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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 September 30, 2012

 

or

 

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

 

For the transition period from               to              

 

Commission File Number: 001-33294

 

Fortress Investment Group LLC

(Exact name of registrant as specified in its charter)

 

 

 

(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  o

 

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).  x  Yes  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

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: 220,367,578 outstanding as of October 30, 2012.

 

Class B Shares: 298,723,852 outstanding as of October 30, 2012.

 

 

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 September 30, 2012 (unaudited) and December 31, 2011		1
	Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2012 and 2011		2
	Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2012 and 2011		3
	Consolidated Statement of Changes in Equity (unaudited) for the nine months ended September 30, 2012		4
	Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2012 and 2011		5
	Notes to Consolidated Financial Statements (unaudited)		6
	Note 1	Organization and Basis of Presentation	6
	Note 2	Management Agreements and Fortress Funds	9
	Note 3	Investments and Fair Value	15
	Note 4	Debt Obligations	21
	Note 5	Income Taxes and Tax Related Payments	22
	Note 6	Related Party Transactions and Interests in Consolidated Subsidiaries	23
	Note 7	Equity-Based and Other Compensation	25
	Note 8	Earnings Per Share and Distributions	28
	Note 9	Commitments and Contingencies	31
	Note 10	Segment Reporting	32
	Note 11	Subsequent Events	39
	Note 12	Consolidating Financial Information	39
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		43
	Overview and Understanding the Asset Management Business		43
	Market Considerations		48
	Assets Under Management		50
	Performance of Our Funds		52
	Results of Operations		55
	Liquidity and Capital Resources		70
	Critical Accounting Policies		76
	Contractual Obligations		83
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		84
Item 4.	Controls and Procedures		87

 

Table of Contents

 

PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	87
Item 1A.	Risk Factors	87
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	118
Item 3.	Defaults upon Senior Securities	118
Item 4.	Mine Safety Disclosures	118
Item 5.	Other Information	118
Item 6.	Exhibits	118
SIGNATURES		121

 

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 and certain advisory engagements which pay fees based on realizations (and on certain managed assets and, in some cases, a fixed fee); and

 

(iv)                              the NAV or fair value 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. Finally, our calculation of AUM differs from the manner in which our affiliates registered with the United States Securities and Exchange Commission report “Regulatory Assets Under Management” on Form ADV and Form PF in various ways.  Significantly, Regulatory Assets Under Management, unlike Management Fee Paying Assets Under Management, is not reduced by liabilities or indebtedness associated with assets under management and it includes assets under management and uncalled capital for which Fortress receives no compensation.

 

‘‘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 are in part owned directly by the principals and one senior employee, and in part owned indirectly by Fortress Investment Group LLC, and whose equity interests are comprised of Fortress Operating Group units (“FOGUs”).

 

‘‘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 (Unaudited)

(dollars in thousands)

 

		September 30,
		2012			December 31,
		(Unaudited)			2011
Assets
Cash and cash equivalents		$	253,731		$	333,166
Due from affiliates		289,889			298,689
Investments		1,199,622			1,079,777
Deferred tax asset		379,372			400,196
Other assets		102,787			108,858
		$	2,225,401		$	2,220,686
Liabilities and Equity
Liabilities
Accrued compensation and benefits		$	222,719		$	247,024
Due to affiliates		345,009			354,158
Deferred incentive income		245,957			238,658
Debt obligations payable		180,528			261,250
Other liabilities		81,193			57,204
		1,075,406			1,158,294
Commitments and Contingencies
Equity
Class A shares, no par value, 1,000,000,000 shares authorized, 220,188,973 and 189,824,053 shares issued and outstanding at September 30, 2012 and December 31, 2011 respectively		—			—
Class B shares, no par value, 750,000,000 shares authorized, 298,723,852 and 305,857,751 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively		—			—
Paid-in capital		2,048,874			1,972,711
Retained earnings (accumulated deficit)		(1,508,043		)	(1,484,120		)
Accumulated other comprehensive income (loss)		(2,175		)	(1,160		)
Total Fortress shareholders’ equity		538,656			487,431
Principals’ and others’ interests in equity of consolidated subsidiaries		611,339			574,961
Total equity		1,149,995			1,062,392
		$	2,225,401		$	2,220,686

 

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 September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
Revenues
Management fees: affiliates		$	112,806		$	118,353		$	336,935		$	353,269
Management fees: non-affiliates		10,762			18,865			32,534			47,641
Incentive income: affiliates		5,976			14,754			38,994			44,361
Incentive income: non-affiliates		788			266			1,564			1,251
Expense reimbursements from affiliates		49,636			42,350			138,317			130,337
Other revenues (affiliate portion disclosed in Note 6)		1,555			1,071			3,885			5,433
		181,523			195,659			552,229			582,292
Expenses
Interest expense		3,375			4,583			11,877			13,883
Compensation and benefits		181,421			158,426			537,267			535,259
Principals agreement compensation (expired in 2011)		—			279,623			—			751,749
General, administrative and other		31,004			34,165			93,365			109,545
Depreciation and amortization		4,982			23,767			11,718			30,114
		220,782			500,564			654,227			1,440,550
Other Income (Loss)
Gains (losses) (affiliate portion disclosed in Note 3)		(2,228		)	(15,229		)	29,542			(26,751		)
Tax receivable agreement liability adjustment		—			—			(6,935		)	(116		)
Earnings (losses) from equity method investees		52,034			(64,483		)	110,417			26,417
		49,806			(79,712		)	133,024			(450		)
Income (Loss) Before Income Taxes		10,547			(384,617		)	31,026			(858,708		)
Income tax benefit (expense)		(3,881		)	2,712			(34,251		)	(24,493		)
Net Income (Loss)		$	6,666		$	(381,905	)	$	(3,225	)	$	(883,201	)
Principals’ and Others’ Interests in Income (Loss) of Consolidated Subsidiaries		$	5,958		$	(239,847	)	$	20,698		$	(543,175	)
Net Income (Loss) Attributable to Class A Shareholders		$	708		$	(142,058	)	$	(23,923	)	$	(340,026	)
Dividends declared per Class A share		$	0.05		$	—		$	0.15		$	—
Earnings Per Class A share
Net income (loss) per Class A share, basic		$	0.00		$	(0.76	)	$	(0.12	)	$	(1.85	)
Net income (loss) per Class A share, diluted		$	(0.04	)	$	(0.83	)	$	(0.13	)	$	(1.88	)
Weighted average number of Class A shares outstanding, basic		220,641,776			190,006,987			212,297,285			185,373,605
Weighted average number of Class A shares outstanding, diluted		520,039,541			495,864,738			517,431,334			492,396,969

 

See notes to consolidated financial statements

 

2

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FORTRESS INVESTMENT GROUP LLC

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(dollars in thousands)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2012			2011			2012			2011
Comprehensive income (loss) (net of tax)
Net income (loss)		$	6,666		$	(381,905	)	$	(3,225	)	$	(883,201	)
Foreign currency translation		168			815			(884		)	917
Comprehensive income (loss) from equity method investees		(1,066		)	559			(1,157		)	1,397
Total comprehensive income (loss)		$	5,768		$	(380,531	)	$	(5,266	)	$	(880,887	)
Comprehensive income (loss) attributable to principals’ and others’ interests		$	5,331		$	(239,149	)	$	19,462		$	(541,691	)
Comprehensive income (loss) attributable to Class A shareholders		$	437		$	(141,382	)	$	(24,728	)	$	(339,196	)

 

3

Table of Contents

 

FORTRESS INVESTMENT GROUP LLC

 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (Unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012

(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, 2011		189,824,053		305,857,751		$	1,972,711		$	(1,484,120	)	$	(1,160	)	$	487,431		$	574,961		$	1,062,392
Contributions from principals’ and others’ interests in equity		—		—		—			—			—			—			24,177			24,177
Distributions to principals’ and others’ interests in equity		—		—		(189		)	—			—			(189		)	(60,159		)	(60,348		)
Dividends declared		—		—		(31,359		)	—			—			(31,359		)	—			(31,359		)
Dividend equivalents accrued in connection with equity-based compensation		—		—		(548		)	—			—			(548		)	(841		)	(1,389		)
Conversion of Class B shares to Class A shares		17,467,232		(17,467,232	)	22,362			—			(196		)	22,166			(22,166		)	—
Net deferred tax effects resulting from acquisition and exchange of Fortress Operating Group units		—		—		9,653			—			—			9,653			4			9,657
Director restricted share grant		257,918		—		344			—			—			344			500			844
Capital increase related to equity-based compensation, net		12,639,770		10,333,333		61,604			—			—			61,604			89,683			151,287
Dilution impact of Class A share issuance		—		—		14,296			—			(14		)	14,282			(14,282		)	—
Comprehensive income (loss) (net of tax)
Net income (loss)		—		—		—			(23,923		)	—			(23,923		)	20,698			(3,225		)
Foreign currency translation		—		—		—			—			(507		)	(507		)	(377		)	(884		)
Comprehensive income (loss) from equity method investees		—		—		—			—			(298		)	(298		)	(859		)	(1,157		)
Total comprehensive income (loss)															(24,728		)	19,462			(5,266		)
Equity - September 30, 2012		220,188,973		298,723,852		$	2,048,874		$	(1,508,043	)	$	(2,175	)	$	538,656		$	611,339		$	1,149,995

 

See notes to consolidated financial statements

 

4

Table of Contents

 

FORTRESS INVESTMENT GROUP LLC

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

		Nine Months Ended September 30,
		2012			2011
Cash Flows From Operating Activities
Net income (loss)		$	(3,225	)	$	(883,201	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Depreciation and amortization		11,718			30,114
Other amortization and accretion		1,467			1,119
(Earnings) losses from equity method investees		(110,417		)	(26,417		)
Distributions of earnings from equity method investees		32,621			19,775
(Gains) losses		(29,542		)	26,751
Deferred incentive income		(36,931		)	(40,146		)
Deferred tax (benefit) expense		32,107			2,924
Reversal of forfeited non-cash compensation		(1,705		)	—
Options received from affiliates		(21,524		)	(12,615		)
Tax receivable agreement liability adjustment		6,935			116
Equity-based compensation		162,372			930,869
Options in affiliates granted to employees		3,378			—
Allowance for doubtful accounts		485			5,037
Cash flows due to changes in
Due from affiliates		(66,183		)	(55,539		)
Other assets		601			20,780
Accrued compensation and benefits		(4,276		)	(19,835		)
Due to affiliates		1,404			(9,601		)
Deferred incentive income		43,382			99,239
Other liabilities		23,061			31,852
Net cash provided by (used in) operating activities		45,728			121,222
Cash Flows From Investing Activities
Contributions to equity method investees		(52,573		)	(69,923		)
Distributions of capital from equity method investees		137,015			179,258
Purchase of fixed assets		(7,367		)	(13,350		)
Net cash provided by (used in) investing activities		77,075			95,985
Cash Flows From Financing Activities
Repayments of debt obligations		(80,722		)	(7,500		)
Repurchase of RSUs (Note 8)		(7,522		)	—
Dividend and dividend equivalents paid		(32,803		)	—
Principals’ and others’ interests in equity of consolidated subsidiaries - contributions		429			13,074
Principals’ and others’ interests in equity of consolidated subsidiaries - distributions		(81,620		)	(119,675		)
Net cash provided by (used in) financing activities		(202,238		)	(114,101		)
Net Increase (Decrease) in Cash and Cash Equivalents		(79,435		)	103,106
Cash and Cash Equivalents, Beginning of Period		333,166			210,632
Cash and Cash Equivalents, End of Period		$	253,731		$	313,738
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest		$	10,198		$	12,049
Cash paid during the period for income taxes		$	5,623		$	7,793
Supplemental Schedule of Non-cash Investing and Financing Activities
Employee compensation invested directly in subsidiaries		$	23,598		$	58,865
Investments of receivable amounts into Fortress Funds		$	74,636		$	143,800
Dividends, dividend equivalents and Fortress Operating Group unit distributions declared but not yet paid		$	7,876		$	2,805

 

See notes to consolidated financial statements

 

5

Table of Contents

 

FORTRESS INVESTMENT GROUP LLC

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(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. In addition, this segment includes an endowment style fund, which invests in Fortress Funds, funds managed by external managers, and direct investments; and a fund that seeks to generate returns by executing a positively convex investment strategy.

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 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), a family of Asia funds, including Japan real estate funds and an Asian investor based global opportunities fund, and a family of real estate opportunities funds.

4)             Logan Circle Partners, L.P. (“Logan Circle”), which represents Fortress’s traditional, fixed income asset management business.

5)    Principal investments in the above described funds.

 

Financial Statement Guide

 

Selected Financial Statement Captions		Note Reference		Explanation
Balance Sheet
Due from Affiliates		6		Generally, management fees, expense reimbursements and incentive income due from Fortress Funds.
Investments		3		Primarily the carrying value of Fortress’s principal investments in the Fortress Funds.
Deferred Tax Asset		5		Relates to potential future tax benefits.
Due to Affiliates		6		Generally, amounts due to the Principals related to their interests in Fortress Operating Group and the tax receivable agreement.
Deferred Incentive Income		2		Incentive income already received from certain Fortress Funds based on past performance, which is subject to contingent repayment based on future performance.

 

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FORTRESS INVESTMENT GROUP LLC

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(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’ and one senior employee’s 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		7		As a result of the principals agreement, which expired in December 2011, the January 2007 value of a significant portion of the Principals’ equity in Fortress was recorded as an expense over an approximate five year period. Fortress was not a party to this agreement. It was an agreement between the Principals to further incentivize them to remain with Fortress. This GAAP expense had 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.

 

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FORTRESS INVESTMENT GROUP LLC

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(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.

 

In May 2011, the FASB issued new guidance regarding the measurement and disclosure of fair value, which became effective for Fortress on January 1, 2012. This guidance did not have a material direct impact on Fortress’s financial position, results of operations or liquidity.

 

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, the definition of an investment company, financial statement presentation, revenue recognition, leases, financial instruments, hedging, and contingencies. Some of the proposed changes are significant and could have a material impact on Fortress’s financial 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 financial statements for the year ended December 31, 2011 and notes thereto included in Fortress’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2012.  Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated financial statements for the year ended December 31, 2011.

 

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

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(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 September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
Private Equity
Private Equity Funds
Management fees - affil.		$	29,891		$	30,333		$	89,148		$	101,443
Management fees - non-affil.		112			—			283			—
Incentive income - affil.		708			4,440			1,815			7,906
Castles
Management fees - affil.		13,744			12,277			38,427			36,312
Management fees, options - affil.		8,298			5,594			21,524			12,615
Management fees - non-affil.		359			1,668			3,563			3,606
Incentive income - affil.		—			—			—			—
Liquid Hedge Funds
Management fees - affil.		14,783			23,715			47,946			70,262
Management fees - non-affil.		3,395			4,223			9,592			13,598
Incentive income - affil.		563			239			1,436			2,299
Incentive income - non-affil.		188			—			312			985
Credit Funds
Credit Hedge Funds
Management fees - affil.		24,688			26,914			76,005			80,548
Management fees - non-affil.		58			8,004			313			15,573
Incentive income - affil.		466			34			1,749			2,182
Incentive income - non-affil.		—			—			130			—
Credit PE Funds
Management fees - affil.		21,402			19,520			63,885			52,089
Management fees - non-affil.		36			30			108			97
Incentive income - affil.		4,239			10,041			33,994			31,974
Incentive income - non-affil.		600			266			1,122			266
Logan Circle
Management fees - non-affil.		6,802			4,940			18,675			14,767
Total
Management fees - affil.		$	112,806		$	118,353		$	336,935		$	353,269
Management fees - non-affil.		$	10,762		$	18,865		$	32,534		$	47,641
Incentive income - affil. (A)		$	5,976		$	14,754		$	38,994		$	44,361
Incentive income - non-affil.		$	788		$	266		$	1,564		$	1,251

 

(A) See “Deferred Incentive Income” below.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2012

(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 nine months ended September 30, 2012 and 2011. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $108.0 million and $46.1 million of additional incentive income from affiliates would have been recognized during the nine months ended September 30, 2012 and 2011, 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 nine months ended September 30, 2012 and 2011, Fortress recognized $34.0 million and $32.0 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, 2011		$	823,097		$	(584,439	)	$	238,658		$	202,805
Share of income (loss) of Fortress Funds		N/A			N/A			N/A			393,152
Distribution of private equity incentive income		44,230			N/A			44,230			(44,230		)
Recognition of previously deferred incentive income		N/A			(36,931		)	(36,931		)	N/A
Deferred incentive income as of September 30, 2012		$	867,327		$	(621,370	)	$	245,957		$	551,727

 

(A)       All related contingencies have been resolved.

(B)       Reflected on the balance sheet.

(C)       At September 30, 2012, the net undistributed incentive income is comprised of $642.4 million of gross undistributed incentive income, net of $90.7 million of intrinsic clawback (see next page). The net undistributed incentive income represents the amount that would be received by Fortress from the related funds if such funds were liquidated on September 30, 2012 at their net asset values.

(D)       From inception to September 30, 2012, Fortress has paid $365.1 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 $642.4 million of gross undistributed incentive income were realized, Fortress would recognize and pay an additional $254.8 million of compensation expense.

 

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