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Fortress Investment Group 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

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

For the quarterly period ended June 30, 2008

or

 

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

For the transition period from              to             

Commission File Number: 001-33294

Fortress Investment Group LLC

(Exact name of registrant as specified in its charter)

 

Delaware   20-5837959

(State or other jurisdiction of incorporation

or organization)

  (I.R.S. Employer Identification No.)
1345 Avenue of the Americas, New York, NY   10105
(Address of principal executive offices)   (Zip Code)

(212) 798-6100

(Registrant’s telephone number, including area code)

  

 

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant 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  ¨    Non-accelerated filer  x (Do not check if a smaller reporting company)

 Smaller reporting company  ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date.

Class A Shares: 94,609,525 outstanding as of August 8, 2008.

Class B Shares: 312,071,550 outstanding as of August 8, 2008.

 

 

 


Table of Contents

FORTRESS INVESTMENT GROUP LLC

FORM 10-Q

INDEX

 

           PAGE
   PART I. FINANCIAL INFORMATION   

Item 1.

  

Financial Statements

  
  

Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December 31, 2007

   1
  

The following statements are presented on a combined basis prior to the date of Fortress’s reorganization (Note 1) on January 17, 2007 and consolidated thereafter:

  
  

Statements of Operations (unaudited) for the three and six months ended June 30, 2008 and 2007

   2
  

Statement of Shareholders’ Equity (unaudited) for the six months ended June 30, 2008

   3
  

Statements of Cash Flows (unaudited) for the six months ended June 30, 2008 and 2007

   4
  

Notes to Consolidated and Combined Financial Statements (unaudited)

   5

Item 2.

  

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

   36

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   62

Item 4.

  

Controls and Procedures

   65
   PART II. OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   65

Item 1A.

  

Risk Factors

   66

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   90

Item 3.

  

Defaults upon Senior Securities

   90

Item 4.

  

Submission of Matters to a Vote of Security Holders

   90

Item 5.

  

Other Information

   90

Item 6.

  

Exhibits

   91

SIGNATURES

   92


Table of Contents

DEFINED TERMS

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

 

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

 

  (iii) the net asset value, or “NAV,” of our hedge funds; 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, (i) following the consummation of the reorganization and the Nomura transaction on January 17, 2007, collectively, to Fortress Investment Group LLC and its subsidiaries, including the Fortress Operating Group and all of its subsidiaries, and, (ii) prior to the consummation of the reorganization and the Nomura transaction on January 17, 2007, to the Fortress Operating Group and all of its subsidiaries, in each case not including funds that, prior to March 31, 2007, were consolidated funds, except with respect to our historical financial statements and discussion thereof unless otherwise specified. Effective March 31, 2007, all of our previously consolidated funds were deconsolidated. The financial statements contained herein represent consolidated financial statements of Fortress Investment Group LLC subsequent to the reorganization and combined financial statements of Fortress Operating Group, considered the predecessor, prior to the reorganization. See Part I, Item 1, “Financial Statements.”

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

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

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part I, Item 3, “Quantitative and Qualitative Disclosures About Market Risk,” Part II, Item 1A, “Risk Factors,” 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. 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.


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

      June 30,
2008
    December 31,
2007
 
     (Unaudited)        

Assets

    

Cash and cash equivalents

   $ 255,155     $ 100,409  

Due from affiliates

     141,765       198,669  

Investments

    

Equity method investees

     961,123       1,091,918  

Options in affiliates

     871       16,001  

Deferred tax asset

     512,237       511,204  

Other assets

     72,684       71,580  
                
   $ 1,943,835     $ 1,989,781  
                

Liabilities and Shareholders’ Equity

    

Liabilities

    

Accrued compensation and benefits

   $ 126,040     $ 269,324  

Due to affiliates

     464,709       455,734  

Dividends payable

     21,286       21,285  

Deferred incentive income

     164,144       173,561  

Debt obligations payable

     800,000       535,000  

Other liabilities

     40,239       36,729  
                
     1,616,418       1,491,633  
                

Commitments and Contingencies

    

Principals’ and Others’ Interests in Equity of Consolidated Subsidiaries

     173,104       308,023  

Shareholders’ Equity

    

Class A shares, no par value, 1,000,000,000 shares authorized, 94,604,806 and 94,597,646 shares issued and outstanding at June 30, 2008 and December 31, 2007, respectively

     —         —    

Class B shares, no par value, 750,000,000 shares authorized, 312,071,550 shares issued and outstanding

     —         —    

Paid-in capital

     469,319       384,700  

Retained earnings (accumulated deficit)

     (315,564 )     (193,200 )

Accumulated other comprehensive income (loss)

     558       (1,375 )
                
     154,313       190,125  
                
   $ 1,943,835     $ 1,989,781  
                

See notes to consolidated and combined financial statements

 

1


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS (Unaudited)

(dollars in thousands, except share data)

 

      Three Months Ended June 30,     Six Months Ended June 30,  
     2008     2007     2008     2007  

Revenues

        

Management fees from affiliates

   $ 149,605     $ 118,678     $ 293,662     $ 161,965  

Incentive income from affiliates

     18,300       132,961       55,444       177,189  

Other revenues (affiliate portion disclosed in Note 6)

     20,191       16,480       39,870       36,265  

Interest and dividend income - investment company holdings

        

Interest income

     —         —         —         243,713  

Interest income from controlled affiliate investments

     —         —         —         4,707  

Dividend income

     —         —         —         7,436  

Dividend income from controlled affiliate investments

     —         —         —         53,174  
                                
     188,096       268,119       388,976       684,449  
                                

Expenses

        

Interest expense

        

Investment company holdings

     —         —         —         132,620  

Other

     9,888       6,711       20,224       18,731  

Compensation and benefits

     137,460       187,783       264,479       405,300  

Principals agreement compensation

     237,367       242,659       474,734       380,933  

General, administrative and other

     19,746       23,603       36,316       62,908  

Depreciation and amortization

     2,436       2,184       4,872       4,193  
                                
     406,897       462,940       800,625       1,004,685  
                                

Other Income (Loss)

        

Gains (losses) from investments

        

Investment company holdings

        

Net realized gains (losses)

     —         —         —         86,264  

Net realized gains (losses) from controlled affiliate investments

     —         —         —         715,024  

Net unrealized gains (losses)

     —         —         —         (19,928 )

Net unrealized gains (losses) from controlled affiliate investments

     —         —         —         (1,428,837 )

Other investments

        

Net realized gains (losses)

     61       (1,735 )     1,674       54  

Net realized gains (losses) from affiliate investments

     (92 )     9,452       155       145,493  

Net unrealized gains (losses)

     —         (396 )     —         (677 )

Net unrealized gains (losses) from affiliate investments

     (6,584 )     (36,338 )     (36,401 )     (167,166 )

Earnings (losses) from equity method investees

     (26,500 )     7,231       (75,629 )     7,427  
                                
     (33,115 )     (21,786 )     (110,201 )     (662,346 )
                                

Income (Loss) Before Deferred Incentive Income, Principals’ and Others’ Interests in Income of Consolidated Subsidiaries and Income Taxes

     (251,916 )     (216,607 )     (521,850 )     (982,582 )

Deferred incentive income

     —         —         —         307,034  

Principals’ and others’ interests in (income) loss of consolidated subsidiaries

     194,411       166,485       402,680       702,016  
                                

Income (Loss) Before Income Taxes

     (57,505 )     (50,122 )     (119,170 )     26,468  

Income tax benefit (expense)

     1,949       (5,009 )     (5,303 )     (19,456 )
                                

Net Income (Loss)

   $ (55,556 )   $ (55,131 )   $ (124,473 )   $ 7,012  
                                

Dividends declared per Class A share

   $ 0.2250     $ 0.2250     $ 0.4500     $ 0.3924  
                                

Earnings Per Unit - Fortress Operating Group

                     January 1
through
January 16
 
        

Net income per Fortress Operating Group unit

         $ 0.36  
              

Weighted average number of Fortress Operating Group units outstanding

           367,143,000  
              
        
Earnings Per Class A share - Fortress Investment Group                      January 17
through June 30
 

Net income (loss) per Class A share, basic

   $ (0.62 )   $ (0.59 )   $ (1.36 )   $ (1.43 )
                                

Net income (loss) per Class A share, diluted

   $ (0.67 )   $ (0.66 )   $ (1.37 )   $ (1.43 )
                                

Weighted average number of Class A shares outstanding, basic

     94,913,677       94,894,636       94,904,157       89,226,434  
                                

Weighted average number of Class A shares outstanding, diluted

     406,985,227       406,966,186       406,975,707       89,226,434  
                                

See notes to consolidated and combined financial statements

 

2


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

CONSOLIDATED AND COMBINED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

FOR THE SIX MONTHS ENDED JUNE 30, 2008

(dollars in thousands)

 

      Class A Shares    Class B Shares    Paid-In Capital     Retained
Earnings
(Accumulated
Deficit)
    Accumulated Other
Comprehensive
Income (Loss)
    Total Shareholders’
Equity
 

Shareholders’ Equity - December 31, 2007

   94,597,646    312,071,550    $ 384,700     $ (193,200 )   $ (1,375 )   $ 190,125  

Director restricted share grant

   7,160    —        164       —         —         164  

Dividends declared

   —      —        (42,572 )     —         —         (42,572 )

Capital increase related to equity-based compensation

   —      —        129,286       —         —         129,286  

Dividend and distribution equivalents accrued in connection with equity-based compensation (net of tax)

   —      —        (2,259 )     —         —         (2,259 )

Cumulative effect adjustment - adoption of SFAS 159 (Note 3)

   —      —        —         2,109       1,212       3,321  

Comprehensive income (loss) (net of tax)

              

Net income (loss)

   —      —        —         (124,473 )     —         (124,473 )

Foreign currency translation

   —      —        —         —         95       95  

Comprehensive income (loss) from equity method investees

   —      —        —         —         274       274  

Allocation to Principals’ and others’ interests in equity of consolidated subsidiaries

   —      —        —         —         352       352  
                    

Total comprehensive income (loss)

                 (123,752 )
                                          

Shareholders’ Equity - June 30, 2008

   94,604,806    312,071,550    $ 469,319     $ (315,564 )   $ 558     $ 154,313  
                                          

See notes to consolidated and combined financial statements

 

3


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

CONSOLIDATED AND COMBINED STATEMENT OF CASH FLOWS (Unaudited)

(dollars in thousands)

 

      Six Months Ended June 30,  
       2008       2007  

Cash Flows From Operating Activities

    

Net income (loss)

   $ (124,473 )   $ 7,012  

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

    

Depreciation and amortization

     4,872       4,193  

Other amortization and accretion

     1,420       1,275  

(Earnings) losses from equity method investees

     75,629       (7,427 )

Distributions of earnings from equity method investees

     2,792       4,211  

(Gains) losses from investments

     34,572       669,773  

Deferred incentive income

     (35,494 )     (311,174 )

Principals’ and others’ interests in income (loss) of consolidated subsidiaries

     (402,680 )     (702,016 )

Deferred tax (benefit) expense

     (3,434 )     2,484  

Options received from affiliates

     —         (2,006 )

Assignments of options to employees

     —         1,717  

Equity-based compensation

     556,131       445,233  

Cash flows due to changes in

    

Cash held at consolidated subsidiaries and restricted cash

     —         (166,199 )

Due from affiliates

     14,841       186,215  

Receivables from brokers and counterparties and other assets

     902       (9,106 )

Accrued compensation and benefits

     (124,550 )     72,733  

Due to affiliates

     (1,066 )     (8,380 )

Deferred incentive income

     26,077       —    

Due to brokers and counterparties and other liabilities

     7,634       65,592  

Investment company holdings

    

Purchases of investments

     —         (5,105,865 )

Proceeds from sale of investments

     —         3,398,739  
                

Net cash provided by (used in) operating activities

     33,173       (1,452,996 )
                

Cash Flows From Investing Activities

    

Proceeds from sale of other loan and security investments

     —         317  

Contributions to equity method investees

     (82,343 )     (58,004 )

Distributions of capital from equity method investees

     182,072       39,906  

Proceeds from sale of equity method investments

     —         29,071  

Cash received on settlement of derivatives

     —         132  

Purchase of fixed assets

     (3,906 )     (7,136 )

Proceeds from disposal of fixed assets

     53       —    
                

Net cash provided by (used in) investing activities

     95,876       4,286  
                

Cash Flows From Financing Activities

    

Borrowings under debt obligations

     450,000       1,924,070  

Repayments of debt obligations

     (185,000 )     (2,010,025 )

Payment of deferred financing costs

     (5,060 )     (6,656 )

Issuance of Class A shares to Nomura

     —         888,000  

Issuance of Class A shares in initial public offering

     —         729,435  

Costs related to initial public offering

     —         (76,766 )

Dividends and dividend equivalents paid

     (52,821 )     (16,542 )

Fortress Operating Group capital distributions to Principals

     —         (219,112 )

Purchase of Fortress Operating Group units from Principals

     —         (888,000 )

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

     145       3,193,618  

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

     (181,567 )     (1,808,987 )
                

Net cash provided by (used in) financing activities

     25,697       1,709,035  
                

Net Increase (Decrease) in Cash and Cash Equivalents

     154,746       260,325  

Cash and Cash Equivalents, Beginning of Period

     100,409       61,120  
                

Cash and Cash Equivalents, End of Period

   $ 255,155     $ 321,445  
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period for interest (excluding interest paid by master funds while such funds were consolidated of $85.1 million in 2007)

   $ 16,790     $ 63,944  
                

Cash paid during the period for income taxes

   $ 5,637     $ 28,407  
                

Supplemental Schedule of Non-cash Investing and Financing Activities

    

Employee compensation invested directly in subsidiaries

   $ 24,716     $ 15,072  
                

Investments of receivable amounts into Fortress Funds

   $ 43,355     $ 36,747  
                

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

   $ 103,776     $ 47,272  
                

Fortress Operating Group pre-IPO distributions of investments to Principals

   $ —       $ 196,764  
                

Fortress Operating Group pre-IPO distributions of investments to employees

   $ —       $ 23,238  
                

See Note 1 regarding the non-cash deconsolidation transaction in 2007

    

See notes to consolidated and combined financial statements

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

1. ORGANIZATION AND BASIS OF PRESENTATION

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

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

 

  1) Private equity funds:

 

  a) Funds which invest in debt and equity securities of public or privately held entities; and

 

  b) Publicly traded alternative investment vehicles that Fortress refers to as the “Castles,” which are companies that invest in operating real estate and real estate related loans and securities (debt and equity).

 

  2) Hedge funds:

 

  a) Liquid hedge funds, which invest in the global fixed income, commodities, currency and equity markets, and their related derivatives; and

 

  b) Hybrid hedge funds, which invest in undervalued, distressed and other less liquid investments, as well as investment funds managed by external managers.

 

  3) Principal investments in the above described funds.

The accompanying consolidated and combined financial statements include the following:

 

   

subsequent to Fortress’s reorganization and the inception of operations of Fortress Investment Group LLC on January 17, 2007, the accounts of Fortress Investment Group LLC and its consolidated subsidiaries, and

 

   

prior to such reorganization and the inception of operations of Fortress Investment Group LLC, the accounts of eight affiliated entities under common control and management (“Fortress Operating Group” or the “predecessor”) and their respective consolidated subsidiaries. Each of the eight entities was owned either directly or indirectly by its members, Peter Briger, Wesley Edens, Robert Kauffman, Randal Nardone, and Michael Novogratz (the “Principals”).

Reorganization of Fortress Operating Group

Fortress Investment Group LLC was formed on November 6, 2006 for the purpose of becoming the general partner of Fortress Operating Group, completing the Nomura Transaction (described below), and effecting a public offering of shares and related transactions (the “Transactions”) in order to carry on the business of its predecessor, Fortress Operating Group, as a publicly traded entity. The Registrant is a limited liability company and its members are not responsible for any of its liabilities beyond the equity they have invested. Fortress’s formation documents allow for an indefinite life.

Nomura Transaction

In December 2006, the Principals entered into a securities purchase agreement with Nomura Investment Managers U.S.A., Inc., or Nomura (whose ultimate parent is Nomura Holdings, Inc., a Japanese corporation). On January 17, 2007, Nomura completed the transaction by purchasing 55,071,450 Class A shares of the Registrant for $888 million and the Registrant, in turn, purchased 55,071,450 Fortress Operating Group units, which then represented 15% of Fortress Operating Group’s economic interests, from the Principals for $888 million.

Initial Public Offering (“IPO”)

On February 8, 2007, the Registrant completed an initial public offering of 39,428,900 of its Class A shares for net proceeds of approximately $652.7 million.

Consolidation and Deconsolidation of Fortress Funds

Certain of the Fortress Funds were consolidated into Fortress prior to the Transactions, notwithstanding the fact that Fortress has only a minority economic interest in these funds. Consequently, Fortress’s financial statements reflected the assets, liabilities, revenues, expenses and cash flows of the consolidated Fortress Funds on a gross basis through the date of their deconsolidation, as described below. The majority ownership interests in these funds, which are not owned by Fortress, were reflected as Principals’ and others’ interests in equity of consolidated subsidiaries in the accompanying financial statements during periods in which such funds were consolidated. The management fees and incentive income earned by Fortress from the consolidated

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Fortress Funds were eliminated in consolidation; however, Fortress’s allocated share of the net income from these funds was increased by the amount of these eliminated fees. Accordingly, the consolidation of these Fortress Funds had no net effect on Fortress’s earnings from the Fortress Funds.

Following the IPO, each Fortress subsidiary that acts as a general partner of a consolidated Fortress Fund granted rights, effective March 31, 2007, to the investors in the fund to provide that a simple majority of the fund’s unrelated investors are able to liquidate the fund, without cause, in accordance with certain procedures, or to otherwise have the ability to exert control over the fund. The granting of these rights has led to the deconsolidation of the Fortress Funds from Fortress’s financial statements as of March 31, 2007. The deconsolidation of the Fortress Funds has had significant effects on many of the items within these financial statements but has had no net effect on net income or equity. Since the deconsolidation did not occur until March 31, 2007, the statement of operations and the statement of cash flows for the six months ended June 30, 2007 are presented with these funds on a consolidated basis for the period prior to the deconsolidation. The unaudited pro forma effects of the deconsolidation on these financial statements are described in Note 12.

The accompanying consolidated and combined financial statements and related notes of Fortress have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under U.S. generally accepted accounting principles have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of Fortress’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with Fortress’s consolidated and combined financial statements for the year ended December 31, 2007 and notes thereto included in Fortress’s annual report on Form 10-K filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in Fortress’s consolidated and combined financial statements for the year ended December 31, 2007.

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

2. MANAGEMENT AGREEMENTS AND FORTRESS FUNDS

Management Fees, Incentive Income and Related Profit Sharing Expense

Fortress recognized management fees and incentive income as follows:

 

      Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007(A)

Private Equity

           

Funds

           

Management fees

   $ 42,588    $ 35,630    $ 84,405    $ 62,294

Incentive income

     3,535      5,502      38,175      211,942

Castles

           

Management fees

     13,136      11,966      26,073      22,995

Management fees- options

     —        1,195      —        2,006

Incentive income

     —        14,217      12      17,905

Hedge Funds

           

Liquid Hedge Funds

           

Management fees

     57,542      38,204      110,189      68,062

Incentive income

     14,346      112,512      16,838      158,199

Hybrid Hedge Funds

           

Management fees

     36,339      31,683      72,995      59,680

Incentive income

     419      730      419      825

Total

           

Management fees

   $ 149,605    $ 118,678    $ 293,662    $ 215,037

Incentive income

   $ 18,300    $ 132,961    $ 55,444    $ 388,871

 

(A) Presented on a pro forma basis (Note 12), as adjusted for the deconsolidation of the Fortress Funds as if it has occurred on January 1, 2007.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Incentive Income Subject to Annual Performance Criteria

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) and has not been recognized for these funds during the six months ended June 30, 2008 and 2007. If the amount of incentive income contingent on achieving annual performance criteria was not contingent on the results of the subsequent quarters, $0.0 million and $83.4 million of additional incentive income from affiliates would have been recognized during the six months ended June 30, 2008 and 2007, respectively. Incentive income based on achieving annual performance criteria that has not yet been recognized is included as “undistributed” deferred incentive income in the table below.

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

 

      June 30,
2008
    December 31,
2007
 

Distributed - gross

   $ 470,798     $ 444,721  

Less: Recognized (A)

     (306,654 )     (271,160 )
                

Distributed - unrecognized

   $ 164,144     $ 173,561  
                

Undistributed, net (B)

     63,858       384,520  
                

Total

   $ 228,002     $ 558,081  
                

 

(A) All related contingencies have been resolved.

 

(B) On a deconsolidated basis, subsequent to March 31, 2007, undistributed incentive income is no longer recorded and is not reflected on the balance sheet. At June 30, 2008, the undistributed incentive income is comprised of $147.4 million of gross undistributed incentive income, net of $83.5 million of previously distributed incentive income that would be returned by Fortress to the related funds if such funds were liquidated on June 30, 2008 at their net asset values.

From inception to June 30, 2008, Fortress has recognized and paid compensation expense under its employee profit sharing arrangements in connection with the $470.8 million of distributed incentive income. If the $63.9 million of undistributed incentive income were realized, Fortress would recognize and pay an additional $28.5 million of compensation expense.

The change in deferred incentive income is summarized as follows:

 

      Distributed     Undistributed     Total  

Deferred incentive income as of December 31, 2007

   $ 173,561     $ 384,520     $ 558,081  

Share of income (loss) of Fortress Funds

     26,077       (320,662 )     (294,585 )

Recognition of previously deferred incentive income

     (35,494 )     —         (35,494 )
                        

Deferred incentive income as of June 30, 2008

   $ 164,144     $ 63,858     $ 228,002  
                        

Recognized profit sharing compensation expense is summarized as follows (see Note 7 regarding Fortress’s compensation expense):

 

      Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Private equity funds

   $ 1,146    $ 20,692    $ 2,544    $ 92,445

Castles

     1,175      4,518      2,341      6,874

Liquid hedge funds

     16,119      58,499      33,117      87,446

Hybrid hedge funds

     1,651      18,728      3,706      38,246
                           

Total

   $ 20,091    $ 102,437    $ 41,708    $ 225,011
                           

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Principals’ and Others’ Interests in Consolidated Subsidiaries

This balance sheet caption was comprised of the following:

 

      June 30, 2008    December 31, 2007

Principals’ Fortress Operating Group units

   $ 120,278    $ 232,826

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

     52,650      75,062

Other

     176      135
             

Total

   $ 173,104    $ 308,023
             

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

 

      Three Months Ended June 30,     Six Months Ended June 30,  
     2008 Actual     2007 Actual     2008 Actual     2007 Actual  

Principals’ Fortress Operating Group units

   $ (194,714 )   $ (169,759 )   $ (403,590 )   $ (247,401 )

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

     303       3,158       442       6,000  

Third party investors in Fortress Funds

     —         —         —         (460,615 )

Other

     —         116       468       —    
                                

Total

   $ (194,411 )   $ (166,485 )   $ (402,680 )   $ (702,016 )
                                

Private Equity Funds

In 2008, Fortress made an additional $100 million commitment to Fund V. Fortress’s affiliates, including employees and the Principals, made additional commitments to this fund of $67.3 million at the same time.

During the six months ended June 30, 2008, Fortress formed new private equity funds which had capital commitments as follows:

 

Fortress’s commitments

   $ 24,327

Fortress’s affiliates’ commitments

     24,950

Third party investors’ commitments

     2,431,575
      

Total capital commitments

   $ 2,480,852
      

Liquid Hedge Funds and Hybrid Hedge Funds

During the six months ended June 30, 2008, Fortress formed new hedge funds with net asset values as follows:

 

      June 30, 2008 NAV
     Liquid    Hybrid

Fortress (A)

   $ 15,719    $ —  

Fortress’s affiliates

     503,408      —  

Third party investors

     1,206,976      —  
             

Total NAV

   $ 1,726,103    $ —  
             

 

(A) Includes a second quarter incentive income allocation of $14.6 million.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

3. INVESTMENTS IN EQUITY METHOD INVESTEES AND OTHER EQUITY INVESTMENTS

Fortress elected to record its investments in and options from Newcastle and Eurocastle at fair value pursuant to SFAS 159 (“The Fair Value Option For Financial Assets and Financial Liabilities”) beginning January 1, 2008. Fortress made this election to simplify its accounting for these publicly traded equity securities (and related options), which were previously recorded based on the equity method of accounting. As a result, Fortress recorded an aggregate increase to the carrying amounts of these assets of $22.9 million, which was recorded as a cumulative effect adjustment to retained earnings ($2.1 million) and also impacted the Principals’ interests in the equity of consolidated subsidiaries (Fortress Operating Group) ($17.6 million), deferred tax assets ($1.9 million), and accumulated other comprehensive income ($1.2 million). Fortress accounts for dividends received from these investments as dividend income, a component of Other Revenues.

Investments in Equity Method Investees

Fortress holds investments in certain unconsolidated Fortress Funds which are recorded based on the equity method of accounting. Upon the deconsolidation of the consolidated Fortress Funds on March 31, 2007 (Note 1), these funds also became equity method investees. Fortress’s maximum exposure to loss with respect to these entities is generally equal to its investment plus its basis in any options received from such entities as described below. In addition, unconsolidated affiliates also hold an ownership interests in certain of these entities. Summary financial information related to these investments is as follows:

 

     Fortress’s Investment    Fortress’s Equity in Net Income (Loss)  
     June 30,    December 31,    Three Months Ended June 30,     Six Months Ended June 30,  
     2008    2007    2008     2007     2008     2007  

Private equity funds, excluding NIH (A)

   $ 634,879    $ 623,830    $ (27,968 )   $ (8,024 )   $ (68,297 )   $ (8,024 )

NIH

     4,540      5,770      (178 )     (843 )     881       (1,024 )

Newcastle (B)

     7,190      3,184      N/A       460       N/A       1,189  

Eurocastle (B)

     9,690      11,799      N/A       309       N/A       (89 )
                                              

Total private equity

     656,299      644,583      (28,146 )     (8,098 )     (67,416 )     (7,948 )

Liquid hedge funds (A)

     42,101      73,748      (412 )     3,993       551       3,993  

Hybrid hedge funds (A)

     260,148      371,310      2,048       11,335       (8,775 )     11,335  

Other

     2,575      2,277      10       1       11       47  
                                              
   $ 961,123    $ 1,091,918    $ (26,500 )   $ 7,231     $ (75,629 )   $ 7,427  
                                              

 

(A) These entities were consolidated prior to March 31, 2007.

 

(B) Fortress elected to record these investments at fair value pursuant to SFAS 159 beginning on January 1, 2008.

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

 

     Six Months Ended June 30, 2008  
     Private Equity Funds     Castles (A)     Liquid
Hedge Funds
    Hybrid
Hedge Funds
             
     NIH     Other     Newcastle     Eurocastle         Other     Total  

Investment, beginning

   $ 5,770     $ 623,830     $ 3,184     $ 11,799     $ 73,748     $ 371,310     $ 2,277     $ 1,091,918  

Earnings from equity method investees

     881       (68,297 )     N/A       N/A       551       (8,775 )     11       (75,629 )

Other comprehensive income from equity method investees

     (9 )     3,322       N/A       N/A       —         —         —         3,313  

Contributions to equity method investees

     —         80,751       N/A       N/A       44,395       262       290       125,698  

Distributions of earnings from equity method investees

     (2,102 )     (180 )     N/A       N/A       (580 )     —         (3 )     (2,865 )

Distributions of capital from equity method investees

     —         (3,410 )     N/A       N/A       (76,013 )     (102,649 )     —         (182,072 )
                                                                

Total distributions from equity method investees

     (2,102 )     (3,590 )     N/A       N/A       (76,593 )     (102,649 )     (3 )     (184,937 )
                                                                

Sale of investments

     —         (1,137 )     —         —         —         —         —         (1,137 )

Mark to fair value - January 1, 2008 (B)

     N/A       N/A       10,110       12,762       N/A       N/A       N/A       22,872  

Mark to fair value - during period (C)

     N/A       N/A       (6,104 )     (16,872 )     N/A       N/A       N/A       (22,976 )

Translation adjustment

     —         —         —         2,001       —         —         —         2,001  
                                                                

Investment, ending

   $ 4,540     $ 634,879     $ 7,190     $ 9,690     $ 42,101     $ 260,148     $ 2,575     $ 961,123  
                                                                

Ending balance of undistributed earnings

   $ 1,430     $ —         N/A       N/A     $ 86     $ 8,004     $ 8     $ 9,528  
                                                                

 

(A) Fortress elected to record the investments at fair value pursuant to SFAS 159 beginning on January 1, 2008.

 

(B) Recorded as a cumulative effect adjustment to Retained Earnings.

 

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

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

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

 

     Private Equity Funds excluding NIH (C)     Newcastle Investment Holdings LLC (“NIH”)  
     June 30,
2008
    December 31,
2007
    June 30,
2008
    December 31,
2007
 

Assets

   $ 16,908,810     $ 16,982,495     $ 304,826     $ 336,176  

Liabilities

     (3,807,070 )     (3,445,658 )     (223,906 )     (230,457 )
                                

Equity

   $ 13,101,740     $ 13,536,837     $ 80,920     $ 105,719  
                                

Fortress’s Investment

   $ 634,879     $ 623,830     $ 4,540     $ 5,770  
                                

Ownership (A)

     4.8 %     4.6 %     4.8 %     4.8 %
                                
     Six Months Ended June 30,     Six Months Ended June 30,  
     2008     2007     2008     2007  

Revenues and gains (losses) on investments

   $ (2,125,980 )   $ (1,477,818 )   $ 33,385     $ (2,876 )

Expenses

     (220,553 )     (102,040 )     (14,225 )     (9,844 )
                                

Net Income (Loss)

   $ (2,346,533 )   $ (1,579,858 )   $ 19,160     $ (12,720 )
                                

Fortress’s equity in net income (loss)

   $ (68,297 )   $ (8,024 )   $ 881     $ (1,024 )
                                
       (B )    

 

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

 

(B) The revenues and expenses of these entities were consolidated through March 31, 2007, the effective date of the deconsolidation (Note 1). As a result, the amounts shown for Fortress’s equity in net income of these entities relate to the period subsequent to March 31, 2007.

 

(C) Includes one entity which is recorded on a one quarter lag (i.e. the balances reflected for this entity are for March 31, 2008 and the period then ended). It is recorded on a lag because it is a German entity and does not provide financial reports under U.S. GAAP within the reporting timeframe necessary for U.S. public entities.

 

     Newcastle Investment Corp.     Eurocastle Investment Ltd.  
     June 30,
2008
    December 31,
2007
    June 30,
2008
    December 31,
2007
 

Assets

   $ 6,216,307     $ 8,037,770     $ 10,875,509     $ 10,713,687  

Liabilities

     (6,120,564 )     (7,590,145 )     (9,177,658 )     (8,865,921 )

Minority interest

     —         —         (8 )     (8 )
                                

Equity

   $ 95,743     $ 447,625     $ 1,697,843     $ 1,847,758  
                                

Ownership, basic (A)

     1.9 %     1.9 %     1.6 %     1.6 %
                                

Ownership, diluted (A) (B)

     4.7 %     4.7 %     9.8 %     9.8 %
                                

Ownership by Fortress and affiliates, diluted (B)

     15.3 %     15.5 %     29.9 %     29.3 %
                                

Market value of shares owned (A) (C)

   $ 7,190     $ 13,293     $ 9,690     $ 24,561  
                                
     Six Months Ended June 30,     Six Months Ended June 30,  
     2008     2007     2008     2007  

Revenues and gains (losses) on investments

   $ 248,589     $ 374,016     $ 405,837     $ 346,862  

Expenses

     (183,802 )     (300,693 )     (445,576 )     (408,234 )

Other income (loss)

     (181,020 )     —         37,808       51,564  

Discontinued operations

     (8,951 )     (19 )     —         —    

Preferred dividends

     (6,751 )     (5,890 )     —         —    
                                

Net Income (Loss)

   $ (131,935 )   $ 67,414     $ (1,931 )   $ (9,808 )
                                

Fortress’s equity in net income (loss)

     N/A     $ 1,189       N/A     $ (89 )
                                

 

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

 

(B) Fully diluted ownership represents the percentage of outstanding common shares assuming that all options are exercised. Currently, all of the options are out of the money (that is, their strike price is below the current market price per share).

 

(C) Based on the closing price of the related shares and, if applicable, the foreign currency exchange rate on the last day of trading in the applicable period.

 

10


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

     Liquid Hedge Funds     Hybrid Hedge Funds  
     June 30,
2008
    December 31,
2007
    June 30,
2008
    December 31,
2007
 

Assets

   $ 10,435,359     $ 8,358,378     $ 12,946,934     $ 12,098,175  

Liabilities

     (139,825 )     (67,483 )     (4,815,718 )     (4,493,901 )

Minority Interest

     —         —         (30,473 )     (26,834 )
                                

Equity

   $ 10,295,534     $ 8,290,895     $ 8,100,743     $ 7,577,440  
                                

Fortress’s Investment

   $ 42,101     $ 73,748     $ 260,148     $ 371,310  
                                

Ownership (A)

     0.4 %     0.9 %     3.2 %     4.9 %
                                
     Six Months Ended June 30,     Six Months Ended June 30,  
     2008     2007     2008     2007  

Revenues and gains (losses) on investments

   $ 161,368     $ 1,108,498     $ 7,427     $ 623,181  

Expenses

     (337,725 )     (541,936 )     (207,400 )     (191,000 )
                                

Net Income

   $ (176,357 )   $ 566,562     $ (199,973 )   $ 432,181  
                                

Fortress’s equity in net income (loss)

   $ 551     $ 3,993     $ (8,775 )   $ 11,335  
                                
       (B )       (B )

 

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

 

(B) The revenues and expenses of these entities were consolidated through March 31, 2007, the effective date of the deconsolidation (Note 1). As a result, the amounts shown for Fortress’s equity in net income of these entities relate to the period subsequent to March 31, 2007.

Options in Affiliates

Fortress holds options to purchase additional shares of its equity method investees with carrying values as follows:

 

     June 30,
2008
   December 31,
2007
   Accounting Treatment

Newcastle options

   $ 62    $ 5    Recorded at fair value

Eurocastle options

     809      15,996    Recorded at fair value
                
   $ 871    $ 16,001   
                

Investments in Variable Interest Entities

As part of the deconsolidation of the consolidated Fortress Funds (Note 1), Fortress caused reconsideration events to occur in each of the variable interest entities in which it was deemed to be the primary beneficiary. As a result of these reconsideration events, Fortress is no longer considered the primary beneficiary of, and therefore does not consolidate, any of the variable interest entities in which it holds an interest. No reconsideration events occurred during the six months ended June 30, 2008 which caused a change in Fortress’s accounting.

The following table presents information as of June 30, 2008 regarding entities formed during the six months ended June 30, 2008 that were determined to be VIEs in which Fortress holds a variable interest:

 

     Fortress is not Primary Beneficiary       

Business Segment

   Gross Assets    Fortress Investment (B)    Notes  

Private Equity Funds

   $ 1,107,144    $ 404    (A )

Liquid Hedge Funds

   $ 313,977    $ 95   

 

(A) Fortress’ investment includes $0.2 million of management fees receivable from the Private Equity Funds.

 

(B) Represents Fortress’s maximum exposure to loss with respect to these entities.

Fair Value of Financial Instruments

The following table presents information regarding Fortress’s financial instruments which are recorded at fair value:

 

     June 30, 2008
Fair Value
    
        Valuation Method

Assets - Carried at Fair Value

     

Newcastle and Eurocastle common shares

   $ 16,880    Level 1 - Quoted prices in active markets for identical assets

Newcastle and Eurocastle options

   $ 871    Level 2 - Lattice-based option valuation models using significant

                observable inputs

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

4. DEBT OBLIGATIONS

 

                               June 30, 2008

Debt Obligation

   Month
Issued
   Face Amount and
Carrying Value
   Contractual
Interest

Rate
    Final
Stated
Maturity
   Weighted
Average
Funding
Cost (A)
    Weighted
Average
Maturity
(Years)
      June 30,
2008
   December 31,
2007
         

Credit agreement (B)

                  

Revolving debt (C)

   May 2007    $ —      $ 185,000    LIBOR + 0.85 % (D)   May 2012    0.00 %   N/A

Term loan

   May 2007      350,000      350,000    LIBOR + 0.85 %   May 2012    3.66 %   3.86

Delayed term loan

   May 2007      450,000      —      LIBOR + 0.85 %   May 2012    3.78 %   1.67
                                

Total

      $ 800,000    $ 535,000         3.73 %   2.63
                                

 

(A) The weighted average funding cost is calculated based on the contractual interest rate (utilizing the most recently reset LIBOR rate) plus the amortization of deferred financing costs. The most recently reset LIBOR rate was 2.48%.

 

(B) Collateralized by substantially all of Fortress Operating Group’s assets as well as Fortress Operating Group’s rights to fees from the Fortress Funds and its equity interests therein.

 

(C) Approximately $189 million was undrawn and available under the revolving debt facility as of June 30, 2008, including a $25 million letter of credit subfacility of which $11 million was utilized.

 

(D) Subject to unused commitment fees of 0.25% per annum.

In connection with the repayment of a portion of a prior term loan, $2.0 million of deferred loan costs were written off to interest expense in February 2007. In May 2007, Fortress entered into a new credit agreement to refinance its existing credit agreement, reduce the amount of interest and other fees payable under its credit facilities, and increase the amount of funds available for investments.

On April 17, 2008, Fortress entered into an amendment to its credit agreement. The amendment, among other things, (i) permits Fortress to issue an unlimited amount of subordinated indebtedness with specified terms so long as 40% of the net proceeds are used to repay amounts outstanding under the credit agreement, (ii) increased the applicable rate on Eurodollar loans and letters of credit by 20 basis points (making the current rate LIBOR plus 0.85%) and the undrawn commitment fee by 5 basis points (making the current fee 0.25%), (iii) added an amortization schedule requiring Fortress to repay $100 million of amounts outstanding under the agreement each year during the next three years (with the first payment due on January 15, 2009), (iv) modified the financial covenants by (a) replacing the EBITDA-based financial covenant with a Consolidated Leverage Ratio covenant, (b) increasing the minimum amount of management fee earning assets by $3 billion to $21.5 billion (which minimum amount increases annually by $500 million) and (c) eliminating the annual $50 million increase in required minimum investment assets, and (v) revised various definitions and clarified terms with respect to swap providers who are lenders under the agreement. In connection with this amendment, Fortress incurred $4.9 million of deferred loan costs which were recorded in Other Assets. In addition, on May 29, 2008, Fortress entered into an amendment to its credit agreement to change from a co-borrower structure to a single borrower structure.

Fortress was in compliance with all of its debt covenants as of June 30, 2008.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

5. INCOME TAXES AND TAX RELATED PAYMENTS

The provision for income taxes consists of the following:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2008     2007     2008     2007  
Current         

Federal income tax

   $ (660 )   $ (1,160 )   $ 1,994     $ 5,055  

Foreign income tax

     562       360       1,199       1,066  

State and local income tax

     1,862       5,722       5,544       10,106  
                                
     1,764       4,922       8,737       16,227  
                                
Deferred         

Federal income tax expense (benefit)

     (1,311 )     5,060       (20 )     11,068  

Foreign income tax expense (benefit)

     22       (219 )     180       (733 )

State and local income tax expense (benefit)

     (2,424 )     (4,754 )     (3,594 )     (7,106 )
                                
     (3,713 )     87       (3,434 )     3,229  
                                

Total

   $ (1,949 )   $ 5,009     $ 5,303     $ 19,456  
                                

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

 

     June 30, 2008    December 31, 2007

Deferred tax assets

   $ 512,237    $ 511,204
             

Deferred tax liabilities (A)

   $ 778    $ 891
             

 

(A) Included in Other Liabilities

For the six months ended June 30, 2008, an estimated annual negative effective tax rate of (4.45%) was used to compute the tax provision. Fortress incurred a loss before income taxes for financial reporting purposes, after deducting the compensation expense arising from the Principals’ forfeiture agreement. However, this compensation expense is not deductible for income tax purposes. Also, a portion of Fortress’s income is not subject to U.S. federal income tax, but is allocated directly to Fortress’s shareholders. For the six months ended June 30, 2008, a deferred income tax provision of $0.3 million was debited to other comprehensive income, primarily related to the equity method investees. A current income tax benefit of $2.1 million was credited to additional paid in capital, related to (i) dividend equivalent payments on RSU’s, and (ii) distributions to Fortress Operating Group restricted partnership unit holders (Note 7), which are currently deductible for income tax purposes.

Tax Receivable Agreement

Although the tax receivable agreement payments are calculated based on annual tax savings, for the six months ended June 30, 2008, the payments which would have been made pursuant to the tax receivable agreement, if such period was calculated by itself, were estimated to be $8.4 million.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

6. RELATED PARTY TRANSACTIONS

Due from affiliates was comprised of the following:

 

June 30, 2008

   Private Equity
Funds
   Castles    Liquid Hedge
Funds
   Hybrid Hedge
Funds
   Other    Total

Management fees and incentive income

   $ 6,194    $ 10,595    $ 14,911    $ 1,857    $ —      $ 33,557

Expense reimbursements

     3,657      4,419      5,542      3,784      —        17,402

Dividends and distributions

     —        345      —        —        —        345

Other (A)

     89,639      —        —        151      671      90,461
                                         

Total

   $ 99,490    $ 15,359    $ 20,453    $ 5,792    $ 671    $ 141,765
                                         

December 31, 2007

   Private Equity
Funds
   Castles    Liquid Hedge
Funds
   Hybrid Hedge
Funds
   Other    Total

Management fees and incentive income

   $ 1,733    $ 45,004    $ 40,751    $ 98,197    $ —      $ 185,685

Expense reimbursements

     1,307      2,051      3,074      3,487      —        9,919

Dividends and distributions

     —        739      —        —        —        739

Other

     —        —        —        1      2,325      2,326
                                         

Total

   $ 3,040    $ 47,794    $ 43,825    $ 101,685    $ 2,325    $ 198,669
                                         

Due to affiliates was comprised of the following:

 

     June 30, 2008    December 31, 2007

Principals

     

- Tax receivable agreement - Note 5

   $ 393,266    $ 393,265

- Distributions payable on Fortress Operating Group units

     70,216      60,176

Other

     1,227      2,293
             
   $ 464,709    $ 455,734
             

 

(A) Includes an $85 million loan to a newly formed fund. The loan was made to finance a fund investment prior to the fund’s related capital call, was outstanding less than two weeks, and bore interest at 7.0%.

For the six months ended June 30, 2008 and 2007, Other Revenues included approximately $31.2 million and $20.5 million, respectively, of revenues from affiliates, primarily expense reimbursements. Dividend income from affiliates of approximately $1.0 million was recorded during the six months ended June 30, 2008.

Fortress has entered into cost sharing arrangements with the Fortress Funds, including subleases of certain of its office space. Expenses borne by the Fortress Funds under these agreements are generally paid directly by those entities (i.e. they are generally not paid by Fortress and reimbursed). For the six months ended June 30, 2008 and 2007, these expenses, mainly related to subscriptions to market data services, approximated $9.4 million and $10.8 million, respectively.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

7. EQUITY-BASED COMPENSATION

The following tables present information regarding equity-based compensation during the six months ended June 30, 2008.

 

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

Outstanding as of December 31, 2007

   43,215,535     $ 16.74    9,318,968     $ 15.22    97,296    $ 18.50    —      $ —  

Issued

   2,063,600       10.79    283,457       10.39    7,159      13.15    31,000,000      13.75

Forfeited

   (1,603,015 )     17.65    (345,069 )     14.54    —        —      —        —  
                                                 

Outstanding as of June 30, 2008 (B)

   43,676,120     $ 16.43    9,257,356     $ 15.10    104,455    $ 18.13    31,000,000    $ 13.75
                                                 

 

     Three Months Ended June 30,     Six Months Ended June 30,
     2008    2007     2008    2007

Expense incurred (B)

          

Employee RSUs

   $ 27,337    $ 24,533     $ 53,909    $ 54,015

Non-Employee RSUs

     5,421      4,664       5,411      8,478

Restricted Shares

     150      149       299      233

LTIP

     1,715      (251 )     3,429      1,574

RPUs

     18,349      —         18,349      —  
                            

Total equity-based compensation expense

   $ 52,972    $ 29,095     $ 81,397    $ 64,300
                            

 

(A) Represents the weighted average grant date estimated fair value per share or unit. The weighted average estimated fair value per unit as of June 30, 2008 for RSU awards granted to non-employees was $9.45.

 

(B) In future periods, Fortress will recognize compensation expense on its non-vested equity based awards of $1,027.7 million, with a weighted average recognition period of 4.6 years.

In April 2008, Fortress granted 31 million Fortress Operating Group (“FOG”) restricted partnership units (“RPUs”) to a senior employee. In connection with the grant of these interests, the employee receives partnership distribution equivalent payments on such units with economic effect as from January 1, 2008. The interests will vest into full capital interests in FOG units in three equal portions on the first business day of 2011, 2012 and 2013, respectively, subject to continued employment with Fortress. In connection with this grant, Fortress has reduced the employee’s profit sharing interests in various Fortress Funds.

When Fortress records equity-based compensation expense, including that related to the Principals Agreement, it records a corresponding increase in capital. Of the total increase in capital during the six months ended June 30, 2008 from equity-based compensation arrangements of $556.1 million, $129.3 million increased Fortress’s paid-in capital, as reflected in the Statement of Shareholders’ Equity, and $426.8 million increased Principals’ interests in equity of consolidated subsidiaries, corresponding to the Principals’ interest in the equity-based compensation expense.

Fortress’s total compensation and benefits expense, excluding Principals Agreement compensation, is comprised of the following:

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Equity-based compensation, per above

   $ 52,972    $ 29,095    $ 81,397    $ 64,300

Profit-sharing expense, per Note 2

     20,091      102,437      41,708      225,011

Discretionary bonuses

     29,599      29,778      74,056      53,059

Other payroll, taxes and benefits

     34,798      26,473      67,318      62,930
                           
   $ 137,460    $ 187,783    $ 264,479    $ 405,300
                           

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

8. EARNINGS PER SHARE AND DISTRIBUTIONS

As a result of Fortress’s reorganization in January 2007 (Note 1), Fortress has calculated its earnings per share for two different periods within the six months ended June 30, 2007. For the first period, prior to the reorganization on January 17, 2007, the calculation is based on the income and outstanding units of Fortress Operating Group, which were owned by the Principals, as if such units had been outstanding from the beginning of the period. For the second period, subsequent to the reorganization and commencement of operations of the Registrant, the calculation is based on the consolidated income of Fortress from January 17, 2007 through June 30, 2007 and the Class A shares outstanding for such period.

The computations of net income per Fortress Operating Group unit are set forth below:

 

     January 1 through January 16, 2007
     Basic    Diluted

Weighted average units outstanding

     

Fortress Operating Group units outstanding

     367,143,000      367,143,000
             

Total weighted average units outstanding

     367,143,000      367,143,000
             

Net income per unit is calculated as follows:

     

Net income

   $ 133,397    $ 133,397

Dilution in earnings of certain equity method investees

     —        —  
             

Net income available to Fortress Operating Group unitholders

   $ 133,397    $ 133,397
             

Weighted average units outstanding

     367,143,000      367,143,000
             

Net income per unit

   $ 0.36    $ 0.36
             

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

 

     Three Months Ended June 30, 2007     January 17 through June 30, 2007  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

     94,500,350       94,500,350       89,004,200       89,004,200  

Fully vested restricted Class A share units with dividend equivalent rights

     394,286       394,286       222,234       222,234  

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

     —         312,071,550       —         —    

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

     —         —         —         —    

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

     —         —         —         —    
                                

Total weighted average shares outstanding

     94,894,636       406,966,186       89,226,434       89,226,434  
                                

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

        

Net income (loss)

   $ (55,131 )   $ (55,131 )   $ (126,385 )   $ (126,385 )

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

     (1,048 )     (1,048 )     (1,617 )     (1,617 )

Dilution in earnings of certain equity method investees

     —         —         —         —    

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

     —         (212,759 )     —         —    
                                

Net income (loss) available to Class A shareholders

   $ (56,179 )   $ (268,938 )   $ (128,002 )   $ (128,002 )
                                

Weighted average shares outstanding

     94,894,636       406,966,186       89,226,434       89,226,434  
                                

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

   $ (0.59 )   $ (0.66 )   $ (1.43 )   $ (1.43 )
                                

 

16


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

     Three Months Ended June 30, 2008     Six Months Ended June 30, 2008  
     Basic     Diluted     Basic     Diluted  

Weighted average shares outstanding

        

Class A shares outstanding

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

Fully vested restricted Class A share units with dividend equivalent rights

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

Fully vested restricted Class A shares

     19,040       19,040       9,520       9,520  

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

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

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

     —         —         —         —    

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

     —         —         —         —    
                                

Total weighted average shares outstanding

     94,913,677       406,985,227       94,904,157       406,975,707  
                                

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

        

Net income (loss)

   $ (55,556 )   $ (55,556 )   $ (124,473 )   $ (124,473 )

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

     (2,040 )     (2,040 )     (1,987 )     (1,987 )

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

     (1,159 )     (1,159 )     (2,276 )     (2,276 )

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

     —         (214,667 )     —         (429,829 )
                                

Net income (loss) available to Class A shareholders

   $ (58,755 )   $ (273,422 )   $ (128,736 )   $ (558,565 )
                                

Weighted average shares outstanding

     94,913,677       406,985,227       94,904,157       406,975,707  
                                

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

   $ (0.62 )   $ (0.67 )   $ (1.36 )   $ (1.37 )
                                

 

(1) The Fortress Operating Group units not held by Fortress (that is, those held by the Principals) are exchangeable into Class A shares on a one-to-one basis. These units are not included in the computation of basic earnings per share. These units enter into the computation of diluted net income (loss) per Class A share when the effect is dilutive using the if-converted method.

 

(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 our Class A shares and therefore participate fully in the results of our operations from the date they are granted. They are included in the computation of both basic and diluted earnings per Class A share using the two-class method for participating securities, except during periods of net losses.

 

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

 

Period

   Share Units

Three months ended:

  

June 30, 2008

   27,641,251

June 30, 2007

   25,705,670

Six months ended June 30, 2008

   27,729,198

Period from January 17, 2007 to June 30, 2007

   21,993,462

 

(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.

The Class B shares have no net income (loss) per share as they do not participate in Fortress’s earnings (losses) or distributions. The Class B shares have no dividend or liquidation rights. Each Class B share, along with one Fortress Operating Group 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. The number of Class B shares outstanding did not change subsequent to the IPO.

 

17


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

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

 

     Weighted Average
     Three Months Ended June 30,    Six Months Ended June 30,
     2008    2007    2008    2007

Class A shares

   94,500,351    94,500,350    94,500,351    81,136,426

Restricted Class A share units (A)

   394,286    394,286    394,286    202,589

Restricted Class A shares

   104,219    97,296    100,757    76,331

Restricted Class A share units

   23,652,206    23,730,308    23,708,849    18,753,486

Fortress Operating Group units

   312,071,550    312,071,550    312,071,550    316,939,744

Fortress Operating Group RPUs

   25,208,791    —      12,604,396    —  
                   

Total

   455,931,403    430,793,790    443,380,189    417,108,576
                   

 

     As of June 30, 2008    As of December 31, 2007

Class A shares

   94,500,351    94,500,350

Restricted Class A share units (A)

   394,286    394,286

Restricted Class A shares

   104,455    97,296

Restricted Class A share units

   24,171,891    23,906,779

Fortress Operating Group units

   312,071,550    312,071,550

Fortress Operating Group RPUs

   31,000,000    —  
         

Total

   462,242,533    430,970,261
         

 

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

Dividends and distributions during the six months ended June 30, 2008 are summarized as follows:

 

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

Dividends on Class A Shares

   $ 21,285    $ 21,286    $ 21,286    $ 42,572

Dividend equivalents on restricted Class A share units (A)

     5,428      5,387      5,527      10,914

Distributions to Fortress Operating Group unit holders (Principals)

     60,176      73,246      70,216      143,462

Distributions to Fortress Operating Group RPU holders (Note 7)

     —        —        6,975      6,975
                           

Total distributions

   $ 86,889    $ 99,919    $ 104,004    $ 203,923
                           

 

(A) A portion of these dividend equivalents, 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.

 

18


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

9. COMMITMENTS AND CONTINGENCIES

Other than as described below, Fortress’s commitments and contingencies remain materially unchanged from December 31, 2007.

Private Equity Fund Capital Commitments – Fortress has remaining capital commitments to certain of the Fortress Funds which aggregated $183.3 million as of June 30, 2008. These commitments can be drawn by the funds on demand.

Minimum Future Rentals – Fortress is a lessee under operating leases for office space located in New York, Atlanta, Charlotte, Chicago, Dallas, Frankfurt, Geneva, Hong Kong, London, Los Angeles, Munich, New Canaan, Rome, San Diego, San Francisco, Shanghai, Sydney, Tokyo, and Toronto.

Minimum future rent payments under these leases is as follows:

 

July 1 to December 31, 2008

   $ 9,124

2009

     18,930

2010

     15,087

2011

     12,141

2012

     10,508

2013

     9,791

Thereafter

     31,021
      

Total

   $ 106,602
      

Rent expense recognized on a straight-line basis during the six months ended June 30, 2008 and 2007 was $9.3 million and $7.4 million, respectively, and during the three months ended June 30, 2008 and 2007 was $4.5 million and $3.8 million, respectively, and was included in General, Administrative and Other Expense.

Litigation – Fortress is, from time to time, a defendant in legal actions from transactions conducted in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate liability arising from such actions that existed as of June 30, 2008, if any, will not materially affect Fortress’s results of operations, liquidity or financial position.

On September 15, 2005, a lawsuit captioned David T. Atkins et al. v. Apollo Real Estate Advisors, L.P. et al. was brought on behalf of current and former limited partners in certain investing partnerships related to the sale of certain facilities to Ventas Realty Limited Partnership (“Ventas”) against a number of defendants, including one of the Portfolio Companies and a subsidiary of Fortress (“FIG”). FIG was the investment manager of consolidated Fortress Funds that were controlling shareholders of the Portfolio Company during the relevant time periods. The suit alleges that the defendants improperly obtained certain rights with respect to such facilities from the investing partnerships. The plaintiffs have asked for damages in excess of $100 million on each of nine counts, as to which FIG is a defendant on seven counts, including treble damages with respect to certain counts. On April 18, 2006, Fortress filed a motion to dismiss the claims with prejudice. On April 30, 2008, the court entered a memorandum and order granting the motion and dismissing the plaintiff’s complaint in its entirety. The plaintiffs were granted a period of 30 days from April 30, 2008 in which to file an amended complaint, after which the parties entered into a preliminary settlement, which will be paid in its entirety by Brookdale.

In addition, in the ordinary course of business, the Fortress Funds are and can be both the defendant and the plaintiff in numerous actions with respect to bankruptcy, insolvency and other types of proceedings. Such lawsuits may involve claims that adversely affect the value of certain financial instruments owned by the Fortress Funds. Although the ultimate outcome of actions cannot be ascertained with certainty, Fortress believes that the resolution of any such actions will not have a material adverse effect on its financial condition, liquidity or results of operations.

 

19


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

10. SEGMENT REPORTING

Fortress conducts its management and investment business through the following five primary segments: (i) private equity funds, (ii) Castles, (iii) liquid hedge funds, (iv) hybrid hedge funds, and (v) principal investments in these funds as well as cash that is available to be invested. These segments are differentiated based on their varying investment strategies. Due to the increased significance of the principal investments segment, it has been disaggregated from the other segments in this period and for all periods presented.

“Distributable earnings” for the existing Fortress businesses is equal to net income adjusted as follows:

Incentive Income

 

  (i)     a. for Fortress Funds which are private equity 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 (net of the reversal of any prior such reserves that are no longer deemed necessary), minus (b) incentive income recorded in accordance with GAAP,

 

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

Other Income

 

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

 

  a. for equity method investments in the Castles (prior to 2008) and private equity funds as well as indirect equity method investments in hedge fund special investment accounts (which generally have investment profiles similar to private equity funds), treating these investments as cost basis investments by adding (a) realizations of income, primarily dividends, from these funds, minus (b) impairment with respect to these funds, if necessary, minus (c) equity method earnings (or losses) recorded in accordance with GAAP,

 

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

 

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

 

  d. subtracting unrealized gains (or adding unrealized losses) from the Castles subsequent to the election of the fair value option under SFAS 159,

 

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

Expenses

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

20


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

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

June 30, 2008 and the Six Months Then Ended

                  

Segment revenues

                  

Management fees

   $ 84,330    $ 27,655    $ 110,325    $ 73,455    $ —       $ —       $ 295,765

Incentive income

     28,741      12      17,040      872      —         —         46,665
                                                  

Segment revenues - total

   $ 113,071    $ 27,667    $ 127,365    $ 74,327    $ —       $ —       $ 342,430
                                                  

Pre-tax distributable earnings

   $ 81,886    $ 8,204    $ 45,426    $ 11,279    $ (30,656 )   $ 7     $ 116,146
                                                  

Total segment assets

   $ 10,023    $ 16,741    $ 20,452    $ 5,474    $ 1,351,895     $ 588,506     $ 1,993,091
                                                  
                   (A )  

 

     Fortress
Subtotal
   Reconciliation
to GAAP
    Fortress
Consolidated
 

Revenues

   $ 342,430    $ 46,546     $ 388,976  
                       

Pre-tax distributable earnings / net income

   $ 116,146    $ (240,619 )   $ (124,473 )
                       

Total assets

   $ 1,993,091    $ (49,256 )   $ 1,943,835  
                       

 

(A) Unallocated assets include deferred tax assets of $512.2 million.

 

21


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

June 30, 2008 and the Six Months Then Ended

Reconciling items between segment measures and GAAP measures:

 

Adjustments from segment revenues to GAAP revenues

    

Adjust management fees*

     $ 325  

Adjust incentive income

       9,434  

Adjust income from the receipt of options

       —    

Other revenues*

       36,787  
          

Total adjustments

     $ 46,546  
          

*  Segment revenues do not include GAAP other revenues; GAAP other revenues are included elsewhere in the calculation of distributable earnings.

     

Adjustments from pre-tax distributable earnings to GAAP net income

    

Adjust incentive income

    

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

   $ (26,077 )  

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

     35,494    

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

     17    

Incentive income received from hedge funds, subject to annual performance achievement

     —      

Reserve for clawback

     —      
          
       9,434  

Adjust other income

    

Distributions of earnings from equity method investees**

     (367 )  

Earnings (losses) from equity method investees**

     (67,483 )  

Gains (losses) on options in equity method investees

     (15,426 )  

Unrealized gains (losses) on Castles

     (20,975 )  

Impairment of investments

     9,507    

Adjust income from the receipt of options

     —      
          
       (94,744 )

Adjust employee compensation

    

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

     (88,507 )  

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

     9,648    

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

     (4 )  
          
       (78,863 )

Adjust Principals’ equity-based compensation expense

       (474,734 )

Adjust Principals’ interests related to Fortress Operating Group units

       403,591  

Adjust income taxes

       (5,303 )
          

Total adjustments

     $ (240,619 )
          

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

        

Adjustments from total segment assets to GAAP assets

    

Adjust equity investments from fair value

     $ —    

Adjust equity investments from cost

       (92,966 )

Adjust investments gross of employee portion

       42,839  

Adjust option investments to intrinsic value

       871  
          

Total adjustments

     $ (49,256 )
          

 

22


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

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

Three Months Ended June 30, 2008

                  

Segment revenues

                  

Management fees

   $ 42,550    $ 13,961    $ 57,606    $ 36,611    $ —       $ —       $ 150,728

Incentive income

     —        —        14,345      447      —         —         14,792
                                                  

Segment revenues - total

   $ 42,550    $ 13,961    $ 71,951    $ 37,058    $ —       $ —       $ 165,520
                                                  

Pre-tax distributable earnings

   $ 31,942    $ 3,928    $ 30,695    $ 9,231    $ (17,326 )   $ (31 )   $ 58,439
                                                  

 

     Fortress
Subtotal
   Reconciliation
to GAAP
    Fortress
Consolidated
 

Revenues

   $ 165,520    $ 22,576     $ 188,096  
                       

Pre-tax distributable earnings / net income

   $ 58,439    $ (113,995 )   $ (55,556 )
                       

 

23


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Three Months Ended June 30, 2008

Reconciling items between segment measures and GAAP measures:

 

Adjustments from segment revenues to GAAP revenues

    

Adjust management fees*

     $ 162  

Adjust incentive income

       3,535  

Adjust income from the receipt of options

       —    

Other revenues*

       18,879  
          

Total adjustments

     $ 22,576  
          

*  Segment revenues do not include GAAP other revenues; GAAP other revenues are included elsewhere in the calculation of distributable earnings.

     

Adjustments from pre-tax distributable earnings to GAAP net income

    

Adjust incentive income

    

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

   $ —      

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

     3,535    

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

     —      

Incentive income received from hedge funds, subject to annual performance achievement

     —      

Reserve for clawback

     —      
          
       3,535  

Adjust other income

    

Distributions of earnings from equity method investees**

     (2 )  

Earnings (losses) from equity method investees**

     (26,841 )  

Gains (losses) on options in equity method investees

     (2,933 )  

Unrealized gains (losses) on Castles

     (3,651 )  

Impairment of investments

     9,507    

Adjust income from the receipt of options

     —      
          
       (23,920 )

Adjust employee compensation

    

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

     (52,906 )  

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

     —      

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

     —      
          
       (52,906 )

Adjust Principals’ equity-based compensation expense

       (237,367 )

Adjust Principals’ interests related to Fortress Operating Group units

       194,714  

Adjust income taxes

       1,949  
          

Total adjustments

     $ (113,995 )
          

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

        

 

24


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

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

Six Months Ended June 30, 2007

                   

Segment revenues

                   

Management fees

   $ 62,616    $ 22,746    $ 69,341    $ 60,720    $ —      $ —       $ 215,423

Incentive income

     190,298      17,905      158,199      84,369      —        —         450,771
                                                 

Segment revenues - total

   $ 252,914    $ 40,651    $ 227,540    $ 145,089    $ —      $ —       $ 666,194
                                                 

Pre-tax distributable earnings

   $ 166,843    $ 18,938    $ 105,387    $ 49,314    $ 29,641    $ (7,286 )   $ 362,837
                                                 

 

     Fortress
Unconsolidated
Subtotal
   Consolidation
of Fortress
Funds
    Eliminations     Reconciliation
to GAAP
    Fortress
Consolidated

Revenues

   $ 666,194    $ 317,114     $ (269,607 )   $ (29,252 )   $ 684,449
                                     

Pre-tax distributable earnings / net income

   $ 362,837    $ (326,375 )   $ 326,375     $ (355,825 )   $ 7,012
                                     

 

25


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Six Months Then Ended June 30, 2007

Reconciling items between segment measures and GAAP measures:

 

Adjustments from segment revenues to GAAP revenues

    

Adjust management fees*

     $ 325  

Adjust incentive income

       (61,793 )

Adjust income from the receipt of options

       2,006  

Other revenues*

       30,210  
          

Total adjustments

     $ (29,252 )
          

*  Segment revenues do not include GAAP other revenues; GAAP other revenues are included elsewhere in the calculation of distributable earnings.

     

Adjustments from pre-tax distributable earnings to GAAP net income

    

Adjust incentive income

    

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

   $ (138,822 )  

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

     211,942    

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

     (51,476 )  

Incentive income received from hedge funds, subject to annual performance achievement

     (83,437 )  

Reserve for clawback

     —      
          
       (61,793 )

Adjust other income

    

Distributions of earnings from equity method investees**

     (12,326 )  

Earnings (losses) from equity method investees**

     (19,248 )  

Gains (losses) on options in equity method investees, treated as derivatives

     (24,456 )  

Adjust income from the receipt of options

     2,006    
          
       (54,024 )

Adjust employee compensation

    

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

     (67,363 )  

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

     (19,657 )  
          
       (87,020 )

Adjust Principals’ equity-based compensation expense

       (380,933 )

Adjust Principals’ interests related to Fortress Operating Group units

       247,401  

Adjust income taxes

       (19,456 )
          

Total adjustments

     $ (355,825 )
          

**     This adjustment relates to all of the Castles, private equity Fortress Funds and hedge fund special investment accounts in which Fortress has an investment. On an unconsolidated basis, each of these funds is accounted for under the equity method.

        

 

26


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

 

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

Three Months Ended June 30, 2007

                   

Segment revenues

                   

Management fees

   $ 35,852    $ 11,841    $ 38,400    $ 31,707    $ —      $ —       $ 117,800

Incentive income

     —        14,217      112,920      38,264      —        —         165,401
                                                 

Segment revenues - total

   $ 35,852    $ 26,058    $ 151,320    $ 69,971    $ —      $ —       $ 283,201
                                                 

Pre-tax distributable earnings

   $ 28,070    $ 13,883    $ 74,871    $ 17,534    $ 13,650    $ (4,752 )   $ 143,256
                                                 

 

     Fortress
Unconsolidated
Subtotal
   Reconciliation
to GAAP
    Fortress
Consolidated
 

Revenues

   $ 283,201    $ (15,082 )   $ 268,119  
                       

Pre-tax distributable earnings / net income

   $ 143,256    $ (198,387 )   $ (55,131 )
                       

 

27


Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Three Months Ended June 30, 2007

Reconciling items between segment measures and GAAP measures:

 

Adjustments from segment revenues to GAAP revenues     

Adjust management fees*

     $ 325  

Adjust incentive income

       (32,376 )

Adjust income from the receipt of options

       1,195  

Other revenues*

       15,774  
          

Total adjustments

     $ (15,082 )
          

*Segment revenues do not include GAAP other revenues; GAAP other revenues are included elsewhere in the calculation of distributable earnings

    
Adjustments from pre-tax distributable earnings to GAAP net income     

Adjust incentive income

    

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

   $ —      

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

     5,502    

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

     —      

Incentive income received from hedge funds, subject to annual performance achievement

     (37,878 )  

Reserve for clawback

     —      
          
       (32,376 )

Adjust other income

    

Distributions of earnings from equity method investees**

     (2,433 )  

Earnings (losses) from equity method investees**

     (8,098 )  

Gains (losses) on options in equity method investees, treated as derivatives

     (29,606 )  

Adjust income from the receipt of options

     1,195    
          
       (38,942 )

Adjust employee compensation

    

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

     (28,934 )  

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

     (19,657 )  

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

     (569 )  
          
       (49,160 )

Adjust Principals’ equity-based compensation expense

       (242,659 )

Adjust Principals’ interests related to Fortress Operating Group units

       169,759  

Adjust income taxes

       (5,009 )
          

Total adjustments

     $ (198,387 )
          

 

** This adjustment relates to all of the Castles, private equity Fortress Funds and hedge fund special investment accounts in which Fortress has an investment. On an unconsolidated basis, each of these funds is accounted for under the equity method.

 

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Table of Contents

FORTRESS INVESTMENT GROUP LLC

(PRIOR TO JANUARY 17, 2007, FORTRESS OPERATING GROUP – NOTE 1)

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (Unaudited)

JUNE 30, 2008

(dollars in tables in thousands, except share data)

Fortress’s depreciation expense by segment was as follows:

 

     Private Equity
Funds
   Castles    Liquid
Hedge
Funds
   Hybrid
Hedge Funds
   Unallocated    Total
Six Months Ended June 30,                  

2008

   $ 546    $ 374    $ 1,495    $ 1,486    $ 971    $ 4,872

2007

   $ 482    $ 426    $ 1,211    $ 1,229    $ 845    $ 4,193
Three Months Ended June 30,                  

2008

   $ 287    $ 182    $ 767    $ 714    $ 486    $ 2,436

2007

   $ 243    $ 212    $ 631    $ 653    $ 445    $ 2,184

11. SUBSEQUENT EVENTS

In July 2008, three of the Principals invested an aggregate of $14.4 million in preferred equity interests of a subsidiary of one of the private equity Fortress Funds. The preferred equity does not pay a dividend.

12. PRO FORMA FINANCIAL INFORMATION

The unaudited pro forma financial information presented below was derived from the application of pro forma adjustments to the combined and consolidated financial statements of Fortress, as applicable, to give effect to the deconso