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

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

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

For the quarterly period ended September 30, 2009

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: 145,511,736 outstanding as of November 2, 2009.

Class B Shares: 307,773,852 outstanding as of November 2, 2009.

 

 

 


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, 2009 (unaudited) and December 31, 2008

   1
  

Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2009 and 2008

   2
  

Consolidated Statement of Equity (unaudited) for the nine months ended September 30, 2009

   3
  

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2009 and 2008

   4
  

Notes to Consolidated Financial Statements (unaudited)

   5

Item 2.

  

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

   35

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   65

Item 4.

  

Controls and Procedures

   68
   PART II. OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   68

Item 1A.

  

Risk Factors

   69

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   99

Item 3.

  

Defaults upon Senior Securities

   99

Item 4.

  

Submission of Matters to a Vote of Security Holders

   99

Item 5.

  

Other Information

   99

Item 6.

  

Exhibits

   100

SIGNATURES

   101


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 hybrid PE funds, depending on which measure management fees are being calculated upon at a given point in time, which in connection with funds raised after March 2006 includes the mark-to-market value of public securities held within the funds,

 

  (ii) the contributed capital of our publicly traded alternative investment vehicles, which we refer to as our “Castles,”

 

  (iii) the net asset value, or “NAV,” of our hedge funds, including the Value Recovery Funds which pay fees based on realizations (and on certain managed assets); and

 

  (iv) the NAV of our managed accounts, to the extent management fees are charged.

For each of the above, the amounts exclude assets under management for which we charge either no or nominal fees, generally related to our principal investments in funds as well as investments in funds by our principals, directors and employees.

Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. Our definition of AUM is not based on any definition of assets under management contained in our operating agreement or in any of our Fortress Fund management agreements.

“Fortress,” “we,” “us,” “our,” and the “company” refer, collectively, to Fortress Investment Group LLC and its subsidiaries, including the Fortress Operating Group and all of its subsidiaries.

“Fortress Funds” and “our funds” refers to the private investment funds and alternative asset companies that are managed by the Fortress Operating Group.

“Fortress Operating Group” refers to the combined entities, which were wholly-owned by the principals prior to January 2007, and in each of which Fortress Investment Group LLC acquired an indirect controlling interest in January 2007.

“principals” or “Principals” refers to Peter Briger, Wesley Edens, Robert Kauffman, Randal Nardone and Michael Novogratz, collectively, who prior to the completion of our initial public offering and related transactions directly owned 100% of the Fortress Operating Group units and following completion of our initial public offering and related transactions own a majority of the Fortress Operating Group units and of the Class B shares, representing a majority of the total combined voting power of all of our outstanding Class A and Class B shares. The principals’ ownership percentage is subject to change based on, among other things, equity offerings and grants by Fortress and dispositions by the principals.


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under Part II, Item 1A, “Risk Factors,” Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk” and elsewhere in this Quarterly Report on Form 10-Q may contain forward-looking statements which reflect our current views with respect to, among other things, future events and financial performance. Readers can identify these forward-looking statements by the use of forward-looking words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of those words or other comparable words. Any forward-looking statements contained in this report are based upon the historical performance of us and our subsidiaries and on our current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business prospects, growth strategy and liquidity. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from those indicated in these statements. Accordingly, you should not place undue reliance on any forward-looking statements. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

SPECIAL NOTE REGARDING EXHIBITS

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

 

   

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

 

   

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

 

   

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

 

   

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

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


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

 

     September 30,
2009

(Unaudited)
    December 31,
2008
 

Assets

    

Cash and cash equivalents

   $ 106,986      $ 263,337   

Due from affiliates

     105,518        38,504   

Investments

    

Equity method investees

     881,768        774,382   

Options in affiliates

     1,417        39   

Deferred tax asset

     444,316        408,066   

Other assets

     91,763        93,407   
                
   $ 1,631,768      $ 1,577,735   
                

Liabilities and Shareholders’ Equity

    

Liabilities

    

Accrued compensation and benefits

   $ 92,950      $ 158,033   

Due to affiliates

     333,320        346,265   

Deferred incentive income

     163,635        163,635   

Debt obligations payable

     411,800        729,041   

Other liabilities

     53,194        26,741   
                
     1,054,899        1,423,715   
                

Commitments and Contingencies

    

Equity

    

Class A shares, no par value, 1,000,000,000 shares authorized, 145,511,736 and 94,609,525 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively

     —          —     

Class B shares, no par value, 750,000,000 shares authorized, 307,773,852 and 312,071,550 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively

     —          —     

Paid-in capital

     932,709        596,803   

Retained earnings (accumulated deficit)

     (683,732     (513,379

Accumulated other comprehensive income (loss)

     (597     (866
                

Total Fortress shareholders’ equity

     248,380        82,558   

Principals’ and others’ interests in equity of consolidated subsidiaries - Note 6

     328,489        71,462   
                

Total equity

     576,869        154,020   
                
   $ 1,631,768      $ 1,577,735   
                

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  

Revenues

        

Management fees from affiliates

   $ 106,926      $ 154,266      $ 321,003      $ 447,928   

Incentive income from affiliates

     7,638        718        14,596        56,162   

Expense reimbursements from affiliates

     24,952        12,501        58,660        42,722   

Other revenues (affiliate portion disclosed in Note 6)

     4,167        17,651        10,807        27,300   
                                
     143,683        185,136        405,066        574,112   
                                

Expenses

        

Interest expense

     4,451        9,481        20,242        29,705   

Compensation and benefits

     132,033        134,774        354,725        399,253   

Principals agreement compensation

     239,975        239,976        712,101        714,710   

General, administrative and other

     18,461        23,536        56,680        59,852   

Depreciation and amortization

     2,719        2,437        8,121        7,309   
                                
     397,639        410,204        1,151,869        1,210,829   
                                

Other Income (Loss)

        

Gains (losses) from investments

        

Net realized gains (losses)

     (408     (2,477     (1,180     (803

Net realized gains (losses) from affiliate investments

     315        (671     301        (516

Net unrealized gains (losses)

     —          —          —          —     

Net unrealized gains (losses) from affiliate investments

     20,282        (6,951     38,036        (43,352

Tax receivable agreement liability reduction

     —          —          (55     —     

Earnings (losses) from equity method investees

     40,345        (37,921     56,553        (113,550
                                
     60,534        (48,020     93,655        (158,221
                                
Income (Loss) Before Income Taxes      (193,422     (273,088     (653,148     (794,938

Income tax benefit (expense)

     3,116        5,636        4,831        333   
                                
Net Income (Loss)    $ (190,306   $ (267,452   $ (648,317   $ (794,605
                                

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

   $ (131,704   $ (210,012   $ (477,964   $ (612,692
                                

Net Income (Loss) Attributable to Class A Shareholders - Note 6

   $ (58,602   $ (57,440   $ (170,353   $ (181,913
                                

Dividends declared per Class A share

   $ —        $ —        $ —        $ 0.450   
                                

Earnings Per Class A share - Fortress Investment Group

        

Net income (loss) per Class A share, basic

   $ (0.41   $ (0.61   $ (1.50   $ (1.96
                                

Net income (loss) per Class A share, diluted

   $ (0.43   $ (0.66   $ (1.53   $ (1.97
                                

Weighted average number of Class A shares outstanding, basic

     143,627,823        94,938,434        118,638,707        94,915,666   
                                

Weighted average number of Class A shares outstanding, diluted

     454,064,379        407,009,984        430,159,270        406,987,216   
                                

 

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENT OF EQUITY (Unaudited)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009

(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, 2008

   94,609,525    312,071,550      $ 596,803      $ (513,379   $ (866   $ 82,558      $ 71,462      $ 154,020   

Contributions from principals’ and others’ interests in equity

   —      —          —          —          —          —          9,650        9,650   

Distributions to principals’ and others’ interests in equity

   —      —          (1,296     —          —          (1,296     (54,030     (55,326

Public offering of Class A shares, net of offering costs

   46,000,000    —          219,500        —          —          219,500        —          219,500   

Dilution impact of public offering

   —      —          (144,572     —          —          (144,572     144,572        —     

Conversion of Class B shares to Class A shares

   4,297,698    (4,297,698     4,100        —          —          4,100        (4,100     —     

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

   —      —          15,080        —          —          15,080        —          15,080   

Net deferred tax effects resulting from exchange of Fortress Operating Group units for Class A shares

   —      —          4,351        —          —          4,351        —          4,351   

Director restricted share grant

   116,672    —          172        —          —          172        229        401   

Capital increase related to equity-based compensation, net

   487,841    —          238,571        —          —          238,571        638,177        876,748   

Comprehensive income (loss) (net of tax)

                 

Net income (loss)

   —      —          —          (170,353     —          (170,353     (477,964     (648,317

Foreign currency translation

   —      —          —          —          282        282        979        1,261   

Comprehensive income (loss) from equity method investees

   —      —          —          —          (13     (13     (486     (499
                       

Total comprehensive income (loss)

                    (647,555
                                                           

Equity - September 30, 2009

   145,511,736    307,773,852      $ 932,709      $ (683,732   $ (597   $ 248,380      $ 328,489      $ 576,869   
                                                           

 

 

 

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

     Nine Months Ended September 30,  
     2009     2008  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (648,317   $ (794,605

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

    

Depreciation and amortization

     8,121        7,309   

Other amortization and accretion

     7,988        3,401   

(Earnings) losses from equity method investees

     (56,553     113,550   

Distributions of earnings from equity method investees

     2,156        9,386   

(Gains) losses from investments

     (37,157     44,671   

Deferred incentive income

     —          (36,003

Deferred tax (benefit) expense

     (12,428     (8,297

Reversal of forfeited non-cash compensation

     (55     —     

Tax receivable agreement liability reduction

     55        —     

Equity-based compensation

     878,808        853,861   

Cash flows due to changes in

    

Due from affiliates

     (66,712     90,724   

Other assets

     (8,166     (13,052

Accrued compensation and benefits

     (58,861     (93,466

Due to affiliates

     (18,087     (50

Deferred incentive income

     —          26,077   

Other liabilities

     26,548        30,076   
                

Net cash provided by (used in) operating activities

     17,340        233,582   
                

Cash Flows From Investing Activities

    

Contributions to equity method investees

     (43,322     (135,036

Distributions of capital from equity method investees

     28,740        211,162   

Purchase of fixed assets

     (1,979     (9,120

Proceeds from disposal of fixed assets

     7        53   
                

Net cash provided by (used in) investing activities

     (16,554     67,059   
                

Cash Flows From Financing Activities

    

Borrowings under debt obligations

     —          450,000   

Repayments of debt obligations

     (317,241     (235,000

Payment of deferred financing costs

     (4,162     (5,020

Proceeds from public offering

     230,000        —     

Costs related to public offering

     (10,500     —     

Dividends and dividend equivalents paid

     —          (81,026

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

     92        145   

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

     (55,326     (270,897
                

Net cash provided by (used in) financing activities

     (157,137     (141,798
                

Net Increase (Decrease) in Cash and Cash Equivalents

     (156,351     158,843   

Cash and Cash Equivalents, Beginning of Period

     263,337        100,409   
                

Cash and Cash Equivalents, End of Period

   $ 106,986      $ 259,252   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest

   $ 11,160      $ 26,084   
                

Cash paid during the period for income taxes

   $ 8,266      $ 7,184   
                

Supplemental Schedule of Non-cash Investing and Financing Activities

    

Employee compensation invested directly in subsidiaries

   $ 7,976      $ 22,861   
                

Investments of receivable amounts into Fortress Funds

   $ —        $ 59,133   
                

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

   $ —        $ —     
                

See notes to consolidated financial statements

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

1. ORGANIZATION AND BASIS OF PRESENTATION

Fortress Investment Group LLC (the “Registrant,” or, together with its subsidiaries, “Fortress”) is a global alternative asset management firm whose predecessor was founded in 1998. Its primary business is to sponsor the formation of, and provide investment management services for, various investment funds and companies (the “Fortress Funds”). Fortress generally makes principal investments in these funds.

Fortress has three primary sources of income from the Fortress Funds: management fees, incentive income, and investment income on its principal investments in the funds. The Fortress Funds fall into the following business segments in which Fortress operates:

 

  1) Private equity:

 

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

 

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

 

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

 

  3) Hybrid funds:

 

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

 

  4) Principal investments in the above described funds.

2007 Reorganization of Fortress Operating Group and Recent Offering

Fortress Investment Group LLC was formed in November 2006 for the purpose of becoming the general partner of Fortress Operating Group, completing the Nomura Transaction (described below), and effecting a public offering of shares and related transactions (the “Transactions”) in order to carry on the business of its predecessor, Fortress Operating Group, as a publicly traded entity. The Registrant is a limited liability company and its members are not responsible for any of its liabilities beyond the equity they have invested. Fortress’s formation documents allow for an indefinite life.

In January 2007, Nomura Investment Managers U.S.A Inc. (“Nomura”) completed a transaction (the “Nomura Transaction”) whereby it purchased 55,071,450 Class A shares of the Registrant and the Registrant, in turn, purchased 55,071,450 Fortress Operating Group units from the Principals. In February 2007, the Registrant completed an initial public offering (“IPO”) of 39,428,900 of its Class A shares.

In May 2009, Fortress sold 46 million Class A shares in a public offering at a price to the public of $5.00 per share, for net proceeds of approximately $219.5 million after deducting the underwriters’ discount and other offering expenses. The Principals purchased an aggregate of 3.6 million of these shares, a senior employee purchased 0.4 million of these shares, and Nomura purchased 5.4 million of these shares, at the public offering price. A portion of the proceeds were used to pay down amounts outstanding under the credit agreement (Note 4).

Financial Statement Guide

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

Balance Sheet

     

Due from Affiliates

   6    Generally, management fees, expense reimbursements and incentive income earned from Fortress Funds.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

Investments in Equity Method Investees

   3    The carrying value of Fortress’s principal investments in the Fortress Funds.

Options in Affiliates

   3    The fair value of common stock options received from the Castles.

Deferred Tax Asset

   5    Relates to 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.

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.

Income Statement

     

Management Fees from Affiliates

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

Incentive Income from Affiliates

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

Compensation and Benefits

   7    Includes equity-based, profit-sharing and other compensation to employees.

Principals Agreement Compensation

   N/A    As a result of the principals agreement, the value of a significant portion of the Principals’ equity in Fortress prior to the Nomura Transaction is being recorded as an expense over a five year period. Fortress is not a party to this agreement. It is an agreement between the Principals to further incentivize them to remain with Fortress. This GAAP expense has no economic effect on Fortress or its shareholders.

Gains (Losses) from Other Investments

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

Tax Receivable Agreement Liability Reduction

   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 Fortress Funds resulting from its principal investments.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Selected Financial Statement Captions

   Note
Reference
  

Explanation

Income Tax Benefit (Expense)

   5    The net tax result related to the current period. Certain of Fortress’s revenues are not subject to taxes because they do not flow through taxable entities. Furthermore, Fortress has significant permanent differences between its GAAP and tax basis earnings.

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

   6    Primarily the Principals’ and employees’ share of Fortress’s earnings based on their ownership interests in subsidiaries, including Fortress Operating Group. This amount is disclosed in order to provide a net income (loss) which relates only to Fortress’s Class A shareholders.

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 accompanying consolidated and combined financial statements and related notes of Fortress have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Fortress’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Fortress’s consolidated and combined financial statements for the year ended December 31, 2008 and notes thereto included in Fortress’s current report on Form 8-K filed with the Securities and Exchange Commission on May 12, 2009. Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated and combined financial statements for the year ended December 31, 2008.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

2. MANAGEMENT AGREEMENTS AND FORTRESS FUNDS

Management Fees, Incentive Income and Related Profit Sharing Expense

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

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

Fortress recognized management fees and incentive income as follows:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2009    2008    2009    2008

Private Equity

           

Private Equity Funds

           

Management fees - affil.

   $ 32,048    $ 40,007    $ 108,638    $ 120,225

Incentive income - affil.

     —        509      —        38,684

Castles

           

Management fees - affil.

     12,358      12,755      35,698      38,828

Incentive income - affil.

     —        —        —        12

Management fees - non-affil. (A)

     596      1,035      1,936      2,867

Liquid Hedge Funds

           

Management fees - affil.

     18,566      59,530      61,063      169,721

Incentive income - affil.

     6,431      47      6,575      16,885

Management fees - non-affil. (A)

     —        110      25      246

Incentive income - non-affil. (A)

     —        36      —        240

Hybrid Funds

           

Hybrid Hedge Funds

           

Management fees - affil.

     31,815      37,760      89,030      110,753

Incentive income - affil.

     —        162      —        581

Management fees - non-affil. (A)

     277      270      686      730

Incentive income - non-affil. (A)

     279      13,094      1,264      13,094

Hybrid PE Funds

           

Management fees - affil.

     12,139      4,214      26,574      8,401

Incentive income - affil.

     1,207      —        8,021      —  

Management fees - non-affil. (A)

     875      —        875      —  

Total

           

Management fees - affil.

   $ 106,926    $ 154,266    $ 321,003    $ 447,928

Incentive income - affil. (B)

   $ 7,638    $ 718    $ 14,596    $ 56,162

Management fees - non-affil. (A)

   $ 1,748    $ 1,415    $ 3,522    $ 3,843

Incentive income - non-affil. (A)

   $ 279    $ 13,130    $ 1,264    $ 13,334

 

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

 

(B) See “Deferred Incentive Income” below.

Deferred Incentive Income

Incentive income from certain Fortress Funds, primarily private equity funds and hybrid 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, primarily hybrid hedge funds, as well as certain liquid hedge funds beginning in the second quarter of 2009, is earned based on achieving annual performance criteria. Accordingly, this incentive income is

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

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, 2009 and 2008. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $1.8 million and $0.0 million of additional incentive income from affiliates would have been recognized during the nine months ended September 30, 2009 and 2008, 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 2009, Fortress received $8.0 million of incentive income distributions from its hybrid PE funds which represented “tax distributions.” These tax distributions are not subject to clawback and reflect a cash amount equal to the amount expected to be paid out by Fortress for taxes or tax-related distributions on the allocated income from such funds.

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

 

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

Deferred incentive income as of December 31, 2008

   $ 470,798    $ (307,163   $ 163,635    $ (89,085

Share of income (loss) of Fortress Funds

     —        —          —        233,136   

Recognition of previously deferred incentive income

     —        —          —        —     
                              

Deferred incentive income as of September 30, 2009

   $ 470,798    $ (307,163   $ 163,635    $ 144,051   
                              

 

(A) All related contingencies have been resolved.

 

(B) Reflected on the balance sheet.

 

(C) At September 30, 2009, the undistributed incentive income is comprised of $227.4 million of gross undistributed incentive income, net of $83.3 million of previously distributed incentive income that would be returned by Fortress to the related funds if such funds were liquidated on September 30, 2009 at their net asset values.

 

(D) From inception to September 30, 2009, Fortress has paid $137.7 million of compensation expense under its employee profit sharing arrangements (Note 7) in connection with distributed incentive income, of which $19.5 million has not been expensed because management has determined that it is not probable of being incurred as an expense and will be recovered from the related employees. If the $227.4 million of gross undistributed incentive income were realized, Fortress would recognize and pay an additional $108.4 million of compensation expense.

Private Equity Funds and Hybrid PE Funds

During the nine months ended September 30, 2009, Fortress formed new private equity funds or hybrid PE funds which had capital commitments as follows as of September 30, 2009 (based on September 30, 2009 foreign exchange rates):

 

Fortress’s commitments

   $ 18,840

Fortress’s affiliates’ commitments

     —  

Third party investors’ commitments

     430,385
      

Total capital commitments

   $ 449,225
      

Unrealized losses in a significant portion of Fortress’s private equity funds have resulted in higher future returns being required before Fortress earns incentive income from such funds.

In February 2009, one of the private equity Fortress Funds issued notes in the amount of $80 million. These notes bear interest at 20% per annum, payable at maturity, and mature in January 2014. The notes were offered to existing investors in proportion to their ownership of the fund’s equity and Fortress consequently subscribed to and received $0.5 million of these notes, which are recorded as part of Fortress’s investment in such fund. In addition, the Principals concurrently acquired $4.7 million of these notes.

In March 2009, one of the private equity Fortress Funds which was formed as a coinvestment fund to invest solely in GAGFAH (XETRA: GFJ), distributed all of its shares in GAGFAH to its investors, including Fortress. As a result, Fortress received 5.7 million shares of GAGFAH. Fortress elected to account for these shares at fair value (Note 3).

In June 2009, one of the private equity Fortress Fund portfolio companies, Eurocastle, issued convertible securities in the amount of €75 million ($105 million). These securities bear interest at 20% per annum, payable annually (but deferrable), have no stated maturity, and are convertible into common shares of Eurocastle at an initial conversion price of €0.30 per share (subject to adjustment based on the occurrence of certain capital events within Eurocastle, including the payment of dividends). The Fortress Fund which had an equity investment in Eurocastle acquired €15.4 million ($21.6 million) of these securities.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Fortress acquired €1.2 million ($1.8 million) of these securities, which were recorded as part of Fortress’s investment in such portfolio company. Fortress elected to account for these securities at fair value (Note 3). In addition, the Principals and certain employees of Fortress acquired €8.8 million ($12.3 million) and €0.2 million ($0.2 million) of these securities, respectively.

Liquid Hedge Funds and Hybrid Hedge Funds

During the nine months ended September 30, 2009, Fortress formed, or became the manager of, hedge funds with net asset values as follows as of September 30, 2009:

 

     Liquid    Hybrid

Fortress

   $ —      $ —  

Fortress’s affiliates

     —        —  

Third party investors

     —        2,750,443
             

Total NAV (A)

   $ —      $ 2,750,443
             

 

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

In the second quarter of 2009, Fortress launched its new flagship liquid hedge fund, Fortress Macro Fund. Fortress will receive management fees of between 1.5% and 2% of NAV and incentive income of between 15% and 20% of profits, based on elections made by investors in Fortress Macro Fund. Investors in Fortress’s prior flagship liquid hedge, Drawbridge Global Macro Fund (“DBGM”), may transfer the liquid portion of their investment in that fund to Fortress Macro Fund and retain their “highwater mark” with respect to incentive income (no incentive income will be earned from these investors’ capital until losses incurred through DBGM are recovered). This fund is not considered a “new fund” for purposes of the above disclosure as it replaces an existing fund.

Historical redemptions during the periods, including affiliates, have been as follows:

 

     Liquid Hedge Funds    Hybrid Hedge Funds

Nine Months Ended September 30,

   Redemption Notices
Received
   Redemptions
Paid
   Redemption Notices
Received
   Redemptions
Paid

2009

   $ 1,427,563    $ 4,159,798    $ 1,548,060    $ 423,319

2008

   $ 430,234    $ 554,082    $ 1,505,412    $ 571,375

The differences between notices received and redemptions paid are a result of timing (notices received prior to quarter end, paid afterwards) and the contractual agreements regarding redemptions, which in some cases allow for delayed payment.

As a result of not meeting the incentive income thresholds with respect to a majority of current investors, incentive income from a substantial portion of the capital invested in Fortress’s liquid and hybrid hedge funds has been suspended. Returns earned on capital from new investors continue to be incentive income eligible.

On May 5, 2009, consolidated affiliates of Fortress executed several agreements, effective June 1, 2009, to become the investment manager of certain investment funds then managed by D.B. Zwirn & Co., L.P. (the “Value Recovery Funds”) and to effect other related transactions. Fortress will receive management fees from these funds equal to 1% of realized proceeds and up to 1% per annum on certain managed assets, and may receive limited incentive income if aggregate realizations exceed an agreed threshold. These funds are now included in the hybrid hedge funds segment. The Value Recovery Funds are reflected in the new fund table above based on the NAV of the funds plus the fee paying basis for certain other managed assets.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

3. INVESTMENTS IN EQUITY METHOD INVESTEES AND OTHER EQUITY INVESTMENTS

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

Investments in Equity Method Investees

Fortress holds investments in certain Fortress Funds which are recorded based on the equity method of accounting. Fortress’s maximum exposure to loss with respect to these entities is generally equal to its investment plus its basis in any options received from such entities as described below, plus any receivables from such entities as described in Note 6. In addition, unconsolidated affiliates also hold ownership interests in certain of these entities. Summary financial information related to these investments is as follows:

 

     Fortress’s Investment    Fortress’s Equity in Net Income (Loss)  
     September 30,    December 31,    Three Months Ended September 30,     Nine Months Ended September 30,  
     2009    2008    2009     2008     2009    2008  

Private equity funds, excluding NIH (A)

   $ 534,299    $ 455,691    $ 22,197      $ (4,280   $ 18,366    $ (71,380

NIH

     3,795      3,666      300        (9     144      872   

Castles (B)

     5,451      1,171      N/A        N/A        N/A      N/A   
                                             

Total private equity

     543,545      460,528      22,497        (4,289     18,510      (70,508

Liquid hedge funds

     14,021      29,338      1,285        (3,668     3,254      (3,117

Hybrid hedge funds

     211,817      185,676      11,299        (27,940     25,641      (36,715

Hybrid PE funds

     107,982      96,610      5,307        (2,029     8,806      (3,226
                                             

Total hybrid funds

     319,799      282,286      16,606        (29,969     34,447      (39,941

Other

     4,403      2,230      (43     5        342      16   
                                             
   $ 881,768    $ 774,382    $ 40,345      $ (37,921   $ 56,553    $ (113,550
                                             

 

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

 

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

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

 

     Nine Months Ended September 30, 2009  
     Private Equity    Liquid     Hybrid              
     NIH     Other Funds (A)     Castles (B)    Hedge Funds     Hedge Funds    PE Funds     Other     Total  

Investment, beginning

   $ 3,666      $ 455,691      $ 1,171    $ 29,338      $ 185,676    $ 96,610      $ 2,230      $ 774,382   

Earnings from equity method investees

     144        18,366        N/A      3,254        25,641      8,806        342        56,553   

Other comprehensive income from equity method investees

     (15     —          N/A      —          —        (190     —          (205

Contributions to equity method investees

     —          29,103        1,664      6,025        500      14,652        1,889        53,833   

Distributions of earnings from equity method investees

     —          (135     N/A      (1,741     —        (241     (39     (2,156

Distributions of capital from equity method investees

     —          (2,823     N/A      (22,855     —        (11,655     (19     (37,352
                                                              

Total distributions from equity method investees

     —          (2,958     N/A      (24,596     —        (11,896     (58     (39,508
                                                              

Mark to fair value - during period (C)

     N/A        30,805        2,491      N/A        N/A      N/A        N/A        33,296   

Translation adjustment

     —          3,292        125      —          —        —          —          3,417   
                                                              

Investment, ending

   $ 3,795      $ 534,299      $ 5,451    $ 14,021      $ 211,817    $ 107,982      $ 4,403      $ 881,768   
                                                              

Ending balance of undistributed earnings

   $ 1,199      $ 514        N/A    $ 85      $ 109      2,176      $ 309      $ 4,392   
                                                              

 

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

 

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

 

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

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

The ownership percentages presented in the following tables are reflective of the ownership interests held as of the end of the respective periods. For tables which include more than one Fortress Fund, the ownership percentages are based on a weighted average by total equity of the funds as of period end.

 

     Private Equity Funds excluding NIH     Newcastle Investment Holdings LLC
(“NIH”)
 
     September 30,
2009
    December 31,
2008
    September 30,
2009
    December 31,
2008
 

Assets

   $ 11,269,447      $ 9,362,237      $ 272,306      $ 278,161   

Liabilities

     (969,146     (1,058,392     (206,884     (215,416
                                

Equity

   $ 10,300,301      $ 8,303,845      $ 65,422      $ 62,745   
                                

Fortress’s Investment (A)

   $ 534,299      $ 455,691      $ 3,795      $ 3,666   
                                

Ownership (B)

     5.2     5.5     4.8     4.8
                                
     Nine Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  

Revenues and gains (losses) on investments

   $ 1,864,675      $ (3,244,034   $ 16,462      $ 35,773   

Expenses

     (188,682     (305,752     (13,154     (16,808
                                

Net Income (Loss)

   $ 1,675,993      $ (3,549,786   $ 3,308      $ 18,965   
                                

Fortress’s equity in net income (loss)

   $ 18,366      $ (71,380   $ 144      $ 872   
                                

 

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

 

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

 

     Liquid Hedge Funds     Hybrid Hedge Funds     Hybrid PE Funds (B)  
     September 30,
2009
    December 31,
2008
    September 30,
2009
    December 31,
2008
    September 30,
2009
    December 31,
2008
 

Assets

   $ 10,491,436      $ 7,819,859      $ 10,868,982      $ 10,803,738      $ 6,444,285      $ 4,103,809   

Liabilities

     (6,310,524     (540,204     (3,384,107     (4,407,170     (2,304,787     (1,517,607

Minority interest

     —          —          (10,947     (29,922     —          —     
                                                

Equity

   $ 4,180,912      $ 7,279,655      $ 7,473,928      $ 6,366,646      $ 4,139,498      $ 2,586,202   
                                                

Fortress’s Investment

   $ 14,021      $ 29,338      $ 211,817      $ 185,676      $ 107,982      $ 96,610   
                                                

Ownership (A)

     0.3     0.4     2.8     2.9     2.6     3.7
                                                
     Nine Months Ended September 30,     Nine Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008     2009     2008  

Revenues and gains (losses) on investments

   $ 899,569      $ (716,901   $ 1,307,348      $ (485,557   $ 1,559,414      $ (81,719

Expenses

     (130,254     (490,442     (216,459     (312,522     (98,119     (39,612
                                                

Net Income (Loss)

   $ 769,315      $ (1,207,343   $ 1,090,889      $ (798,079   $ 1,461,295      $ (121,331
                                                

Fortress’s equity in net income (loss)

   $ 3,254      $ (3,117   $ 25,641      $ (36,715   $ 8,806      $ (3,226
                                                

 

(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 June 30, 2009 and 2008, respectively). It is recorded on a lag because it is a German entity and does not provide financial reports under U.S. GAAP within the reporting timeframe necessary for U.S. public entities.

Investments in Variable Interest Entities

Fortress is not considered the primary beneficiary of, and therefore does not consolidate, any of the variable interest entities in which it holds an interest. No reconsideration events occurred during the nine months ended September 30, 2009 which caused a change in Fortress’s accounting.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

The following table presents information as of September 30, 2009 regarding entities formed during the nine months ended September 30, 2009 that were determined to be VIEs in which Fortress holds a variable interest. The amounts presented below are included in, and not in addition to, the equity method investment tables above.

 

     Fortress is not Primary Beneficiary     

Business Segment

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

Hybrid PE Funds

   $ 120,893    $ —      $ 1,658    (C) (D)

Liquid Hedge Funds

   $ 7,358,533    $ 5,392,124    $ 2,297    (C) (D)

Hybrid Hedge Funds

   $ 819,699    $ 595,812    $ —      (D) (E)

 

(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, $595.8 million represent financial borrowings which have a weighted average maturity of 3.5 years for hybrid hedge funds.

 

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

 

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

 

(D) Fortress’s investment includes $0.3 million of management fees receivable from the liquid hedge funds. Fortress’s investment also includes $0.5 million and $1.8 million of other receivables from the hybrid PE funds and liquid hedge funds, respectively.

 

(E) Fortress is not the primary beneficiary of these entities, which represent collateralized loan obligation (“CLO”) structures whose equity is owned by one of the Fortress hybrid hedge funds, because the related funds (which are not consolidated) are more closely associated with the CLOs than Fortress based on both a quantitative and qualitative analysis.

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 Net Unrealized Gains (Losses) from Affiliate Investments.

 

     Fair Value   

Valuation Method

      September 30, 2009    December 31, 2008     

Assets - Carried at Fair Value

        

Newcastle and Eurocastle common shares

   $ 3,694    $ 1,171    Level 1 - Quoted prices in active markets for identical assets

GAGFAH common shares

   $ 64,029    $ —      Level 1 - Quoted prices in active markets for identical assets

Eurocastle convertible debt (A)

   $ 1,757    $ —      Level 3B - Internal model

Newcastle and Eurocastle options

   $ 1,417    $ 39    Level 2 - Lattice-based option valuation models using significant observable inputs

 

(A) The debt bears interest 20% per annum and is perpetual, but ECT may redeem the securities after two years at a premium of 20%. As of September 30, 2009, it has a face amount of €1.2 million ($1.8 million) and is convertible into ECT common shares at €0.30 per share.

Fortress’s investments in instruments measured at fair value using Level 3 inputs changed during the nine months ended September 30, 2009 as follows:

 

Balance at December 31, 2008

   $ —  

Transfers into Level 3

     1,684

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

     73
      

Balance at September 30, 2009

   $ 1,757
      

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

4. DEBT OBLIGATIONS

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

 

                         September 30, 2009
     Face Amount and              Weighted     Weighted
     Carrying Value    Contractual    Final    Average     Average
Debt Obligation    September 30,
2009
   December 31,
2008
  

Interest

Rate

   Stated
Maturity
   Funding
Cost (A)
    Maturity
(Years)

Credit agreement (B)

                

Revolving debt (C)

   $ —      $ 104,041    LIBOR + 2.50% (D)    May 2012    —        —  

Term loan

     350,000      350,000    LIBOR + 2.50%    May 2012    3.99   1.60

Delayed term loan (C)

     61,800      275,000    LIBOR + 2.50%    May 2012    3.23   0.33
                              

Total

   $ 411,800    $ 729,041          3.88   1.41
                              

 

(A) The weighted average funding cost is calculated based on the contractual interest rate (utilizing the most recently reset LIBOR rate) plus the amortization of deferred financing costs. The most recently reset LIBOR rate was 0.25%.

 

(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 $65.9 million was undrawn on the revolving debt facility as of September 30, 2009. The revolving debt facility includes a $25 million letter of credit subfacility of which $9.1 million was utilized. Lehman Brothers Commercial Paper, Inc., which is committed to fund $7.2 million (including $0.9 million of the outstanding letters of credit) of the $75 million revolving credit facility, has filed for bankruptcy protection, did not fund its pro rata portion of the last borrowing under this facility, and it is reasonably possible that it will not fund its portion of the commitments. As a result, $59.6 million of the undrawn amount was available.

 

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

On March 12 and March 13, 2009, Fortress entered into amendments to its credit agreement. The amendments, among other things: (i) modified the financial covenants by (a) amending the amount of required management fee earning assets to $22 billion as of the end of each fiscal quarter through December 31, 2009 and $20 billion as of the end of each fiscal quarter thereafter; (b) reducing the amount of investment assets required as of any point in time to an amount equal to the term loans and revolving loans (including outstanding letters of credit) then outstanding; (c) changing the required Consolidated Leverage Ratio to 3.5 to 1.0 for the remainder of the term of the credit agreement; (ii) increased the rate on LIBOR loans to LIBOR + 2.50 (and Base Rate loans to the prime rate plus 1.50%); (iii) reduced the revolving credit facility commitments to $75 million; (iv) established an annual requirement, beginning in 2010, that outstanding loans be prepaid in an amount equal to 75% of Free Cash Flow (as defined in the agreement) generated during the previous year; (v) increased the amount of Fortress’s scheduled amortization payments (the amortization schedule now requires the following payments: $50 million in July 2009, $25 million in each of October 2009 and January, April, July and October 2010, and $75 million in January 2011); (vi) established a requirement that 50% of the net proceeds from any equity issuance by the Fortress Operating Group be applied to prepay outstanding term loans; (vii) reduced the amount of certain types of distributions Fortress can make to equity holders of the Fortress Operating Group and, in turn, Fortress’s Class A shareholders, and (viii) provided that the dissolution or termination of specified material funds would not constitute an event of default. In connection with the amendment, Fortress prepaid $75 million of outstanding term loans and $50 million of outstanding revolving facility loans.

On June 11, 2009, Fortress entered into an amendment to its credit agreement. This amendment, among other things, (i) allows Fortress to repurchase outstanding loans made under the credit agreement subject to certain conditions, (ii) permits Fortress to make investments in Fortress Funds in any amount it deems appropriate, provided that investments in Fortress Funds created after June 11, 2009 in excess of 1.5% of such Fund’s aggregate called capital may not be deducted from Free Cash Flow (as defined in the credit agreement), (iii) excludes Managed Accounts (as defined in the credit agreement) from the definition of Material Fortress Funds, (iv) expands the term “Permitted Fund Termination” to include the termination, dissolution, liquidation or windup of a Fortress Fund either (a) after the last asset or investment is sold in the ordinary course of business or (b) after the date of dissolution as stated in the applicable fund document, and (v) revises the financial covenants by (a) reducing the percentage of Free Cash Flow that must be applied to prepay outstanding term loans from 75% to 50% if, on the applicable measurement dates, the amount of outstanding commitments and loans does not exceed $315 million, the amount of outstanding loans does not exceed $300 million and the Consolidated Leverage Ratio (as calculated according to the terms of the Credit Agreement) does not exceed 2.0 to 1.0, and (b) increasing the amount of restricted payments that can be made, with such increase specified according to formulas set forth in the Credit Agreement.

In connection with the repayment of a portion of the term loan from proceeds of our May 2009 capital raise (Note 1), $1.6 million of deferred loan coasts were written off to interest expense.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

To management’s knowledge, there have not been any market transactions in Fortress’s debt obligations. However, management believes the fair value of this debt was between 80% and 90% of face value at September 30, 2009.

Fortress was in compliance with all of its debt covenants as of September 30, 2009. The following table sets forth the financial covenant requirements as of September 30, 2009 (dollars in millions).

 

     Requirement    Actual

AUM

   >$ 22,000    $ 32,000

Consolidated Leverage Ratio

   <   3.50      1.52

Required Investment Assets

   >$ 421    $ 868

Fortress Fund Investments

   >$ 168    $ 518

Total Investments

   >$ 253    $ 662

5. INCOME TAXES AND TAX RELATED PAYMENTS

For the nine months ended September 30, 2009, an estimated annual effective tax rate of 2.76% was used to compute the tax provision. Fortress incurred a loss before income taxes for financial reporting purposes, after deducting the compensation expense arising from the Principals’ forfeiture agreement. However, this compensation expense is not deductible for income tax purposes. Also, a portion of Fortress’s income is not subject to U.S. federal income tax, but is allocated directly to Fortress’s shareholders.

The provision for income taxes consists of the following:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
Current         

Federal income tax (benefit)

   $ (232   $ (3,310   $ 387      $ (1,316

Foreign income tax

     433        891        1,424        2,090   

State and local income tax

     1,951        1,646        5,786        7,190   
                                
     2,152        (773     7,597        7,964   
                                
Deferred         

Federal income tax expense (benefit)

     (1,956     (2,506     (5,227     (2,526

Foreign income tax expense (benefit)

     (127     (281     219        (101

State and local income tax expense (benefit)

     (3,185     (2,076     (7,420     (5,670
                                
     (5,268     (4,863     (12,428     (8,297
                                

Total expense (benefit)

   $ (3,116   $ (5,636   $ (4,831   $ (333
                                

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

 

     September 30, 2009     December 31, 2008  

Total deferred tax assets

   $ 545,722      $ 504,017   

Valuation allowance

     (101,406     (95,951
                

Net deferred tax assets

   $ 444,316      $ 408,066   
                

Total deferred tax liabilities (A)

   $ 515      $ 592   
                

 

(A) Included in Other Liabilities

The equity offering during the second quarter increased FIG Corp’s ownership percentage in the underlying Fortress Operating Group entities. As a result of the increased ownership, the deferred tax asset was increased by $24.2 million with an offsetting increase of $9.1 million to the valuation allowance. The establishment of the net deferred tax asset of $15.1 million increased additional paid-in capital.

The exchange by the principals of Fortress Operating Group units and Class B shares for Class A shares during the third quarter (as described in Note 8) increased FIG Corp’s ownership percentage in the underlying Fortress Operating group entities. As a result of the increased ownership, the deferred tax asset was increased by $4.0 million with an offsetting increase of $1.9 million to the valuation allowance. In addition, the deferred tax asset was increased by $6.8 million 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.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

For the nine months ended September 30, 2009, a deferred income tax provision of $0.1 million was debited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $0.5 million was credited to additional paid in capital, related to (i) dividend equivalent payments on RSUs (Note 7), and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 7), which are currently deductible for income tax purposes.

Tax Receivable Agreement

Although the tax receivable agreement payments are calculated based on annual tax savings, for the nine months ended September 30, 2009, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $11.3 million.

As a result of the share exchange by the principals, the liability for the tax receivable agreement was increased by $5.1 million to represent 85% of the expected cash tax savings resulting from the increase in tax basis deductions.

6. RELATED PARTY TRANSACTIONS AND INTERESTS IN CONSOLIDATED SUBSIDIARIES

Affiliate Receivables and Payables

Due from affiliates was comprised of the following:

 

     Private Equity         Hybrid          
     Funds    Castles    Liquid Hedge
Funds
   Hedge
Funds
   PE Funds    Other    Total
September 30, 2009                     

Management fees and incentive income (A)

   $ 45,937    $ 7,969    $ 6,824    $ 2,230    $ 10,511    $ —      $ 73,471

Expense reimbursements (A)

     13,948      3,742      4,663      5,208      2,594      —        30,155

Dividends and distributions

     —        —        —        —        —        —        —  

Other

     64      94      —        —        95      1,639      1,892
                                                

Total

   $ 59,949    $ 11,805    $ 11,487    $ 7,438    $ 13,200    $ 1,639    $ 105,518
                                                
     Private Equity         Hybrid          
     Funds    Castles    Liquid Hedge
Funds
   Hedge
Funds
   PE Funds    Other    Total
December 31, 2008                     

Management fees and incentive income

   $ 7,833    $ 4,094    $ 329    $ 1,285    $ 6,907    $ —      $ 20,448

Expense reimbursements

     6,289      2,734      1,211      2,115      3,536      —        15,885

Dividends and distributions

     —        89      —        —        —        —        89

Other

     1      —        —        —        —        2,081      2,082
                                                

Total

   $ 14,123    $ 6,917    $ 1,540    $ 3,400    $ 10,443    $ 2,081    $ 38,504
                                                

 

(A) Net of reserves of $1.7 million and $0.4 million, respectively.

Due to affiliates was comprised of the following:

 

     September 30, 2009    December 31, 2008

Principals

     

- Tax receivable agreement - Note 5

   $ 326,485    $ 338,649

- Distributions payable on Fortress Operating Group units

     —        —  

Other

     6,835      7,616
             
   $ 333,320    $ 346,265
             

As of September 30, 2009, Due from Affiliates included $45.6 million of past due management fees from, and $8.1 million of private equity general and administrative expenses advanced on behalf of, certain Fortress Funds. Of these amounts, $22.4 million has been collected subsequent to September 30, 2009. Although such funds are currently experiencing liquidity issues, Fortress believes these fees will ultimately be collectable as the NAV’s of the respective funds exceed the amounts owed.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Other Related Party Transactions

For the nine months ended September 30, 2009 and 2008, Other Revenues included approximately $5.0 million and $1.9 million, respectively, of revenues from affiliates, including 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 nine months ended September 30, 2009 and 2008, these expenses, mainly related to subscriptions to market data services, approximated $12.5 million and $15.6 million, respectively.

In February 2007, we entered into an agreement with two employees who were departing from Fortress to form their own investment management company. We received a minority ownership interest in the management company, which receives management fees and incentive income from all funds formed by such company, and as part of the transaction a Fortress Fund received certain rights to invest at discounted fee rates in the fund being formed by the departing employees, and committed to invest $200 million in that fund subject to certain conditions (of which that Fortress Fund has invested approximately $100 million as of April 2009). In December 2008, the Fortress Fund agreed to eliminate its $100 million unfunded commitment and provide that fund with a $25 million revolving credit facility.

In March 2009, a private equity Fortress Fund repaid in full the remaining $14.4 million of non-dividend bearing preferred equity it had issued to three of the Principals.

In April 2009, five employees terminated their employment with Fortress’s private equity funds’ operating subsidiary in order to become employees of GAGFAH, one of Fortress’s private equity portfolio companies. These employees had received RSUs from Fortress. Fortress has modified these awards, valued at approximately $0.9 million in the aggregate, such that each employee’s vesting continues on the original vesting schedule as long as such employee remains employed by GAGFAH.

In April 2009, Fortress advanced $0.7 million to one of its senior employees who is not an officer. This advance bears interest at LIBOR+3% and is payable on the earlier of (i) April 6, 2012, or (ii) the termination of employment.

In May 2009, in connection with the launch of a new Fortress Fund in Asia, Fortress entered into an agreement under which Nomura acted as a placement agent and assisted the fund in raising investor capital. Nomura raised a total of $250.8 million in committed capital for the fund during 2009 and receives, from Fortress, a fee equal to 1% of all such capital.

In July 2009, Fortress entered into an employment offer letter with Daniel H. Mudd, pursuant to which Mr. Mudd began serving as the Chief Executive Officer of Fortress on August 11, 2009. Fortress will provide Mr. Mudd with an annual base salary of $200,000 for each of 2009 and 2010. Mr. Mudd will receive a cash bonus of $1.3 million for 2009 and $1.8 million for 2010.

Mr. Mudd received a grant of 7,243,577 restricted stock units (the “RSU Grant”) with a value, as defined in the agreement, of $25,000,000. One-half of the RSU Grant consisted of dividend-paying restricted stock units. The RSU Grant will vest in equal annual installments on each of the first eight (8) anniversaries of Mr. Mudd’s start date, subject to Mr. Mudd’s continued employment on each such anniversary. Mr. Mudd will be granted restricted Class A Shares with a value of $500,000 on January 1, 2010, subject to his continued employment on such date. In addition, Fortress purchased a residential property from Mr. Mudd in August 2009 for $8.5 million, which was equal to its estimated market value.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Principals’ and Others’ Interests in Consolidated Subsidiaries

These amounts relate to equity interests in Fortress’s consolidated, but not wholly owned, subsidiaries, which are held by the Principals, employees and others.

This balance sheet caption was comprised of the following:

 

     September 30, 2009    December 31, 2008

Principals’ Fortress Operating Group units

   $ 291,282    $ 47,305

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

     36,370      23,981

Other

     837      176
             

Total

   $ 328,489    $ 71,462
             

This statement of operations caption was comprised of shares of consolidated net income (loss) related to the following, on a pre-tax basis:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  

Principals’ Fortress Operating Group units

   $ (133,712   $ (208,169   $ (482,261   $ (611,760

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

     2,013        (1,843     4,234        (1,401

Other

     (5     —          63        469   
                                

Total

   $ (131,704   $ (210,012   $ (477,964   $ (612,692
                                

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 September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  

Net income (loss) attributable to Fortress

   $ (58,602   $ (57,440   $ (170,353   $ (181,913

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

        

Decrease in Fortress’s paid-in-capital for Purchase of 46,000,000 Fortress Operating Group Units

     —          —          (144,572     —     

Conversion to Class A Shares (A)

     4,100        —          4,100        —     
                                

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

   $ (54,502   $ (57,440   $ (310,825   $ (181,913
                                

 

(A) In August 2009, the Principals exchanged an aggregate of 4,297,698 FOG units and Class B shares for an equal number of Class A shares. Of these shares, 2,410,904 were simultaneously contributed by the Principals to various charitable organizations.

As a result of the May 2009 capital raise (Note 1), the Principals’ recorded interests in FOG were increased by $151.3 million (the capital raise was accretive to the Principals’ interests).

In December 2007, the FASB issued FASB Accounting Standards Codification (“FASB ASC”) Section 810-10-65 Transition Related to SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements.” FASB ASC Section 810-10-65 clarifies the classification of non-controlling interests in consolidated statements of financial position and the accounting for and reporting of transactions between the reporting entity and holders of such non-controlling interests. FASB ASC Section 810-10-65 applies to reporting periods beginning after December 15, 2008. FASB ASC Section 810-10-65 had the following effects on Fortress’s financial statements: (i) reclassification of Principals’ and Others’ Interests in Equity of Consolidated Subsidiaries from the “mezzanine” section of the balance sheet (between liabilities and equity) to equity, (ii) removal of Principals’ and Others’ Interests in Income of Consolidated Subsidiaries from the calculation of Net Income (Loss) on the statement of operations, and disclosure thereof below Net Income (Loss), and (iii) with respect to potential future transactions in which Fortress could acquire Fortress Operating Group units from the Principals pursuant to their exchange (along with Class B shares) for Class A shares (or otherwise), these transactions would be accounted for as equity transactions rather than as a step acquisition of Fortress Operating Group (as would be required under prior accounting principles). There is no effect from adoption of FASB ASC Section 810-10-65 on the equity which pertains to Class A shareholders, or net income (loss) allocable to Class A shareholders, or on Fortress’s liquidity.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(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 September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008

Equity-based compensation, per below

   $ 60,883    $ 57,755    $ 166,707    $ 139,152

Profit-sharing expense, per below

     8,949      8,142      20,798      50,132

Discretionary bonuses

     31,396      35,737      77,545      109,793

Other payroll, taxes and benefits

     30,805      33,140      89,675      100,176
                           
   $ 132,033    $ 134,774    $ 354,725    $ 399,253
                           

Equity-Based Compensation

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

 

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

Outstanding as of December 31, 2008

   40,865,316      $ 16.53    8,600,867      $ 14.84    109,174      $ 17.76    31,000,000    $ 13.75

Issued

   7,243,577        3.25    352,162        2.58    127,482        3.77    —        —  

Converted to Class A shares

   (345,463     12.16    (555,120     24.82    (9,479     15.60    —        —  

Forfeited

   (2,633,738     14.31    (1,531,942     14.63    (10,810     18.50    —        —  
                                                  

Outstanding as of September 30, 2009 (B)

   45,129,692      $ 14.56    6,865,967      $ 13.45    216,367      $ 9.58    31,000,000    $ 13.75
                                                  

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008

Expense incurred (B)

           

Employee RSUs

   $ 29,431    $ 29,088    $ 78,696    $ 82,997

Non-Employee RSUs

     6,607      3,970      14,577      9,381

Restricted Shares

     299      151      596      450

LTIP

     1,733      1,733      5,143      5,162

RPUs

     22,813      22,813      67,695      41,162
                           

Total equity-based compensation expense

   $ 60,883    $ 57,755    $ 166,707    $ 139,152
                           

 

(A) Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of September 30, 2009 for awards granted to non-employees was $5.20, which is equal to the closing trading price per share of Fortress’s Class A shares on such date.

 

(B) In future periods, Fortress will recognize compensation expense on its non-vested equity based awards of $698.6 million, with a weighted average recognition period of 3.4 years. This does not include 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. When Fortress delivers Class A shares as a result of the vesting of equity-based compensation, to the extent that it pays withholding taxes in cash (rather than through the sale of employee shares upon delivery) it will record a decrease in capital related to these payments.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Profit Sharing Expense

Recognized profit sharing compensation expense is summarized as follows:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  

Private equity funds (A)

   $ —        $ (5,412   $ (15   $ (2,868

Castles (A)

     (55     1,231        (192     3,388   

Liquid hedge funds

     6,723        5,455        12,173        38,572   

Hybrid hedge funds

     1,646        6,867        4,603        10,573   

Hybrid private equity funds

     635        —          4,229        —     

Other

     —          1        —          467   
                                

Total

   $ 8,949      $ 8,142      $ 20,798      $ 50,132   
                                

 

(A) Negative amounts reflect the reversal of previously accrued profit sharing expense resulting from the determination that this expense is no longer probable of being incurred.

8. EARNINGS PER SHARE AND DISTRIBUTIONS

 

     Three Months Ended September 30, 2009     Nine Months Ended September 30, 2009  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

     142,369,630        142,369,630        117,408,542        117,408,542   

Fully vested restricted Class A share units with dividend equivalent rights

     1,158,673        1,158,673        1,137,275        1,137,275   

Fully vested restricted Class A shares

     99,520        99,520        92,890        92,890   

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

     —          310,436,556        —          311,520,563   

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

     143,627,823        454,064,379        118,638,707        430,159,270   
                                

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

        

Net income (loss)

   $ (58,602   $ (58,602   $ (170,353   $ (170,353

Dilution in earnings due to RPUs treated as a participating security of Fortress Operating Group (4)

     (855     (855     (7,318     (7,318

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 Fortress Investment Group LLC Class A shares (1)

     —          (135,087     —          (479,890
                                

Net income (loss) available to Class A shareholders

   $ (59,457   $ (194,544   $ (177,671   $ (657,561
                                

Weighted average shares outstanding

     143,627,823        454,064,379        118,638,707        430,159,270   
                                

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

   $ (0.41   $ (0.43   $ (1.50   $ (1.53
                                

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

     Three Months Ended September 30, 2008     Nine Months Ended September 30, 2008  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

     94,500,351        94,500,351        94,500,351        94,500,351   

Fully vested restricted Class A share units with dividend equivalent rights

     394,286        394,286        394,286        394,286   

Fully vested restricted Class A shares

     43,797        43,797        21,029        21,029   

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

     —          312,071,550        —          312,071,550   

Class A restricted shares and Class A restricted share units granted to employees and directors (eligible for dividend and dividend equivalent payments) (2)

     —          —          —          —     

Class A restricted share units granted to employees (not eligible for dividend and dividend equivalent payments) (3)

     —          —          —          —     
                                

Total weighted average shares outstanding

     94,938,434        407,009,984        94,915,666        406,987,216   
                                

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

        

Net income (loss)

   $ (57,440   $ (57,440   $ (181,913   $ (181,913

Dilution in earnings due to RPUs treated as a participating security of Fortress dividend equivalent rights treated as outstanding Fortress Operating Group units (4)

     (298     (298     (2,071     (2,071

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

     —          —          (2,276     (2,276

Add back Principals’ and others’ interests in loss of Fortress Operating Group, net of assumed corporate income taxes at enacted rates, attributable to Fortress Operating Group units exchangeable into Fortress Investment Group LLC Class A shares (1)

     —          (210,477     —          (613,553
                                

Net income (loss) available to Class A shareholders

   $ (57,738   $ (268,215   $ (186,260   $ (799,813
                                

Weighted average shares outstanding

     94,938,434        407,009,984        94,915,666        406,987,216   
                                

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

   $ (0.61   $ (0.66   $ (1.96   $ (1.97
                                

 

(1) The Fortress Operating Group units not held by Fortress (that is, those held by the Principals) are exchangeable into Class A shares on a one-to-one basis. These units are not included in the computation of basic earnings per share. These units enter into the computation of diluted net income (loss) per Class A share when the effect is dilutive using the if-converted method. To the extent charges, particularly tax related charges, are incurred by the Registrant (i.e. not at the Fortress Operating Group level), the effect may be anti-dilutive.

 

(2) Restricted Class A shares granted to directors and certain restricted Class A share units granted to employees are eligible to receive dividend or dividend equivalent payments when dividends are declared and paid on Fortress’s Class A shares and therefore participate fully in the results of Fortress’s operations from the date they are granted. They are included in the computation of both basic and diluted earnings per Class A share using the two-class method for participating securities, except during periods of net losses.

 

(3) Certain restricted Class A share units granted to employees are not entitled to dividend or dividend equivalent payments until they are vested and are therefore non-participating securities. These units are not included in the computation of basic earnings per share. They are included in the computation of diluted earnings per share when the effect is dilutive using the treasury stock method. As a result of the net loss incurred in the periods presented, the effect of the units on the calculation is anti-dilutive for each of the periods. The weighted average restricted Class A share units which are not entitled to receive dividend or dividend equivalent payments outstanding were:

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008

Share Units

   25,932,813    28,063,543    24,964,718    27,841,459

 

(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.

In August 2009, the Principals exchanged an aggregate of 4,297,698 FOG units and Class B shares for an equal number of Class A shares. Of these shares, 2,410,904 were simultaneously contributed by the Principals to various charitable organizations.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

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

 

     Weighted Average    Weighted Average
     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008

Class A shares (public shareholders)

   142,369,630    94,500,351    117,408,542    94,500,351

Restricted Class A shares (directors)

   183,173    108,661    138,999    103,411

Restricted Class A share units (employees) (A)

   1,158,673    394,286    1,137,275    394,286

Restricted Class A share units (employees) (B)

   25,480,488    24,101,891    23,794,771    23,840,819

Fortress Operating Group units (Principals)

   310,436,556    312,071,550    311,520,563    312,071,550

Fortress Operating Group RPUs (senior employee)

   31,000,000    31,000,000    31,000,000    18,781,022
                   

Total

   510,628,520    462,176,739    485,000,150    449,691,439
                   

 

     As of September 30, 2009    As of December 31, 2008

Class A shares (public shareholders)

   145,295,369    94,500,351

Restricted Class A shares (directors)

   216,367    109,174

Restricted Class A share units (employees) (A)

   959,831    631,260

Restricted Class A share units (employees) (B)

   25,218,073    22,955,132

Fortress Operating Group units (Principals)

   307,773,852    312,071,550

Fortress Operating Group RPUs (senior employee)

   31,000,000    31,000,000
         

Total

   510,463,492    461,267,467
         

 

(A) Represents fully vested restricted Class A share units which are entitled to dividend equivalent payments.

 

(B) Represents nonvested restricted Class A share units which are entitled to dividend equivalent payments.

Dividends and distributions during the nine months ended September 30, 2009 are summarized as follows:

 

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

Dividends on Class A Shares

   $ —      $ —      $ —      $ —  

Dividend equivalents on restricted Class A share units (A)

     —        —        —        —  

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

     —        45,468      —        45,468

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

     —        4,540      —        4,540
                           

Total distributions

   $ —      $ 50,008    $ —      $ 50,008
                           

 

(A) A portion of these dividend equivalents, if any, related to RSUs expected to be forfeited, is included as compensation expense in the consolidated statement of operations and is therefore considered an operating cash flow.

 

(B) Fortress Operating Group made distributions to the principals and RPU holders in connection with distributions made to FIG Corp. to pay Fortress’s income taxes.

The following table summarizes our comprehensive income (loss) (net of taxes) for the nine months ended September 30, 2008:

 

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

Net income (loss)

   $ (181,913   $ (612,692   $ (794,605

Foreign currency translation

     654        (1,441     (787

Comprehensive income (loss) from equity method investees

     346        (13     333   
                        

Total comprehensive income (loss)

   $ (180,913   $ (614,146   $ (795,059
                        

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

9. COMMITMENTS AND CONTINGENCIES

Other than as described below, Fortress’s commitments and contingencies remain materially unchanged from December 31, 2008.

Private Equity Fund and Hybrid PE Fund Capital Commitments – Fortress has remaining capital commitments to certain of the Fortress Funds which aggregated $129.9 million as of September 30, 2009. These commitments can be drawn by the funds on demand.

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

Minimum future rent payments under these leases is as follows:

 

October 1 to December 31, 2009

   $ 4,712

2010

     18,608

2011

     12,406

2012

     11,917

2013

     11,724

2014

     11,107

Thereafter

     22,423
      

Total

   $ 92,897
      

Rent expense recognized on a straight-line basis during the nine months ended September 30, 2009 and 2008 was $14.4 million and $14.7 million, respectively, and during the three months ended September 30, 2009 and 2008 was $4.6 million and $5.3 million, respectively, and was included in General, Administrative and Other Expense.

Litigation – Fortress is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions that existed as of September 30, 2009, if any, will not materially affect Fortress’s results of operations, liquidity or financial position.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

10. SEGMENT REPORTING

Fortress conducts its management and investment business through the following six primary segments: (i) private equity funds, (ii) Castles, (iii) liquid hedge funds, (iv) hybrid hedge funds, (v) hybrid private equity (“PE”) funds, and (vi) principal investments in these funds as well as cash that is available to be invested. Due to the increased significance of the hybrid PE funds segment, it has been disaggregated from the private equity fund segment in this period and for all periods presented.

“Distributable earnings” is a measure of operating performance used by management in analyzing its segment and overall results. For the existing Fortress businesses it is equal to net income (loss) attributable to Fortress’s Class A shareholders adjusted as follows:

Incentive Income

 

  (i)    a. for Fortress Funds which are private equity funds and hybrid PE funds, adding (a) incentive income paid (or declared as a distribution) to Fortress, less an applicable reserve for potential future clawbacks if the likelihood of a clawback is deemed greater than remote by Fortress’s chief operating decision maker as described below (net of the reversal of any prior such reserves that are no longer deemed necessary), minus (b) incentive income recorded in accordance with GAAP,

 

  b. for other Fortress Funds, at interim periods, adding (a) incentive income on an accrual basis as if the incentive income from these funds were payable on a quarterly basis, minus (b) incentive income recorded in accordance with GAAP,

Other Income

 

  (ii) with respect to income from certain principal investments and certain other interests that cannot be readily transferred or redeemed:

 

  a. for equity method investments in the private equity funds and hybrid PE funds as well as indirect equity method investments in hedge fund special investment accounts (which generally have investment profiles similar to private equity funds), treating these investments as cost basis investments by adding (a) realizations of income, primarily dividends, from these funds, minus (b) impairment with respect to these funds, if necessary, minus (c) equity method earnings (or losses) recorded in accordance with GAAP,

 

  b. subtracting gains (or adding losses) on stock options held in the Castles,

 

  c. subtracting unrealized gains (or adding unrealized losses) from consolidated private equity funds and hybrid PE funds,

 

  d. subtracting unrealized gains (or adding unrealized losses) on direct investments in publicly traded portfolio companies and in the Castles,

 

  (iii) adding (a) proceeds from the sale of shares received pursuant to the exercise of stock options in certain of the Castles, in excess of their strike price, minus (b) management fee income recorded in accordance with GAAP in connection with the receipt of these options,

Expenses

 

  (iv) adding or subtracting, as necessary, the employee profit sharing in incentive income described in (i) above to match the timing of the expense with the revenue,

 

  (v) adding back equity-based compensation expense (including Castle options assigned to employees, RSUs and RPUs (including the portion of related dividend and distribution equivalents recorded as compensation expense), restricted shares and the LTIP),

 

  (vi) adding back compensation expense recorded in connection with the forfeiture arrangements entered into among the principals,

 

  (vii) adding the income (or subtracting the loss) allocable to the interests in consolidated subsidiaries attributable to Fortress Operating Group units, and

 

  (viii) adding back income tax benefit or expense and any expense recorded in connection with the tax receivable agreement (Note 5).

Total segment assets are equal to total GAAP assets adjusted for:

 

  (i) the difference between the GAAP carrying amount of equity method investments and their carrying amount for segment reporting purposes, which is generally fair value for publicly traded investments and cost for nonpublic investments,

 

  (ii) employee portions of investments, which are reported gross for GAAP purposes (as assets offset by Principals’ and others’ interests in equity of consolidated subsidiaries) but net for segment reporting purposes, and

 

  (iii) the difference between the GAAP carrying amount for options owned in certain of the Castles and their carrying amount for segment reporting purposes, which is intrinsic value.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Distributable Earnings Impairment

Investment Impairment for DE purposes

Fortress had the following direct and indirect investments in private equity funds, Castles and hybrid PE funds as of September 30, 2009:

 

Fund

   Fortress
Share of
NAV
   Fortress
Current Cost
Basis (A)
   Deficit     % Below
Current Cost
Basis (A)
   % Below
Original Cost
Basis (B)
   Periods
in
Deficit
   Nine Months Ended
Sep 30, 2009
DE Impairment
Recorded
    Notes  

Main Funds

                     

Fund I

   $ 245    $ —        N/A      N/A    N/A    N/A    $ —       

Fund II

     6,179      2,317      N/A      N/A    N/A    N/A      (248  

Fund III and Fund III CO

     8,774      5,286      N/A      N/A    (22%)    6 Quarters      (232  

Fund IV and Fund IV CO

     107,588      98,747      N/A      N/A    (29%)    8 Quarters      (6,184  

Fund V and Fund V CO

     56,071      34,926      N/A      N/A    (52%)    8 Quarters      (5,553  

Mortgage Opportunities Funds

     3,995      2,572      N/A      N/A    (55%)    6 Quarters      (518  

Long Dated Value Funds

     20,682      17,853      N/A      N/A    N/A    N/A      —       

Real Assets Funds

     16,654      12,551      N/A      N/A    N/A    N/A      —       

Credit Opportunities Funds

     31,306      17,030      N/A      N/A    N/A    N/A      (562  

Japan Opportunity Fund

     1,199      1,035      N/A      N/A    N/A    N/A      —       

Yama 1 and 2 GK

     2,394      2,042      N/A      N/A    N/A    N/A      —       

Single Investment Funds and Direct Investments (combined)

                     

GAGFAH (XETRA: GFJ)

     75,319      32,327      N/A      N/A    (23%)    6 Quarters      (6,588  

Brookdale (NYSE: BKD)

     24,808      8,200      N/A      N/A    (45%)    8 Quarters      (749  

Aircastle (NYSE: AYR)

     638      366      N/A      N/A    N/A    N/A      —       

Private investment #1

     43,691      43,115      N/A      N/A    (34%)    6 Quarters      (10,002  

Private investment #2

     255      590      (335   (57%)    (97%)    7 Quarters      (1,018  

Private investment #3

     233,730      275,708      (41,978   (15%)    (15%)    8 Quarters      —        (C

Private investment #4

     36,823      31,525      N/A      N/A    N/A    N/A      —       

Other, net

     40,598      43,170      (2,572   (6%)    N/A    Various      (2,210   (D

Castles

                     

Eurocastle (EURONEXT: ECT)

     2,404      1,973      N/A      N/A    (84%)    6 Quarters      —       

Newcastle (NYSE: NCT)

     3,046      667      N/A      N/A    (82%)    5 Quarters      (195  
                                         

Total

   $ 716,399    $ 632,000    $ (44,885            $ (34,059  
                                         

 

(A) Current cost basis is net of any impairments taken in prior quarters but before impairment taken at September 30, 2009.

 

(B) Original cost basis is before any impairment.

 

(C) This fund is a single asset fund invested in a railroad and commercial real estate company. The net asset value of this investment is only 15% below Fortress’s basis and the fund’s life extends to 2017. Fortress anticipates that this value will recover during the fund’s life and has the intent and ability to hold its investment until recovery. As a result, Fortress’s CODM has determined that this decline in value does not meet the definition of other than temporary impairment at this time.

 

(D) This primarily represents indirect investments in funds through hedge fund special investment accounts, including Fortress Funds not represented individually in the table as well as funds managed by third parties. Fortress’s CODM has analyzed each of these investments individually and recorded other than temporary impairment where it was deemed appropriate.

 

25


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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Clawback Reserve on Incentive Income for DE Purposes

Fortress had recognized incentive income for DE purposes from the following private equity funds, which are subject to contingent clawback, as of September 30, 2009:

 

Fund

  Incentive
Income
Received
  No Longer
Subject to
Clawback
  Subject to
Clawback
(A)
  Intrinsic
Clawback
(B)
  Employee
Portion
(C)
  Net
Clawback
  Prior Net
DE Reserves
Taken (D)
    Periods
in Intrinsic
Clawback
  Nine Months Ended
September 30, 2009
Gross DE Reserve
Recorded (D)
  Notes  

Fund I

  $ 308,633   $ 296,882   $ 11,751   $ —     $ —     $ —     $ —        N/A   $ —     (E

Fund II - A

    191,726     71,126     120,600     —       —       —       (18,376   N/A     —     (F

Fund II - B

    62,962     44,612     18,350     8,355     3,013     5,342     (7,466   4 Quarters     —     (F

Fund III

    72,483     —       72,483     72,483     27,375     45,108     (45,108   7 Quarters     —     (G

FRID

    16,739     —       16,739     16,739     6,698     10,041     (10,041   9 Quarters     —     (G
                                                     

Total

  $ 652,543   $ 412,620   $ 239,923   $ 97,577   $ 37,086   $ 60,491   $ (80,991     $ —    
                                                     

 

(A) Includes deferred incentive income from the consolidated balance sheet plus the maximum payment under the guarantee, in both cases gross of promote related to non-fee paying investors (affiliates).

 

(B) Intrinsic clawback is the maximum amount of clawback that would be required to be repaid to the fund if the fund were liquidated at its NAV as of the reporting date. It has not been reduced for any tax related effects.

 

(C) Employees who have received profit sharing payments in connection with private equity or hybrid PE incentive income are liable to repay Fortress for their share of any clawback. Fortress remains liable to the funds for these amounts even if it is unable to collect the amounts from employees (or former employees).

 

(D) Net of promote related to non-fee paying investors (affiliates).

 

(E) This fund had significant unrealized gains at September 30, 2009. As a result, the CODM determined that no reserve for clawback was required.

 

(F) The net intrinsic clawback in this fund, after the employee portion, is less than previously recorded reserves. As a result, no further reserve was deemed necessary.

 

(G) The potential clawback on these funds has been fully reserved in prior quarters.

Impairment Determination

Fortress has recorded a total of approximately $34.1 million of impairment and reserves for DE purposes on certain private equity funds and hybrid PE funds as described above for DE purposes during the nine months ended September 30, 2009. Fortress expects aggregate returns on its other private equity funds and hybrid PE funds that are in an unrealized investment loss or intrinsic clawback position to ultimately exceed their carrying amount or breakeven point, as applicable. If such funds were liquidated at their September 30, 2009 NAV (although Fortress has no current intention of doing so), the result would be additional impairment losses and reserves for DE purposes of approximately $46.3 million.

Summary financial data on Fortress’s segments is presented on the following pages, together with a reconciliation to revenues, assets and net income (loss) for Fortress as a whole. Fortress’s investments in, and earnings (losses) from, its equity method investees by segment are presented in Note 3.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

September 30, 2009 and the Nine Months Then Ended

 

               Liquid
Hedge
Funds
   Hybrid    Principal
Investments
    Unallocated     Fortress
Subtotal
     Private Equity       Hedge
Funds
   PE
Funds
      
     Funds    Castles                

Segment revenues

                     

Management fees

   $ 108,525    $ 37,260    $ 61,088    $ 89,715    $ 27,449    $ —        $ —        $ 324,037

Incentive income

     —        —        8,243      1,386      8,022      —          —          17,651
                                                         

Segment revenues - total

   $ 108,525    $ 37,260    $ 69,331    $ 91,101    $ 35,471    $ —        $ —        $ 341,688
                                                         

Pre-tax distributable earnings

   $ 81,856    $ 16,248    $ 18,831    $ 16,112    $ 15,230    $ (23,313   $ (10   $ 124,954
                                                         

Total segment assets

   $ 59,886    $ 11,708    $ 13,155    $ 7,564    $ 13,200    $ 911,897      $ 529,405      $ 1,546,815
                                                         
                      (A  

 

     Fortress
Subtotal
   Reconciliation
to GAAP
    Fortress
Consolidated*
    Principals
and Others
    GAAP
Net Income
(Loss)
 

Revenues

   $ 341,688    $ 63,378      $ 405,066       
                           

Pre-tax distributable earnings / net income (loss)

   $ 124,954    $ (295,307   $ (170,353   $ (477,964   $ (648,317
                                       

Total assets

   $ 1,546,815    $ 84,953      $ 1,631,768       
                           

 

(A) Unallocated assets include deferred tax assets of $444.3 million.

Nine Months Ended September 30, 2008

 

               Liquid
Hedge
Funds
   Hybrid    Principal
Investments
    Unallocated    Fortress
Subtotal
     Private Equity       Hedge
Funds
   PE
Funds
       
     Funds    Castles                 

Segment revenues

                      

Management fees

   $ 120,113    $ 41,320    $ 169,965    $ 111,483    $ 8,401    $ —        $ —      $ 451,282

Incentive income

     12,294      12      17,125      14,128      —        —          —        43,559
                                                        

Segment revenues - total

   $ 132,407    $ 41,332    $ 187,090    $ 125,611    $ 8,401    $ —        $ —      $ 494,841
                                                        

Pre-tax distributable earnings

   $ 99,555    $ 12,033    $ 70,662    $ 26,099    $ 906    $ (113,506   $ 21    $ 95,770
                                                        

 

     Fortress
Subtotal
   Reconciliation
to GAAP
    Fortress
Consolidated*
    Principals
and Others
    GAAP
Net Income
(Loss)
 

Revenues

   $ 494,841    $ 79,271      $ 574,112       
                           

Pre-tax distributable earnings / net income (loss)

   $ 95,770    $ (277,683   $ (181,913   $ (612,692   $ (794,605
                                       

 

* Net income (loss) presented herein represents net income (loss) attributable to Fortress’s Class A shareholders.

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Reconciling items between segment measures and GAAP measures:

 

     September 30, 2009 and
the Nine Months then
Ended
    Nine Months Ended
September 30, 2008
 

Adjustments from segment revenues to GAAP revenues

    

Adjust management fees*

   $ 488      $ 488   

Adjust incentive income

     (1,791     26,390   

Adjust income from the receipt of options

     —          —     

Other revenues*

    

Adjust management fees from non-affiliates

     (3,522     (3,842

Adjust incentive income from non-affiliates

     (1,264     (13,787

Adjust other revenues (including expense reimbursements)

     69,467        70,022   
                
     64,681        52,393   
                

Total adjustments

   $ 63,378      $ 79,271   
                

*  Segment revenues do not include GAAP other revenues, except to the extent they represent management fees or incentive income; such revenues are included elsewhere in the calculation of distributable earnings.

      

Adjustments from pre-tax distributable earnings to GAAP net income (loss)**

    

Adjust incentive income

    

Incentive income received from private equity funds and hybrid PE funds, subject to contingent repayment

   $ —        $ (26,077

Incentive income accrued from private equity funds and hybrid PE funds, no longer subject to contingent repayment

     —          36,003   

Incentive income received from private equity funds and hybrid PE funds, not subject to contingent repayment

     —          17   

Incentive income from hedge funds, subject to annual performance achievement

     (1,791     —     

Reserve for clawback, gross (see discussion above)

     —          16,447   
                
     (1,791     26,390   

Adjust other income

    

Distributions of earnings from equity method investees***

     (32     (367

Earnings (losses) from equity method investees***

     26,359        (80,297

Gains (losses) on options in equity method investees

     1,323        (16,160

Unrealized gains (losses) on publicly traded investments

     36,713        (27,192

Impairment of investments (see discussion above)

     34,059        59,162   

Adjust income from the receipt of options

     —          —     
                
     98,422        (64,854

Adjust employee compensation

    

Adjust employee equity-based compensation expense (including Castle options assigned)

     (166,653     (146,246

Adjust employee portion of incentive income from private equity funds, accrued prior to the realization of incentive income

     —          9,648   

Adjust employee portion of incentive income from one private equity fund, not subject to contingent repayment

     —          (4
                
     (166,653     (136,602

Adjust Principals’ equity-based compensation expense

     (712,101     (714,710

Adjust Principals’ interests related to Fortress Operating Group units

     482,261        611,760   

Adjust tax receivable agreement liability

     (55     —     

Adjust income taxes

     4,610        333   
                

Total adjustments

   $ (295,307   $ (277,683
                

**     Net income (loss) presented herein represents net income (loss) attributable to Fortress’s Class A shareholders.

        

***  This adjustment relates to all of the Castles, private equity and hybrid PE Fortress Funds and hedge fund special investment accounts in which Fortress has an investment.

      

Adjustments from total segment assets to GAAP assets

    

Adjust equity investments from fair value

   $ —       

Adjust equity investments from cost

     48,971     

Adjust investments gross of employee portion

     34,565     

Adjust option investments from intrinsic value

     1,417     
          

Total adjustments

   $ 84,953     
          

 

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FORTRESS INVESTMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2009

(dollars in tables in thousands, except share data)

 

Three Months Ended September 30, 2009

 

               Liquid
Hedge
Funds
   Hybrid    Principal
Investments
   Unallocated    Fortress
Subtotal
     Private Equity       Hedge
Funds
   PE
Funds
        
     Funds    Castles                  

Segment revenues

                       

Management fees

   $ 32,010    $ 12,830    $ 18,566    $ 32,091    $ 13,014    $ —      $ —      $ 108,511

Incentive income

     —        —        7,996      373      1,208      —        —