UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 001-33294
Fortress Investment Group LLC
(Exact name of registrant as specified in its charter)
Delaware | 20-5837959 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
1345 Avenue of the Americas, New York, NY | 10105 | |
(Address of principal executive offices) | (Zip Code) |
(212) 798-6100
(Registrants 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 issuers classes of common stock, as of the last practicable date.
Class A Shares: 177,590,138 outstanding as of May 1, 2011.
Class B Shares: 305,857,751 outstanding as of May 1, 2011.
FORM 10-Q
INDEX
PAGE | ||||||||
PART I. FINANCIAL INFORMATION | ||||||||
Item 1. |
||||||||
Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010 |
1 | |||||||
Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2011 and 2010 |
2 | |||||||
Consolidated Statement of Equity (unaudited) for the three months ended March 31, 2011 |
3 | |||||||
Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010 |
4 | |||||||
5 | ||||||||
Note 1 |
5 | |||||||
Note 2 |
8 | |||||||
Note 3 |
14 | |||||||
Note 4 |
19 | |||||||
Note 5 |
20 | |||||||
Note 6 |
Related Party Transactions and Interests in Consolidated Subsidiaries |
21 | ||||||
Note 7 |
24 | |||||||
Note 8 |
26 | |||||||
Note 9 |
28 | |||||||
Note 10 |
29 | |||||||
Note 11 |
35 | |||||||
Note 12 |
35 | |||||||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
39 | ||||||
39 | ||||||||
44 | ||||||||
47 | ||||||||
48 | ||||||||
49 | ||||||||
57 | ||||||||
63 | ||||||||
68 | ||||||||
Item 3. |
70 | |||||||
Item 4. |
73 | |||||||
PART II. OTHER INFORMATION | ||||||||
Item 1. |
74 | |||||||
Item 1A. |
74 | |||||||
Item 2. |
104 | |||||||
Item 3. |
104 |
Item 4. |
104 | |||||||
Item 5. |
104 | |||||||
Item 6. |
105 | |||||||
107 |
As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires:
Management Fee Paying Assets Under Management, or AUM, refers to the management fee paying assets we manage, including, as applicable, capital we have the right to call from our investors pursuant to their capital commitments to various funds. Our AUM equals the sum of:
(i) | the capital commitments or invested capital (or NAV, if lower) of our private equity funds and credit PE funds, depending on which measure management fees are being calculated upon at a given point in time, which in connection with private equity funds raised after March 2006 includes the mark-to-market value of public securities held within the funds, |
(ii) | the contributed capital of our publicly traded alternative investment vehicles, which we refer to as our Castles, |
(iii) | the net asset value, or NAV, of our hedge funds, including the Value Recovery Funds which pay fees based on realizations (and on certain managed assets); and |
(iv) | the NAV of our managed accounts, to the extent management fees are charged. |
For each of the above, the amounts exclude assets under management for which we charge either no or nominal fees, generally related to our principal investments in funds as well as investments in funds by our principals, directors and employees.
Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. Our definition of AUM is not based on any definition of assets under management contained in our operating agreement or in any of our Fortress Fund management agreements.
Fortress, we, us, our, and the company refer, collectively, to Fortress Investment Group LLC and its subsidiaries, including the Fortress Operating Group and all of its subsidiaries.
Fortress Funds and our funds refers to the private investment funds, alternative asset companies and related managed accounts that are managed by the Fortress Operating Group. The Fortress Macro Fund is our flagship liquid hedge fund and the Drawbridge Special Opportunities Fund is our flagship credit hedge fund.
Fortress Operating Group refers to the combined entities, which were wholly-owned by the principals prior to January 2007, and in each of which Fortress Investment Group LLC acquired an indirect controlling interest in January 2007.
principals or Principals refers to Peter Briger, Wesley Edens, Robert Kauffman, Randal Nardone and Michael Novogratz, collectively, who prior to the completion of our initial public offering and related transactions directly owned 100% of the Fortress Operating Group units and following completion of our initial public offering and related transactions own a majority of the Fortress Operating Group units and of the Class B shares, representing a majority of the total combined voting power of all of our outstanding Class A and Class B shares. The principals ownership percentage is subject to change based on, among other things, equity offerings and grants by Fortress and dispositions by the principals.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under Part II, Item 1A, Risk Factors, Part I, Item 2, Managements 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 Companys other public filings, which are available without charge through the SECs website at http://www.sec.gov.
The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for considering whether additional specific disclosures of material information regarding material contractual provisions are required to make the statements in this report not misleading.
ITEM 1. | FINANCIAL STATEMENTS |
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
March 31, 2011 (Unaudited) |
December 31, 2010 |
|||||||
Assets |
||||||||
Cash and cash equivalents |
$ | 219,450 | $ | 210,632 | ||||
Due from affiliates |
190,842 | 303,043 | ||||||
Investments |
1,091,256 | 1,012,883 | ||||||
Deferred tax asset |
411,387 | 415,990 | ||||||
Other assets |
106,852 | 134,147 | ||||||
$ | 2,019,787 | $ | 2,076,695 | |||||
Liabilities and Equity |
||||||||
Liabilities |
||||||||
Accrued compensation and benefits |
$ | 92,239 | $ | 260,790 | ||||
Due to affiliates |
304,103 | 342,397 | ||||||
Deferred incentive income |
245,779 | 198,363 | ||||||
Debt obligations payable |
275,000 | 277,500 | ||||||
Other liabilities |
105,877 | 68,230 | ||||||
1,022,998 | 1,147,280 | |||||||
Commitments and Contingencies |
||||||||
Equity |
||||||||
Class A shares, no par value, 1,000,000,000 shares authorized, 177,562,804 and 169,536,968 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively |
| | ||||||
Class B shares, no par value, 750,000,000 shares authorized, 305,857,751 and 300,273,852 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively |
| | ||||||
Paid-in capital |
1,585,042 | 1,465,358 | ||||||
Retained earnings (accumulated deficit) |
(1,156,037 | ) | (1,052,605 | ) | ||||
Accumulated other comprehensive income (loss) |
(1,240 | ) | (1,289 | ) | ||||
Total Fortress shareholders equity |
427,765 | 411,464 | ||||||
Principals and others interests in equity of consolidated subsidiaries |
569,024 | 517,951 | ||||||
Total equity |
996,789 | 929,415 | ||||||
$ | 2,019,787 | $ | 2,076,695 | |||||
See notes to consolidated financial statements
1
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(dollars in thousands)
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Revenues |
||||||||
Management fees: affiliates |
$ | 118,868 | $ | 106,536 | ||||
Management fees: non-affiliates |
14,401 | 2,601 | ||||||
Incentive income: affiliates |
15,076 | 17,556 | ||||||
Incentive income: non-affiliates |
978 | 5,154 | ||||||
Expense reimbursements from affiliates |
44,342 | 23,067 | ||||||
Other revenues (affiliate portion disclosed in Note 6) |
3,152 | 5,274 | ||||||
196,817 | 160,188 | |||||||
Expenses |
||||||||
Interest expense |
4,660 | 3,796 | ||||||
Compensation and benefits |
215,435 | 179,393 | ||||||
Principals agreement compensation |
234,759 | 234,759 | ||||||
General, administrative and other |
40,182 | 21,108 | ||||||
Depreciation and amortization |
3,080 | 2,682 | ||||||
498,116 | 441,738 | |||||||
Other Income (Loss) |
||||||||
Gains (losses) (affiliate portion disclosed in Note 3) |
(4,763 | ) | 572 | |||||
Tax receivable agreement liability adjustment |
(116 | ) | 1,317 | |||||
Earnings (losses) from equity method investees |
72,403 | 19,881 | ||||||
67,524 | 21,770 | |||||||
Income (Loss) Before Income Taxes |
(233,775 | ) | (259,780 | ) | ||||
Income tax benefit (expense) |
(21,419 | ) | (1,552 | ) | ||||
Net Income (Loss) |
$ | (255,194 | ) | $ | (261,332 | ) | ||
Principals and Others Interests in Income (Loss) of Consolidated Subsidiaries |
$ | (151,762 | ) | $ | (177,181 | ) | ||
Net Income (Loss) Attributable to Class A Shareholders |
$ | (103,432 | ) | $ | (84,151 | ) | ||
Dividends declared per Class A share |
$ | | $ | | ||||
Earnings Per Class A share |
||||||||
Net income (loss) per Class A share, basic |
$ | (0.58 | ) | $ | (0.56 | ) | ||
Net income (loss) per Class A share, diluted |
$ | (0.58 | ) | $ | (0.58 | ) | ||
Weighted average number of Class A shares outstanding, basic |
181,019,501 | 157,821,895 | ||||||
Weighted average number of Class A shares outstanding, diluted |
181,019,501 | 465,595,747 | ||||||
See notes to consolidated financial statements
2
CONSOLIDATED STATEMENT OF EQUITY (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2011
(dollars in thousands)
Class A Shares | Class B Shares | Paid-In Capital |
Retained Earnings (Accumulated Deficit) |
Accumulated Other Comprehensive Income (Loss) |
Total Fortress Shareholders Equity |
Principals and Others Interests in Equity of Consolidated Subsidiaries |
Total Equity |
|||||||||||||||||||||||||
Equity - December 31, 2010 |
169,536,968 | 300,273,852 | $ | 1,465,358 | $ | (1,052,605 | ) | $ | (1,289 | ) | $ | 411,464 | $ | 517,951 | $ | 929,415 | ||||||||||||||||
Contributions from principals and others interests in equity |
| | | | | | 45,836 | 45,836 | ||||||||||||||||||||||||
Distributions to principals and others interests in equity |
| | (277 | ) | | | (277 | ) | (28,585 | ) | (28,862 | ) | ||||||||||||||||||||
Conversion of Class B shares to Class A shares |
4,749,434 | (4,749,434 | ) | 3,878 | | (33 | ) | 3,845 | (3,845 | ) | | |||||||||||||||||||||
Net deferred tax effects resulting from acquisition and exchange of Fortress Operating Group units |
| | 6,519 | | | 6,519 | | 6,519 | ||||||||||||||||||||||||
Director restricted share grant |
26,351 | | 113 | | | 113 | 200 | 313 | ||||||||||||||||||||||||
Capital increase related to equity-based compensation, net |
3,250,051 | 10,333,333 | 108,427 | | | 108,427 | 190,510 | 298,937 | ||||||||||||||||||||||||
Dilution impact of Class A share issuance |
| | 1,024 | | (8 | ) | 1,016 | (1,016 | ) | | ||||||||||||||||||||||
Comprehensive income (loss) (net of tax) |
||||||||||||||||||||||||||||||||
Net income (loss) |
| | | (103,432 | ) | | (103,432 | ) | (151,762 | ) | (255,194 | ) | ||||||||||||||||||||
Foreign currency translation |
| | | | 193 | 193 | 45 | 238 | ||||||||||||||||||||||||
Comprehensive income (loss) from equity method investees |
| | | | (103 | ) | (103 | ) | (310 | ) | (413 | ) | ||||||||||||||||||||
Total comprehensive income (loss) |
(255,369 | ) | ||||||||||||||||||||||||||||||
Equity - March 31, 2011 |
177,562,804 | 305,857,751 | $ | 1,585,042 | $ | (1,156,037 | ) | $ | (1,240 | ) | $ | 427,765 | $ | 569,024 | $ | 996,789 | ||||||||||||||||
See notes to consolidated financial statements
3
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
MARCH 31, 2011
(dollars in thousands)
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Cash Flows From Operating Activities |
||||||||
Net income (loss) |
$ | (255,194 | ) | $ | (261,332 | ) | ||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities |
||||||||
Depreciation and amortization |
3,080 | 2,682 | ||||||
Other amortization and accretion |
385 | 877 | ||||||
(Earnings) losses from equity method investees |
(72,403 | ) | (19,881 | ) | ||||
Distributions of earnings from equity method investees |
7,954 | 2,707 | ||||||
(Gains) losses |
4,763 | (572 | ) | |||||
Deferred incentive income |
(11,272 | ) | (17,944 | ) | ||||
Deferred tax (benefit) expense |
10,909 | (726 | ) | |||||
Options received from affiliates |
(7,021 | ) | | |||||
Tax receivable agreement liability adjustment |
116 | (1,317 | ) | |||||
Equity-based compensation, including Principals Agreement |
299,089 | 298,566 | ||||||
Allowance for doubtful accounts |
4,718 | 1,122 | ||||||
Cash flows due to changes in |
||||||||
Due from affiliates |
(22,371 | ) | (45,653 | ) | ||||
Other assets |
27,756 | (1,292 | ) | |||||
Accrued compensation and benefits |
(134,265 | ) | (21,211 | ) | ||||
Due to affiliates |
(11,894 | ) | 3,128 | |||||
Deferred incentive income |
56,171 | 85,150 | ||||||
Other liabilities |
39,796 | 32,302 | ||||||
Net cash provided by (used in) operating activities |
(59,683 | ) | 56,606 | |||||
Cash Flows From Investing Activities |
||||||||
Contributions to equity method investees |
(33,805 | ) | (28,485 | ) | ||||
Distributions of capital from equity method investees |
151,559 | 41,616 | ||||||
Purchase of fixed assets |
(2,596 | ) | (388 | ) | ||||
Net cash provided by (used in) investing activities |
115,158 | 12,743 | ||||||
Cash Flows From Financing Activities |
||||||||
Repayments of debt obligations |
(2,500 | ) | (27,950 | ) | ||||
Principals and others interests in equity of consolidated subsidiaries - contributions |
11,282 | 37 | ||||||
Principals and others interests in equity of consolidated subsidiaries - distributions |
(55,439 | ) | (15,114 | ) | ||||
Net cash provided by (used in) financing activities |
(46,657 | ) | (43,027 | ) | ||||
Net Increase (Decrease) in Cash and Cash Equivalents |
8,818 | 26,322 | ||||||
Cash and Cash Equivalents, Beginning of Period |
210,632 | 197,099 | ||||||
Cash and Cash Equivalents, End of Period |
$ | 219,450 | $ | 223,421 | ||||
Supplemental Disclosure of Cash Flow Information |
||||||||
Cash paid during the period for interest |
$ | 4,097 | $ | 3,384 | ||||
Cash paid during the period for income taxes |
$ | 5,469 | $ | 2,464 | ||||
Supplemental Schedule of Non-cash Investing and Financing Activities |
||||||||
Employee compensation invested directly in subsidiaries |
$ | 34,285 | $ | 45,095 | ||||
Investments of receivable amounts into Fortress Funds |
$ | 130,774 | $ | 7,652 | ||||
Dividends, dividend equivalents and Fortress Operating Group unit distributions declared but not yet paid |
$ | 12,877 | $ | 31,335 | ||||
See notes to consolidated financial statements
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
1. ORGANIZATION AND BASIS OF PRESENTATION
Fortress Investment Group LLC (the Registrant, or, together with its subsidiaries, Fortress) is a leading, highly diversified global investment management firm whose predecessor was founded in 1998. Its primary business is to sponsor the formation of, and provide investment management services for, various investment funds and companies, including related managed accounts (collectively, the Fortress Funds). Fortress generally makes principal investments in these funds.
Fortress has three primary sources of income from the Fortress Funds: management fees, incentive income, and investment income on its principal investments in the funds. The Fortress Funds fall into the following business segments in which Fortress operates:
1) | Private equity: |
a) | Private equity funds, which make significant, control-oriented investments in debt and equity securities of public or privately held entities in North America and Western Europe, with a focus on acquiring and building asset-based businesses with significant cash flows; and |
b) | Publicly traded alternative investment vehicles, which Fortress refers to as Castles, which are companies that invest primarily in real estate and real estate related debt investments. |
2) | Liquid hedge funds, which invest globally in fixed income, currency, equity and commodity markets, and related derivatives to capitalize on imbalances in the financial markets. |
3) | Credit funds: |
a) | Credit hedge funds, which make highly diversified investments globally in assets, opportunistic lending situations and securities throughout the capital structure with a value orientation, as well as in investment funds managed by external managers, and which include non-Fortress originated funds for which Fortress has been retained as manager as part of an advisory business; and |
b) | Credit private equity (PE) funds which are comprised of a family of credit opportunities funds focused on investing in distressed and undervalued assets, a family of long dated value funds focused on investing in undervalued assets with limited current cash flows and long investment horizons, a family of real assets funds focused on investing in tangible and intangible assets in four principal categories (real estate, capital assets, natural resources and intellectual property), and two Asia funds, a Japan real estate fund and an Asian investor based global opportunities fund. |
4) | Principal investments in the above described funds. |
Financial Statement Guide
Selected Financial Statement Captions |
Note Reference |
Explanation | ||||
Balance Sheet | ||||||
Due from Affiliates |
|
6 |
|
Generally, management fees, expense reimbursements and incentive income due from Fortress Funds. | ||
Investments |
3 | Primarily the carrying value of Fortresss principal investments in the Fortress Funds. | ||||
Deferred Tax Asset |
5 | Relates to potential future tax benefits. | ||||
Due to Affiliates |
6 | Generally, amounts due to the Principals related to their interests in Fortress Operating Group and the tax receivable agreement. | ||||
Deferred Incentive Income |
2 | Incentive income already received from certain Fortress Funds based on past performance, which is subject to contingent repayment based on future performance. |
5
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Selected Financial Statement Captions |
Note Reference |
Explanation | ||
Debt Obligations Payable |
4 | The balance outstanding on the credit agreement. | ||
Principals and Others Interests in Equity of Consolidated Subsidiaries |
6 | The GAAP basis of the Principals ownership interests in Fortress Operating Group as well as employees ownership interests in certain subsidiaries. | ||
Statement of Operations |
||||
Management Fees: Affiliates |
2 | Fees earned for managing Fortress Funds, generally determined based on the size of such funds. | ||
Management Fees: Non-Affiliates |
2 | Fees earned from managed accounts and our traditional fixed income asset management business, generally determined based on the amount managed. | ||
Incentive Income: Affiliates |
2 | Income earned from Fortress Funds, based on the performance of such funds. | ||
Incentive Income: Non-Affiliates |
2 | Income earned from managed accounts, based on the performance of such accounts. | ||
Compensation and Benefits |
7 | Includes equity-based, profit-sharing and other compensation to employees. | ||
Principals Agreement Compensation |
N/A | As a result of the principals agreement, the January 2007 value of a significant portion of the Principals equity in Fortress is being recorded as an expense over a five year period. Fortress is not a party to this agreement. It is an agreement between the Principals to further incentivize them to remain with Fortress. This GAAP expense has no economic effect on Fortress or its shareholders. | ||
Gains (Losses) |
3 | The result of asset dispositions or changes in the fair value of investments or other financial instruments which are marked to market (including the Castles and GAGFAH). | ||
Tax Receivable Agreement Liability Adjustment |
5 | Represents a change in the amount due to the Principals under the tax receivable agreement. | ||
Earnings (Losses) from Equity Method Investees |
3 | Fortresss share of the net earnings (losses) of the Fortress Funds resulting from its principal investments. | ||
Income Tax Benefit (Expense) |
5 | The net tax result related to the current period. Certain of Fortresss revenues are not subject to taxes because they do not flow through taxable entities. Furthermore, Fortress has significant permanent differences between its GAAP and tax basis earnings. |
6
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Selected Financial Statement Captions |
Note Reference |
Explanation | ||
Principals and Others Interests in (Income) Loss of Consolidated Subsidiaries |
6 | Primarily the Principals and employees share of Fortresss earnings based on their ownership interests in subsidiaries, including Fortress Operating Group. | ||
Earnings Per Share |
8 | GAAP earnings per Class A share based on Fortresss capital structure, which is comprised of outstanding and unvested equity interests, including interests which participate in Fortresss 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 Fortresss management committee. |
The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging, contingencies and fair value. Some of the proposed changes are significant and could have a material impact on Fortresss reporting. Fortress has not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.
The accompanying consolidated financial statements and related notes of Fortress have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Fortresss 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 Fortresss consolidated and combined financial statements for the year ended December 31, 2010 and notes thereto included in Fortresss Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2011. Capitalized terms used herein, and not otherwise defined, are defined in Fortresss consolidated financial statements for the year ended December 31, 2010.
Certain prior period amounts have been reclassified to conform to the current periods presentation.
7
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
2. MANAGEMENT AGREEMENTS AND FORTRESS FUNDS
Fortress has two principal sources of income from its agreements with the Fortress Funds: contractual management fees, which are generally based on a percentage of fee paying assets under management, and related incentive income, which is generally based on a percentage of profits subject to the achievement of performance criteria. Substantially all of Fortresss net assets, after deducting the portion attributable to principals and others interests, are a result of principal investments in, or receivables from, these funds. The terms of agreements between Fortress and the Fortress Funds are generally determined in connection with third party fund investors.
The Fortress Funds are divided into segments and Fortresss agreements with each are detailed below.
Management Fees, Incentive Income and Related Profit Sharing Expense
Fortress recognized management fees and incentive income as follows:
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
Private Equity |
||||||||
Private Equity Funds |
||||||||
Management fees - affil. |
$ | 35,289 | $ | 33,465 | ||||
Incentive income - affil. |
3,219 | | ||||||
Castles |
||||||||
Management fees - affil. |
11,614 | 11,780 | ||||||
Management fees, options - affil. |
7,021 | | ||||||
Management fees - non-affil. |
661 | 884 | ||||||
Incentive income - affil. |
| | ||||||
Liquid Hedge Funds |
||||||||
Management fees - affil. |
17,498 | 17,466 | ||||||
Management fees - non-affil. |
4,789 | 1,336 | ||||||
Incentive income - affil. |
1,715 | (259 | ) | |||||
Incentive income - non-affil. |
978 | | ||||||
Credit Funds |
||||||||
Credit Hedge Funds |
||||||||
Management fees - affil. |
31,457 | 33,668 | ||||||
Management fees - non-affil. |
4,055 | 381 | ||||||
Incentive income - affil. |
2,089 | (129 | ) | |||||
Incentive income - non-affil. |
| 5,154 | ||||||
Credit PE Funds |
||||||||
Management fees - affil. |
15,989 | 10,157 | ||||||
Management fees - non-affil. |
33 | | ||||||
Incentive income - affil. |
8,053 | 17,944 | ||||||
Other (A) |
||||||||
Management fees - non-affil. |
4,863 | | ||||||
Total |
||||||||
Management fees - affil. |
$ | 118,868 | $ | 106,536 | ||||
Management fees - non-affil. |
$ | 14,401 | $ | 2,601 | ||||
Incentive income - affil. (B) |
$ | 15,076 | $ | 17,556 | ||||
Incentive income - non-affil. |
$ | 978 | $ | 5,154 |
(A) | Related to Logan Circle. |
(B) | See Deferred Incentive Income below. |
8
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Deferred Incentive Income
Incentive income from certain Fortress Funds, primarily private equity funds and credit PE funds, is received when such funds realize profits, based on the related agreements. However, this incentive income is subject to contingent repayment by Fortress to the funds until certain overall fund performance criteria are met. Accordingly, Fortress does not recognize this incentive income as revenue until the related contingencies are resolved. Until such time, this incentive income is recorded on the balance sheet as deferred incentive income and is included as distributed-unrecognized deferred incentive income in the table below. Incentive income from such funds, based on their net asset value, which has not yet been received is not recorded on the balance sheet and is included as undistributed deferred incentive income in the table below.
Incentive income from certain Fortress Funds is earned based on achieving annual performance criteria. Accordingly, this incentive income is recorded as revenue at year end (in the fourth quarter of each year), is generally received subsequent to year end, and has not been recognized for these funds during the three months ended March 31, 2011 and 2010. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $53.0 million and $6.2 million of additional incentive income from affiliates would have been recognized during the three months ended March 31, 2011 and 2010, respectively. Incentive income based on achieving annual performance criteria that has not yet been recognized, if any, is not recorded on the balance sheet and is included as undistributed deferred incentive income in the table below.
During the three months ended March 31, 2011 and 2010, Fortress recognized $8.1 million and $17.9 million, respectively, of incentive income distributions from its credit PE funds which represented tax distributions. These tax distributions are not subject to clawback and reflect a cash amount approximately equal to the amount expected to be paid out by Fortress for taxes or tax-related distributions on the allocated income from such funds.
Deferred incentive income from the Fortress Funds was comprised of the following, on an inception to date basis. This does not include any amounts related to third party funds, receipts from which are reflected as Other Liabilities until all contingencies are resolved.
Distributed- Gross |
Distributed- Recognized (A) |
Distributed- Unrecognized (B) |
Undistributed net of intrinsic clawback (C) (D) |
|||||||||||||
Deferred incentive income as of December 31, 2010 |
$ | 702,709 | $ | (504,346 | ) | $ | 198,363 | $ | 200,066 | |||||||
Share of income (loss) of Fortress Funds |
| | | 139,672 | ||||||||||||
Distribution of incentive income |
58,688 | | 58,688 | (58,688 | ) | |||||||||||
Recognition of previously deferred incentive income |
| (11,272 | ) | (11,272 | ) | | ||||||||||
Deferred incentive income as of March 31, 2011 |
$ | 761,397 | $ | (515,618 | ) | $ | 245,779 | $ | 281,050 | |||||||
(A) | All related contingencies have been resolved. |
(B) | Reflected on the balance sheet. |
(C) | At March 31, 2011, the net undistributed incentive income is comprised of $375.6 million of gross undistributed incentive income, net of $94.5 million of intrinsic clawback (see next page). The net undistributed incentive income amount represents the amount that would be received by Fortress from the related funds if such funds were liquidated on March 31, 2011 at their net asset values. |
(D) | From inception to March 31, 2011, Fortress has paid $311.3 million of compensation expense under its employee profit sharing arrangements (Note 7) in connection with distributed incentive income, of which $27.9 million has not been expensed because management has determined that it is not probable of being incurred as an expense and will be recovered from the related individuals. If the $375.6 million of gross undistributed incentive income were realized, Fortress would recognize and pay an additional $159.6 million of compensation expense. |
9
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
The following tables summarize information with respect to the Fortress Funds, other than the Castles, and their related incentive income thresholds as of March 31, 2011:
Fund (Vintage) (A) |
Maturity Date (B) |
Inception to Date Capital Invested |
Inception to Date Distributions |
Net Asset Value (NAV) |
NAV Surplus (Deficit) (C) |
Current Preferred Return Threshold (D) |
Gain
to Cross Incentive Income Threshold (E) |
Undistributed Incentive Income (F) |
Distributed Incentive Income (G) |
Distributed Incentive Income Subject to Clawback (H) |
Gross Intrinsic Clawback (I) |
Net Intrinsic Clawback (I) |
||||||||||||||||||||||||||||||||||||
Private Equity Funds |
||||||||||||||||||||||||||||||||||||||||||||||||
NIH (1998) |
Indefinite | $ | 415,574 | $ | (801,926 | ) | $ | 17,266 | $ | N/A | $ | N/A | $ | N/A | $ | | $ | 94,513 | $ | | $ | | $ | | ||||||||||||||||||||||||
Fund I (1999) (J) |
Apr-10 | 1,027,871 | (2,759,045 | ) | 108,076 | 1,839,250 | | N/A | 9,572 | 325,931 | | | | |||||||||||||||||||||||||||||||||||
Fund II (2002) |
Feb-13 | 1,974,296 | (3,245,088 | ) | 130,966 | 1,401,758 | | N/A | | 287,024 | 46,412 | 11,198 | 7,170 | |||||||||||||||||||||||||||||||||||
Fund III (2004) |
Jan-15 | 2,762,993 | (1,307,375 | ) | 1,644,988 | 189,370 | 1,018,836 | 829,466 | | 66,903 | 66,903 | 66,903 | 45,108 | |||||||||||||||||||||||||||||||||||
Fund III Coinvestment (2004) |
Jan-15 | 273,648 | (115,925 | ) | 172,751 | 15,028 | 132,356 | 117,328 | | | | | | |||||||||||||||||||||||||||||||||||
Fund IV (2006) |
Jan-17 | 3,639,561 | (119,445 | ) | 3,201,662 | (318,454 | ) | 1,248,388 | 1,566,842 | | | | | | ||||||||||||||||||||||||||||||||||
Fund IV Coinvestment (2006) |
Jan-17 | 762,696 | (12,651 | ) | 654,311 | (95,734 | ) | 269,714 | 365,448 | | | | | | ||||||||||||||||||||||||||||||||||
Fund V (2007) |
Feb-18 | 3,973,747 | (2,862 | ) | 3,093,356 | (877,529 | ) | 883,132 | 1,760,661 | | | | | | ||||||||||||||||||||||||||||||||||
Fund V Coinvestment (2007) |
Feb-18 | 936,145 | (132 | ) | 543,507 | (392,506 | ) | 247,459 | 639,965 | | | | | | ||||||||||||||||||||||||||||||||||
GAGACQ Fund (2004) |
Nov-09 | 545,663 | (595,401 | ) | N/A | N/A | N/A | N/A | N/A | 51,476 | N/A | N/A | N/A | |||||||||||||||||||||||||||||||||||
FRID (2005) |
Apr-15 | 1,220,228 | (505,605 | ) | 425,091 | (289,532 | ) | 489,112 | 778,644 | | 16,447 | 16,447 | 16,447 | 10,041 | ||||||||||||||||||||||||||||||||||
FRIC (2006) |
May-16 | 328,754 | (17,460 | ) | 248,622 | (62,672 | ) | 139,437 | 202,109 | | | | | | ||||||||||||||||||||||||||||||||||
FICO (2006) |
Jan-17 | 724,525 | (5 | ) | (23,988 | ) | (748,508 | ) | 286,645 | 1,035,153 | | | | | | |||||||||||||||||||||||||||||||||
FHIF (2006) |
Jan-17 | 1,493,484 | (63,169 | ) | 1,752,798 | 322,483 | 517,542 | 195,059 | | | | | | |||||||||||||||||||||||||||||||||||
FECI (2007) |
Feb-18 | 982,779 | (144 | ) | 842,599 | (140,036 | ) | 316,755 | 456,791 | | | | | | ||||||||||||||||||||||||||||||||||
Mortgage Opportunities Fund III (2008) |
Jun-13 | 193,861 | (46,963 | ) | 117,610 | (29,288 | ) | | 29,288 | | | | | | ||||||||||||||||||||||||||||||||||
$ | 9,572 | $ | 842,294 | $ | 129,762 | $ | 94,548 | $ | 62,319 | |||||||||||||||||||||||||||||||||||||||
Credit PE Funds |
||||||||||||||||||||||||||||||||||||||||||||||||
Long Dated Value Fund I (2005) |
Apr-30 | $ | 267,325 | $ | (45,656 | ) | $ | 263,584 | $ | 41,915 | $ | 77,244 | $ | 35,329 | $ | | $ | | $ | | $ | | $ | | ||||||||||||||||||||||||
Long Dated Value Fund II (2005) |
Nov-30 | 270,958 | (60,723 | ) | 244,039 | 33,804 | 61,851 | 28,047 | | 412 | | | | |||||||||||||||||||||||||||||||||||
Long Dated Value Fund III (2007) |
Feb-32 | 340,740 | (119,298 | ) | 308,414 | 86,972 | | N/A | 14,298 | 1,983 | | | | |||||||||||||||||||||||||||||||||||
LDVF Patent Fund (2007) |
Nov-27 | 40,803 | (10,002 | ) | 52,814 | 22,013 | | N/A | 1,521 | 461 | | | | |||||||||||||||||||||||||||||||||||
Real Assets Fund (2007) |
Jun-17 | 355,783 | (165,375 | ) | 257,834 | 67,426 | | N/A | 9,219 | 1,316 | | | | |||||||||||||||||||||||||||||||||||
$ | 25,038 | $ | 4,172 | $ | | $ | | $ | | |||||||||||||||||||||||||||||||||||||||
Credit PE Funds in Investment Period |
||||||||||||||||||||||||||||||||||||||||||||||||
Credit Opportunities Fund (2008) |
Oct-20 | $ | 4,301,750 | $ | (4,365,262 | ) | $ | 1,543,286 | $ | 1,606,798 | $ | | $ | N/A | $ | 138,242 | $ | 179,254 | $ | 85,700 | $ | | $ | | ||||||||||||||||||||||||
Credit Opportunities Fund II (2009) |
Jul-22 | 1,018,804 | (196,409 | ) | 1,079,860 | 257,465 | | N/A | 52,386 | | | | | |||||||||||||||||||||||||||||||||||
FTS SIP L.P. (2008) |
Oct-18 | 1,024,373 | (901,001 | ) | 453,046 | 329,674 | | N/A | 22,077 | 44,550 | 28,800 | | | |||||||||||||||||||||||||||||||||||
SIP L.P. (2010) |
Sep-20 | 11,000 | (5,312 | ) | 16,803 | 11,115 | | N/A | 2,779 | | | | | |||||||||||||||||||||||||||||||||||
FCO MA LSS (2010) |
Jun-24 | 91,546 | (7,003 | ) | 94,906 | 10,363 | | N/A | 2,080 | | | | | |||||||||||||||||||||||||||||||||||
FCO MA II (2010) |
Jun-22 | 183,718 | (18,302 | ) | 206,150 | 40,734 | | N/A | 7,739 | | | | | |||||||||||||||||||||||||||||||||||
FCO MA Maple Leaf (2010) |
Oct-20 | 70,600 | | 71,201 | 601 | 1,893 | 1,292 | | | | | | ||||||||||||||||||||||||||||||||||||
Assets Overflow Fund (2008) |
May-18 | 90,500 | (112,344 | ) | 1 | 21,845 | | N/A | | 2,180 | 1,517 | | | |||||||||||||||||||||||||||||||||||
Japan Opportunity Fund (2009) |
Jun-19 | 782,322 | (257,842 | ) | 663,149 | 138,669 | | N/A | 19,979 | 8,053 | | | | |||||||||||||||||||||||||||||||||||
Net Lease Fund I (2010) |
Feb-23 | 32,136 | (4,880 | ) | 31,820 | 4,564 | | N/A | 601 | | | | | |||||||||||||||||||||||||||||||||||
Global Opportunities Fund (2010) |
Sep-20 | 37,927 | | 35,846 | (2,081 | ) | 950 | 3,031 | | | | | | |||||||||||||||||||||||||||||||||||
Life Settlements Fund (2010) |
Dec-22 | 261,896 | | 258,051 | (3,845 | ) | 5,457 | 9,302 | | | | | | |||||||||||||||||||||||||||||||||||
Life Settlements Fund MA (2010) |
Dec-22 | 21,437 | | 21,095 | (342 | ) | 451 | 793 | | | | | | |||||||||||||||||||||||||||||||||||
$ | 245,883 | $ | 234,037 | $ | 116,017 | $ | | $ | | |||||||||||||||||||||||||||||||||||||||
10
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Incentive Income Eligible NAV (K) |
Gain to Cross Incentive Income Threshold (L) |
Percentage of Incentive Income Eligible NAV Above Incentive Income Threshold (M) |
Undistributed Incentive Income (N) |
Year to date Incentive Income Crystallized (O) |
||||||||||||||||
Liquid Hedge Funds |
||||||||||||||||||||
Macro Funds (P) |
||||||||||||||||||||
Main fund investments |
$ | 2,516,963 | $ | 29 | 99.9 | % | $ | 11,777 | $ | 721 | ||||||||||
Sidepocket investments (Q) |
64,088 | 32,567 | N/A | 720 | | |||||||||||||||
Sidepocket investments - redeemers (R) |
269,022 | 124,777 | N/A | 3,305 | | |||||||||||||||
Managed accounts |
799,866 | | 100.0 | % | 1,638 | | ||||||||||||||
Fortress Commodities Funds (S) |
||||||||||||||||||||
Main fund investments |
936,419 | | 100.0 | % | 5,593 | 964 | ||||||||||||||
Managed accounts |
149,110 | | 100.0 | % | | 890 | ||||||||||||||
Credit Hedge Funds |
||||||||||||||||||||
Special Opportunities Funds (S) |
||||||||||||||||||||
Main fund investments |
$ | 2,762,713 | $ | | 100.0 | % | $ | 31,820 | $ | | ||||||||||
Sidepocket investments (Q) |
131,737 | 1,549 | N/A | 3,417 | | |||||||||||||||
Sidepocket investments - redeemers (R) |
214,464 | 77,413 | N/A | 1,676 | | |||||||||||||||
Main fund investments (liquidating) (T) |
1,906,364 | 173,872 | 87.4 | % | 31,576 | 1,505 | ||||||||||||||
Managed accounts |
34,469 | 13,136 | 0.0 | % | | | ||||||||||||||
Fortress Partners Funds (S) |
||||||||||||||||||||
Main fund investments |
186,364 | 34,867 | 0.1 | % | 1 | | ||||||||||||||
Sidepocket investments (Q) |
96,071 | 26,876 | N/A | 664 | | |||||||||||||||
Worden Funds |
||||||||||||||||||||
Main fund investments |
206,896 | | 100.0 | % | 2,474 | | ||||||||||||||
Value Recovery Funds (U) |
||||||||||||||||||||
Managed accounts |
98,161 | 6,637 | 68.7 | % | 444 | |
(A) | Vintage represents the year in which the fund was formed. |
(B) | Represents the contractual maturity date including the assumed exercise of all extension options, which in some cases may require the approval of the applicable fund advisory board. Private equity funds that have reached their maturity date are included in the table to the extent they have generated incentive income. |
(C) | A NAV deficit represents the gain needed to cross the incentive income threshold (as described in (E) below), excluding the impact of any relevant performance (i.e. preferred return) thresholds (as described in (D) below). As of period end, there is an aggregate NAV surplus within both the private equity funds and credit PE funds. |
(D) | Represents the gain needed to achieve the current relevant performance thresholds, assuming the gain described in (C) above is already achieved. |
(E) | Represents the immediate increase in NAV needed for Fortress to begin earning incentive income, including the achievement of any relevant performance thresholds. It does not include the amount needed to earn back intrinsic clawback (see (I) below), if any. Incentive income is not recorded as revenue until it is received and any related contingencies are resolved (see (H) below). |
(F) | Represents the amount of additional incentive income Fortress would receive if the fund were liquidated at the end of the period at its NAV. |
(G) | Represents the amount of incentive income previously received from the fund since inception. |
(H) | Represents the amount of incentive income previously received from the fund which is still subject to contingencies and is therefore recorded on the consolidated balance sheet as Deferred Incentive Income. This amount will either be recorded as revenue when all related contingencies are resolved, or, if the fund does not meet certain performance thresholds, will be returned by Fortress to the fund (i.e., clawed back). |
(I) | Represents the amount of incentive income previously received from the fund that would be clawed back (i.e., returned by Fortress to the fund) if the fund were liquidated at the end of the period at its NAV, excluding the effect of any tax adjustments. Employees, former employees and affiliates of Fortress would be required to return a portion of this incentive income that was paid to them under profit sharing arrangements. Gross and Net refer to amounts that are gross and net, respectively, of this employee/affiliate portion of the intrinsic clawback. Fortress remains liable to the funds for these amounts even if it is unable to collect the amounts from employees/affiliates. Fortress withheld a portion of the amounts due to employees under these profit sharing arrangements as a reserve against future clawback; as of March 31, 2011, Fortress held $48.2 million of such amounts on behalf of employees related to all of the private equity funds. |
(J) | Fund I undistributed and distributed incentive income amounts are presented for the total fund, of which Fortress is entitled to approximately 50%. Distributed incentive income subject to clawback for Fund I is presented with respect to Fortresss portion only. |
(K) | Represents the portion of a funds NAV or trading level that is eligible to earn incentive income. |
(L) | Represents, for those fund investors whose NAV is below the performance threshold Fortress needs to obtain before it can earn incentive income |
11
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
from such investors (their incentive income threshold or high water mark), the amount by which their aggregate incentive income thresholds exceed their aggregate NAVs. The amount by which the NAV of each investor within this category is below their respective incentive income threshold varies and, therefore, Fortress may begin earning incentive income from certain investors before this entire amount is earned back. Fortress earns incentive income whenever the assets of new investors, as well as of investors whose NAV exceeds their incentive income threshold, increase in value. |
(M) | Represents the percentage which is computed by dividing (i) the aggregate NAV of all investors who are at or above their respective incentive income thresholds, by (ii) the total incentive income eligible NAV of the fund. The amount by which the NAV of each fund investor who is not in this category is below their respective incentive income threshold may vary, and may vary significantly. This percentage represents the performance of only the main fund investments and managed accounts relative to their respective incentive income thresholds. It does not incorporate the impact of unrealized losses on sidepocket investments that can reduce the amount of incentive income earned from certain funds. See footnote Q below. |
(N) | Represents the amount of additional incentive income Fortress would earn from the fund if it were liquidated at the end of the period at its NAV. This amount is currently subject to performance contingencies generally until the end of the year or, in the case of sidepocket investments, until such investments are realized. For the Value Recovery Fund managed accounts, Fortress can earn incentive income if aggregate realizations exceed an agreed threshold. Main Fund Investments (Liquidating) pay incentive income only after all capital is returned. |
(O) | Represents the amount of incentive income Fortress has earned in the current period from the fund which is no longer subject to contingencies. |
(P) | Represents the Drawbridge Global Macro Funds, Fortress Macro Funds and Fortress Asia Macro Fund. The Drawbridge Global Macro SPV (the SPV), which was established in February 2009 to liquidate illiquid investments and distribute the proceeds to then existing investors, is not subject to incentive income and is therefore not presented in the table. However, realized gains or losses within the SPV can decrease or increase, respectively, the gain needed to cross the incentive income threshold for investors with a corresponding investment in the main fund. The impact of the unrealized gains and losses within the SPV at March 31, 2011, as if they became realized, was immaterial to the amounts presented in the table for the Macro main fund. |
(Q) | Represents investments held in sidepockets (also known as special investment accounts), which generally have investment profiles similar to private equity funds. The performance of these investments may impact Fortresss ability to earn incentive income from main fund investments. For the credit hedge funds, realized and unrealized losses from individual sidepockets below original cost may reduce the incentive income earned from main fund investments. For the Macro Funds, only realized losses from individual sidepockets reduce the incentive income earned from main fund investments. Based on current unrealized losses in Macro Fund sidepockets, if all of the Macro Fund sidepockets were liquidated at their NAV at March 31, 2011, the undistributed incentive income from the Macro main fund would be decreased by approximately $3.8 million. |
(R) | Represents investments held in sidepockets for investors with no corresponding investment in the related main fund investments. In the case of the Macro Funds, such investors may have investments in the SPV (see (P) above). |
(S) | Includes onshore and offshore funds. |
(T) | Relates to accounts where investors have provided return of capital notices and are subject to payout as underlying fund investments are realized. |
(U) | Excludes the Value Recovery Funds which had a NAV of $783.4 million at March 31, 2011. Fortress began managing the third party originated Value Recovery Funds in June 2009 and does not expect to earn any incentive income from the fund investments. |
Private Equity Funds and Credit PE Funds
During the three months ended March 31, 2011, the capital commitment period of Fund V, Fund V Coinvestment and FECI expired. At such time, the AUM for these funds were reduced in aggregate by approximately $2.0 billion and, beginning in July 2011, these funds will generate lower management fees.
Liquid Hedge Funds and Credit Hedge Funds
During the three months ended March 31, 2011, Fortress formed, or became the manager of, hedge funds with net asset values as follows as of March 31, 2011:
Liquid | Credit | |||||||
Fortress |
$ | 20,601 | $ | | ||||
Fortresss affiliates |
10,300 | | ||||||
Third party investors |
23,372 | | ||||||
Total NAV (A) |
$ | 54,273 | $ | | ||||
(A) | Or other fee paying basis, as applicable. |
12
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Redemption notices received, and redemption payments which are made in periods after notices are received, including affiliates, have been as follows:
Liquid Hedge Funds | Credit Hedge Funds | |||||||||||||||
Three Months Ended March 31, |
Redemption Notices Received |
Redemptions Paid During the Period |
Redemption Notices Received |
Redemptions Paid During the Period |
||||||||||||
2011 |
$ | 147,187 | $ | 250,555 | $ | 21,238 | $ | 408,276 | ||||||||
2010 |
$ | 263,180 | $ | 715,385 | $ | 16,995 | $ | 450,847 |
The differences between notices received and redemptions paid are a result of timing (such as notices received prior to quarter end, paid afterwards), performance between the notice date and the payment date, and the contractual agreements regarding redemptions, which, in some cases, including all of the credit hedge funds, allow for delayed payment.
Traditional Asset Management
Logan Circle Partners, L.P. (Logan Circle) is a fixed income asset manager with approximately $12.5 billion in assets under management as of March 31, 2011, which Fortress acquired in April 2010. Logan Circle is initially being reported in the unallocated section of Fortresss segments until such time as it becomes material to Fortresss operations.
Part of the acquisition price was paid with contingent consideration, which is contingent on the growth and performance of Logan Circles business (but not contingent on the continued employment of any employees). The contingent consideration is payable in cash or Class A shares, at Fortresss option, and had an estimated fair value of approximately $4 million at closing (maximum payment of $28 million). The contingent consideration is measured at fair value with changes in fair value being recorded as a gain (loss). This fair value is measured based on the expected performance of Logan Circle in 2011 and a discount rate, and therefore is considered a Level 3 valuation (Note 3).
The assets acquired primarily included goodwill and other intangible assets, which have been recorded in Other Assets. The intangible assets are being amortized over their estimated useful lives, which range from 1 to 8 years. Fortress tests the Logan Circle goodwill and other intangible assets for impairment annually in the fourth quarter of each calendar year, or whenever events or circumstances indicate that it is more likely than not that Logan Circles fair value has declined below its carrying value. No impairment was recorded during the three months ended March 31, 2011. Logan Circles fair value is estimated based on the following key assumptions: expected retention rate of existing investors, growth expectations, estimated future fee rates, estimated operating margin, and market discount rates. These assumptions are determined primarily based on Logan Circles past experience, Logan Circles historical and recent investment performance, Logan Circles business plans, current industry trends, and general economic expectations. These assumptions, particularly those relating to investor retention and growth expectations, as well as discount rates, are highly subjective and are subject to significant uncertainty with respect to future events. Continued challenging credit market conditions could adversely impact the value of Logan Circle.
During the three months ended March 31, 2011, Logan Circle generated approximately $4.9 million of revenues (primarily management fees from non-affiliates) and $(4.8) million of net (loss). This net (loss) does not include the change in fair value of the contingent consideration, but does include approximately $1.6 million of allocated corporate overhead. In connection with the acquisition of Logan Circle, Fortress established a compensation plan for former Logan Circle employees who became employees of Fortress (the Logan Circle Comp Plan see Note 7).
13
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Investments consist primarily of investments in equity method investees and options in these investees. The investees are primarily Fortress Funds.
Investments can be summarized as follows:
March 31, 2011 |
December 31, 2010 |
|||||||
Equity method investees |
$ | 1,024,794 | $ | 949,410 | ||||
Equity method investees, held at fair value |
56,988 | 60,324 | ||||||
Total equity method investments |
1,081,782 | 1,009,734 | ||||||
Options in equity method investees |
9,474 | 3,149 | ||||||
Total investments |
$ | 1,091,256 | $ | 1,012,883 | ||||
Gains (losses) from investments can be summarized as follows:
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
Net realized gains (losses) |
$ | 278 | $ | 400 | ||||
Net realized gains (losses) from affiliate investments |
(383 | ) | (329 | ) | ||||
Net unrealized gains (losses) |
(1,468 | ) | | |||||
Net unrealized gains (losses) from affiliate investments |
(3,190 | ) | 501 | |||||
Total gains (losses) |
$ | (4,763 | ) | $ | 572 | |||
Investments in Equity Method Investees
Fortress holds investments in certain Fortress Funds which are recorded based on the equity method of accounting. Fortresss maximum exposure to loss with respect to these entities is generally equal to its investment plus its basis in any options received from such entities, plus any receivables from such entities as described in Note 6. In addition, unconsolidated affiliates also hold ownership interests in certain of these entities. Summary financial information related to these investments is as follows:
Fortresss Investment | Fortresss Equity in Net Income (Loss) | |||||||||||||||
March 31, | December 31, | Three Months Ended March 31, |
||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Private equity funds, excluding NIH (A) |
$ | 663,849 | $ | 611,794 | $ | 55,263 | $ | 9,242 | ||||||||
NIH |
1,476 | 1,664 | (43 | ) | (149 | ) | ||||||||||
Newcastle (B) |
6,195 | 6,872 | N/A | N/A | ||||||||||||
Eurocastle (B) |
2,451 | 2,184 | N/A | N/A | ||||||||||||
Total private equity |
673,971 | 622,514 | 55,220 | 9,093 | ||||||||||||
Liquid hedge funds |
49,537 | 16,670 | 1,867 | 266 | ||||||||||||
Credit hedge funds |
229,345 | 238,783 | 10,978 | 9,334 | ||||||||||||
Credit PE funds |
122,415 | 125,265 | 4,505 | (48 | ) | |||||||||||
Other |
6,514 | 6,502 | (167 | ) | 1,236 | |||||||||||
$ | 1,081,782 | $ | 1,009,734 | $ | 72,403 | $ | 19,881 | |||||||||
(A) | Includes Fortresss direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH. |
(B) | Fortress elected to record these investments, as well as its direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH, at fair value pursuant to the fair value option for financial instruments. |
14
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
A summary of the changes in Fortresss investments in equity method investees is as follows:
Three Months Ended March 31, 2011 | ||||||||||||||||||||||||||||||||
Private Equity | Liquid | Credit | ||||||||||||||||||||||||||||||
NIH | Other Funds (A) | Castles (B) | Hedge Funds | Hedge Funds | PE Funds | Other | Total | |||||||||||||||||||||||||
Investment, beginning |
$ | 1,664 | $ | 611,794 | $ | 9,056 | $ | 16,670 | $ | 238,783 | $ | 125,265 | $ | 6,502 | $ | 1,009,734 | ||||||||||||||||
Earnings from equity method investees |
(43 | ) | 55,263 | N/A | 1,867 | 10,978 | 4,505 | (167 | ) | 72,403 | ||||||||||||||||||||||
Other comprehensive income from equity method investees |
(2 | ) | | N/A | | | (671 | ) | | (673 | ) | |||||||||||||||||||||
Contributions to equity method investees |
| 114 | | 76,616 | 95,988 | 6,016 | 195 | 178,929 | ||||||||||||||||||||||||
Distributions of earnings from equity method investees |
| | N/A | (739 | ) | (3,851 | ) | (3,348 | ) | (16 | ) | (7,954 | ) | |||||||||||||||||||
Distributions of capital from equity method investees |
(143 | ) | (288 | ) | N/A | (44,877 | ) | (112,553 | ) | (7,526 | ) | | (165,387 | ) | ||||||||||||||||||
Total distributions from equity method investees |
(143 | ) | (288 | ) | N/A | (45,616 | ) | (116,404 | ) | (10,874 | ) | (16 | ) | (173,341 | ) | |||||||||||||||||
Mark to fair value - during period (C) |
N/A | (6,411 | ) | (538 | ) | N/A | N/A | N/A | N/A | (6,949 | ) | |||||||||||||||||||||
Translation adjustment |
| 3,377 | 128 | | | | | 3,505 | ||||||||||||||||||||||||
Dispositions |
| | | | | (1,826 | ) | | (1,826 | ) | ||||||||||||||||||||||
Investment, ending |
$ | 1,476 | $ | 663,849 | $ | 8,646 | $ | 49,537 | $ | 229,345 | $ | 122,415 | $ | 6,514 | $ | 1,081,782 | ||||||||||||||||
Ending balance of undistributed earnings |
$ | | $ | 14,406 | N/A | $ | 981 | $ | 9,535 | $ | 3,409 | $ | 1,724 | $ | 30,055 | |||||||||||||||||
(A) | Includes Fortresss direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH. |
(B) | Fortress elected to record these investments, as well as its direct investment in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH, at fair value pursuant to the fair value option for financial instruments. |
(C) | Recorded to Gains (Losses). |
The ownership percentages presented in the following tables are reflective of the ownership interests held as of the end of the respective periods. For tables which include more than one Fortress Fund, the ownership percentages are based on a weighted average by total equity of the funds as of period end. NIH, the Castles, GAGFAH and Other are not presented as they are insignificant to Fortresss investments.
Private Equity Funds excluding NIH | ||||||||
March 31, 2011 |
December 31, 2010 |
|||||||
Assets |
$ | 13,788,995 | $ | 12,490,411 | ||||
Debt |
(232,685 | ) | (145,043 | ) | ||||
Other liabilities |
(197,261 | ) | (197,587 | ) | ||||
Equity |
$ | 13,359,049 | $ | 12,147,781 | ||||
Fortresss Investment (A) |
$ | 663,849 | $ | 611,794 | ||||
Ownership (B) |
5.0 | % | 5.0 | % | ||||
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Revenues and gains (losses) on investments |
$ | 1,306,321 | $ | 301,821 | ||||
Expenses |
(61,001 | ) | (56,796 | ) | ||||
Net Income (Loss) |
$ | 1,245,320 | $ | 245,025 | ||||
Fortresss equity in net income (loss) |
$ | 55,263 | $ | 9,242 | ||||
(A) | Includes Fortresss direct investments in the common stock of publicly traded private equity portfolio companies, primarily GAGFAH. These companies summary financial information is not included in this table. |
(B) | Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates. |
15
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Liquid Hedge Funds | Credit Hedge Funds | Credit PE Funds (B) (C) | ||||||||||||||||||||||
March 31, 2011 |
December 31, 2010 |
March 31, 2011 |
December 31, 2010 |
March 31, 2011 |
December 31, 2010 |
|||||||||||||||||||
Assets |
$ | 5,298,780 | $ | 4,937,105 | $ | 11,661,139 | $ | 12,060,662 | $ | 6,188,626 | $ | 6,593,935 | ||||||||||||
Debt |
| | (3,285,168 | ) | (3,487,573 | ) | (123,060 | ) | (358,095 | ) | ||||||||||||||
Other liabilities |
(1,107,454 | ) | (944,497 | ) | (535,880 | ) | (945,594 | ) | (412,304 | ) | (573,000 | ) | ||||||||||||
Non-controlling interest |
| | (10,978 | ) | (15,647 | ) | (1,671 | ) | (4,945 | ) | ||||||||||||||
Equity |
$ | 4,191,326 | $ | 3,992,608 | $ | 7,829,113 | $ | 7,611,848 | $ | 5,651,591 | $ | 5,657,895 | ||||||||||||
Fortresss Investment |
$ | 49,537 | $ | 16,670 | $ | 229,345 | $ | 238,783 | $ | 122,415 | $ | 125,265 | ||||||||||||
Ownership (A) |
1.2 | % | 0.4 | % | 2.9 | % | 3.1 | % | 2.2 | % | 2.2 | % | ||||||||||||
Three Months Ended March 31, | Three Months Ended March 31, | Three Months Ended March 31, | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
Revenues and gains (losses) on investments |
$ | 141,890 | $ | 128,834 | $ | 397,420 | $ | 425,999 | $ | 407,833 | $ | 436,771 | ||||||||||||
Expenses |
(33,772 | ) | (46,982 | ) | (65,773 | ) | (66,014 | ) | (48,688 | ) | (78,305 | ) | ||||||||||||
Net Income (Loss) |
$ | 108,118 | $ | 81,852 | $ | 331,647 | $ | 359,985 | $ | 359,145 | $ | 358,466 | ||||||||||||
Fortresss equity in net income (loss) |
$ | 1,867 | $ | 266 | $ | 10,978 | $ | 9,334 | $ | 4,505 | $ | (48 | ) | |||||||||||
(A) | Excludes ownership interests held by other Fortress Funds, the Principals, employees and other affiliates. |
(B) | Includes one entity which is recorded on a one quarter lag (i.e., the balances reflected for this entity are for the periods ended December 31, 2010 and 2009, respectively) and several entities which are recorded on a one month lag. They are recorded on a lag because they are foreign entities and do not provide financial reports under U.S. GAAP within the reporting timeframe necessary for U.S. public entities. |
(C) | Includes certain entities in which Fortress has both a direct and an indirect investment. |
Investments in Variable Interest Entities
Fortress is not considered the primary beneficiary of, and, therefore, does not consolidate, any of the variable interest entities in which it holds an interest, except as described below. No reconsideration events occurred during the three months ended March 31, 2011 which caused a change in Fortresss accounting.
The following tables set forth certain information as of March 31, 2011 regarding variable interest entities in which Fortress holds a variable interest. The amounts presented below are included in, and not in addition to, the equity method investment tables above.
Entities formed during the three months ended March 31, 2011:
Fortress is not Primary Beneficiary | ||||||||||||||
Business Segment |
Gross Assets | Financial Obligations (A) | Fortress Investment (B) | Notes | ||||||||||
Credit PE Funds |
$ | 71,921 | $ | 71,167 | $ | 758 | (C) |
(A) | Represents financial obligations at the fund level, which are not recourse to Fortress. Financial obligations include financial borrowings, derivative liabilities and short securities. In many cases, these funds have additional debt within unconsolidated subsidiaries. Of the financial obligations represented herein as of March 31, 2011, $4.0 million represent financial borrowings which have a weighted average maturity of 1 year for the credit PE funds. |
(B) | Represents Fortresss maximum exposure to loss with respect to these entities, which includes direct and indirect investments in these funds. In addition to the table above, Fortress is exposed to potential changes in cash flow and revenues attributable to the management fees and/or incentive income Fortress earns from those entities. |
(C) | Fortress is not the primary beneficiary of these entities, which represent investing vehicles, because the related funds (which are not consolidated) are more closely associated with these entities than Fortress based on both a quantitative and qualitative analysis. The investing vehicles were formed for the sole purpose of acting as investment vehicles for the related funds. |
16
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
All variable interest entities:
Fortress is not Primary Beneficiary | ||||||||||||||||||||||||||||
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||
Business Segment |
Gross Assets | Financial Obligations (A) |
Fortress Investment (B) |
Gross Assets | Financial Obligations (A) |
Fortress Investment (B) |
Notes | |||||||||||||||||||||
Private Equity Funds |
$ | 327,739 | $ | 190,705 | $ | 1,514 | $ | 329,999 | $ | 189,738 | $ | 1,974 | (C) (D) | |||||||||||||||
Castles |
10,813,492 | 10,127,537 | 25,121 | 10,183,554 | 9,944,424 | 19,122 | (C) (D) | |||||||||||||||||||||
Liquid Hedge Funds |
3,514,444 | 772,670 | 2,292 | 3,335,418 | 690,280 | 41,051 | (C) (D) | |||||||||||||||||||||
Credit Hedge Funds |
2,154,898 | 388,807 | 19,697 | 2,287,545 | 410,682 | 41,358 | (C) (D) | |||||||||||||||||||||
Credit PE Funds |
804,197 | 800,010 | 3,069 | 930,513 | 450,530 | 1,962 | (C) (D) |
(A) | Represents financial obligations at the fund level, which are not recourse to Fortress. Financial obligations include financial borrowings, derivative liabilities and short securities. In many cases, these funds have additional debt within unconsolidated subsidiaries. |
(B) | Represents Fortresss maximum exposure to loss with respect to these entities, which includes direct and indirect investments in these funds. In addition to the table above, Fortress is exposed to potential changes in cash flow and revenues attributable to the management fee and/or incentive income Fortress earns from those entities. |
(C) | Fortress is not the primary beneficiary of the Castles and NIH because it does not absorb a majority of their expected income or loss based on a quantitative analysis. Of the remaining entities represented herein, which represent investing vehicles, intermediate entities and master funds, Fortress is not the primary beneficiary because the related funds, intermediate entities and feeder funds (which are not consolidated) are more closely associated with these entities than Fortress based on both a quantitative and qualitative analysis. The investing vehicles, intermediate entities and master funds were formed for the sole purpose of acting as investment vehicles for the related funds. |
(D) | Fortresss investment includes management fees receivable, incentive income receivable, expense reimbursements and other receivables from these entities, as applicable. |
In March 2010, Fortress determined that a reconsideration event had occurred with respect to an operating subsidiary (FCF) of one of its private equity funds. FCF provides operating services to all of Fortresss private equity funds and is reimbursed for related costs by the private equity funds based on a contractual formula. Therefore, FCF by design does not produce net income or have equity. As a result of this reconsideration event, FCF was deemed to be a VIE and Fortress, as a result of directing the operations of FCF through its management contracts with the private equity funds, and providing financial support to FCF, was deemed to be its primary beneficiary. Therefore, Fortress consolidated FCF beginning in March 2010. As of March 31, 2011, FCFs gross assets were approximately $37.4 million, primarily comprised of affiliate receivables. Fortresss exposure to loss from FCF is limited to its unreserved outstanding advances, which were approximately $24.8 million at March 31, 2011, plus any future advances. Subsequent to Fortresss consolidation of FCF, these advances are eliminated in consolidation. FCFs creditors do not have recourse to Fortresss other assets.
In March 2011, Fortress launched a liquid hedge fund and a related onshore feeder fund, which is a VIE. The onshore feeder fund invests substantially all of its equity directly into the liquid hedge fund. Based on a quantitative and qualitative analysis, management has determined that Fortress is currently the entity that is most closely associated with the onshore feeder fund. Therefore, Fortress is the onshore feeder funds primary beneficiary and must consolidate it. As of March 31, 2011, the onshore feeder funds gross assets were approximately $30.9 million. Fortresss exposure to loss from the onshore feeder fund is limited to its investment in the entity, which was approximately $19.6 million at March 31, 2011. As a result of Fortresss consolidation of the onshore feeder fund, Fortresss investment in the entity is eliminated in consolidation. As of March 31, 2011, the onshore feeder fund did not have any outstanding financial obligations. Creditors of the onshore feeder fund do not have recourse to Fortresss other assets.
17
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Fair Value of Financial Instruments
The following table presents information regarding Fortresss financial instruments that are recorded at fair value. Investments denominated in foreign currencies have been translated at the period end exchange rate. Changes in fair value are recorded in Gains (Losses).
Fair Value | Valuation Method | |||||||||
March 31, 2011 | December 31, 2010 | |||||||||
Assets (within Investments) |
||||||||||
Newcastle and Eurocastle common shares |
$ | 6,565 | $ | 7,222 | Level 1 - Quoted prices in active markets for identical assets | |||||
Common stock of publicly traded private equity portfolio companies, primarily GAGFAH |
$ | 48,342 | $ | 51,267 | Level 1 - Quoted prices in active markets for identical assets | |||||
Eurocastle convertible debt (A) |
$ | 2,081 | $ | 1,834 | Level 3 - Binomial lattice-based option valuation models, adjusted for non-option characteristics | |||||
Newcastle and Eurocastle options |
$ | 9,474 | $ | 3,149 | Level 2 - Lattice-based option valuation models using significant observable inputs | |||||
Liabilities (within Other Liabilities) |
||||||||||
Logan Circle Contingent Consideration |
$ | (2,174 | ) | $ | (3,122 | ) | Level 3 - Internal model using significant unobservable inputs | |||
Derivatives |
$ | (3,758 | ) | $ | (2,732 | ) | Level 2 - See below |
(A) | The debt bears interest at 20% per annum and is perpetual, but Eurocastle may redeem the securities after June 2011 at a premium of 20%. As of March 31, 2011, it had a face amount of 1.2 million ($1.7 million) and was convertible into Eurocastle common shares at 0.30 per share. The fair value was determined using the market value approach. |
Fortresss interests in instruments measured at fair value using Level 3 inputs changed during the three months ended March 31, 2011 as follows:
Assets | Liabilities | |||||||
Balance at December 31, 2010 |
$ | 1,834 | $ | (3,122 | ) | |||
Total gains (losses) included in net income (including foreign currency translation) |
247 | 948 | ||||||
Balance at March 31, 2011 |
$ | 2,081 | $ | (2,174 | ) | |||
See Note 4 regarding the fair value of Fortresss outstanding debt.
In March 2011, Newcastle issued 17.3 million shares of its common stock in a public offering at a price to the public of $6.00 per share. For the purposes of compensating Fortress for its successful efforts in raising capital for Newcastle, in connection with this offering, Newcastle granted options to Fortress to purchase 1,725,000 shares of Newcastles common stock at the public offering price, which were valued at approximately $7.0 million. The options were fully vested upon issuance, become exercisable over thirty months and have a 10-year term.
Derivatives
Fortress is exposed to certain risks relating to its ongoing business operations. The primary risk managed by Fortress using derivative instruments is foreign currency risk. Fortress enters into foreign exchange forward contracts and options to economically hedge the risk of fluctuations in foreign exchange rates with respect to certain foreign currency denominated assets. Gains and losses on these contracts are reported currently in Gains (Losses).
Fortresss derivative instruments are carried at fair value and are generally valued using models with observable market inputs that can be verified and which do not involve significant judgment. The significant observable inputs used in determining the fair value of our Level 2 derivative contracts are contractual cash flows and market based parameters such as foreign exchange rates.
18
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Fortresss derivatives (not designated as hedges) are recorded as follows:
Balance Sheet Location (A) |
Fair Value March 31, 2011 |
Notional Amount March 31, 2011 |
Gains/(Losses) Three Months Ended March 31, 2011 |
Maturity Date |
||||||||||||||||
Foreign exchange forward contract |
Other Liabilities | ($ | 4,299 | ) | | 20,000 | ($ | 1,567 | ) | Jun-11 | ||||||||||
Foreign exchange forward contract |
Other Liabilities | $ | 764 | | 20,000 | $ | 764 | Jun-11 | ||||||||||||
Foreign exchange option contract |
Other Liabilities | $ | 1,082 | | 30,000 | ($ | 432 | ) | Feb-12 | |||||||||||
Foreign exchange option contract |
Other Liabilities | ($ | 1,305 | ) | | 30,000 | ($ | 233 | ) | Feb-12 |
(A) | Fortress has a master netting agreement with its counterparty. |
The counterparty on these derivatives is Citibank N.A.
March 31, 2011 | ||||||||||||||||||||||||
Face Amount and | Weighted | Weighted | ||||||||||||||||||||||
Carrying Value | Final | Average | Average | |||||||||||||||||||||
March 31, | December 31, | Contractual | Stated | Funding | Maturity | |||||||||||||||||||
Debt Obligation | 2011 | 2010 | Interest Rate | Maturity | Cost (A) | (Years) | ||||||||||||||||||
Credit agreement (B) |
||||||||||||||||||||||||
Revolving debt (C) |
$ | | $ | | LIBOR + 4.00% (D) | Oct-13 | | | ||||||||||||||||
Term loan |
275,000 | 277,500 | LIBOR + 4.00% (D) | Oct-15 | 5.87 | % | 3.48 | |||||||||||||||||
Total |
$ | 275,000 | $ | 277,500 | 5.87 | % | 3.48 | |||||||||||||||||
(A) | The weighted average funding cost is calculated based on the contractual interest rate (utilizing the most recently reset LIBOR rate or the minimum rate, as applicable) plus the amortization of deferred financing costs. The most recently reset LIBOR rate was below the minimum of 1.75%. |
(B) | Collateralized by substantially all of Fortress Operating Groups assets as well as Fortress Operating Groups rights to fees from the Fortress Funds and its equity interests therein. |
(C) | Approximately $51.4 million was undrawn on the revolving debt facility as of March 31, 2011. The revolving debt facility includes a $25 million letter of credit subfacility of which $8.6 million was utilized. |
(D) | With a minimum LIBOR rate of 1.75% and, in the case of the revolving debt, subject to unused commitment fees of 0.625% per annum. |
To managements knowledge, there have not been any market transactions in Fortresss debt obligations. However, management believes the fair value of this debt was approximately equal to its face amount at March 31, 2011.
Fortress was in compliance with all of its debt covenants as of March 31, 2011. The following table sets forth the financial covenant requirements as of March 31, 2011.
March 31, 2011 (dollars in millions) |
||||||||||||||
Requirement |
Actual | Notes | ||||||||||||
AUM |
³$ |
25,000 | $ | 34,784 | (A | ) | ||||||||
Consolidated Leverage Ratio |
£ |
2.75 | 0.62 | (B | ) | |||||||||
Minimum Investment Assets Ratio |
³ |
2.00 | 3.93 | (C | ) | |||||||||
Consolidated Fixed Charge Coverage Ratio |
³ |
1.75 | 9.53 | (B | ) |
(A) | Impacted by capital raised in funds, redemptions from funds, and valuations of fund investments. The AUM presented here is based on the definition in the credit agreement. |
(B) | Impacted by EBITDA, as defined, which is impacted by the same factors as distributable earnings, except EBITDA is not impacted by changes in clawback reserves or gains and losses, including impairment, on investments. |
(C) | Impacted by capital investments in funds and the valuation of such funds investments. |
19
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
5. INCOME TAXES AND TAX RELATED PAYMENTS
Fortress incurred a loss before income taxes for financial reporting purposes, after deducting the compensation expense arising from the Principals forfeiture agreement. However, this compensation expense is not deductible for income tax purposes. Also, a portion of Fortresss income is not subject to U.S. federal income tax, but is allocated directly to Fortresss shareholders.
Fortress recognizes compensation expense from the issuance of RSUs and RPUs over their vesting period. Consequently, Fortress records an estimated income tax benefit associated with RSUs and RPUs. However, Fortress is not entitled to an actual deduction on its income tax returns until a later date when the compensation is considered taxable to the employee. The actual income tax deduction can vary significantly from the amount recorded as an income tax benefit in earlier periods and is based on the value of the stock at the date the compensation is taxable to the employee.
At each tax deduction date, Fortress is required to compare the amount of the actual income tax benefit to the estimated amount recognized earlier. If the actual tax benefit is less than that estimated, which will occur if the price of the stock has declined during the vesting period, Fortress has a tax shortfall. The tax shortfall must be charged to income tax expense to the extent Fortress does not have prior excess tax benefits (i.e., prior actual tax benefits associated with RSUs and RPUs that were greater than the estimated benefits).
Based on the value of the RSUs and RPUs which vested during the three months ended March 31, 2011, Fortress has estimated an $18 million tax shortfall which was charged to income tax expense during the first quarter.
The provision for income taxes consists of the following:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Current |
||||||||
Federal income tax expense (benefit) |
$ | 5,270 | $ | 81 | ||||
Foreign income tax expense (benefit) |
3,004 | 587 | ||||||
State and local income tax expense (benefit) |
2,236 | 1,610 | ||||||
10,510 | 2,278 | |||||||
Deferred |
||||||||
Federal income tax expense (benefit) |
8,290 | (1,069 | ) | |||||
Foreign income tax expense (benefit) |
5 | 3 | ||||||
State and local income tax expense (benefit) |
2,614 | 340 | ||||||
10,909 | (726 | ) | ||||||
Total expense (benefit) |
$ | 21,419 | $ | 1,552 | ||||
The tax effects of temporary differences have resulted in deferred income tax assets and liabilities as follows:
March 31, 2011 | December 31, 2010 | |||||||
Total deferred tax assets |
$ | 505,808 | $ | 512,201 | ||||
Valuation allowance |
(94,421 | ) | (96,211 | ) | ||||
Net deferred tax assets |
$ | 411,387 | $ | 415,990 | ||||
Total deferred tax liabilities (A) |
$ | 503 | $ | 495 | ||||
(A) | Included in Other Liabilities |
For the three months ended March 31, 2011, a deferred income tax benefit of $0.2 million was credited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $0.5 million was credited to paid-in capital, related to (i) dividend equivalent payments on RSUs and RPUs (Note 8), as applicable, and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 8), which are currently deductible for income tax purposes.
20
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
FIG Corp increased its ownership in the underlying Fortress Operating Group entities during the three months ended March 31, 2011 through (i) the exchanges by one senior employee of Fortress Operating Group units and Class B shares for Class A shares (as described in Note 8), and (ii) the delivery of vested RSUs and RPUs (Note 8). As a result of this increased ownership, the deferred tax asset was increased by $2.1 million with an offsetting increase of $0.8 million to the valuation allowance. In addition, the deferred tax asset was increased by $5.3 million with an offsetting increase of $0.3 million to the valuation allowance related to a step-up in tax basis due to the share exchange which will result in additional tax deductions. The establishment of these net deferred tax assets also increased additional paid-in capital.
Tax Receivable Agreement
Although the tax receivable agreement payments are calculated based on annual tax savings, for the three months ended March 31, 2011, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $4.6 million. During the three months ended March 31, 2011, $13.5 million was paid under the tax receivable agreement relating to 2009.
6. RELATED PARTY TRANSACTIONS AND INTERESTS IN CONSOLIDATED SUBSIDIARIES
Affiliate Receivables and Payables
Due from affiliates was comprised of the following:
Private Equity | Credit | |||||||||||||||||||||||||||
Funds | Castles | Liquid Hedge Funds |
Hedge Funds | PE Funds |
Other | Total | ||||||||||||||||||||||
March 31, 2011 |
||||||||||||||||||||||||||||
Management fees and incentive income (A) |
$ | 79,366 | $ | 3,916 | $ | 1,676 | $ | 26,978 | $ | 12,659 | $ | | $ | 124,595 | ||||||||||||||
Expense reimbursements (A) |
1,589 | 3,085 | 3,994 | 5,403 | 3,661 | | 17,732 | |||||||||||||||||||||
Expense reimbursements - FCF (A)(B) |
29,530 | | | | | | 29,530 | |||||||||||||||||||||
Dividends and distributions |
806 | | | | | | 806 | |||||||||||||||||||||
Other |
8 | 652 | 13,219 | | 1,246 | 3,054 | 18,179 | |||||||||||||||||||||
Total |
$ | 111,299 | $ | 7,653 | $ | 18,889 | $ | 32,381 | $ | 17,566 | $ | 3,054 | $ | 190,842 | ||||||||||||||
Private Equity | Credit | |||||||||||||||||||||||||||
Funds | Castles | Liquid Hedge Funds |
Hedge Funds | PE Funds |
Other | Total | ||||||||||||||||||||||
December 31, 2010 |
||||||||||||||||||||||||||||
Management fees and incentive income (A) |
$ | 53,282 | $ | 3,836 | $ | 45,591 | $ | 110,952 | $ | 15,508 | $ | | $ | 229,169 | ||||||||||||||
Expense reimbursements (A) |
1,170 | 3,081 | 2,052 | 4,034 | 3,949 | 4 | 14,290 | |||||||||||||||||||||
Expense reimbursements - FCF (B) |
42,385 | | | | | | 42,385 | |||||||||||||||||||||
Dividends and distributions |
762 | | | | | | 762 | |||||||||||||||||||||
Other |
3 | 521 | 13,219 | | 1 | 2,693 | 16,437 | |||||||||||||||||||||
Total |
$ | 97,602 | $ | 7,438 | $ | 60,862 | $ | 114,986 | $ | 19,458 | $ | 2,697 | $ | 303,043 | ||||||||||||||
(A) | Net of allowances for uncollectable management fees and expense reimbursements of $11.7 million and $4.9 million at March 31, 2011, respectively, and of $11.6 million and $1.5 million as of December 31, 2010, respectively. Allowances are recorded as General and Administrative expenses. |
(B) | Represents expense reimbursements due to FCF, a consolidated VIE (Note 3). |
As of March 31, 2011, amounts due from Fortress Funds recorded in Due from Affiliates included $73.7 million of past due management fees, excluding $11.7 million which has been fully reserved by Fortress, and $25.9 million of private equity general and administrative expenses advanced on behalf of certain Fortress Funds. Although such funds are currently experiencing liquidity issues, Fortress believes the unreserved portion of these fees will ultimately be collectable since the NAVs of the respective funds exceed the amounts owed.
21
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Due to affiliates was comprised of the following:
March 31, 2011 | December 31, 2010 | |||||||
Principals - Tax receivable agreement - Note 5 |
$ | 282,092 | $ | 295,541 | ||||
Distributions payable on Fortress Operating Group units |
16,345 | 42,900 | ||||||
Other |
5,666 | 3,956 | ||||||
$ | 304,103 | $ | 342,397 | |||||
Other Related Party Transactions
For the three months ended March 31, 2011 and 2010, Other Revenues included approximately $1.0 million and $2.1 million, respectively, of revenues from affiliates, primarily dividends.
Fortress has entered into cost sharing arrangements with the Fortress Funds, including market data services and subleases of certain of its office space. Expenses borne by the Fortress Funds under these agreements are generally paid directly by those entities (i.e. they are generally not paid by Fortress and reimbursed). For the three months ended March 31, 2011 and 2010, these expenses approximated $0.5 million and $3.6 million, respectively.
In February 2011, Fortress made $1.3 million of advances to senior employees (not officers) in connection with their investments in one of the Fortress Funds. These advances bear interest generally at LIBOR+4% and are due upon the maturity of the fund or, at Fortresss option, upon the termination of employment.
In February 2011, Fortress made a $9.5 million advance to a senior employee (not an officer) in connection with his investments in Fortress Funds. This advance bore interest generally at LIBOR+4% and was repaid in March 2011.
Principals and Others Interests in Consolidated Subsidiaries
These amounts relate to equity interests in Fortresss consolidated, but not wholly owned, subsidiaries, which are held by the Principals, employees and others.
This balance sheet caption was comprised of the following:
March 31, 2011 | December 31, 2010 | |||||||
Fortress Operating Group units held by the Principals and one senior employee |
$ | 477,558 | $ | 458,842 | ||||
Employee interests in majority owned and controlled fund advisor and general partner entities |
88,784 | 57,609 | ||||||
Other |
2,682 | 1,500 | ||||||
Total |
$ | 569,024 | $ | 517,951 | ||||
This statement of operations caption was comprised of shares of consolidated net income (loss) related to the following, on a pre-tax basis:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Fortress Operating Group units held by the Principals and one senior employee |
$ | (154,328 | ) | $ | (180,123 | ) | ||
Employee interests in majority owned and controlled fund advisor and general partner entities |
2,578 | 2,654 | ||||||
Other |
(12 | ) | 288 | |||||
Total |
$ | (151,762 | ) | $ | (177,181 | ) | ||
22
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
The purpose of this schedule is to disclose the effects of changes in Fortresss ownership interest in Fortress Operating Group on Fortresss equity:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Net income (loss) attributable to Fortress |
$ | (103,432 | ) | $ | (84,151 | ) | ||
Transfers (to) from the Principals and Others Interests: |
||||||||
Increase in Fortresss shareholders equity for the conversion of Fortress Operating Group units by the Principals and one senior employee |
3,845 | | ||||||
Increase in Fortresss shareholders equity for the delivery of Class A shares primarily in connection with vested RSUs and RPUs |
1,016 | 3,433 | ||||||
Decrease in Fortresss shareholders equity for the purchase of Fortress Operating Group units in connection with an equity offering |
| | ||||||
Change from net income (loss) attributable to Fortress and transfers (to) from Principals and Others Interests |
$ | (98,571 | ) | $ | (80,718 | ) | ||
23
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
7. EQUITY-BASED AND OTHER COMPENSATION
Fortresss total compensation and benefits expense, excluding Principals Agreement compensation, is comprised of the following:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Equity-based compensation, per below |
$ | 64,330 | $ | 63,806 | ||||
Profit-sharing expense, per below |
58,656 | 50,414 | ||||||
Discretionary bonuses |
50,082 | 34,359 | ||||||
Other payroll, taxes and benefits |
42,367 | 30,814 | ||||||
$ | 215,435 | $ | 179,393 | |||||
Equity-Based Compensation
The following tables set forth information regarding equity-based compensation activities.
RSUs | Restricted Shares Issued to Directors |
RPUs | ||||||||||||||||||||||||||||||
Employees | Non-Employees | Employees | ||||||||||||||||||||||||||||||
Number | Value (A) | Number | Value (A) | Number | Value (A) | Number | Value (A) | |||||||||||||||||||||||||
Outstanding as of December 31, 2010 |
44,289,586 | $ | 11.63 | 1,196,943 | $ | 11.11 | 426,669 | $ | 6.58 | 31,000,000 | $ | 13.75 | ||||||||||||||||||||
Issued |
5,169,104 | 5.65 | | | 26,351 | 5.76 | | | ||||||||||||||||||||||||
Converted to Class A shares |
(3,250,051 | ) | 17.88 | | | | | (4,749,434 | ) | 13.75 | ||||||||||||||||||||||
Converted to Class B shares |
| | | | | | (5,583,899 | ) | 13.75 | |||||||||||||||||||||||
Forfeited |
(492,660 | ) | 14.25 | | | | | | | |||||||||||||||||||||||
Outstanding as of March 31, 2011 (B) |
45,715,979 | $ | 10.48 | 1,196,943 | $ | 11.11 | 453,020 | $ | 6.53 | 20,666,667 | $ | 13.75 | ||||||||||||||||||||
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Expense incurred (B) |
||||||||
Employee RSUs |
$ | 41,467 | $ | 38,453 | ||||
Non-Employee RSUs |
386 | 1,250 | ||||||
Restricted Shares |
160 | 90 | ||||||
LTIP |
| 1,696 | ||||||
RPUs |
22,317 | 22,317 | ||||||
Total equity-based compensation expense |
$ | 64,330 | $ | 63,806 | ||||
(A) | Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of March 31, 2011 for awards granted to non-employees was $5.68, which is equal to the closing trading price per share of Fortresss Class A shares on such date. |
(B) | In future periods, Fortress will recognize compensation expense on its non-vested equity based awards outstanding as of March 31, 2011 of $393 million, with a weighted average recognition period of 2.16 years. This does not include contingent amounts or amounts related to the Principals Agreement. |
When Fortress records equity-based compensation expense, including that related to the Principals Agreement, it records a corresponding increase in capital.
In April 2010, in connection with the acquisition of Logan Circle, Fortress created the Logan Circle Comp Plan. The Logan Circle Comp Plan provides for annual bonuses to a senior employee which may be paid partially in RSUs, as well as for potential Class A share awards to certain employees, including this senior employee, in the years 2015, 2016 and 2017. $0.1 million of equity-based compensation expense relating to the Logan Circle Comp Plan has been recorded during the three months ended March 31, 2011.
24
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
In January 2011, Fortress granted 5.2 million RSUs to its employees and affiliates valued at an aggregate of $29.2 million on the grant date. These RSUs generally vest over two and a half years.
In April 2011, one of the Principals entered into an agreement with a senior employee whereby such employee will receive 2,857,143 Fortress Operating Group units from such Principal if the employee remains with Fortress until January 2012. As a result of the service requirement, the fair value of these units of $15.9 million will be charged to compensation expense in 2011.
Profit Sharing Expense
Recognized profit sharing compensation expense is summarized as follows:
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Private equity funds |
$ | 491 | $ | | ||||
Castles |
| | ||||||
Liquid hedge funds |
11,904 | 3,026 | ||||||
Credit hedge funds |
18,386 | 4,145 | ||||||
Credit PE funds |
27,875 | 43,243 | ||||||
Total |
$ | 58,656 | $ | 50,414 | ||||
25
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
8. EARNINGS PER SHARE AND DISTRIBUTIONS
The computations of basic and diluted net income (loss) per Class A share are set forth below:
Three Months Ended March 31, 2011 | ||||||||
Basic | Diluted | |||||||
Weighted average shares outstanding |
||||||||
Class A shares outstanding |
171,287,024 | 171,287,024 | ||||||
Fully vested restricted Class A share units with dividend equivalent rights |
9,481,968 | 9,481,968 | ||||||
Fully vested restricted Class A shares |
250,509 | 250,509 | ||||||
Fortress Operating Group units exchangeable into Class A shares (1) |
| | ||||||
Class A restricted shares and Class A restricted share units granted to employees and directors (eligible for dividend and dividend equivalent payments) (2) |
| | ||||||
Class A restricted share units granted to employees (not eligible for dividend and dividend equivalent payments) (3) |
| | ||||||
Total weighted average shares outstanding |
181,019,501 | 181,019,501 | ||||||
Basic and diluted net income (loss) per Class A share |
||||||||
Net income (loss) attributable to Class A shareholders |
$ | (103,432 | ) | $ | (103,432 | ) | ||
Dilution in earnings due to RPUs treated as a participating security of Fortress Operating Group and fully vested restricted Class A share units with dividend equivalent rights treated as outstanding Fortress Operating Group units (4) |
(1,970 | ) | (1,970 | ) | ||||
Dividend equivalents declared on non-vested restricted Class A shares and restricted Class A share units |
| | ||||||
Add back Principals and others interests in loss of Fortress Operating Group, net of assumed corporate income taxes at enacted rates, attributable to Fortress Operating Group units exchangeable into Class A shares (1) |
| | ||||||
Net income (loss) available to Class A shareholders |
$ | (105,402 | ) | $ | (105,402 | ) | ||
Weighted average shares outstanding |
181,019,501 | 181,019,501 | ||||||
Basic and diluted net income (loss) per Class A share |
$ | (0.58 | ) | $ | (0.58 | ) | ||
Three Months Ended March 31, 2010 | ||||||||
Basic | Diluted | |||||||
Weighted average shares outstanding |
||||||||
Class A shares outstanding |
146,073,810 | 146,073,810 | ||||||
Fully vested restricted Class A share units with dividend equivalent rights |
11,606,613 | 11,606,613 | ||||||
Fully vested restricted Class A shares |
141,472 | 141,472 | ||||||
Fortress Operating Group units exchangeable into Class A shares (1) |
| 307,773,852 | ||||||
Class A restricted shares and Class A restricted share units granted to employees and directors (eligible for dividend and dividend equivalent payments) (2) |
| | ||||||
Class A restricted share units granted to employees (not eligible for dividend and dividend equivalent payments) (3) |
| | ||||||
Total weighted average shares outstanding |
157,821,895 | 465,595,747 | ||||||
Basic and diluted net income (loss) per Class A share |
||||||||
Net income (loss) attributable to Class A shareholders |
$ | (84,151 | ) | $ | (84,151 | ) | ||
Dilution in earnings due to RPUs treated as a participating security of Fortress Operating Group and fully vested restricted Class A share units with dividend equivalent rights treated as outstanding Fortress Operating Group units (4) |
(4,934 | ) | (4,934 | ) | ||||
Dividend equivalents declared on non-vested restricted Class A shares and restricted Class A share units |
| | ||||||
Add back Principals and others interests in loss of Fortress Operating Group, net of assumed corporate income taxes at enacted rates, attributable to Fortress Operating Group units exchangeable into Class A shares (1) |
| (180,051 | ) | |||||
Net income (loss) available to Class A shareholders |
$ | (89,085 | ) | $ | (269,136 | ) | ||
Weighted average shares outstanding |
157,821,895 | 465,595,747 | ||||||
Basic and diluted net income (loss) per Class A share |
$ | (0.56 | ) | $ | (0.58 | ) | ||
26
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
(1) | The Fortress Operating Group units not held by Fortress (that is, those held by the Principals and one senior employee) are exchangeable into Class A shares on a one-to-one basis. These units are not included in the computation of basic earnings per share. These units enter into the computation of diluted net income (loss) per Class A share when the effect is dilutive using the if-converted method. To the extent charges, particularly tax related charges, are incurred by the Registrant (i.e. not at the Fortress Operating Group level), the effect may be anti-dilutive. |
(2) | Restricted Class A shares granted to directors and certain restricted Class A share units granted to employees are eligible to receive dividend or dividend equivalent payments when dividends are declared and paid on Fortresss Class A shares and therefore participate fully in the results of Fortresss operations from the date they are granted. They are included in the computation of both basic and diluted earnings per Class A share using the two-class method for participating securities, except during periods of net losses. |
(3) | Certain restricted Class A share units granted to employees are not entitled to dividend or dividend equivalent payments until they are vested and are therefore non-participating securities. These units are not included in the computation of basic earnings per share. They are included in the computation of diluted earnings per share when the effect is dilutive using the treasury stock method. As a result of the net losses incurred in the periods presented, the effect of the units on the calculation is anti-dilutive for each of the periods. The weighted average restricted Class A share units which are not entitled to receive dividend or dividend equivalent payments outstanding were: |
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Share Units |
25,501,235 | 27,632,927 |
(4) | Fortress Operating Group RPUs are eligible to receive partnership distribution equivalent payments when distributions are declared and paid on Fortress Operating Group units. The RPUs represent a participating security of Fortress Operating Group and the resulting dilution in Fortress Operating Group earnings available to Fortress is reflected in the computation of both basic and diluted earnings per Class A share using the method prescribed for securities issued by a subsidiary. For purposes of the computation of basic and diluted earnings per Class A share, the fully vested restricted Class A share units with dividend equivalent rights are treated as outstanding Class A shares of Fortress and as outstanding partnership units of Fortress Operating Group. |
The Class B shares have no net income (loss) per share as they do not participate in Fortresss 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.
Fortresss dividend paying shares and units were as follows:
Weighted Average | ||||||||
Three Months Ended March 31, | ||||||||
2011 | 2010 | |||||||
Class A shares (public shareholders) |
171,287,024 | 146,073,810 | ||||||
Restricted Class A shares (directors) |
452,434 | 231,292 | ||||||
Restricted Class A share units (employees) (A) |
9,481,968 | 11,606,613 | ||||||
Restricted Class A share units (employees) (B) |
14,281,131 | 19,651,275 | ||||||
Fortress Operating Group units (Principals and one senior employee) |
301,700,848 | 307,773,852 | ||||||
Fortress Operating Group RPUs (one senior employee) |
28,359,260 | 31,000,000 | ||||||
Total |
525,562,665 | 516,336,842 | ||||||
As of March 31, 2011 | As of December 31, 2010 | |||||||
Class A shares (public shareholders) |
177,109,784 | 169,110,299 | ||||||
Restricted Class A shares (directors) |
453,020 | 426,669 | ||||||
Restricted Class A share units (employees) (A) |
7,380,075 | 1,058,331 | ||||||
Restricted Class A share units (employees) (B) |
14,022,083 | 19,257,978 | ||||||
Fortress Operating Group units (Principals and one senior employee) |
305,857,751 | 300,273,852 | ||||||
Fortress Operating Group RPUs (one senior employee) |
20,666,667 | 31,000,000 | ||||||
Total |
525,489,380 | 521,127,129 | ||||||
(A) | Represents fully vested restricted Class A share units which are entitled to dividend equivalent payments. |
(B) | Represents nonvested restricted Class A share units which are entitled to dividend equivalent payments. |
In January 2011, 10.0 million existing RSUs and 10.3 million existing RPUs vested and the related Class A and Class B shares, as applicable, were delivered, or, in the case of certain RSUs, are expected to be delivered within six months of vesting pursuant to the plan documents. In March 2011, one senior employee exchanged an aggregate of 4,749,434 FOG units and Class B shares for an equal number of Class A shares. A portion of the vested shares are being sold to cover withholding tax requirements.
27
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Dividends and distributions during the three months ended March 31, 2011 are summarized as follows:
Declared in Prior Year, Paid Current Year (C) |
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 and one senior employee) (B) |
38,886 | | 11,958 | 11,958 | ||||||||||||
Distributions to Fortress Operating Group RPU holders (Note 7) (B) |
4,014 | | 919 | 919 | ||||||||||||
Total distributions |
$ | 42,900 | $ | | $ | 12,877 | $ | 12,877 | ||||||||
(A) | A portion of these dividend equivalents, if any, related to RSUs expected to be forfeited, is included as compensation expense in the consolidated statement of operations and is therefore considered an operating cash flow. |
(B) | Fortress Operating Group made tax-related distributions to the FOGU holders (the Principals and one senior employee) and the RPU holder (one senior employee). |
(C) | Of this amount, $3.5 million was paid subsequent to March 31, 2011. |
The following table summarizes our comprehensive income (loss) (net of taxes) for the three months ended March 31, 2010:
Impact to Total Fortress Shareholders Equity |
Impact to Principals and Others Interests in Equity of Consolidated Subsidiaries |
Impact to Total Equity |
||||||||||
Net income (loss) |
$ | (84,151 | ) | $ | (177,181 | ) | $ | (261,332 | ) | |||
Foreign currency translation |
(144 | ) | (534 | ) | (678 | ) | ||||||
Comprehensive income (loss) from equity method investees |
(166 | ) | (545 | ) | (711 | ) | ||||||
Total comprehensive income (loss) |
$ | (84,461 | ) | $ | (178,260 | ) | $ | (262,721 | ) | |||
9. COMMITMENTS AND CONTINGENCIES
Other than as described below, Fortresss commitments and contingencies remain materially unchanged from December 31, 2010.
General Partner Liability Certain of Fortress consolidated subsidiaries act as the general partner of various Fortress Funds and accordingly have potentially unlimited liability for the obligations of the funds under applicable partnership law principles. In the event that any such fund was to fall into a negative net equity position, the full amount of the negative net equity would be recorded on the balance sheet of the general partner entity. Such amount would be recorded on the Fortress balance sheet in consolidation until it is legally resolved. While these entities are limited liability companies and generally have no material assets other than their general partner interests, these entities and Fortress may be subject to litigation in connection with such amounts if fund creditors choose to sue Fortress to seek repayment. See Litigation below.
In March 2011, one private equity fund fell into a $7.6 million negative equity position, after considering all of Fortresss interests in such fund and its reserves related thereto. As described above, the amount of the negative equity was recorded, through earnings (losses) from equity method investees, by the general partner entity and is therefore included in the consolidated financial statements of Fortress. When the fund matures and is liquidated, Fortress will record a gain in the event and to the extent it does not fund this negative equity.
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 March 31, 2011, if any, will not materially affect Fortresss results of operations, liquidity or financial position.
Private Equity Fund and Credit PE Fund Capital Commitments Fortress has remaining capital commitments to certain of the Fortress Funds which aggregated $102.1 million as of March 31, 2011. These commitments can be drawn by the funds on demand.
28
FORTRESS INVESTMENT GROUP LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2011
(dollars in tables in thousands, except share data)
Minimum Future Rentals Fortress is a lessee under a number of operating leases for office space.
Minimum future rent payments under these leases are as follows:
April 1 to December 31, 2011 |
$ | 15,779 | ||
2012 |
19,956 | |||
2013 |
18,952 | |||
2014 |
18,160 | |||
2015 |
16,563 | |||
2016 |
14,808 | |||
Thereafter |
1,634 | |||
Total |
$ | 105,852 | ||
Rent expense recognized on a straight-line basis during the three months ended March 31, 2011 and 2010 was $7.6 million and $5.0 million, respectively, and was included in General, Administrative and Other Expense.
Fortress conducts its management and investment business through the following primary segments: (i) private equity funds, (ii) Castles, (iii) liquid hedge funds, (iv) credit hedge funds, (v) credit private equity (PE) funds, and (vi) principal investments in these funds as well as cash that is available to be invested. Logan Circle (Note 2) is initially being reported in the unallocated section of Fortresss segments until such time as it becomes material to Fortresss operations.
Distributable earnings is a measure of operating performance used by management in analyzing its segment and overall results. For the existing Fortress businesses it is equal to net income (loss) attributable to Fortresss Class A shareholders adjusted as follows:
Incentive Income
(i) a. | for Fortress Funds which are private equity funds and credit PE funds, adding (a) incentive income paid (or declared as a distribution) to Fortress, less an applicable reserve for potential future clawbacks if the likelihood of a clawback is deemed greater than remote by Fortresss chief operating decision maker (net of the reversal of any prior such reserves that are no longer deemed necessary), minus (b) incentive income recorded in accordance with GAAP, |