  (A)
   Fortress
Investment  (B)
   Notes

Private Equity Funds

   $ 341,206    $ 193,497    $ 2,515    $ 352,787    $ 197,791    $ 2,740    (C) (D)

Castles

     9,787,316      10,055,736      12,347      11,150,750      12,066,365      13,335    (C) (D)

Liquid Hedge Funds

     7,626,116      4,799,323      6,377      7,773,895      5,090,344      7,170    (C) (D)

Credit Hedge Funds

     2,236,956      287,486      13,747      2,153,220      598,216      3,132    (C) (D)

Credit PE Funds

     460,352      46,449      1,160      268,919      5,300      3,710    (C) (D)

 

(A) Represents financial obligations at the fund level, which are not recourse to Fortress. Financial obligations include financial borrowings, derivative liabilities and short securities. In many cases, these funds have additional debt within unconsolidated subsidiaries. Of the financial obligations represented herein as of June 30, 2010, $193.4 million, $9,426.7 million, $253.0 million and $46.4 million represent financial borrowings which have weighted average maturities of 0.9, 4.0, 7.9, and 3.7 years for the private equity funds, Castles, credit hedge funds and credit PE funds, respectively. Of the financial obligations represented herein as of December 31, 2009, $197.8 million, $11,438.7 million, $551.4 million, and $5.3 million represent financial borrowings which have weighted average maturities of 1.4, 4.5, 3.2, and 0.5 years for the private equity funds, Castles, credit hedge funds, and credit PE funds, respectively.

 

(B) Represents Fortress’s maximum exposure to loss with respect to these entities, which includes direct and indirect investments in these funds. In addition to the table above, Fortress is exposed to potential changes in cash flow and revenues attributable to the management fee and/or incentive income Fortress earns from those entities.

 

(C) Fortress is not the primary beneficiary of the Castles and NIH because it does not absorb a majority of their expected income or loss based on a quantitative analysis. Of the remaining entities represented herein, which represent investing vehicles, intermediate entities and master funds, Fortress is not the primary beneficiary because the related funds, intermediate entities and feeder funds (which are not consolidated) are more closely associated with these funds than Fortress based on both a quantitative and qualitative analysis. The investing vehicles, intermediate entities and master funds were formed for the sole purpose of acting as investment vehicles for the related funds.

 

(D) As of June 30, 2010, Fortress’s investment includes $3.6 million, $0.8 million, $11.4 million, and $0.2 million of management fees receivable from the Castles, liquid hedge funds, credit hedge funds, and credit PE funds, respectively, as well as $0.1 million in incentive income receivable from the liquid hedge funds. As of June 30, 2010, Fortress’s investment also includes $0.2 million, $3.6 million, $3.7 million and $1.0 million of expense reimbursements and other receivables from the private equity funds, Castles, liquid hedge funds and credit hedge funds, respectively. As of December 31, 2009, Fortress’s investment includes $4.1 million, $0.5 million, and $1.0 million of management fees receivable from the Castles, credit hedge funds, and credit PE funds, respectively, as well as $3.7 million and $0.9 million in incentive income receivable from the liquid hedge funds and credit hedge funds, respectively. As of December 31, 2009, Fortress’s investment also includes $0.2 million, $3.7 million, $1.5 million, $0.6 million and $0.7 million of expense reimbursements and other receivables from the private equity funds, Castles, liquid hedge funds, credit hedge funds and credit PE funds, respectively. In addition, Fortress has remaining capital commitments to certain credit PE funds which are VIEs which aggregated $0.2 million at June 30, 2010.

In March 2010, Fortress determined that a reconsideration event had occurred with respect to an operating subsidiary (“FCF”) of one of its private equity funds. FCF provides operating services to all of Fortress’s private equity funds and is reimbursed for related costs by the private equity funds based on a contractual formula. Therefore, FCF by design does not produce net income or have equity. Historically, Fortress has provided temporary advances to FCF as a result of certain funds having insufficient current liquidity to make their required reimbursements on a timely basis; these advances were deemed fully collectable. In March 2010, Fortress determined it would make advances to FCF related to a fund from which reimbursement was subject to significant uncertainty. Management determined that these advances would represent the provision of financial support to FCF. As a result of this reconsideration event, FCF was deemed to be a VIE and Fortress, as a result of directing the operations of FCF through its management contracts with the private equity funds, and providing financial support to FCF beginning in March 2010, was deemed to be its primary beneficiary. Therefore, Fortress consolidated FCF beginning in March 2010, which resulted in a gross up of reimbursement revenues, compensation and miscellaneous expenses, receivables, and payables, but had no impact on Fortress’s net income or equity. As of June 30, 2010, FCF’s gross assets were approximately $27.5 million, primarily comprised of affiliate receivables. Fortress’s exposure to loss from FCF is limited to its outstanding advances, which were approximately $10.7 million at June 30, 2010, plus any future advances. Subsequent to Fortress’s consolidation of FCF, these advances are eliminated in consolidation. FCF’s creditors do not have recourse to Fortress’s other assets.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Fair Value of Financial Instruments

The following table presents information regarding Fortress’s financial instruments that are recorded at fair value. Investments denominated in foreign currencies have been translated at the period end exchange rate. Changes in fair value are recorded in Gains (Losses) from Investments.

 

     Fair Value   

Valuation Method

      June 30, 2010    December 31, 2009     
Assets         

Newcastle and Eurocastle common shares

   $ 3,032    $ 2,662    Level 1 - Quoted prices in active markets for identical assets

GAGFAH common shares

   $ 41,359    $ 51,950    Level 1 - Quoted prices in active markets for identical assets

Eurocastle convertible debt (A)

   $ 1,304    $ 2,098    Level 3 - Black-Scholes option valuation models, adjusted for non-option characteristics

Newcastle and Eurocastle options

   $ 852    $ 748    Level 2 - Lattice-based option valuation models using significant observable inputs

Liabilities

        

Logan Circle Contingent Consideration

   $ 4,000    $ —      Level 3 - Internal model using significant unobservable inputs

Derivatives

   $ 637    $ —      Level 2 - See below

 

(A) The debt bears interest at 20% per annum and is perpetual, but ECT may redeem the securities after June 2011 at a premium of 20%. As of June 30, 2010, it had a face amount of €1.2 million ($1.5 million) and was convertible into ECT common shares at €0.30 per share. The fair value was determined using the market value approach.

Fortress’s interests in instruments measured at fair value using Level 3 inputs changed during the six months ended June 30, 2010 as follows:

 

     Assets     Liabilities  

Balance at December 31, 2009

   $ 2,098      $ —     

Total gains (losses) included in net income (including foreign currency translation)

     (794     —     

Issuance of Logan Circle contingent consideration (Note 2)

     —          (4,000
                

Balance at June 30, 2010

   $ 1,304      $ (4,000
                

See Note 5 regarding the fair value of Fortress’s outstanding debt.

Derivatives

Fortress is exposed to certain risks relating to its ongoing business operations. The primary risk managed by Fortress using derivative instruments is foreign currency risk. Fortress enters into foreign exchange forward contracts to economically hedge the risk of fluctuations in foreign exchange rates with respect to certain foreign currency denominated assets. Foreign exchange forward contracts involve the purchase and sale of a designated currency at an agreed upon rate for settlement on a specified date. Fortress entered into four foreign exchange forward contracts in June 2010 which were not designated as hedges for accounting purposes. Gains and losses on these contracts are reported currently in Gains (Losses) from Investments.

Fortress’s derivative instruments are carried at fair value and are generally valued using models with observable market inputs that can be verified and which do not involve significant judgment. The significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash flows and market based parameters such as foreign exchange rates.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Fortress’s derivatives are recorded as follows:

 

     Balance Sheet
Location
   Fair Value
June 30, 2010
    Notional Amount
June 30, 2010
   Gains/(Losses) Six
Months Ended
June 30, 2010
    Range of
Maturity
Dates

Foreign Exchange forward contracts (not designated as hedges)

   Other Liabilities    ($ 637   29,180    ($ 637   Sept 2010 -
June 2011

4. DEBT OBLIGATIONS

The following table presents summarized information regarding Fortress’s debt obligations:

 

                    June 30, 2010
     Face Amount and
Carrying Value
  

Contractual

Interest Rate

   Final
Stated
Maturity
   Weighted
Average

Funding
Cost (A)
    Weighted
Average

Maturity
(Years)
Debt Obligation    June 30,
2010
   December 31,
2009
          

Credit agreement (B)

                

Revolving debt (C)

   $ —      $ —      LIBOR + 2.50% (D)    May 2012    —        —  

Term loan

     350,000      350,000    LIBOR + 2.50%    May 2012    3.66   1.67

Delayed term loan (C)

     5,900      47,825    LIBOR + 2.50%    May 2012    3.02   0.29
                              

Total

   $ 355,900    $ 397,825          3.65   1.65
                              

 

(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 0.35%.

 

(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 $66.9 million was undrawn on the revolving debt facility as of June 30, 2010. The revolving debt facility includes a $25 million letter of credit subfacility of which $8.1 million was utilized. Lehman Brothers Commercial Paper, Inc., which is committed to fund $7.2 million (including $0.8 million of the outstanding letters of credit) of the $75 million revolving credit facility, has filed for bankruptcy protection, did not fund its pro rata portion of the last borrowing under this facility, and it is reasonably possible that it will not fund its portion of the commitments. As a result, $60.5 million of the undrawn amount was available.

 

(D) Subject to unused commitment fees of 0.50% per annum.

To management’s knowledge, there have not been any market transactions in Fortress’s debt obligations. However, management believes the fair value of this debt was between 95% and 100% of face value at June 30, 2010.

Fortress was in compliance with all of its debt covenants as of June 30, 2010. The following table sets forth the financial covenant requirements as of June 30, 2010 (dollars in millions).

 

   

June 30, 2010

(dollars in millions)

    
   

Requirement

   Actual    Notes

AUM

 

³$

     20,000    $ 41,660    (A)

Consolidated Leverage Ratio

 

£

     3.50      1.14    (B)

Required Investment Assets

 

³$

     366    $ 871    (C)

Fortress Fund Investments

 

³$

     147    $ 545    (C)

Total Investments

 

³$

     220    $ 701    (C)

 

(A) Impacted by capital raised in funds, redemptions from funds, and valuations of fund investments.

 

(B) Impacted by EBITDA, as defined, which is impacted by the same factors as distributable earnings, except EBITDA is not impacted by changes in clawback reserves or gains and losses, including impairment, on investments.

 

(C) Impacted by capital investments in funds and the valuation of such funds’ investments.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

5. INCOME TAXES AND TAX RELATED PAYMENTS

For the six months ended June 30, 2010, an estimated annual effective tax rate of (5.49)% 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 June 30,     Six Months Ended June 30,  
     2010    2009     2010    2009  

                     Current

          

Federal income tax expense (benefit)

   $ 2,548    $ (196   $ 2,629    $ 619   

Foreign income tax expense (benefit)

     505      580        1,092      992   

State and local income tax expense (benefit)

     1,417      1,709        3,025      3,834   
                              
     4,470      2,093        6,746      5,445   
                              

                     Deferred

          

Federal income tax expense (benefit)

     1,596      (1,752     528      (3,271

Foreign income tax expense (benefit)

     28      443        31      347   

State and local income tax expense (benefit)

     1,540      (2,092     1,881      (4,236
                              
     3,164      (3,401     2,440      (7,160
                              

Total expense (benefit)

   $ 7,634    $ (1,308   $ 9,186    $ (1,715
                              

The tax effects of temporary differences have resulted in deferred income tax assets and liabilities as follows:

 

     June 30, 2010     December 31, 2009  

Total deferred tax assets

   $ 566,459      $ 545,253   

Valuation allowance

     (111,653     (104,614
                

Net deferred tax assets

   $ 454,806      $ 440,639   
                

Total deferred tax liabilities (A)

   $ 494      $ 456   
                

 

(A) Included in Other Liabilities

For the six months ended June 30, 2010, a deferred income tax benefit of $0.5 million was credited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $0.4 million was credited to paid-in capital, related to (i) dividend equivalent payments on RSUs (Note 8), and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 7), which are currently deductible for income tax purposes.

The exchange by the principals of Fortress Operating Group units and Class B shares for Class A shares during the second quarter (as described in Note 8) increased FIG Corp’s ownership percentage in the underlying Fortress Operating Group entities. As a result of the increased ownership, the deferred tax asset was increased by $7.2 million with an offsetting increase of $2.8 million to the valuation allowance. In addition, the deferred tax asset was increased by $8.0 million related to a step-up in tax basis due to the share exchange which will result in additional tax deductions, while the liability for the tax receivable agreement was increased by $5.2 million to represent 85% of the expected cash tax savings resulting from the increase in tax basis deductions. The establishment of these net deferred tax assets, net of the change in the tax receivable agreement liability, as well as a $4.6 million increase to the deferred tax asset relating to the vesting of RSUs, also increased paid-in capital.

Tax Receivable Agreement

Although the tax receivable agreement payments are calculated based on annual tax savings, for the six months ended June 30, 2010, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $8.0 million.

In April 2010, $14.7 million was paid out under the tax receivable agreement related to prior periods.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

6. RELATED PARTY TRANSACTIONS AND INTERESTS IN CONSOLIDATED SUBSIDIARIES

Affiliate Receivables and Payables

Due from affiliates was comprised of the following:

 

     Private Equity    Liquid Hedge    Credit    Other    Total
     Funds    Castles       Hedge Funds    PE
Funds
     
June 30, 2010                     

Management fees and incentive income (A)

   $ 38,385    $ 3,554    $ 1,014    $ 17,394    $ 11,483    $ —      $ 71,830

Expense reimbursements (A)

     9,439      3,035      4,149      7,922      4,568      —        29,113

Expense reimbursements - FCF (B)

     16,151      —        —        —        —        —        16,151

Dividends and distributions

     —        —        —        —        —        —        —  

Other

     48      299      —        14      13,092      1,696      15,149
                                                

Total

   $ 64,023    $ 6,888    $ 5,163    $ 25,330    $ 29,143    $ 1,696    $ 132,243
                                                
     Private Equity    Liquid Hedge
Funds
   Credit    Other    Total
     Funds    Castles       Hedge Funds    PE
Funds
     
December 31, 2009                     

Management fees and incentive income (C)

   $ 17,116    $ 4,087    $ 7,557    $ 4,038    $ 11,200    $ —      $ 43,998

Expense reimbursements (C)

     5,471      3,750      1,802      4,752      3,010      —        18,785

Dividends and distributions

     —        —        —        —        —        —        —  

Other

     88      179      —        —        1      1,460      1,728
                                                

Total

   $ 22,675    $ 8,016    $ 9,359    $ 8,790    $ 14,211    $ 1,460    $ 64,511
                                                

 

(A) Net of allowances for uncollectable management fees and expense reimbursements of $11.3 million and $0.6 million, respectively.

 

(B) Represents expense reimbursements due to FCF, a consolidated VIE (Note 3).

 

(C) Net of allowances for uncollectable management fees and expense reimbursements of $13.8 million and $0.8 million, respectively.

As of June 30, 2010, amounts due from Fortress Funds recorded in Due from Affiliates included $38.4 million of past due management fees, excluding $11.3 million which has been subordinated to other liabilities of the related fund and has been fully reserved by Fortress, and $10.7 million of private equity general and administrative expenses advanced on behalf of certain Fortress Funds. Although such funds are currently experiencing liquidity issues, Fortress believes the unreserved fees will ultimately be collectable as the NAV’s of the respective funds exceed the amounts owed.

Due to affiliates was comprised of the following:

 

     June 30, 2010    December 31, 2009

Principals

     

- Tax receivable agreement - Note 5

   $ 315,794    $ 326,467

- Distributions payable on Fortress Operating Group units

     4,337      16,552

- Distributions payable on other non-controlling interests

     23,614      —  

Other

     8,234      2,957
             
   $ 351,979    $ 345,976
             

Other Related Party Transactions

For the six months ended June 30, 2010 and 2009, Other Revenues included approximately $4.0 million and $3.3 million, respectively, of revenues from affiliates, primarily dividends.

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 six months ended June 30, 2010 and 2009, these expenses, mainly related to subscriptions to market data services, approximated $8.4 million and $8.5 million, respectively.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

In February 2010, two employees terminated their employment at Fortress in order to form their own management company. Effective April 1, 2010, a subsidiary of Fortress entered into a sub-advisory agreement with them and their management company for the purpose of continuing to have them advise on an existing portfolio of illiquid investments in emerging markets on which they previously worked while they were employees. Pursuant to the terms of the agreement, the subsidiary will pay their management company an annual advisory fee and pay them a percentage of realized net proceeds from certain of such investments. As part of the agreement, the former employees have agreed to notify Fortress about certain investment opportunities in which they are involved. Through June 30, 2010, such payments have aggregated $0.8 million.

In April 2010, Fortress entered into a software sublicensing agreement on an “as is” basis with a subsidiary of several Fortress Funds. The software is designed to facilitate cash management, legal entity management and data reconciliation. Fortress paid a one-time licensing fee of $150,000. The license is perpetual and irrevocable and for the non-exclusive use of Fortress’s affiliates.

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:

 

     June 30, 2010    December 31, 2009

Principals’ Fortress Operating Group units

   $ 304,367    $ 301,469

Employee interests in majority owned and controlled fund advisor and general partner entities

     36,651      35,789

Other

     1,476      839
             

Total

   $ 342,494    $ 338,097
             

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 June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Principals’ Fortress Operating Group units

   $ (160,653   $ (128,926   $ (340,775   $ (348,549

Employee interests in majority owned and controlled fund advisor and general partner entities

     1,592        2,183        4,246        2,211   

Other

     204        5        491        78   
                                

Total

   $ (158,857   $ (126,738   $ (336,038   $ (346,260
                                

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

The purpose of this schedule is to disclose the effects of changes in Fortress’s ownership interest in Fortress Operating Group on Fortress’s equity:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  

Net income (loss) attributable to Fortress

   $ (92,384   $ (44,592   $ (176,535   $ (111,751

Transfers (to) from the Principals’ and Others’ Interests:

        

Increase in Fortress’s paid-in capital for the conversion of Fortress Operating Group Units by the Principals

     7,188        —          7,188        —     

Increase in Fortress’s paid-in capital for the delivery of Class A shares primarily in connection with vested RSUs

     4,100        —          7,533        —     

Decrease in Fortress’s paid-in capital for the purchase of Fortress Operating Group units in connection with an equity offering

     —          (144,572     —          (144,572
                                

Change from net income (loss) attributable to Fortress and transfers (to) from Principals’ and Others’ Interests

   $ (81,096   $ (189,164   $ (161,814   $ (256,323
                                

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 June 30,    Six Months Ended June 30,
     2010    2009    2010    2009

Equity-based compensation, per below

   $ 48,222    $ 52,779    $ 112,029    $ 105,823

Profit-sharing expense, per below

     29,020      8,245      79,434      11,849

Discretionary bonuses

     44,321      23,290      78,679      46,148

Other payroll, taxes and benefits

     37,966      29,142      68,780      58,872
                           
   $ 159,529    $ 113,456    $ 338,922    $ 222,692
                           

Equity-Based Compensation

The following tables set forth information regarding equity-based compensation activities.

 

     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, 2009

   44,941,811      $ 14.59    6,689,054      $ 13.42    216,367    $ 9.58    31,000,000    $ 13.75

Issued

   7,708,357        4.70    1,004,551        4.70    210,302      3.50    —        —  

Converted to Class A shares

   (10,528,934     16.85    (938,390     13.40    —        —      —        —  

Transfers (C)

   5,345,717        12.50    (5,345,717     12.50    —        —      —        —  

Forfeited

   (1,525,221     12.84    (212,555     8.42    —        —      —        —  
                                                 

Outstanding as of June 30, 2010 (B)

   45,941,730      $ 12.23    1,196,943      $ 11.11    426,669    $ 6.58    31,000,000    $ 13.75
                                                 

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009

Expense incurred (B)

           

Employee RSUs

   $ 23,175    $ 24,842    $ 61,629    $ 49,265

Non-Employee RSUs

     565      3,509      1,815      7,970

Restricted Shares

     70      149      161      297

LTIP

     1,714      1,714      3,410      3,410

RPUs

     22,565      22,565      44,881      44,881

Logan Circle Comp Plan

     133      —        133      —  
                           

Total equity-based compensation expense

   $ 48,222    $ 52,779    $ 112,029    $ 105,823
                           

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

(A) Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of June 30, 2010 for awards granted to non-employees was $2.87, which is equal to the closing trading price per share of Fortress’s Class A shares on such date.

 

(B) In future periods, Fortress will recognize compensation expense on its non-vested equity based awards of $549 million, with a weighted average recognition period of 2.7 years. This does not include contingent amounts or amounts related to the Principals Agreement.

 

(C) Relates to FCF employees who became employees of Fortress (see Note 3).

When Fortress records equity-based compensation expense, including that related to the Principals Agreement, it records a corresponding increase in capital. When Fortress delivers Class A shares as a result of the vesting of equity-based compensation, to the extent that it pays withholding taxes in cash (rather than through the sale of employee shares upon delivery) it will record a decrease in capital related to these payments.

In January 2010, Fortress granted 8.0 million RSUs to its employees and affiliates. These RSUs generally vest over two and a half years.

In April 2010, in connection with the acquisition of Logan Circle, Fortress created the Logan Circle Comp Plan (see Note 2). The Logan Circle Comp Plan provides for annual bonuses to a senior employee which may be paid partially in RSUs, as well as for potential Class A share awards to certain employees, including this senior employee, in the years 2015, 2016 and 2017. These awards are annual performance-based awards and depend on the future performance of Logan Circle in the specific years to which they relate. Furthermore, the amounts of RSUs or shares to be awarded are not fixed until the respective year is completed. As such, these awards are expensed in the year to which they pertain based on the estimated value of awards expected to vest in that year.

Profit Sharing Expense

Recognized profit sharing compensation expense is summarized as follows:

 

     Three Months Ended June 30,    Six Months Ended June 30,  
     2010    2009    2010    2009  

Private equity funds (A)

   $ —      $ —      $ —      $ (15

Castles (A)

     —        —        —        (137

Liquid hedge funds

     820      2,886      3,846      5,450   

Credit hedge funds

     4,049      1,765      8,194      2,957   

Credit private equity funds

     24,151      3,594      67,394      3,594   
                             

Total

   $ 29,020    $ 8,245    $ 79,434    $ 11,849   
                             

 

(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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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

8. EARNINGS PER SHARE AND DISTRIBUTIONS

 

     Three Months Ended June 30, 2010     Six Months Ended June 30, 2010  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

     161,432,497        161,432,497        153,795,581        153,795,581   

Fully vested restricted Class A share units with dividend equivalent rights

     3,683,174        3,683,174        7,466,731        7,466,731   

Fully vested restricted Class A shares

     131,110        131,110        122,823        122,823   

Fortress Operating Group units exchangeable into Class A shares (1)

     —          —          —          304,003,134   

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

     165,246,781        165,246,781        161,385,135        465,388,269   
                                

Basic and diluted net income (loss) per Class A share

        

Net income (loss) attributable to Class A shareholders

   $ (92,384   $ (92,384   $ (176,535   $ (176,535

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)

     (1,452     (1,452     (6,923     (6,923

Dividend equivalents declared on non-vested restricted Class A shares and restricted Class A share units

     —          —          —          —     

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 Class A shares (1)

     —          —          —          (357,150
                                

Net income (loss) available to Class A shareholders

   $ (93,836   $ (93,836   $ (183,458   $ (540,608
                                

Weighted average shares outstanding

     165,246,781        165,246,781        161,385,135        465,388,269   
                                

Basic and diluted net income (loss) per Class A share

   $ (0.57   $ (0.57   $ (1.14   $ (1.16
                                
     Three Months Ended June 30, 2009     Six Months Ended June 30, 2009  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

     114,810,756        114,810,756        104,711,660        104,711,660   

Fully vested restricted Class A share units with dividend equivalent rights

     631,260        631,260        631,260        631,260   

Fully vested restricted Class A shares

     105,728        105,728        104,404        104,404   

Fortress Operating Group units exchangeable into 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

     115,547,744        427,619,294        105,447,324        417,518,874   
                                

Basic and diluted net income (loss) per Class A share

        

Net income (loss) attributable to Class A shareholders

   $ (44,592   $ (44,592   $ (111,751   $ (111,751

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)

     (2,052     (2,052     (3,729     (3,729

Dividend equivalents declared on non-vested restricted Class A shares and restricted Class A share units

     —          —          —          —     

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 Class A shares (1)

     —          (129,046     —          (345,672
                                

Net income (loss) available to Class A shareholders

   $ (46,644   $ (175,690   $ (115,480   $ (461,152
                                

Weighted average shares outstanding

     115,547,744        427,619,294        105,447,324        417,518,874   
                                

Basic and diluted net income (loss) per Class A share

   $ (0.40   $ (0.41   $ (1.10   $ (1.10
                                

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

(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. To the extent charges, particularly tax related charges, are incurred by the Registrant (i.e. not at the Fortress Operating Group level), the effect may be anti-dilutive.

 

(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 Fortress’s Class A shares and therefore participate fully in the results of Fortress’s 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.

 

(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 in the periods presented, the effect of the units on the calculation is anti-dilutive for each of the periods. The weighted average restricted Class A share units which are not entitled to receive dividend or dividend equivalent payments outstanding were:

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009

Share Units

   27,490,829    24,558,303    27,583,603    24,950,597

 

(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 (“FOG”) 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.

Fortress’s dividend paying shares and units were as follows:

 

     Weighted Average    Weighted Average
     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009

Class A shares (public shareholders)

   161,432,497    114,810,756    153,795,581    104,711,660

Restricted Class A shares (directors)

   270,395    138,160    250,951    136,836

Restricted Class A share units (employees) (A)

   3,683,174    631,260    7,466,731    631,260

Restricted Class A share units (employees) (B)

   19,518,811    22,955,132    19,719,641    22,955,132

Fortress Operating Group units (Principals)

   300,273,852    312,071,550    304,003,134    312,071,550

Fortress Operating Group RPUs (senior employee)

   31,000,000    31,000,000    31,000,000    31,000,000
                   

Total

   516,178,729    481,606,858    516,236,038    471,506,438
                   

 

     As of June 30, 2010    As of December 31, 2009

Class A shares (public shareholders)

   164,610,217    145,485,255

Restricted Class A shares (directors)

   426,669    216,367

Restricted Class A share units (employees) (A)

   779,678    1,174,117

Restricted Class A share units (employees) (B)

   19,294,749    25,218,073

Fortress Operating Group units (Principals)

   300,273,852    307,773,852

Fortress Operating Group RPUs (senior employee)

   31,000,000    31,000,000
         

Total

   516,385,165    510,867,664
         

 

(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.

In January 2010, 11.4 million existing RSUs vested and the related Class A shares were delivered within six months of vesting pursuant to the plan documents.

In April 2010, certain Principals exchanged an aggregate of 7,500,000 FOG units and Class B shares for an equal number of Class A shares and simultaneously contributed these shares to a charitable organization.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

Dividends and distributions during the six months ended June 30, 2010 are summarized as follows:

 

           Current Year
     Declared in Prior Year,
Paid Current Year
   Declared and
Paid
   Declared but not
yet Paid
   Total

Dividends on Class A Shares

   $ —      $ —      $ —      $ —  

Dividend equivalents on restricted Class A share units (A)

     —        —        —        —  

Distributions to Fortress Operating Group unit holders (Principals) (B)

     9,442      28,468      3,931      32,399

Distributions to Fortress Operating Group RPU holders (Note 7) (B)

     951      2,867      406      3,273
                           

Total distributions

   $ 10,393    $ 31,335    $ 4,337    $ 35,672
                           

 

(A) A portion of these dividend equivalents, if any, 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.

 

(B) Fortress Operating Group made tax-related distributions to the Principals and RPU holders. In the fourth quarter of 2009, Fortress declared $16.6 million of such distributions of which $10.4 million were paid, as reflected in the table, and $6.2 million were not paid as a result of a change in tax estimates.

The following table summarizes our comprehensive income (loss) (net of taxes) for the six months ended June 30, 2009:

 

     Impact to  Total
Fortress

Shareholders’
Equity
    Impact to Principals’
and Others’ Interests
in Equity of
Consolidated
Subsidiaries
    Impact to
Total Equity
 

Net income (loss)

   $ (111,751   $ (346,260   $ (458,011

Foreign currency translation

     172        584        756   

Comprehensive income (loss) from equity method investees

     (441     (1,932     (2,373
                        

Total comprehensive income (loss)

   $ (112,020   $ (347,608   $ (459,628
                        

9. COMMITMENTS AND CONTINGENCIES

Other than as described below, Fortress’s commitments and contingencies remain materially unchanged from December 31, 2009.

Private Equity Fund and Credit PE Fund Capital Commitments – Fortress has remaining capital commitments to certain of the Fortress Funds which aggregated $130.5 million as of June 30, 2010. These commitments can be drawn by the funds on demand.

Minimum Future Rentals – Fortress is a lessee under a number of operating leases for office space.

Minimum future rent payments under these leases are as follows:

 

July 1 to December 31, 2010

   $ 9,447

2011

     13,292

2012

     12,522

2013

     11,949

2014

     11,031

2015

     10,610

Thereafter

     12,172
      

Total

   $ 81,023
      

Rent expense recognized on a straight-line basis during the six months ended June 30, 2010 and 2009 was $10.6 million and $9.8 million, respectively, and was included in General, Administrative and Other Expense.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2010

(dollars in tables in thousands, except share data)

 

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 June 30, 2010, if any, will not materially affect Fortress’s results of operations, liquidity or financial position.

10. SEGMENT REPORTING

Fortress conducts its management and investment business through the following six primary segments: (i) private equity funds, (ii) Castles, (iii) liquid hedge funds, (iv) credit hedge funds, (v) credit private equity (“PE”) funds, and (vi) principal investments in these funds as well as cash that is available to be invested. Logan Circle (Note 2) is initially being reported in the “unallocated” section of Fortress’s segments until such time as it becomes material to Fortress’s operations.

“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 (loss) attributable to Fortress’s Class A shareholders adjusted as follows:

Incentive Income

 

  (i)     a. for Fortress Funds which are private equity funds and credit PE 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 described 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 private equity funds and credit PE 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) on direct investments in publicly traded portfolio companies and in the Castles,

 

  (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,