Toggle SGML Header (+)


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 March 31, 2011

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: 177,590,138 outstanding as of May 1, 2011.

Class B Shares: 305,857,751 outstanding as of May 1, 2011.

 

 

 


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 March 31, 2011 (unaudited) and December 31, 2010

     1   
  

Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2011 and 2010

     2   
  

Consolidated Statement of Equity (unaudited) for the three months ended March 31, 2011

     3   
  

Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010

     4   
  

Notes to Consolidated Financial Statements (unaudited)

     5   
  

Note 1

 

Organization and Basis of Presentation

     5   
  

Note 2

 

Management Agreements and Fortress Funds

     8   
  

Note 3

 

Investments and Fair Value

     14   
  

Note 4

 

Debt Obligations

     19   
  

Note 5

 

Income Taxes and Tax Related Payments

     20   
  

Note 6

 

Related Party Transactions and Interests in Consolidated Subsidiaries

     21   
  

Note 7

 

Equity-Based and Other Compensation

     24   
  

Note 8

 

Earnings Per Share and Distributions

     26   
  

Note 9

 

Commitments and Contingencies

     28   
  

Note 10

 

Segment Reporting

     29   
  

Note 11

 

Subsequent Events

     35   
  

Note 12

 

Consolidating Financial Information

     35   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     39   
  

Overview and Understanding the Asset Management Business

     39   
  

Market Considerations

     44   
  

Results of Operations

     47   
    

Assets Under Management

     48   
    

Performance of our Funds

     49   
  

Liquidity and Capital Resources

     57   
  

Critical Accounting Policies

     63   
  

Contractual Obligations

     68   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     70   

Item 4.

  

Controls and Procedures

     73   
   PART II. OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     74   

Item 1A.

  

Risk Factors

     74   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     104   

Item 3.

  

Defaults upon Senior Securities

     104   


Table of Contents

Item 4.

  

(Removed and Reserved)

     104   

Item 5.

  

Other Information

     104   

Item 6.

  

Exhibits

     105   

SIGNATURES

     107   


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, alternative asset companies and related managed accounts that are managed by the Fortress Operating Group. The Fortress Macro Fund is our flagship liquid hedge fund and the Drawbridge Special Opportunities Fund is our flagship credit hedge fund.

“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.

The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

 

     March 31,
2011
(Unaudited)
    December 31,
2010
 

Assets

    

Cash and cash equivalents

   $ 219,450      $ 210,632   

Due from affiliates

     190,842        303,043   

Investments

     1,091,256        1,012,883   

Deferred tax asset

     411,387        415,990   

Other assets

     106,852        134,147   
                
   $ 2,019,787      $ 2,076,695   
                

Liabilities and Equity

    

Liabilities

    

Accrued compensation and benefits

   $ 92,239      $ 260,790   

Due to affiliates

     304,103        342,397   

Deferred incentive income

     245,779        198,363   

Debt obligations payable

     275,000        277,500   

Other liabilities

     105,877        68,230   
                
     1,022,998        1,147,280   
                

Commitments and Contingencies

    

Equity

    

Class A shares, no par value, 1,000,000,000 shares authorized, 177,562,804 and 169,536,968 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively

     —          —     

Class B shares, no par value, 750,000,000 shares authorized, 305,857,751 and 300,273,852 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively

     —          —     

Paid-in capital

     1,585,042        1,465,358   

Retained earnings (accumulated deficit)

     (1,156,037     (1,052,605

Accumulated other comprehensive income (loss)

     (1,240     (1,289
                

Total Fortress shareholders’ equity

     427,765        411,464   

Principals’ and others’ interests in equity of consolidated subsidiaries

     569,024        517,951   
                

Total equity

     996,789        929,415   
                
   $ 2,019,787      $ 2,076,695   
                

See notes to consolidated financial statements

 

1


Table of Contents

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands)

 

 

     Three Months Ended March 31,  
     2011     2010  

Revenues

    

Management fees: affiliates

   $ 118,868      $ 106,536   

Management fees: non-affiliates

     14,401        2,601   

Incentive income: affiliates

     15,076        17,556   

Incentive income: non-affiliates

     978        5,154   

Expense reimbursements from affiliates

     44,342        23,067   

Other revenues (affiliate portion disclosed in Note 6)

     3,152        5,274   
                
     196,817        160,188   
                

Expenses

    

Interest expense

     4,660        3,796   

Compensation and benefits

     215,435        179,393   

Principals agreement compensation

     234,759        234,759   

General, administrative and other

     40,182        21,108   

Depreciation and amortization

     3,080        2,682   
                
     498,116        441,738   
                

Other Income (Loss)

    

Gains (losses) (affiliate portion disclosed in Note 3)

     (4,763     572   

Tax receivable agreement liability adjustment

     (116     1,317   

Earnings (losses) from equity method investees

     72,403        19,881   
                
     67,524        21,770   
                

Income (Loss) Before Income Taxes

     (233,775     (259,780

Income tax benefit (expense)

     (21,419     (1,552
                

Net Income (Loss)

   $ (255,194   $ (261,332
                

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

   $ (151,762   $ (177,181
                

Net Income (Loss) Attributable to Class A Shareholders

   $ (103,432   $ (84,151
                

Dividends declared per Class A share

   $ —        $ —     
                

Earnings Per Class A share

    

Net income (loss) per Class A share, basic

   $ (0.58   $ (0.56
                

Net income (loss) per Class A share, diluted

   $ (0.58   $ (0.58
                

Weighted average number of Class A shares outstanding, basic

     181,019,501        157,821,895   
                

Weighted average number of Class A shares outstanding, diluted

     181,019,501        465,595,747   
                

See notes to consolidated financial statements

 

2


Table of Contents

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENT OF EQUITY (Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2011

(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, 2010

     169,536,968         300,273,852      $ 1,465,358      $ (1,052,605   $ (1,289   $ 411,464      $ 517,951      $ 929,415   

Contributions from principals’ and others’ interests in equity

     —           —          —          —          —          —          45,836        45,836   

Distributions to principals’ and others’ interests in equity

     —           —          (277     —          —          (277     (28,585     (28,862

Conversion of Class B shares to Class A shares

     4,749,434         (4,749,434     3,878        —          (33     3,845        (3,845     —     

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

     —           —          6,519        —          —          6,519        —          6,519   

Director restricted share grant

     26,351         —          113        —          —          113        200        313   

Capital increase related to equity-based compensation, net

     3,250,051         10,333,333        108,427        —          —          108,427        190,510        298,937   

Dilution impact of Class A share issuance

     —           —          1,024        —          (8     1,016        (1,016     —     

Comprehensive income (loss) (net of tax)

                 

Net income (loss)

     —           —          —          (103,432     —          (103,432     (151,762     (255,194

Foreign currency translation

     —           —          —          —          193        193        45        238   

Comprehensive income (loss) from equity method investees

     —           —          —          —          (103     (103     (310     (413
                       

Total comprehensive income (loss)

                    (255,369
                                                                 

Equity - March 31, 2011

     177,562,804         305,857,751      $ 1,585,042      $ (1,156,037   $ (1,240   $ 427,765      $ 569,024      $ 996,789   
                                                                 

See notes to consolidated financial statements

 

3


Table of Contents

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

MARCH 31, 2011

(dollars in thousands)

 

 

     Three Months Ended March 31,  
     2011     2010  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (255,194   $ (261,332

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

    

Depreciation and amortization

     3,080        2,682   

Other amortization and accretion

     385        877   

(Earnings) losses from equity method investees

     (72,403     (19,881

Distributions of earnings from equity method investees

     7,954        2,707   

(Gains) losses

     4,763        (572

Deferred incentive income

     (11,272     (17,944

Deferred tax (benefit) expense

     10,909        (726

Options received from affiliates

     (7,021     —     

Tax receivable agreement liability adjustment

     116        (1,317

Equity-based compensation, including Principals’ Agreement

     299,089        298,566   

Allowance for doubtful accounts

     4,718        1,122   

Cash flows due to changes in

    

Due from affiliates

     (22,371     (45,653

Other assets

     27,756        (1,292

Accrued compensation and benefits

     (134,265     (21,211

Due to affiliates

     (11,894     3,128   

Deferred incentive income

     56,171        85,150   

Other liabilities

     39,796        32,302   
                

Net cash provided by (used in) operating activities

     (59,683     56,606   
                

Cash Flows From Investing Activities

    

Contributions to equity method investees

     (33,805     (28,485

Distributions of capital from equity method investees

     151,559        41,616   

Purchase of fixed assets

     (2,596     (388
                

Net cash provided by (used in) investing activities

     115,158        12,743   
                

Cash Flows From Financing Activities

    

Repayments of debt obligations

     (2,500     (27,950

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

     11,282        37   

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

     (55,439     (15,114
                

Net cash provided by (used in) financing activities

     (46,657     (43,027
                

Net Increase (Decrease) in Cash and Cash Equivalents

     8,818        26,322   

Cash and Cash Equivalents, Beginning of Period

     210,632        197,099   
                

Cash and Cash Equivalents, End of Period

   $ 219,450      $ 223,421   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest

   $ 4,097      $ 3,384   
                

Cash paid during the period for income taxes

   $ 5,469      $ 2,464   
                

Supplemental Schedule of Non-cash Investing and Financing Activities

    

Employee compensation invested directly in subsidiaries

   $ 34,285      $ 45,095   
                

Investments of receivable amounts into Fortress Funds

   $ 130,774      $ 7,652   
                

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

   $ 12,877      $ 31,335   
                

See notes to consolidated financial statements

 

4


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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 leading, highly diversified global investment 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, including related managed accounts (collectively, 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 asset-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 two Asia funds, a Japan real estate fund and an Asian investor based global opportunities 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.

 

5


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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: Affiliates

   2    Fees earned for managing Fortress Funds, generally determined based on the size of such funds.

Management Fees: Non-Affiliates

   2    Fees earned from managed accounts and our traditional fixed income asset management business, generally determined based on the amount managed.

Incentive Income: Affiliates

   2    Income earned from Fortress Funds, based on the performance of such funds.

Incentive Income: Non-Affiliates

   2    Income earned from managed accounts, based on the performance of such accounts.

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 January 2007 value of a significant portion of the Principals’ equity in Fortress 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)

   3    The result of asset dispositions or changes in the fair value of investments or other financial instruments which are marked to market (including 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.

 

6


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

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.

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 FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging, contingencies and fair value. Some of the proposed changes are significant and could have a material impact on Fortress’s reporting. Fortress has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

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, 2010 and notes thereto included in Fortress’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2011. Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated financial statements for the year ended December 31, 2010.

Certain prior period amounts have been reclassified to conform to the current period’s presentation.

 

7


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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 terms of agreements between Fortress and the Fortress Funds are generally determined in connection with third party fund investors.

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

Management Fees, Incentive Income and Related Profit Sharing Expense

Fortress recognized management fees and incentive income as follows:

 

     Three Months Ended
March 31,
 
     2011      2010  

Private Equity

     

Private Equity Funds

     

Management fees - affil.

   $ 35,289       $ 33,465   

Incentive income - affil.

     3,219         —     

Castles

     

Management fees - affil.

     11,614         11,780   

Management fees, options - affil.

     7,021         —     

Management fees - non-affil.

     661         884   

Incentive income - affil.

     —           —     

Liquid Hedge Funds

     

Management fees - affil.

     17,498         17,466   

Management fees - non-affil.

     4,789         1,336   

Incentive income - affil.

     1,715         (259

Incentive income - non-affil.

     978         —     

Credit Funds

     

Credit Hedge Funds

     

Management fees - affil.

     31,457         33,668   

Management fees - non-affil.

     4,055         381   

Incentive income - affil.

     2,089         (129

Incentive income - non-affil.

     —           5,154   

Credit PE Funds

     

Management fees - affil.

     15,989         10,157   

Management fees - non-affil.

     33         —     

Incentive income - affil.

     8,053         17,944   

Other (A)

     

Management fees - non-affil.

     4,863         —     

Total

     

Management fees - affil.

   $ 118,868       $ 106,536   

Management fees - non-affil.

   $ 14,401       $ 2,601   

Incentive income - affil. (B)

   $ 15,076       $ 17,556   

Incentive income - non-affil.

   $ 978       $ 5,154   

 

(A) Related to Logan Circle.

 

(B) See “Deferred Incentive Income” below.

 

8


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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 three months ended March 31, 2011 and 2010. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $53.0 million and $6.2 million of additional incentive income from affiliates would have been recognized during the three months ended March 31, 2011 and 2010, 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 three months ended March 31, 2011 and 2010, Fortress recognized $8.1 million and $17.9 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 approximately 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 was comprised of the following, on an inception to date basis. This does not include any amounts related to third party funds, receipts from which are reflected as Other Liabilities until all contingencies are resolved.

 

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

Deferred incentive income as of December 31, 2010

   $ 702,709       $ (504,346   $ 198,363      $ 200,066   

Share of income (loss) of Fortress Funds

     —           —          —          139,672   

Distribution of incentive income

     58,688         —          58,688        (58,688

Recognition of previously deferred incentive income

     —           (11,272     (11,272     —     
                                 

Deferred incentive income as of March 31, 2011

   $ 761,397       $ (515,618   $ 245,779      $ 281,050   
                                 

 

(A) All related contingencies have been resolved.

 

(B) Reflected on the balance sheet.

 

(C) At March 31, 2011, the net undistributed incentive income is comprised of $375.6 million of gross undistributed incentive income, net of $94.5 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 March 31, 2011 at their net asset values.

 

(D) From inception to March 31, 2011, Fortress has paid $311.3 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 individuals. If the $375.6 million of gross undistributed incentive income were realized, Fortress would recognize and pay an additional $159.6 million of compensation expense.

 

9


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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 March 31, 2011:

 

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      $ (801,926   $ 17,266      $ N/A      $ N/A      $ N/A      $ —        $ 94,513      $ —        $ —        $ —     

Fund I (1999) (J)

    Apr-10        1,027,871        (2,759,045     108,076        1,839,250        —          N/A        9,572        325,931        —          —          —     

Fund II (2002)

    Feb-13        1,974,296        (3,245,088     130,966        1,401,758        —          N/A        —          287,024        46,412        11,198        7,170   

Fund III (2004)

    Jan-15        2,762,993        (1,307,375     1,644,988        189,370        1,018,836        829,466        —          66,903        66,903        66,903        45,108   

Fund III Coinvestment (2004)

    Jan-15        273,648        (115,925     172,751        15,028        132,356        117,328        —          —          —          —          —     

Fund IV (2006)

    Jan-17        3,639,561        (119,445     3,201,662        (318,454     1,248,388        1,566,842        —          —          —          —          —     

Fund IV Coinvestment (2006)

    Jan-17        762,696        (12,651     654,311        (95,734     269,714        365,448        —          —          —          —          —     

Fund V (2007)

    Feb-18        3,973,747        (2,862     3,093,356        (877,529     883,132        1,760,661        —          —          —          —          —     

Fund V Coinvestment (2007)

    Feb-18        936,145        (132     543,507        (392,506     247,459        639,965        —          —          —          —          —     

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     425,091        (289,532     489,112        778,644        —          16,447        16,447        16,447        10,041   

FRIC (2006)

    May-16        328,754        (17,460     248,622        (62,672     139,437        202,109        —          —          —          —          —     

FICO (2006)

    Jan-17        724,525        (5     (23,988     (748,508     286,645        1,035,153        —          —          —          —          —     

FHIF (2006)

    Jan-17        1,493,484        (63,169     1,752,798        322,483        517,542        195,059        —          —          —          —          —     

FECI (2007)

    Feb-18        982,779        (144     842,599        (140,036     316,755        456,791        —          —          —          —          —     

Mortgage Opportunities Fund III (2008)

    Jun-13        193,861        (46,963     117,610        (29,288     —          29,288        —          —          —          —          —     
                                                     
                $ 9,572      $ 842,294      $ 129,762      $ 94,548      $ 62,319   
                                                     

Credit PE Funds

                       

Long Dated Value Fund I (2005)

    Apr-30      $ 267,325      $ (45,656   $ 263,584      $ 41,915      $ 77,244      $ 35,329      $ —        $ —        $ —        $ —        $ —     

Long Dated Value Fund II (2005)

    Nov-30        270,958        (60,723     244,039        33,804        61,851        28,047        —          412        —          —          —     

Long Dated Value Fund III (2007)

    Feb-32        340,740        (119,298     308,414        86,972        —          N/A        14,298        1,983        —          —          —     

LDVF Patent Fund (2007)

    Nov-27        40,803        (10,002     52,814        22,013        —          N/A        1,521        461        —          —          —     

Real Assets Fund (2007)

    Jun-17        355,783        (165,375     257,834        67,426        —          N/A        9,219        1,316        —          —          —     
                                                     
                $ 25,038      $ 4,172      $ —        $ —        $ —     
                                                     

Credit PE Funds in Investment Period

                       

Credit Opportunities Fund (2008)

    Oct-20      $ 4,301,750      $ (4,365,262   $ 1,543,286      $ 1,606,798      $ —        $ N/A      $ 138,242      $ 179,254      $ 85,700      $ —        $ —     

Credit Opportunities Fund II (2009)

    Jul-22        1,018,804        (196,409     1,079,860        257,465        —          N/A        52,386        —          —          —          —     

FTS SIP L.P. (2008)

    Oct-18        1,024,373        (901,001     453,046        329,674        —          N/A        22,077        44,550        28,800        —          —     

SIP L.P. (2010)

    Sep-20        11,000        (5,312     16,803        11,115        —          N/A        2,779        —          —          —          —     

FCO MA LSS (2010)

    Jun-24        91,546        (7,003     94,906        10,363        —          N/A        2,080        —          —          —          —     

FCO MA II (2010)

    Jun-22        183,718        (18,302     206,150        40,734        —          N/A        7,739        —          —          —          —     

FCO MA Maple Leaf (2010)

    Oct-20        70,600        —          71,201        601        1,893        1,292        —          —          —          —          —     

Assets Overflow Fund (2008)

    May-18        90,500        (112,344     1        21,845        —          N/A        —          2,180        1,517        —          —     

Japan Opportunity Fund (2009)

    Jun-19        782,322        (257,842     663,149        138,669        —          N/A        19,979        8,053        —          —          —     

Net Lease Fund I (2010)

    Feb-23        32,136        (4,880     31,820        4,564        —          N/A        601        —          —          —          —     

Global Opportunities Fund (2010)

    Sep-20        37,927        —          35,846        (2,081     950        3,031        —          —          —          —          —     

Life Settlements Fund (2010)

    Dec-22        261,896        —          258,051        (3,845     5,457        9,302        —          —          —          —          —     

Life Settlements Fund MA (2010)

    Dec-22        21,437        —          21,095        (342     451        793        —          —          —          —          —     
                                                     
                $ 245,883      $ 234,037      $ 116,017      $ —        $ —     
                                                     

 

10


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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

  $ 2,516,963      $ 29        99.9   $ 11,777      $ 721   

Sidepocket investments (Q)

    64,088        32,567        N/A        720        —     

Sidepocket investments - redeemers (R)

    269,022        124,777        N/A        3,305        —     

Managed accounts

    799,866        —          100.0     1,638        —     

Fortress Commodities Funds (S)

         

Main fund investments

    936,419        —          100.0     5,593        964   

Managed accounts

    149,110        —          100.0     —          890   

Credit Hedge Funds

         

Special Opportunities Funds (S)

         

Main fund investments

  $ 2,762,713      $ —          100.0   $ 31,820      $ —     

Sidepocket investments (Q)

    131,737        1,549        N/A        3,417        —     

Sidepocket investments - redeemers (R)

    214,464        77,413        N/A        1,676        —     

Main fund investments (liquidating) (T)

    1,906,364        173,872        87.4     31,576        1,505   

Managed accounts

    34,469        13,136        0.0     —          —     

Fortress Partners Funds (S)

         

Main fund investments

    186,364        34,867        0.1     1        —     

Sidepocket investments (Q)

    96,071        26,876        N/A        664        —     

Worden Funds

         

Main fund investments

    206,896        —          100.0     2,474        —     

Value Recovery Funds (U)

         

Managed accounts

    98,161        6,637        68.7     444        —     

 

(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) A NAV deficit 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). As of period end, there is an aggregate NAV surplus within both the private equity funds and credit PE funds.

 

(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 March 31, 2011, Fortress held $48.2 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 or trading level 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

 

11


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

 

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.

 

(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 may vary, and may vary significantly. This percentage represents the performance of only the main fund investments and managed accounts relative to their respective incentive income thresholds. It does not incorporate the impact of unrealized losses on sidepocket investments that can reduce the amount of incentive income earned from certain funds. See footnote Q below.

 

(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. For the Value Recovery Fund managed accounts, Fortress can earn incentive income if aggregate realizations exceed an agreed threshold. 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, Fortress Macro Funds and Fortress Asia Macro Fund. 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 March 31, 2011, 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 March 31, 2011, the undistributed incentive income from the Macro main fund would be decreased by approximately $3.8 million.

 

(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.

 

(U) Excludes the Value Recovery Funds which had a NAV of $783.4 million at March 31, 2011. Fortress began managing the third party originated Value Recovery Funds in June 2009 and does not expect to earn any incentive income from the fund investments.

Private Equity Funds and Credit PE Funds

During the three months ended March 31, 2011, the capital commitment period of Fund V, Fund V Coinvestment and FECI expired. At such time, the AUM for these funds were reduced in aggregate by approximately $2.0 billion and, beginning in July 2011, these funds will generate lower management fees.

Liquid Hedge Funds and Credit Hedge Funds

During the three months ended March 31, 2011, Fortress formed, or became the manager of, hedge funds with net asset values as follows as of March 31, 2011:

 

     Liquid      Credit  

Fortress

   $ 20,601       $ —     

Fortress’s affiliates

     10,300         —     

Third party investors

     23,372         —     
                 

Total NAV (A)

   $ 54,273       $ —     
                 

 

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

 

12


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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  

Three Months Ended March 31,

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

2011

   $ 147,187       $ 250,555       $ 21,238       $ 408,276   

2010

   $ 263,180       $ 715,385       $ 16,995       $ 450,847   

The differences between notices received and redemptions paid are a result of timing (such as notices received prior to quarter end, paid afterwards), performance between the notice date and the payment date, and the contractual agreements regarding redemptions, which, in some cases, including all of the credit hedge funds, allow for delayed payment.

Traditional Asset Management

Logan Circle Partners, L.P. (“Logan Circle”) is a fixed income asset manager with approximately $12.5 billion in assets under management as of March 31, 2011, which Fortress acquired in April 2010. 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.

Part of the acquisition price was paid with contingent consideration, which 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). 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).

The assets acquired primarily included goodwill and other intangible assets, which have been recorded in Other Assets. The intangible assets are being amortized over their estimated useful lives, which range from 1 to 8 years. Fortress tests 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. No impairment was recorded during the three months ended March 31, 2011. Logan Circle’s fair value is estimated based on the following key assumptions: expected retention rate of existing investors, growth expectations, estimated future fee rates, estimated operating margin, and market discount rates. These assumptions are determined primarily based on Logan Circle’s past experience, Logan Circle’s historical and recent investment performance, Logan Circle’s business plans, current industry trends, and general economic expectations. These assumptions, particularly those relating to investor retention and growth expectations, as well as discount rates, 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.

During the three months ended March 31, 2011, Logan Circle generated approximately $4.9 million of revenues (primarily management fees from non-affiliates) and $(4.8) million of net (loss). This net (loss) does not include the change in fair value of the contingent consideration, but does include approximately $1.6 million of allocated corporate overhead. 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” – see Note 7).

 

13


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

3. INVESTMENTS AND FAIR VALUE

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:

 

     March 31,
2011
     December 31,
2010
 

Equity method investees

   $ 1,024,794       $ 949,410   

Equity method investees, held at fair value

     56,988         60,324   
                 

Total equity method investments

     1,081,782         1,009,734   

Options in equity method investees

     9,474         3,149   
                 

Total investments

   $ 1,091,256       $ 1,012,883   
                 

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

 

     Three Months Ended
March 31,
 
     2011     2010  

Net realized gains (losses)

   $ 278      $ 400   

Net realized gains (losses) from affiliate investments

     (383     (329

Net unrealized gains (losses)

     (1,468     —     

Net unrealized gains (losses) from affiliate investments

     (3,190     501   
                

Total gains (losses)

   $ (4,763   $ 572   
                

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, 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)  
     March 31,      December 31,      Three Months Ended
March 31,
 
     2011      2010      2011     2010  

Private equity funds, excluding NIH (A)

   $ 663,849       $ 611,794       $ 55,263      $ 9,242   

NIH

     1,476         1,664         (43     (149

Newcastle (B)

     6,195         6,872         N/A        N/A   

Eurocastle (B)

     2,451         2,184         N/A        N/A   
                                  

Total private equity

     673,971         622,514         55,220        9,093   

Liquid hedge funds

     49,537         16,670         1,867        266   

Credit hedge funds

     229,345         238,783         10,978        9,334   

Credit PE funds

     122,415         125,265         4,505        (48

Other

     6,514         6,502         (167     1,236   
                                  
   $ 1,081,782       $ 1,009,734       $ 72,403      $ 19,881   
                                  

 

(A) Includes Fortress’s direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH.

 

(B) Fortress elected to record these investments, as well as its direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH, at fair value pursuant to the fair value option for financial instruments.

 

14


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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

 

    Three Months Ended March 31, 2011  
    Private Equity     Liquid     Credit              
    NIH     Other Funds (A)     Castles (B)     Hedge Funds     Hedge Funds     PE Funds     Other     Total  

Investment, beginning

  $ 1,664      $ 611,794      $ 9,056      $ 16,670      $ 238,783      $ 125,265      $ 6,502      $ 1,009,734   

Earnings from equity method investees

    (43     55,263        N/A        1,867        10,978        4,505        (167     72,403   

Other comprehensive income from equity method investees

    (2     —          N/A        —          —          (671     —          (673

Contributions to equity method investees

    —          114        —          76,616        95,988        6,016        195        178,929   

Distributions of earnings from equity method investees

    —          —          N/A        (739     (3,851     (3,348     (16     (7,954

Distributions of capital from equity method investees

    (143     (288     N/A        (44,877     (112,553     (7,526     —          (165,387
                                                               

Total distributions from equity method investees

    (143     (288     N/A        (45,616     (116,404     (10,874     (16     (173,341
                                                               

Mark to fair value - during period (C)

    N/A        (6,411     (538     N/A        N/A        N/A        N/A        (6,949

Translation adjustment

    —          3,377        128        —          —          —          —          3,505   

Dispositions

    —          —          —          —          —          (1,826     —          (1,826
                                                               

Investment, ending

  $ 1,476      $ 663,849      $ 8,646      $ 49,537      $ 229,345      $ 122,415      $ 6,514      $ 1,081,782   
                                                               

Ending balance of undistributed earnings

  $ —        $ 14,406        N/A      $ 981      $ 9,535      $ 3,409      $ 1,724      $ 30,055   
                                                               

 

(A) Includes Fortress’s direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH.

 

(B) Fortress elected to record these investments, as well as its direct investment in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH, at fair value pursuant to the fair value option for financial instruments.

 

(C) Recorded to Gains (Losses).

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  
     March 31,
2011
    December 31,
2010
 

Assets

   $ 13,788,995      $ 12,490,411   

Debt

     (232,685     (145,043

Other liabilities

     (197,261     (197,587
                

Equity

   $ 13,359,049      $ 12,147,781   
                

Fortress’s Investment (A)

   $ 663,849      $ 611,794   
                

Ownership (B)

     5.0     5.0
                
     Three Months Ended March 31,  
     2011     2010  

Revenues and gains (losses) on investments

   $ 1,306,321      $ 301,821   

Expenses

     (61,001     (56,796
                

Net Income (Loss)

   $ 1,245,320      $ 245,025   
                

Fortress’s equity in net income (loss)

   $ 55,263      $ 9,242   
                

 

(A) Includes Fortress’s direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH. These companies’ summary financial information is not included in this table.

 

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

 

15


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

     Liquid Hedge Funds     Credit Hedge Funds     Credit PE Funds (B) (C)  
     March 31,
2011
    December 31,
2010
    March 31,
2011
    December 31,
2010
    March 31,
2011
    December 31,
2010
 

Assets

   $ 5,298,780      $ 4,937,105      $ 11,661,139      $ 12,060,662      $ 6,188,626      $ 6,593,935   

Debt

     —          —          (3,285,168     (3,487,573     (123,060     (358,095

Other liabilities

     (1,107,454     (944,497     (535,880     (945,594     (412,304     (573,000

Non-controlling interest

     —          —          (10,978     (15,647     (1,671     (4,945
                                                

Equity

   $ 4,191,326      $ 3,992,608      $ 7,829,113      $ 7,611,848      $ 5,651,591      $ 5,657,895   
                                                

Fortress’s Investment

   $ 49,537      $ 16,670      $ 229,345      $ 238,783      $ 122,415      $ 125,265   
                                                

Ownership (A)

     1.2     0.4     2.9     3.1     2.2     2.2
                                                
     Three Months Ended March 31,     Three Months Ended March 31,     Three Months Ended March 31,  
     2011     2010     2011     2010     2011     2010  

Revenues and gains (losses) on investments

   $ 141,890      $ 128,834      $ 397,420      $ 425,999      $ 407,833      $ 436,771   

Expenses

     (33,772     (46,982     (65,773     (66,014     (48,688     (78,305
                                                

Net Income (Loss)

   $ 108,118      $ 81,852      $ 331,647      $ 359,985      $ 359,145      $ 358,466   
                                                

Fortress’s equity in net income (loss)

   $ 1,867      $ 266      $ 10,978      $ 9,334      $ 4,505      $ (48
                                                

 

(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 December 31, 2010 and 2009, respectively) and several 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.

 

(C) Includes certain entities in which Fortress has both a direct and an indirect investment.

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, except as described below. No reconsideration events occurred during the three months ended March 31, 2011 which caused a change in Fortress’s accounting.

The following tables set forth certain information as of March 31, 2011 regarding variable interest entities 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.

Entities formed during the three months ended March 31, 2011:

 

     Fortress is not Primary Beneficiary       

Business Segment

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

Credit PE Funds

   $ 71,921       $ 71,167       $ 758       (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 March 31, 2011, $4.0 million represent financial borrowings which have a weighted average maturity of 1 year for the credit PE funds.

 

(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 fees and/or incentive income Fortress earns from those entities.

 

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

 

16


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

All variable interest entities:

 

     Fortress is not Primary Beneficiary         
     March 31, 2011      December 31, 2010         

Business Segment

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

Private Equity Funds

   $ 327,739       $ 190,705       $ 1,514       $ 329,999       $ 189,738       $ 1,974         (C) (D)   

Castles

     10,813,492         10,127,537         25,121         10,183,554         9,944,424         19,122         (C) (D)   

Liquid Hedge Funds

     3,514,444         772,670         2,292         3,335,418         690,280         41,051         (C) (D)   

Credit Hedge Funds

     2,154,898         388,807         19,697         2,287,545         410,682         41,358         (C) (D)   

Credit PE Funds

     804,197         800,010         3,069         930,513         450,530         1,962         (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.

 

(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 entities 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) Fortress’s investment includes management fees receivable, incentive income receivable, expense reimbursements and other receivables from these entities, as applicable.

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. 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, was deemed to be its primary beneficiary. Therefore, Fortress consolidated FCF beginning in March 2010. As of March 31, 2011, FCF’s gross assets were approximately $37.4 million, primarily comprised of affiliate receivables. Fortress’s exposure to loss from FCF is limited to its unreserved outstanding advances, which were approximately $24.8 million at March 31, 2011, 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.

In March 2011, Fortress launched a liquid hedge fund and a related onshore feeder fund, which is a VIE. The onshore feeder fund invests substantially all of its equity directly into the liquid hedge fund. Based on a quantitative and qualitative analysis, management has determined that Fortress is currently the entity that is most closely associated with the onshore feeder fund. Therefore, Fortress is the onshore feeder fund’s primary beneficiary and must consolidate it. As of March 31, 2011, the onshore feeder fund’s gross assets were approximately $30.9 million. Fortress’s exposure to loss from the onshore feeder fund is limited to its investment in the entity, which was approximately $19.6 million at March 31, 2011. As a result of Fortress’s consolidation of the onshore feeder fund, Fortress’s investment in the entity is eliminated in consolidation. As of March 31, 2011, the onshore feeder fund did not have any outstanding financial obligations. Creditors of the onshore feeder fund do not have recourse to Fortress’s other assets.

 

17


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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).

 

     Fair Value    

Valuation Method

     March 31, 2011     December 31, 2010      

Assets (within Investments)

      

Newcastle and Eurocastle common shares

   $ 6,565      $ 7,222      Level 1 - Quoted prices in active markets for identical assets

Common stock of publicly traded private equity portfolio companies, primarily GAGFAH

   $ 48,342      $ 51,267      Level 1 - Quoted prices in active markets for identical assets

Eurocastle convertible debt (A)

   $ 2,081      $ 1,834      Level 3 - Binomial lattice-based option valuation models, adjusted for non-option characteristics

Newcastle and Eurocastle options

   $ 9,474      $ 3,149      Level 2 - Lattice-based option valuation models using significant observable inputs

Liabilities (within Other Liabilities)

      

Logan Circle Contingent Consideration

   $ (2,174   $ (3,122   Level 3 - Internal model using significant unobservable inputs

Derivatives

   $ (3,758   $ (2,732   Level 2 - See below

 

(A) The debt bears interest at 20% per annum and is perpetual, but Eurocastle may redeem the securities after June 2011 at a premium of 20%. As of March 31, 2011, it had a face amount of €1.2 million ($1.7 million) and was convertible into Eurocastle 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 three months ended March 31, 2011 as follows:

 

     Assets      Liabilities  

Balance at December 31, 2010

   $ 1,834       $ (3,122

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

     247         948   
                 

Balance at March 31, 2011

   $ 2,081       $ (2,174
                 

See Note 4 regarding the fair value of Fortress’s outstanding debt.

In March 2011, Newcastle issued 17.3 million shares of its common stock in a public offering at a price to the public of $6.00 per share. For the purposes of compensating Fortress for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to Fortress to purchase 1,725,000 shares of Newcastle’s common stock at the public offering price, which were valued at approximately $7.0 million. The options were fully vested upon issuance, become exercisable over thirty months and have a 10-year term.

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 and options to economically hedge the risk of fluctuations in foreign exchange rates with respect to certain foreign currency denominated assets. Gains and losses on these contracts are reported currently in Gains (Losses).

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.

 

18


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Fortress’s derivatives (not designated as hedges) are recorded as follows:

     Balance Sheet
Location (A)
     Fair Value
March 31, 2011
    Notional Amount
March 31, 2011
     Gains/(Losses) Three
Months Ended
March 31, 2011
    Maturity
Date
 

Foreign exchange forward contract

     Other Liabilities       ($ 4,299   20,000       ($ 1,567     Jun-11   

Foreign exchange forward contract

     Other Liabilities       $ 764      20,000       $ 764        Jun-11   

Foreign exchange option contract

     Other Liabilities       $ 1,082      30,000       ($ 432     Feb-12   

Foreign exchange option contract

     Other Liabilities       ($ 1,305   30,000       ($ 233     Feb-12   

 

(A) Fortress has a master netting agreement with its counterparty.

The counterparty on these derivatives is Citibank N.A.

4. DEBT OBLIGATIONS

 

                         March 31, 2011  
     Face Amount and                   Weighted     Weighted  
     Carrying Value            Final      Average     Average  
     March 31,      December 31,      Contractual     Stated      Funding     Maturity  
Debt Obligation    2011      2010      Interest Rate     Maturity      Cost (A)     (Years)  

Credit agreement (B)

               

Revolving debt (C)

   $ —         $ —           LIBOR + 4.00% (D)        Oct-13         —          —     

Term loan

     275,000         277,500         LIBOR + 4.00% (D)        Oct-15         5.87     3.48   
                                       

Total

   $ 275,000       $ 277,500              5.87     3.48   
                                       

 

(A) The weighted average funding cost is calculated based on the contractual interest rate (utilizing the most recently reset LIBOR rate or the minimum rate, as applicable) plus the amortization of deferred financing costs. The most recently reset LIBOR rate was below the minimum of 1.75%.

 

(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 $51.4 million was undrawn on the revolving debt facility as of March 31, 2011. The revolving debt facility includes a $25 million letter of credit subfacility of which $8.6 million was utilized.

 

(D) With a minimum LIBOR rate of 1.75% and, in the case of the revolving debt, subject to unused commitment fees of 0.625% 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 approximately equal to its face amount at March 31, 2011.

Fortress was in compliance with all of its debt covenants as of March 31, 2011. The following table sets forth the financial covenant requirements as of March 31, 2011.

 

   

March 31, 2011

(dollars in millions)

        
   

Requirement

     Actual      Notes  

AUM

 

³$

     25,000       $ 34,784         (A

Consolidated Leverage Ratio

 

£

     2.75         0.62         (B

Minimum Investment Assets Ratio

 

³

     2.00         3.93         (C

Consolidated Fixed Charge Coverage Ratio

 

³

     1.75         9.53         (B

 

(A) Impacted by capital raised in funds, redemptions from funds, and valuations of fund investments. The AUM presented here is based on the definition in the credit agreement.

 

(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.

 

19


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

5. INCOME TAXES AND TAX RELATED PAYMENTS

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.

Fortress recognizes compensation expense from the issuance of RSUs and RPUs over their vesting period. Consequently, Fortress records an estimated income tax benefit associated with RSUs and RPUs. However, Fortress is not entitled to an actual deduction on its income tax returns until a later date when the compensation is considered taxable to the employee. The actual income tax deduction can vary significantly from the amount recorded as an income tax benefit in earlier periods and is based on the value of the stock at the date the compensation is taxable to the employee.

At each tax deduction date, Fortress is required to compare the amount of the actual income tax benefit to the estimated amount recognized earlier. If the actual tax benefit is less than that estimated, which will occur if the price of the stock has declined during the vesting period, Fortress has a “tax shortfall.” The tax shortfall must be charged to income tax expense to the extent Fortress does not have prior excess tax benefits (i.e., prior actual tax benefits associated with RSUs and RPUs that were greater than the estimated benefits).

Based on the value of the RSUs and RPUs which vested during the three months ended March 31, 2011, Fortress has estimated an $18 million tax shortfall which was charged to income tax expense during the first quarter.

The provision for income taxes consists of the following:

 

     Three Months Ended March 31,  
     2011      2010  

                     Current

     

Federal income tax expense (benefit)

   $ 5,270       $ 81   

Foreign income tax expense (benefit)

     3,004         587   

State and local income tax expense (benefit)

     2,236         1,610   
                 
     10,510         2,278   
                 

                     Deferred

     

Federal income tax expense (benefit)

     8,290         (1,069

Foreign income tax expense (benefit)

     5         3   

State and local income tax expense (benefit)

     2,614         340   
                 
     10,909         (726
                 

Total expense (benefit)

   $ 21,419       $ 1,552   
                 

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

 

     March 31, 2011     December 31, 2010  

Total deferred tax assets

   $ 505,808      $ 512,201   

Valuation allowance

     (94,421     (96,211
                

Net deferred tax assets

   $ 411,387      $ 415,990   
                

Total deferred tax liabilities (A)

   $ 503      $ 495   
                

 

(A) Included in Other Liabilities

For the three months ended March 31, 2011, a deferred income tax benefit of $0.2 million was credited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $0.5 million was credited to paid-in capital, related to (i) dividend equivalent payments on RSUs and RPUs (Note 8), as applicable, and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 8), which are currently deductible for income tax purposes.

 

20


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

FIG Corp increased its ownership in the underlying Fortress Operating Group entities during the three months ended March 31, 2011 through (i) the exchanges by one senior employee of Fortress Operating Group units and Class B shares for Class A shares (as described in Note 8), and (ii) the delivery of vested RSUs and RPUs (Note 8). As a result of this increased ownership, the deferred tax asset was increased by $2.1 million with an offsetting increase of $0.8 million to the valuation allowance. In addition, the deferred tax asset was increased by $5.3 million with an offsetting increase of $0.3 million to the valuation allowance related to a step-up in tax basis due to the share exchange which will result in additional tax deductions. The establishment of these net deferred tax assets also increased additional paid-in capital.

Tax Receivable Agreement

Although the tax receivable agreement payments are calculated based on annual tax savings, for the three months ended March 31, 2011, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $4.6 million. During the three months ended March 31, 2011, $13.5 million was paid under the tax receivable agreement relating to 2009.

6. RELATED PARTY TRANSACTIONS AND INTERESTS IN CONSOLIDATED SUBSIDIARIES

Affiliate Receivables and Payables

Due from affiliates was comprised of the following:

 

    Private Equity           Credit              
    Funds     Castles     Liquid Hedge
Funds
    Hedge Funds     PE
Funds
    Other     Total  

                    March 31, 2011

             

Management fees and incentive income (A)

  $ 79,366      $ 3,916      $ 1,676      $ 26,978      $ 12,659      $ —        $ 124,595   

Expense reimbursements (A)

    1,589        3,085        3,994        5,403        3,661        —          17,732   

Expense reimbursements - FCF (A)(B)

    29,530        —          —          —          —          —          29,530   

Dividends and distributions

    806        —          —          —          —          —          806   

Other

    8        652        13,219        —          1,246        3,054        18,179   
                                                       

Total

  $ 111,299      $ 7,653      $ 18,889      $ 32,381      $ 17,566      $ 3,054      $ 190,842   
                                                       
    Private Equity           Credit              
    Funds     Castles     Liquid Hedge
Funds
    Hedge Funds     PE
Funds
    Other     Total  

                    December 31, 2010

             

Management fees and incentive income (A)

  $ 53,282      $ 3,836      $ 45,591      $ 110,952      $ 15,508      $ —        $ 229,169   

Expense reimbursements (A)

    1,170        3,081        2,052        4,034        3,949        4        14,290   

Expense reimbursements - FCF (B)

    42,385        —          —          —          —          —          42,385   

Dividends and distributions

    762        —          —          —          —          —          762   

Other

    3        521        13,219        —          1        2,693        16,437   
                                                       

Total

  $ 97,602      $ 7,438      $ 60,862      $ 114,986      $ 19,458      $ 2,697      $ 303,043   
                                                       

 

(A) Net of allowances for uncollectable management fees and expense reimbursements of $11.7 million and $4.9 million at March 31, 2011, respectively, and of $11.6 million and $1.5 million as of December 31, 2010, respectively. Allowances are recorded as General and Administrative expenses.

 

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

As of March 31, 2011, amounts due from Fortress Funds recorded in Due from Affiliates included $73.7 million of past due management fees, excluding $11.7 million which has been fully reserved by Fortress, and $25.9 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 portion of these fees will ultimately be collectable since the NAV’s of the respective funds exceed the amounts owed.

 

21


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Due to affiliates was comprised of the following:

 

     March 31, 2011      December 31, 2010  

Principals - Tax receivable agreement - Note 5

   $ 282,092       $ 295,541   

Distributions payable on Fortress Operating Group units

     16,345         42,900   

Other

     5,666         3,956   
                 
   $ 304,103       $ 342,397   
                 

Other Related Party Transactions

For the three months ended March 31, 2011 and 2010, Other Revenues included approximately $1.0 million and $2.1 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 three months ended March 31, 2011 and 2010, these expenses approximated $0.5 million and $3.6 million, respectively.

In February 2011, Fortress made $1.3 million of advances to senior employees (not officers) in connection with their investments in one of the Fortress Funds. These advances bear interest generally at LIBOR+4% and are due upon the maturity of the fund or, at Fortress’s option, upon the termination of employment.

In February 2011, Fortress made a $9.5 million advance to a senior employee (not an officer) in connection with his investments in Fortress Funds. This advance bore interest generally at LIBOR+4% and was repaid in March 2011.

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:

 

     March 31, 2011      December 31, 2010  

Fortress Operating Group units held by the Principals and one senior employee

   $ 477,558       $ 458,842   

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

     88,784         57,609   

Other

     2,682         1,500   
                 

Total

   $ 569,024       $ 517,951   
                 

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 March 31,  
     2011     2010  

Fortress Operating Group units held by the Principals and one senior employee

   $ (154,328   $ (180,123

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

     2,578        2,654   

Other

     (12     288   
                

Total

   $ (151,762   $ (177,181
                

 

22


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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 March 31,  
     2011     2010  

Net income (loss) attributable to Fortress

   $ (103,432   $ (84,151

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

    

Increase in Fortress’s shareholders’ equity for the conversion of Fortress Operating Group units by the Principals and one senior employee

     3,845        —     

Increase in Fortress’s shareholders’ equity for the delivery of Class A shares primarily in connection with vested RSUs and RPUs

     1,016        3,433   

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

     —          —     
                

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

   $ (98,571   $ (80,718
                

 

23


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

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 March 31,  
     2011      2010  

Equity-based compensation, per below

   $ 64,330       $ 63,806   

Profit-sharing expense, per below

     58,656         50,414   

Discretionary bonuses

     50,082         34,359   

Other payroll, taxes and benefits

     42,367         30,814   
                 
   $ 215,435       $ 179,393   
                 

Equity-Based Compensation

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

 

    RSUs     Restricted Shares
Issued to Directors
    RPUs  
    Employees     Non-Employees       Employees  
    Number     Value (A)     Number     Value (A)     Number     Value (A)     Number     Value (A)  

Outstanding as of December 31, 2010

    44,289,586      $ 11.63        1,196,943      $ 11.11        426,669      $ 6.58        31,000,000      $ 13.75   

Issued

    5,169,104        5.65        —          —          26,351        5.76        —          —     

Converted to Class A shares

    (3,250,051     17.88        —          —          —          —          (4,749,434     13.75   

Converted to Class B shares

    —          —          —          —          —          —          (5,583,899     13.75   

Forfeited

    (492,660     14.25        —          —          —          —          —          —     
                                                               

Outstanding as of March 31, 2011 (B)

    45,715,979      $ 10.48        1,196,943      $ 11.11        453,020      $ 6.53        20,666,667      $ 13.75   
                                                               

 

     Three Months Ended March 31,  
     2011      2010  

Expense incurred (B)

     

Employee RSUs

   $ 41,467       $ 38,453   

Non-Employee RSUs

     386         1,250   

Restricted Shares

     160         90   

LTIP

     —           1,696   

RPUs

     22,317         22,317   
                 

Total equity-based compensation expense

   $ 64,330       $ 63,806   
                 

 

(A) Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of March 31, 2011 for awards granted to non-employees was $5.68, 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 outstanding as of March 31, 2011 of $393 million, with a weighted average recognition period of 2.16 years. This does not include contingent amounts or amounts related to the Principals Agreement.

When Fortress records equity-based compensation expense, including that related to the Principals Agreement, it records a corresponding increase in capital.

In April 2010, in connection with the acquisition of Logan Circle, Fortress created the Logan Circle Comp Plan. 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. $0.1 million of equity-based compensation expense relating to the Logan Circle Comp Plan has been recorded during the three months ended March 31, 2011.

 

24


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

In January 2011, Fortress granted 5.2 million RSUs to its employees and affiliates valued at an aggregate of $29.2 million on the grant date. These RSUs generally vest over two and a half years.

In April 2011, one of the Principals entered into an agreement with a senior employee whereby such employee will receive 2,857,143 Fortress Operating Group units from such Principal if the employee remains with Fortress until January 2012. As a result of the service requirement, the fair value of these units of $15.9 million will be charged to compensation expense in 2011.

Profit Sharing Expense

Recognized profit sharing compensation expense is summarized as follows:

 

     Three Months Ended March 31,  
     2011      2010  

Private equity funds

   $ 491       $ —     

Castles

     —           —     

Liquid hedge funds

     11,904         3,026   

Credit hedge funds

     18,386         4,145   

Credit PE funds

     27,875         43,243   
                 

Total

   $ 58,656       $ 50,414   
                 

 

25


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

8. EARNINGS PER SHARE AND DISTRIBUTIONS

The computations of basic and diluted net income (loss) per Class A share are set forth below:

 

     Three Months Ended March 31, 2011  
     Basic     Diluted  

Weighted average shares outstanding

    

Class A shares outstanding

     171,287,024        171,287,024   

Fully vested restricted Class A share units with dividend equivalent rights

     9,481,968        9,481,968   

Fully vested restricted Class A shares

     250,509        250,509   

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

     —          —     

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

     181,019,501        181,019,501   
                

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

    

Net income (loss) attributable to Class A shareholders

   $ (103,432   $ (103,432

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)

     (1,970     (1,970

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)

     —          —     
                

Net income (loss) available to Class A shareholders

   $ (105,402   $ (105,402
                

Weighted average shares outstanding

     181,019,501        181,019,501   
                

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

   $ (0.58   $ (0.58
                
     Three Months Ended March 31, 2010  
     Basic     Diluted  

Weighted average shares outstanding

    

Class A shares outstanding

     146,073,810        146,073,810   

Fully vested restricted Class A share units with dividend equivalent rights

     11,606,613        11,606,613   

Fully vested restricted Class A shares

     141,472        141,472   

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

     —          307,773,852   

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

     157,821,895        465,595,747   
                

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

    

Net income (loss) attributable to Class A shareholders

   $ (84,151   $ (84,151

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)

     (4,934     (4,934

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)

     —          (180,051
                

Net income (loss) available to Class A shareholders

   $ (89,085   $ (269,136
                

Weighted average shares outstanding

     157,821,895        465,595,747   
                

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

   $ (0.56   $ (0.58
                

 

26


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(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 and one senior employee) 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 losses 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 March 31,  
     2011      2010  

Share Units

     25,501,235         27,632,927   

 

(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  
     Three Months Ended March 31,  
     2011      2010  

Class A shares (public shareholders)

     171,287,024         146,073,810   

Restricted Class A shares (directors)

     452,434         231,292   

Restricted Class A share units (employees) (A)

     9,481,968         11,606,613   

Restricted Class A share units (employees) (B)

     14,281,131         19,651,275   

Fortress Operating Group units (Principals and one senior employee)

     301,700,848         307,773,852   

Fortress Operating Group RPUs (one senior employee)

     28,359,260         31,000,000   
                 

Total

     525,562,665         516,336,842   
                 

 

     As of March 31, 2011      As of December 31, 2010  

Class A shares (public shareholders)

     177,109,784         169,110,299   

Restricted Class A shares (directors)

     453,020         426,669   

Restricted Class A share units (employees) (A)

     7,380,075         1,058,331   

Restricted Class A share units (employees) (B)

     14,022,083         19,257,978   

Fortress Operating Group units (Principals and one senior employee)

     305,857,751         300,273,852   

Fortress Operating Group RPUs (one senior employee)

     20,666,667         31,000,000   
                 

Total

     525,489,380         521,127,129   
                 

 

(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 2011, 10.0 million existing RSUs and 10.3 million existing RPUs vested and the related Class A and Class B shares, as applicable, were delivered, or, in the case of certain RSUs, are expected to be delivered within six months of vesting pursuant to the plan documents. In March 2011, one senior employee exchanged an aggregate of 4,749,434 FOG units and Class B shares for an equal number of Class A shares. A portion of the vested shares are being sold to cover withholding tax requirements.

 

27


Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

MARCH 31, 2011

(dollars in tables in thousands, except share data)

 

 

Dividends and distributions during the three months ended March 31, 2011 are summarized as follows:

 

    Declared in Pri