Attached files

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EX-31.2 - CERTIFICATE OF CFO PURSUANT TO RULE 13A-14(A) / RULE 15D-14(A) - Och-Ziff Capital Management Group LLCdex312.htm
EX-10.4 - FIRST GUARANTY OF PAYMENT MODIFICATION AGREEMENT - Och-Ziff Capital Management Group LLCdex104.htm
EX-31.1 - CERTIFICATE OF CEO PURSUANT TO RULE 13A-14(A) / RULE 15D-14(A) - Och-Ziff Capital Management Group LLCdex311.htm
EX-10.1 - AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF OZ MANAGEMENT LP - Och-Ziff Capital Management Group LLCdex101.htm
EX-10.3 - AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF OZ ADVISORS II LP - Och-Ziff Capital Management Group LLCdex103.htm
EX-32.1 - CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 - Och-Ziff Capital Management Group LLCdex321.htm
EX-10.2 - AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF OZ ADVISORS LP - Och-Ziff Capital Management Group LLCdex102.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2009

OR

 

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

Commission File Number 1-33805

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

(Exact Name of Registrant as Specified in its Charter)

 

Delaware   26-0354783
(State of Incorporation)   (I.R.S. Employer Identification Number)

 

9 West 57th Street, New York, New York, 10019
(Address of Principal Executive Offices)

 

Registrant’s telephone number: (212) 790-0041

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  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

Large accelerated filer  ¨                    Accelerated filer  þ

Non-accelerated filer  ¨    (Do not check if a smaller reporting company) Smaller reporting company  ¨

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

As of October 31, 2009, there were 79,834,339 Class A Shares and 277,946,526 Class B Shares outstanding.

 

 

 


Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

TABLE OF CONTENTS

 

          Page
PART I — FINANCIAL INFORMATION   
Item 1.    Financial Statements (Unaudited)    2
   Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008    2
   Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008    3
   Consolidated Statement of Changes in Shareholders’ Deficit for the Nine Months Ended September 30, 2009    4
   Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008    5
   Notes to Consolidated Financial Statements    6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    26
Item 3.    Quantitative and Qualitative Disclosures about Market Risk    49
Item 4.    Controls and Procedures    51
PART II — OTHER INFORMATION   
Item 1.    Legal Proceedings    52
Item 1A.    Risk Factors    52
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    52
Item 3.    Defaults upon Senior Securities    52
Item 4.    Submission of Matters to a Vote of Security Holders    52
Item 5.    Other Information    52
Item 6.    Exhibits    52
Signatures    53

 

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Table of Contents

In this quarterly report, references to “Och-Ziff,” “our Company,” “the Company,” “we,” “us,” or “our” refer, unless context requires otherwise, to Och-Ziff Capital Management Group LLC, a Delaware limited liability company, and its consolidated subsidiaries, including the Och-Ziff Operating Group. References to the “Och-Ziff Operating Group” refer, collectively, to OZ Management LP and OZ Management II LP, each a Delaware limited partnership, which collectively we refer to as “OZ Management,” OZ Advisors LP, a Delaware limited partnership, which we refer to as “OZ Advisors I,” OZ Advisors II LP, a Delaware limited partnership, which we refer to as “OZ Advisors II,” and their consolidated subsidiaries. References to our “intermediate holding companies” refer, collectively, to Och-Ziff Holding Corporation, a Delaware corporation, which we refer to as “Och-Ziff Corp,” and Och-Ziff Holding LLC, a Delaware limited liability company, which we refer to as “Och-Ziff Holding,” both of which are wholly-owned subsidiaries of Och-Ziff Capital Management Group LLC. References to our “partners” refer to the current limited partners of the Och-Ziff Operating Group entities, except where the context requires otherwise and refers to our partners at the time of a prior event or transaction being disclosed. References to our “founding partners” refer, collectively, to our founder, Mr. Daniel Och, and our other partners at the time of our initial public offering. References to the “Ziffs” refer to Ziff Brothers Investments, L.L.C. and certain of its affiliates and control persons, which, together with Mr. Och, founded our business in 1994. References to “Class A Shares” refer to our Class A Shares, representing Class A limited liability company interests of Och-Ziff Capital Management Group LLC, which are publicly traded and listed on the New York Stock Exchange. References to “Class B Shares” refer to Class B Shares of Och-Ziff Capital Management Group LLC, which are not publicly traded, are currently held solely by our partners and have no economic rights but entitle the holders thereof to one vote per share together with the holders of our Class A Shares.

Forward-Looking Statements

Some of the statements under “Part 1–Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this quarterly report may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to as the “Securities Act,” and Section 21E of the Securities Exchange Act of 1934, as amended, which we refer to as the “Exchange Act,” that reflect our current views with respect to, among other things, future events and financial performance, strategies and expectations, including but not limited to statements regarding our financial performance and results, including our ability to generate returns and preserve capital and our ability to expand our investment platforms. We generally identify forward-looking statements by terminology such as “outlook,” “believe,” “expect,” “potential,” “continue,” “may,” “will,” “should,” “could,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates,” “opportunity,” “pipeline,” “comfortable,” “assume,” “remain,” “maintain,” “sustain,” “achieve” or the negative version of those words or other comparable words. Any forward-looking statements contained in this quarterly report are based upon historical information and on our current plans, estimates and expectations. The inclusion of this or any other 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, including but not limited to global economic and market conditions, global business conditions, the success of government initiatives worldwide to address economic, market and business conditions, the conditions impacting the hedge fund industry, our ability to successfully compete for fund investors, professional investment talent and investment opportunity, our successful formulation and execution of business and growth strategies and our ability to appropriately manage conflicts of interest and tax and other regulatory factors relevant to our business, as well as 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 quarterly report. In addition, the most significant of these risks, uncertainties and other factors are described in our annual report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on March 12, 2009, including the factors described in “Item 1A. Risk Factors.” Other risks may be described from time to time in our news releases and other filings made under the securities laws, including our quarterly reports on Form 10-Q and our current reports on Form 8-K. There may be additional risks, uncertainties and factors that we do not currently view as material or that are not necessarily known. The forward-looking statements included in this document are made only as of the date of this document and 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.

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS — UNAUDITED

 

     September 30, 2009     December 31, 2008  
     (dollars in thousands)  

Assets

    

Cash and cash equivalents

   $ 184,489      $ 81,403   

Income and fees receivable

     19,766        30,151   

Due from affiliates

     1,807        2,276   

Deferred balances, at fair value

     374,798        558,530   

Deferred income tax asset

     1,007,490        980,788   

Other assets, net (includes investments in Och-Ziff Funds of $10,142 and $22,356, respectively)

     102,646        138,225   

Assets of consolidated Och-Ziff funds:

    

Investments, at fair value

     284,398        208,508   

Other assets of Och-Ziff funds

     667        1,127   
                

Total Assets

   $ 1,976,061      $ 2,001,008   
                

Liabilities and Shareholders’ Deficit

    

Liabilities

    

Due to affiliates

   $ 1,212,364      $ 1,388,183   

Debt obligations

     754,289        764,889   

Profit sharing payable

     10,846        16,500   

Other liabilities

     86,908        52,572   

Liabilities of consolidated Och-Ziff funds:

    

Other liabilities of Och-Ziff funds

     16        —     
                

Total Liabilities

     2,064,423        2,222,144   
                

Commitments and Contingencies (Note 12)

    

Shareholders’ Deficit

    

Class A Shares, no par value, 1,000,000,000 shares authorized, 79,830,851 and 76,279,134 shares issued and outstanding as of September 30, 2009 and December 31, 2008, respectively

     —          —     

Class B Shares, no par value, 750,000,000 shares authorized, 277,946,526 and 279,989,571 shares issued and outstanding as of September 30, 2009 and December 31, 2008, respectively

     —          —     

Paid-in capital

     1,409,607        1,137,161   

Retained deficit

     (1,826,785     (1,567,305

Accumulated other comprehensive income

     (48     37   
                

Shareholders’ deficit attributable to Class A shareholders

     (417,226     (430,107

Partners’ and others’ interests in consolidated subsidiaries

     328,864        208,971   
                

Total Shareholders’ Deficit

     (88,362     (221,136
                

Total Liabilities and Shareholders’ Deficit

   $ 1,976,061      $ 2,001,008   
                

See notes to consolidated financial statements.

 

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Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
     (dollars in thousands, except per share amounts)  

Revenues

        

Management fees

   $ 88,127      $ 148,976      $ 268,598      $ 441,770   

Incentive income

     3,071        4,373        3,336        5,483   

Other revenues

     355        925        908        3,179   

Income of consolidated Och-Ziff funds

     10,127        2,768        21,629        7,654   
                                

Total Revenues

     101,680        157,042        294,471        458,086   
                                

Expenses

        

Compensation and benefits

     64,074        50,377        191,975        155,388   

Allocations to non-equity partner interests

     8,052        (3,039     12,627        (865

Reorganization expenses

     417,486        425,585        1,262,171        1,276,753   

Profit sharing

     663        (305     954        (1,736

Interest expense

     2,168        7,118        10,823        24,791   

General, administrative and other

     40,687        24,732        84,069        83,771   

Expenses of consolidated Och-Ziff funds

     880        1,043        2,776        2,400   
                                

Total Expenses

     534,010        505,511        1,565,395        1,540,502   
                                

Other Income (Loss)

        

Net earnings (losses) on deferred balances

     20,840        (18,776     24,270        (18,975

Net gains (losses) on investments in Och-Ziff funds and joint ventures

     730        (2,049     1,036        (6,020

Gain on early retirement of debt

     —          —          2,013        —     

Net gains (losses) of consolidated Och-Ziff funds

     (47     1,290        (145     787   
                                

Total Other Income (Loss)

     21,523        (19,535     27,174        (24,208
                                

Loss Before Income Taxes

     (410,807     (368,004     (1,243,750     (1,106,624

Income taxes

     (20,889     14,735        (17,611     22,696   
                                

Consolidated Net Loss

   $ (389,918   $ (382,739   $ (1,226,139   $ (1,129,320
                                

Net Loss Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ (309,891   $ (313,295   $ (975,945   $ (730,957
                                

Net Loss Allocated to Class A Shareholders

   $ (80,027   $ (69,444   $ (250,194   $ (398,363
                                

Net Loss Per Class A Share

        

Basic

   $ (1.02   $ (0.94   $ (3.23   $ (5.37
                                

Diluted

   $ (1.06   $ (1.07   $ (3.25   $ (5.37
                                

Weighted-Average Class A Shares Outstanding

        

Basic

     78,818,314        74,138,572        77,398,416        74,138,572   
                                

Diluted

     387,874,793        385,238,096        387,719,637        74,138,572   
                                

Dividends Paid per Class A Share

   $ 0.02      $ 0.11      $ 0.12      $ 1.39   
                                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ DEFICIT — UNAUDITED

 

     Och-Ziff Capital Management Group LLC Shareholders              
                            Accumulated
Other
Comprehensive
Income
             
     Number of
Class A
Shares
   Number of
Class B
Shares
    Paid-in
Capital
    Retained
Deficit
    Foreign
Currency
Translation
Adjustment
    Partners’ and
Others’ Interests in
Consolidated
Subsidiaries
    Total
Shareholders’
Deficit
 
                      (dollars in thousands)        

As of December 31, 2008

   76,279,134    279,989,571      $ 1,137,161      $ (1,567,305   $ 37      $ 208,971      $ (221,136

Cash dividends declared on Class A Shares

   —      —          —          (9,203     —          —          (9,203

Dividend equivalents on restricted share units

   —      —          83        (83     —          (a     —     

Share-based compensation

   1,578,765    —          15,559        —          —          69,863        85,422   

Och-Ziff Operating Group A Unit transactions and cancellation of related Class B Shares (See Note 3)

   1,972,952    (2,043,045     172        —          —          11,476        11,648   

Contribution of right to future payments under tax receivable agreement (See Note 12)

   —      —          2,266        —          —          15,734        18,000   

Acquisition of partners’ and others’ interests in consolidated subsidiaries

   —      —          (2     —          —          (9     (11

Impact of amortization of Reorganization charges to capital

   —      —          254,368        —          —          1,007,803        1,262,171   

Capital contributions

   —      —          —          —          —          88,456        88,456   

Capital distributions

   —      —          —          —          —          (97,155     (97,155

Comprehensive income:

               

Consolidated net loss

   —      —          —          (250,194     —          (975,945     (1,226,139

Foreign currency translation adjustment

   —      —          —          —          (85     (330     (415
                     

Total comprehensive income

                  (1,226,554
                                                   

As of September 30, 2009

   79,830,851    277,946,526      $ 1,409,607      $ (1,826,785   $ (48   $ 328,864      $ (88,362
                                                   

 

(a) The dividend equivalents on restricted share units impacted partners’ and others’ interests in consolidated subsidiaries by increasing the paid-in capital component and increasing the retained deficit component of partners’ and others’ interests in consolidated subsidiaries each by $332 thousand.

See notes to consolidated financial statements.

 

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Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

 

     Nine Months Ended September 30,  
     2009     2008  
     (dollars in thousands)  

Cash Flows from Operating Activities

    

Consolidated net loss

   $ (1,226,139   $ (1,129,320

Adjustments to reconcile consolidated net loss to net cash provided by operating activities:

    

Reorganization expenses

     1,262,171        1,276,753   

Amortization of share-based compensation

     86,069        67,721   

Amortization of deferred compensation

     5,470        9,004   

Depreciation and amortization

     6,272        4,821   

Gain on early retirement of debt

     (2,013     —     

Deferred income taxes

     (25,235     (3,426

Operating cash flows due to changes in:

    

Income and fees receivable

     10,385        631,552   

Due from affiliates

     469        (1,690

Deferred balances, at fair value

     183,734        362,829   

Other assets, net

     35,370        (7,218

Assets of consolidated Och-Ziff funds

     (75,430     (72,221

Due to affiliates

     (44,302     (287,892

Profit sharing payable

     (5,654     (53,630

Other liabilities

     34,569        (41,374

Liabilities of consolidated Och-Ziff funds

     16        —     
                

Net Cash Provided by Operating Activities

     245,752        755,909   
                

Cash Flows from Investing Activities

    

Loan to joint venture partners

     (2,351     (11,870

Repayment of loan to joint venture partners

     —          11,870   

Investments in joint ventures

     (4,808     (10,720

Return of investments in joint ventures

     3,730        —     

Collateral deposit on aircraft loan

     (2,009     —     

Purchases of fixed assets

     (1,123     (7,416
                

Net Cash Used in Investing Activities

     (6,561     (18,136
                

Cash Flows from Financing Activities

    

Withholding taxes paid on vested Class A restricted share units

     (649     —     

Repayments of debt obligations

     (8,587     (219

Och-Ziff Operating Group capital distributions declared prior to the Reorganization

     (122,422     (660,793

Dividends on Class A Shares

     (9,203     (103,053

Partners’ and others’ interests in consolidated subsidiaries contributions

     88,456        114,327   

Partners’ and others’ interests in consolidated subsidiaries distributions

     (83,700     (547,580
                

Net Cash Used in Financing Activities

     (136,105     (1,197,318
                

Net Increase (Decrease) in Cash and Cash Equivalents

     103,086        (459,545

Cash and Cash Equivalents, Beginning of Period

     81,403        614,159   
                

Cash and Cash Equivalents, End of Period

   $ 184,489      $ 154,614   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid (received) during the period:

    

Interest

   $ 10,307      $ 28,729   
                

Income taxes

   $ (5,833   $ 90,818   
                

See notes to consolidated financial statements.

 

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Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

1. BUSINESS OVERVIEW

Och-Ziff Capital Management Group LLC (the “Registrant”), a Delaware limited liability company, together with its consolidated subsidiaries (collectively, the “Company”), is a global alternative asset management firm with offices in New York, London, Hong Kong, Tokyo, Bangalore and Beijing. The Company provides investment management services to its various hedge funds (the “Och-Ziff funds” or the “funds”) and separately managed accounts on behalf of a diverse group of institutional investors worldwide, including funds-of-funds, pension and profit-sharing funds, endowments, foundations and other financial institutions. The Och-Ziff funds seek to deliver consistent, positive, risk-adjusted returns throughout market cycles, with a focus on risk management and capital preservation.

The Company’s principal sources of revenues are management fees, which are calculated based on the amount of assets under management, and incentive income, which is calculated based on the annual performance of the Och-Ziff funds and separately managed accounts. Accordingly, for any given period, the Company’s revenues will be heavily influenced by the combination of assets under management and the investment performance of the Och-Ziff funds.

The Company conducts substantially all of its operations through its one reportable segment, the Och-Ziff Funds segment, which provides management and advisory services to the Company’s hedge funds and separately managed accounts. The funds’ main investment strategies include merger arbitrage, convertible and derivative arbitrage, equity restructuring, credit and distressed investments, and private investments. The Company’s other operations are currently comprised of its real estate business, which provides advisory services to the Company’s real estate funds. Also included in other operations are investments in new businesses established to expand the Company’s private investment platforms. The businesses and investments included in the Company’s other operations do not meet the thresholds of reportable business segments under U.S. generally accepted accounting principles (“U.S. GAAP”).

The Company transacts its business primarily in the United States and substantially all of its revenues are generated domestically. The liability of the Company’s Class A shareholders is limited to the extent of their capital contributions.

References to the Company’s “partners” refer to the current limited partners of OZ Management LP, OZ Advisors LP and OZ Advisors II LP (collectively, the “Och-Ziff Operating Group”), except where the context requires otherwise and refers to the partners at the time of a prior event or transaction being disclosed. References to the Company’s “founding partners” refer, collectively, to its founder, Mr. Daniel Och, and the other partners at the time of the Company’s initial public offering (“IPO”). The term “Och-Ziff Operating Group A Unit” is used to refer collectively to a Class A Common Unit of each Och-Ziff Operating Group entity. Similarly, the term “Och-Ziff Operating Group B Unit” is used to refer collectively to a Class B Common Unit of each Och-Ziff Operating Group entity.

In November 2007, the Company completed its IPO of 36 million Class A Shares and a private offering of approximately 38.1 million Class A Shares to DIC Sahir, a wholly-owned subsidiary of Dubai International Capital LLC (collectively, the “Offerings”). The Company used the net proceeds from the Offerings to acquire a 19.2% interest in the Och-Ziff Operating Group from the founding partners and Ziff Brothers Investments, L.L.C. (the “Ziffs”), who collectively held all of the interests in the Och-Ziff Operating Group prior to the Offerings. The Company conducts substantially all of its operations through the Och-Ziff Operating Group.

Prior to the Offerings, the Company completed a reorganization of entities under the common control of Daniel Och (the “Reorganization”), whereby the general partner interests in each of the Och-Ziff Operating Group entities and the real estate management business were transferred to the Company. As the Registrant, the Och-Ziff Operating Group and the real estate management business were under the common control of Daniel Och at the time of the Reorganization, the transfer of control of the Och-Ziff Operating Group and the real estate management business to the Registrant was accounted for as a transaction among entities under common control. As a result, the assets, liabilities and statements of operations and cash flows of the Registrant, the Och-Ziff Operating Group and the real estate management business were combined and carried forward at their existing carrying values. As part of the Reorganization, Daniel Och’s equity interests, the other founding partners’ non-equity interests and the Ziffs’ profit sharing interests were reclassified as Och-Ziff Operating Group A Units.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

2. BASIS OF PRESENTATION AND RECENT ACCOUNTING PRONOUNCEMENTS

Basis of Presentation

These unaudited interim consolidated financial statements are prepared in accordance with U.S. GAAP and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company’s unaudited interim consolidated financial statements have been included and are of a normal and recurring nature. The results of operations presented for the interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year, primarily as a result of incentive income being recorded in the fourth quarter each year. All significant intercompany transactions and balances have been eliminated in consolidation.

Recently Adopted Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“SFAS 168”) (subsequently codified into FASB Accounting Standards Codification (“FASB ASC” or the “Codification”) Topic 105). SFAS 168 was issued to establish the Codification as the single source of authoritative accounting principles for U.S. GAAP issued by the FASB. SFAS 168 was effective for reporting periods ending on or after September 15, 2009. The adoption of SFAS 168 did not have any impact on the Company’s financial position or results of operations at the date of adoption.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”) (subsequently codified into FASB ASC Topic 855). SFAS 165 addresses the accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. In addition, SFAS 165 requires an entity to disclose the date through which an entity has evaluated subsequent events. SFAS 165 was effective for interim or annual periods ending after June 15, 2009. The adoption of SFAS 165 did not have any impact on the Company’s financial position or results of operations at the date of adoption. See Note 14 for the required disclosure.

In April 2009, the FASB issued FASB Staff Position SFAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”) (subsequently codified into FASB ASC Topic 820). FSP 157-4 provides additional guidance to expand on the factors that should be considered in estimating fair value when there has been a significant decrease in market activity for an asset or liability. FSP 157-4 was effective for interim and annual periods ending after June 15, 2009. The adoption of FSP 157-4 did not have any impact on the Company’s financial position or results of operations at the date of adoption.

In April 2009, the FASB issued FASB Staff Position SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP 115-2”) (subsequently codified into FASB ASC Topic 320). FSP 115-2 establishes a new method of recognizing and reporting other-than-temporary impairments for debt securities. An entity will be required to record in current period earnings an other-than-temporary impairment for debt securities if it (i) intends to sell the security, (ii) will more likely than not be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis. Additionally, if an other-than-temporary impairment exists but an entity does not intend to sell the impaired debt security and it is not more likely than not that the entity is not required to sell the security before recovery of its cost, only the credit loss component is recognized in current period earnings and the remainder of the impairment is recognized in accumulated other comprehensive income. FSP 115-2 was effective for interim and annual periods ending after June 15, 2009. The adoption of FSP 115-2 did not have any impact on the Company’s financial position or results of operations at the date of adoption.

In April 2009, the FASB issued FASB Staff Position SFAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”) (subsequently codified into FASB ASC Topic 825). FSP 107-1 provides that the disclosures required annually under FASB ASC Topic 825 (formerly, SFAS No. 107, Disclosure about Fair Value of Financial Instruments), also be disclosed in interim periods. FSP 107-1 was effective for interim periods ending after June 15, 2009. The adoption of FSP 107-1 did not have any impact on the Company’s financial position or results of operations at the date of adoption. See Note 4 for the required disclosure.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”) (subsequently codified into FASB ASC Topic 805). SFAS 141(R) requires assets acquired, liabilities assumed and determinable contingent consideration to be measured at their fair values at the acquisition date. In addition, SFAS 141(R) requires subsequent adjustments to any acquisition-related tax reserves to be recognized in net income rather than as an adjustment to the purchase price. SFAS 141(R) was effective for business combinations completed in periods beginning on or after December 15, 2008. The adoption of SFAS 141(R) did not have any impact on the Company’s financial position or results of operations at the date of adoption.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS 160”) (subsequently codified into FASB ASC Topic 810). SFAS 160 requires a company to clearly identify and present ownership interests in subsidiaries held by parties other than the company within the equity section of the consolidated financial statements. SFAS 160 also requires: (i) the amount of consolidated net income attributable to the controlling and the noncontrolling interests to be clearly identified and presented on the face of the consolidated statement of operations; (ii) acquisitions of noncontrolling interest to be accounted for as equity transactions with no step-up to fair value; (iii) when a subsidiary is deconsolidated, any retained noncontrolling interest and the gain or loss upon deconsolidation to be measured at fair value; and (iv) losses to be allocated to noncontrolling interest regardless of whether cumulative losses have exceeded the noncontrolling interest in the subsidiary’s capital. SFAS 160 was effective for reporting periods beginning on or after December 15, 2008. The Company’s adoption of SFAS 160 resulted in the reclassification of noncontrolling interests (partners’ and others’ interests in consolidated subsidiaries, including deficit amounts previously recorded within other assets) into equity at the date of adoption. In addition, as a result of the adoption of SFAS 160, the Company no longer absorbs losses when cumulative losses applicable to partners’ and others’ interests in a consolidated subsidiary exceed the partners’ and others’ interests in the subsidiary’s capital. Under the methodology applied prior to the adoption of SFAS 160, the net loss allocated to Class A shareholders would have amounted to $60.7 million, or $0.77 per basic and $1.06 per diluted Class A Share, for the three months ended September 30, 2009, and $205.7 million, or $2.66 per basic and $3.25 per diluted Class A Share, for the nine months ended September 30, 2009, as partners’ and others’ interests in consolidated subsidiaries would have absorbed excess losses previously absorbed by the Company.

Future Adoption of Accounting Pronouncements

The FASB has issued various changes to the Codification that have not gone into effect as of September 30, 2009. The following is an overview of the changes relevant to the Company:

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 (“SFAS 166”) (not yet incorporated into the Codification). SFAS 166 was issued to improve the information that a reporting entity provides in its financial statements about a transfer of financial assets, the effects of a transfer on its financial statements, and a transferor’s continuing involvement, if any, in transferred financial assets. SFAS 166 eliminates the concept of qualifying special purpose entities from U.S. GAAP. These entities will now be evaluated for consolidation in accordance with the applicable consolidation criteria. SFAS 166 is effective for reporting periods beginning on or after November 15, 2009. The adoption of SFAS 166 is not expected to have a material impact on the Company’s financial position or results of operations at the date of adoption.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”) (not yet incorporated into the Codification). SFAS 167 was issued to address the effects of the removal of the concept of qualifying special purpose entities by SFAS 166 and to address concerns regarding the consolidation of variable interest entities. SFAS 167 will require a qualitative approach rather than a quantitative approach when determining the primary beneficiary of a variable interest entity. In addition, SFAS 167 will no longer consider removal rights when determining whether an entity is a variable interest entity and whether to consolidate a variable interest entity as the primary beneficiary unless those rights are held by a single party. SFAS 167 is effective for reporting periods beginning on or after November 15, 2009. The Company will adopt SFAS 167 on a prospective basis beginning on January 1, 2010. As a result of the adoption of SFAS 167, the Company expects to consolidate the funds it manages. The consolidation of these funds will result in the following: (i) the assets and liabilities of the funds will be included in the Company’s balance sheet; (ii) the revenues, expenses and other income (loss) of the consolidated funds will be included in the Company’s statement of operations; and (iii) management fees and incentive income earned from the funds will be eliminated in consolidation. Consolidated net income and total shareholders’ equity is expected to increase as a result of the consolidation of the funds we manage; however, the net income allocated to Class A shareholders and the balance of

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

the shareholders’ deficit attributable to Class A shareholders will not be affected. The net income allocated to partners’ and others’ interests in income of consolidated subsidiaries and the balance of partners’ and others’ interest in consolidated subsidiaries recorded within shareholders’ equity are expected to increase as a result of the consolidation of the funds the Company manages.

3. OCH-ZIFF OPERATING GROUP OWNERSHIP

As of September 30, 2009, the Company’s interest in the Och-Ziff Operating Group had increased to approximately 20.5% from 19.2% at the time of the Offerings. This increase was as a result of (i) the issuance of Class A Shares under the Company’s Amended and Restated 2007 Equity Incentive Plan, primarily related to the vesting of Class A restricted share units (“RSUs”), which resulted in a reallocation of deficit capital in the amount of $1.7 million from partners’ and others’ interests in consolidated subsidiaries to the Company during the nine months ended September 30, 2009; (ii) the exchange of Och-Ziff Operating Group A Units for Class A Shares by former partners, which resulted in a reallocation of deficit capital in the amount of $2.9 million from partners’ and others’ interests in consolidated subsidiaries to the Company during the nine months ended September 30, 2009; and (iii) the forfeiture of Och-Ziff Operating Group A Units that were not subsequently reallocated to the other partners, which resulted in a reallocation of deficit capital in the amount of $17 thousand from partners’ and others’ interests in consolidated subsidiaries to the Company during the nine months ended September 30, 2009. The Company’s interest in the Och-Ziff Operating Group is expected to continue to increase over time as additional Class A Shares are issued upon the vesting of RSUs or exchanges of Och-Ziff Operating Group A Units. For the nine months ended September 30, 2008, there was no change in the Company’s ownership interest in the Och-Ziff Operating Group.

In connection with the exchange of Och-Ziff Operating Group A Units for Class A Shares by former partners, the Company, in addition to the $2.9 million of reallocated deficit, recorded an increase to paid-in capital of $3.1 million and an increase to partners’ and others’ interests in consolidated subsidiaries of $8.5 million related to deferred income tax assets and deferred income tax liabilities arising from the exchange.

4. FAIR VALUE DISCLOSURES

Fair value represents the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants at the measurement date (an exit price). Assets and liabilities measured at fair value are classified into one of the following categories:

 

   

Level I – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Assets and liabilities in this category include listed securities.

 

   

Level II – Fair value is determined through the use of models or other valuation methodologies based on pricing inputs that are either directly or indirectly observable as of the reporting date. Assets and liabilities in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives.

 

   

Level III – Fair value is determined based on pricing inputs that are unobservable and includes situations where there is little, if any, market activity for the asset or liability. The determination of fair value for assets and liabilities in this category requires significant management judgment or estimation. Assets and liabilities in this category include general and limited partnership interests in private equity and real estate.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

As of September 30, 2009, the Company did not have any liabilities carried at fair value. The following table summarizes the Company’s assets carried at fair value within the fair value hierarchy levels:

 

     Level I    Level II    Level III    Total
     (dollars in thousands)

As of September 30, 2009

  

Deferred balances, at fair value

   $ —      $ —      $ 374,798    $ 374,798

Investments, at fair value

   $ —      $ —      $ 284,398    $ 284,398

As of December 31, 2008

  

Deferred balances, at fair value

   $ —      $ —      $ 558,530    $ 558,530

Investments, at fair value

   $ —      $ —      $ 208,508    $ 208,508

Deferred balances are made up of deferred incentive income receivable from the Company’s offshore funds. Deferred balances are valued based on net asset value information provided by the Och-Ziff funds. The investments within these funds are carried at fair value and are categorized as Level I, II, and III financial instruments, as appropriate. Investments, which are primarily related to holdings of the Och-Ziff real estate funds, are initially valued at transaction price and subsequently valued based on third-party investments, pending transactions or changes in financial ratios (e.g., earnings multiples) or discounted cash flow models, as appropriate.

The following table summarizes the changes in the Company’s Level III assets for the three months ended September 30, 2009:

 

     Deferred
Balances,
at Fair Value
   Investments,
at Fair Value
    Total  
     (dollars in thousands)  

As of June 30, 2009

   $ 353,958    $ 244,885      $ 598,843   

Net earnings on deferred balances

     20,840      —          20,840   

Net losses of consolidated Och-Ziff funds

     —        (47     (47

Investment purchases, net

     —        39,560        39,560   
                       

As of September 30, 2009

   $ 374,798    $ 284,398      $ 659,196   
                       

Amounts related to assets that continue to be held as of September 30, 2009:

       

Net earnings on deferred balances

   $ 20,840    $ —        $ 20,840   

Net losses of consolidated Och-Ziff funds

     —        (47     (47
                       

Total

   $ 20,840    $ (47   $ 20,793   
                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The following table summarizes the changes in the Company’s Level III assets for the three months ended September 30, 2008:

 

     Deferred
Balances,
at Fair Value
    Investments,
at Fair Value
   Total  
     (dollars in thousands)  

As of June 30, 2008

   $ 700,231      $ 187,733    $ 887,964   

Net losses on deferred balances

     (18,776     —        (18,776

Net gains of consolidated Och-Ziff funds

     —          1,290      1,290   

Investment purchases, net

     —          41,827      41,827   
                       

As of September 30, 2008

   $ 681,455      $ 230,850    $ 912,305   
                       

Amounts related to assets that continue to be held as of September 30, 2008:

       

Net losses on deferred balances

   $ (18,776   $ —      $ (18,776

Net gains of consolidated Och-Ziff funds

     —          1,290      1,290   
                       

Total

   $ (18,776   $ 1,290    $ (17,486
                       

The following table summarizes the changes in the Company’s Level III assets for the nine months ended September 30, 2009:

 

     Deferred
Balances,
at Fair Value
    Investments,
at Fair Value
    Total  
     (dollars in thousands)  

As of December 31, 2008

   $ 558,530      $ 208,508      $ 767,038   

Net earnings on deferred balances

     24,270        —          24,270   

Net losses of consolidated Och-Ziff funds

     —          (145     (145

Collection of deferred balances

     (208,002     —          (208,002

Investment purchases, net

     —          76,035        76,035   
                        

As of September 30, 2009

   $ 374,798      $ 284,398      $ 659,196   
                        

Amounts related to assets that continue to be held as of September 30, 2009:

      

Net earnings on deferred balances

   $ 24,270      $ —        $ 24,270   

Net losses of consolidated Och-Ziff funds

     —          (145     (145
                        

Total

   $ 24,270      $ (145   $ 24,125   
                        

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The following table summarizes the changes in the Company’s Level III assets for the nine months ended September 30, 2008:

 

     Deferred
Balances,
at Fair Value
    Investments,
at Fair Value
    Total  
     (dollars in thousands)  

As of December 31, 2007

   $ 1,044,284      $ 158,857      $ 1,203,141   

Net losses on deferred balances

     (18,975     —          (18,975

Net gains of consolidated Och-Ziff funds

     —          787        787   

Collection of deferred balances

     (343,854     —          (343,854

Investment purchases, net

     —          71,206        71,206   
                        

As of September 30, 2008

   $ 681,455      $ 230,850      $ 912,305   
                        

Amounts related to assets that continue to be held as of September 30, 2008:

      

Net losses on deferred balances

   $ (18,975   $ —        $ (18,975

Net losses of consolidated Och-Ziff funds

     —          (473     (473
                        

Total

   $ (18,975   $ (473   $ (19,448
                        

As further discussed in Note 7, the Company repurchased and retired $5.0 million of the term loan outstanding during the second quarter of 2009 for approximately 60% of its carrying value. Based on this transaction, management estimates that the fair value of its term loan is approximately 60% of its carrying value as of September 30, 2009. Management believes that the carrying values of all other financial instruments presented on the consolidated balance sheets approximate their fair values.

5. VARIABLE INTEREST ENTITIES

In the ordinary course of business, the Company sponsors the formation of various entities considered to be variable interest entities (“VIEs”). These VIEs are primarily funds in which the Company serves as the general partner or the investment manager with decision making rights. VIEs consolidated by the Company are primarily funds in which kick-out or liquidation rights, if any, were not deemed to be substantive as a result of these rights being held by related parties of the Company.

The Company’s involvement with funds that are VIEs and not consolidated is limited to providing investment management services in exchange for a management fee and incentive income allocation. The Company’s exposure to loss with these entities is limited to a decrease in the management fees and incentive income allocations earned in future periods. The net assets of these VIEs were $21.5 billion and $21.0 billion as of September 30, 2009 and December 31, 2008, respectively. The Company does not provide, nor is it required to provide, any type of financial or other support to these entities.

The Company’s determination of whether it is the primary beneficiary of a VIE is based on an analysis of which variable interest holder of a VIE is exposed to the majority of the expected losses or receives a majority of the expected residual returns. Fund investors are entitled to all of the economics of these VIEs with the exception of the management fee (generally 1.5% to 2.5%) and incentive income allocation (generally 20% of net appreciation in a given year), if any, earned by the Company. Accordingly, the Company’s determination of the primary beneficiary is not impacted by changes in the underlying assumptions made regarding future results or expected cash flows of these VIEs.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The following table sets forth the assets and liabilities of funds determined to be VIEs and consolidated by the Company as primary beneficiary:

 

     September 30, 2009    December 31, 2008
     (dollars in thousands)

Assets

     

Assets of consolidated Och-Ziff funds:

     

Investments, at fair value

   $ 47,539    $ 39,831

Other assets of consolidated Och-Ziff funds

     1,809      313
             

Total Assets

   $ 49,348    $ 40,144
             

Liabilities

     

Liabilities of consolidated Och-Ziff funds:

     

Other liabilities of consolidated Och-Ziff funds

   $ 16    $ —  
             

Total Liabilities

     16      —  
             

Shareholders’ Deficit

     

Partners’ and others’ interests in consolidated subsidiaries

     48,771      39,624
             

Total Liabilities and Shareholders’ Deficit

   $ 48,787    $ 39,624
             

The assets presented in the table above belong to the investors in those funds, are available for use only by the fund to which they belong, and are not available for use by the Company. The consolidated funds have no recourse with respect to any liability to the general credit of the Company. The Company also consolidates funds not considered to be VIEs, and therefore, the assets and liabilities of those funds are not included in the table above.

The Company’s variable interests in funds determined to be VIEs that are not consolidated relate primarily to management fees and incentive income earned from those VIEs. As of September 30, 2009 and December 31, 2008, the only assets related to these variable interests amounted to $14.3 million and $16.7 million, respectively, which are included within income and fees receivable in the Company’s consolidated balance sheets. In addition, the Company holds variable interests in certain joint ventures determined to be VIEs. The Company’s exposure to loss for these joint ventures is limited to its investments in these entities, which totaled $2.7 million and $3.3 million as of September 30, 2009 and December 31, 2008, respectively, and are recorded within other assets in the Company’s consolidated balance sheets. The Company has not recorded any liabilities with respect to VIEs not consolidated.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

6. OTHER ASSETS AND OTHER LIABILITIES

Other Assets, Net

The following table presents the components of other assets, net as reported in the consolidated balance sheets:

 

     September 30, 2009     December 31, 2008  
     (dollars in thousands)  

Fixed Assets:

    

Corporate aircraft

   $ 22,600      $ 22,600   

Leasehold improvements

     20,778        20,556   

Computer hardware and software

     17,579        17,776   

Furniture, fixtures and equipment

     3,182        4,139   

Accumulated depreciation and amortization

     (23,290     (19,633
                

Fixed assets, net

     40,849        45,438   

Goodwill

     22,691        22,691   

Investments in Och-Ziff funds

     10,142        22,356   

Refundable security deposits

     6,827        4,740   

Intangible assets, net

     5,295        5,855   

Prepaid expenses

     4,782        13,987   

Current income taxes receivable

     4,722        15,668   

Investments in joint ventures

     2,700        3,273   

Other

     4,638        4,217   
                

Total Other Assets, Net

   $ 102,646      $ 138,225   
                

Other Liabilities

The following table presents the components of other liabilities as reported in the consolidated balance sheets:

 

     September 30, 2009    December 31, 2008
     (dollars in thousands)

Compensation payable

   $ 47,372    $ 5,385

Unearned revenues

     11,547      11,172

Deferred income tax liability

     10,748      19,315

Deferred rent credit

     7,307      4,737

Current income taxes payable

     4,443      1,932

Other

     5,491      10,031
             

Total Other Liabilities

   $ 86,908    $ 52,572
             

7. DEBT OBLIGATIONS

Term Loan

In June 2009, the Company repurchased and retired $5.0 million of its outstanding term loan for $3.0 million, which resulted in the recognition of a gain on early retirement of debt in the amount of $2.0 million in the consolidated statements of operations.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

Note Payable on Corporate Aircraft

On March 30, 2009, the Company amended the terms of the note payable on its corporate aircraft. The principal amount borrowed under the amended note is approximately $16.8 million, bears an annual interest rate of LIBOR plus 2.35%, is due in full at maturity on May 31, 2011 and is secured by a first priority lien on the aircraft. The terms of the amended note payable require the Company to comply with the following financial maintenance covenants in order for it to avoid an event of default:

 

   

The minimum amount of assets under management is $17 billion, tested quarterly;

 

   

Annual management fees earned by the Och-Ziff Operating Group must not fall below $286.1 million, tested annually;

 

   

All revenues earned by the Och-Ziff Operating Group, less compensation expenses and all other cash operating expenses, must exceed three times the annual principal payments and interest payments due on all direct or indirect indebtedness of the Och-Ziff Operating Group, tested quarterly; and

 

   

Maintain average cash, unrestricted marketable securities and other liquid investments that may be converted to cash within 90 days equal to an amount greater than the outstanding principal balance of the note, tested quarterly.

Upon an event of default, subject to certain cure periods set forth in the note, the lender may declare all amounts outstanding under the note to be due and payable. The terms of the amended note also require the Company to make one or more prepayments of the note or post cash collateral with the lender in the event that the outstanding principal balance of the loan at any time exceeds an amount equal to 65% of the fair market value of the aircraft, as determined by the lender pursuant to an appraisal obtained by the lender no more than once every 12 months.

8. GENERAL, ADMINISTRATIVE AND OTHER

The following table presents the components of general, administrative and other expenses as reported in the consolidated statements of operations:

 

     Three Months Ended September 30,     Nine Months Ended September 30,
     2009    2008     2009    2008
     (dollars in thousands)

Occupancy and equipment

   $ 7,214    $ 5,165      $ 20,960    $ 13,271

Professional services

     3,998      8,841        13,699      30,125

Information processing and communications

     3,403      4,207        10,291      11,811

Insurance

     3,238      1,537        9,584      4,654

Business development

     1,492      3,562        4,960      9,926

Other expenses

     4,425      2,102        8,442      5,839
                            
     23,770      25,414        67,936      75,626

Changes in tax receivable agreement liability

     16,917      (682     16,133      8,145
                            

Total General, Administrative and Other

   $ 40,687    $ 24,732      $ 84,069    $ 83,771
                            

9. EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing income available to Class A shareholders by the weighted-average number of Class A Shares outstanding for the period. In addition, 299,272 RSUs that have vested but have not been settled in Class A Shares are included in weighted-average Class A Shares outstanding in the calculation of basic and diluted EPS.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The following table presents the computation of basic and diluted EPS for the three months ended September 30, 2009 and 2008:

 

     Net Earnings
Applicable to Class A
Shareholders
    Weighted-
Average
Class A Shares
Outstanding
   Earnings
Per Class A
Share
    Number of
Antidilutive Units
Excluded from Diluted
Calculation
     (dollars in thousands, except per share amounts)

Three Months Ended September 30, 2009

  

Basic EPS

   $ (80,027   78,818,314    $ (1.02  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     (330,405   309,056,479      —  

Class A Restricted Share Units

     —        —        15,973,252
                       

Diluted EPS

   $ (410,432   387,874,793    $ (1.06  
                       

Three Months Ended September 30, 2008

         

Basic EPS

   $ (69,444   74,138,572    $ (0.94  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     (341,568   311,099,524      —  

Class A Restricted Share Units

     —        —        15,876,515
                       

Diluted EPS

   $ (411,012   385,238,096    $ (1.07  
                       

The following table presents the computation of basic and diluted EPS for the nine months ended September 30, 2009 and 2008:

 

     Net Earnings
Applicable to Class A
Shareholders
    Weighted-
Average
Class A Shares
Outstanding
   Earnings
Per Class A
Share
    Number of
Antidilutive Units
Excluded from Diluted
Calculation
     (dollars in thousands, except per share amounts)

Nine Months Ended September 30, 2009

  

Basic EPS

   $ (250,194   77,398,416    $ (3.23  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     (1,008,280   310,321,221      —  

Class A Restricted Share Units

     —        —        15,973,252
                       

Diluted EPS

   $ (1,258,474   387,719,637    $ (3.25  
                       

Nine Months Ended September 30, 2008

         

Basic EPS

   $ (398,363   74,138,572    $ (5.37  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —        —        311,099,524

Class A Restricted Share Units

     —        —        15,876,515
                       

Diluted EPS

   $ (398,363   74,138,572    $ (5.37  
                       

10. INCOME TAXES

The computation of the effective tax rate and provision at each interim period requires use of certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent differences, and the likelihood of recovering deferred tax assets existing as of September 30, 2009. The estimates used to compute the provision for income taxes may change as new events

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

occur, additional information is obtained or as tax laws and regulations change. Additionally, the Company does not record incentive income in its interim financial statements, other than incentive income resulting from investor redemptions during the period. Accordingly, the effective tax rate for interim periods is not indicative of the tax rate expected for a full year.

The Registrant and the Och-Ziff Operating Group entities are partnerships for U.S. federal income tax purposes. As a result of the Company’s legal structure, only a portion of the income earned by the Company is subject to corporate-level tax rates in the U.S. and foreign jurisdictions. The provision for income taxes for the three and nine months ended September 30, 2009, includes U.S. federal, state, local and foreign taxes at an approximate effective tax rate of 20.7% and 6.6%, respectively. The reconciling items from the Company’s statutory rate to the effective tax rate were driven primarily by the following: (i) a portion of the income earned by the Company is subject to U.S. federal, state and local corporate income taxes; (ii) a portion of the income earned by the Company is subject to the New York City unincorporated business tax; (iii) certain foreign subsidiaries are subject to foreign corporate income taxes; and (iv) the Reorganization expenses related to the reclassification of the founding partners’ and the Ziffs’ interests as Och-Ziff Operating Group A Units are not deductible for tax purposes. The change in the Company’s effective tax rate during the third quarter of 2009 was primarily due to an increase in deferred tax assets resulting from a change in future enacted tax rates at the state and local level.

As of September 30, 2009 and December 31, 2008, the Company was not required to establish a liability for uncertain tax positions.

11. RELATED PARTY TRANSACTIONS

Due to Affiliates

The following table presents the amounts included within due to affiliates:

 

     September 30, 2009    December 31, 2008
     (dollars in thousands)

Amounts payable under tax receivable agreement

   $ 854,080    $ 857,593

Och-Ziff Operating Group distributions declared prior to the Reorganization

     231,071      342,943

Allocations to non-equity partner interests payable

     127,213      187,647
             

Total Due To Affiliates

   $ 1,212,364    $ 1,388,183
             

As of September 30, 2009 and December 31, 2008, the amounts presented above relating to (i) Och-Ziff Operating Group distributions declared prior to the Reorganization, where Mr. Och’s distributions were treated as equity distributions, and (ii) allocations to non-equity partner interests payable, where the other founding partners’ distributions were treated as operating expenses, each represent the deferred balances payable to the Company’s partners, net of taxes. These balances relate to incentive income allocated to the founding partners and the Ziffs prior to the IPO, and are adjusted each period for earnings and losses on deferred balances, net of taxes.

Management Fees and Incentive Income Earned from Och-Ziff Funds

The Company earns substantially all of its management fees and incentive income from the Och-Ziff funds, which are considered related parties as the Company manages the operations of and makes investment decisions for these funds. Management fees related to the real estate funds included within the Company’s other operations are collected directly from the investors in those funds and, therefore, are not considered revenues earned from related parties. The following table presents management fees and incentive income earned from related parties:

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008
     (dollars in thousands)

Management fees

   $ 85,172    $ 144,682    $ 260,108    $ 428,681

Incentive income

   $ 3,071    $ 4,373    $ 3,336    $ 5,483

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

Management Fees and Incentive Income Earned from Affiliates and Waived Fees

The Company charged management fees on investments in the Och-Ziff funds held by partners and other related parties in the amount of $4.6 million and $5.8 million for the three months ended September 30, 2009 and 2008, respectively, and $15.4 million and $17.1 million for the nine months ended September 30, 2009 and 2008, respectively. Following the Offerings, the Company continues to waive management fees and incentive income for investments made by employees (other than our partners) and certain other related parties, for amounts invested by the founding partners prior to the Offerings and for the reinvestment of deferred balances by the founding partners. As a result, management fees of $3.6 million and $5.0 million were waived during the three months ended September 30, 2009 and 2008, respectively, and $10.2 million and $15.8 million were waived during the nine months ended September 30, 2009 and 2008, respectively.

Corporate Aircraft

The Company’s corporate aircraft is used primarily for business purposes. From time to time, Mr. Och uses the aircraft for personal use. The Company recorded revenues of $186 thousand and $97 thousand for Mr. Och’s personal use of the corporate aircraft based on market rates for the use of a private aircraft for the three months ended September 30, 2009 and 2008, respectively, and $386 thousand and $367 thousand for the nine months ended September 30, 2009 and 2008, respectively.

12. COMMITMENTS AND CONTINGENCIES

Tax Receivable Agreement

The purchase of Och-Ziff Operating Group A Units from the founding partners and the Ziffs with the proceeds from the Offerings, as well as subsequent taxable exchanges by the partners and the Ziffs of Och-Ziff Operating Group A Units for Class A Shares on a one-for-one basis (or, at the Company’s option, a cash equivalent), resulted, and, in the case of future exchanges, are anticipated to result, in an increase in the tax basis of the tangible and intangible assets of the Och-Ziff Operating Group that would not otherwise have been available. As a result, the Company expects that in future periods the amount of tax that it otherwise would have been required to pay will be reduced. Pursuant to the tax receivable agreement entered into among the Company, the partners and the Ziffs, the Company has agreed to pay to the partners and the Ziffs 85% of the amount of tax savings, if any, actually realized by the Company.

The Company recorded its initial estimate of future payments under the tax receivable agreement by recording a decrease to paid-in capital and an increase in amounts due to affiliates in the consolidated financial statements. Subsequent adjustments to the liability for future payments under the tax receivable agreement related to changes in estimated future tax rates or state income tax apportionment are recognized through current period earnings within general, administrative and other expenses in the consolidated statements of operations.

In connection with the departure of certain former partners, such former partners contributed their right to receive payments under the tax receivable agreement to the Och-Ziff Operating Group. As a result, the Company now expects to pay to the remaining founding partners and the Ziffs approximately 82% (from 85%) of the amount of cash savings, if any, in U.S. federal, state and local income tax that the Company actually realizes as a result of the increases in tax basis discussed above. In connection with the contributions, the Company recorded a decrease in the liability for amounts payable under the tax receivable agreement of $19.6 million, a decrease of deferred income tax assets of $1.6 million related to income tax expense expected to be incurred as a result of the payments to the Och-Ziff Operating Group, an increase to the Company’s paid-in capital of $2.3 million and an increase to partners’ and others’ interests in consolidated subsidiaries of $15.7 million.

The estimate of the timing and the amount of future payments under the tax receivable agreement involves several assumptions that do not account for the significant uncertainties associated with these potential payments, including an assumption that Och-Ziff Corp will have sufficient taxable income in the relevant tax years to utilize the tax benefits that would give rise to an obligation to make payments. The actual timing and amount of any actual payments under the tax receivable agreement will vary based upon a number of factors.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

Lease Obligations

The Company has non-cancelable operating leases for its headquarters in New York and its offices in London, Hong Kong, Tokyo, Bangalore and Beijing. The related lease commitments have not changed materially since December 31, 2008.

Litigation

From time to time, the Company is involved in litigation and claims incidental to the conduct of the Company’s business. The Company is also subject, from time to time in the ordinary course of business, to reviews, inquiries and investigations by agencies that have regulatory authority over the Company’s business activities. The Company is currently not subject to any pending judicial, administrative or arbitration proceedings that are expected to have a material impact on the Company’s results of operations or financial condition.

Investment Commitments

As of September 30, 2009, an Och-Ziff fund consolidated by the Company had a commitment to fund investments in the amount of $194.5 million. This commitment will be funded through contributions from investors in the consolidated fund, as the Company is only the investment manager and not an investor in the fund. The Company expects this commitment to be funded over the next five years. In addition, the Company has committed to fund a portion of the annual operating budget for a joint venture, currently approximately $4.7 million, of which $3.5 million has been funded through September 30, 2009. The Company expects to continue to fund the remaining commitment during the fourth quarter of 2009. The joint venture periodically returns substantially all of the capital that is contributed, as expenses incurred by the joint venture are generally reimbursed by the projects it manages.

Other Contingencies

In the normal course of business, the Company enters into contracts that provide a variety of general indemnifications. Such contracts include those with certain service providers, brokers and trading counterparties. Any exposure to the Company under these arrangements could involve future claims that may be made against the Company. Currently, no such claims exist or are expected to arise and, accordingly, the Company has not accrued any liability in connection with such indemnifications.

13. SEGMENT INFORMATION

The Och-Ziff Funds segment represents the Company’s core business, as substantially all of the Company’s operations are conducted through this segment, and is currently the Company’s only reportable segment. The Och-Ziff Funds segment provides management and advisory services to the Company’s hedge funds and separately managed accounts.

The Company’s other operations are currently comprised of its real estate business, which manages and provides advisory services to the Company’s real estate funds. Also included in other operations are investments in new businesses established to expand the Company’s private investment platforms. Management does not regularly review assets by operating segment in assessing operating segment performance and the allocation of company resources; therefore, the Company does not present total assets by operating segment.

Och-Ziff Funds Segment

Management uses “Economic Income” of the Och-Ziff Funds segment to evaluate the financial performance of and make operating decisions for the Och-Ziff Funds segment. Economic Income is a pre-tax measure of performance that (i) presents the results of operations without the impact of eliminations resulting from the consolidation of any of the Och-Ziff funds; (ii) presents management fees net of recurring placement and related service fees on assets under management; (iii) recognizes the full amount of deferred cash compensation as an expense on the date it is awarded irrespective of any requisite service period or deferral; and (iv) excludes the following: Reorganization expenses, equity-based compensation expense, allocations to non-equity partner interests, profit sharing, net earnings (losses) on deferred balances and investments in the Och-Ziff funds and joint ventures, gain on early retirement of debt, depreciation, changes in tax receivable agreement liability and amounts allocated to partners’ and others’ interests in income of consolidated subsidiaries. See the footnotes that follow the reconciliation tables below for additional information regarding the adjustments made to arrive at Economic Income of the Och-Ziff Funds segment.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The following table presents Economic Income of the Och-Ziff Funds segment for the three and nine months ended September 30, 2009 and 2008:

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008
     (dollars in thousands)

Economic Income Revenues

           

Management fees

   $ 86,262    $ 147,747    $ 263,209    $ 438,034

Incentive income

     3,071      4,373      3,336      5,483

Other revenues

     268      919      713      3,149
                           

Total Economic Income Revenues

     89,601      153,039      267,258      446,666
                           

Economic Income Expenses

           

Compensation and benefits

     23,539      28,813      86,502      76,989

Non-compensation expenses

     22,255      30,463      68,149      94,967
                           

Total Economic Income Expenses

     45,794      59,276      154,651      171,956
                           

Economic Income

   $ 43,807    $ 93,763    $ 112,607    $ 274,710
                           

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

The tables below present Economic Income of the Och-Ziff Funds segment, other operations and the related adjustments necessary to reconcile the Economic Income of the Och-Ziff Funds segment to the Company’s consolidated U.S. GAAP net loss. For a description of these adjustments, see the notes following the tables:

 

     Economic
Income -
Och-Ziff
Funds
   Other
Operations
    Reconciling Adjustments     Total
Company
U.S. GAAP
Basis
 

Three Months Ended September 30, 2009

        Funds
Consolidation
    Other
Adjustments
   
     (dollars in thousands)  

Revenues

           

Management fees

   $ 86,262    $ 1,312      $ (56   $ 609  (a)    $ 88,127   

Incentive income

     3,071      —          —          —          3,071   

Other revenues

     268      87        —          —          355   

Income of consolidated Och-Ziff funds

     —        10,127        —          —          10,127   
                                       

Total Revenues

     89,601      11,526        (56     609        101,680   
                                       

Expenses

           

Compensation and benefits

     23,539      11,338        —          29,197  (b)(c)      64,074   

Allocations to non-equity partner interests

     —        —          —          8,052  (d)      8,052   

Reorganization expenses

     —        —          —          417,486  (e)      417,486   

Profit sharing

     —        —          —          663  (f)      663   

Interest expense

     2,168      —          —          —          2,168   

General, administrative and other

     20,087      1,000        —          19,600  (a)(g)      40,687   

Expenses of consolidated Och-Ziff funds

     —        869        11        —          880   
                                       

Total Expenses

     45,794      13,207        11        474,998        534,010   
                                       

Other Income (Loss)

           

Net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures

     —        (244     —          21,814  (h)      21,570   

Net gains (losses) of consolidated Och-Ziff funds

     —        10        (57     —          (47
                                       

Total Other Income (Loss)

     —        (234     (57     21,814        21,523   
                                       

Income (Loss) Before Income Taxes

     43,807      (1,915     (124     (452,575     (410,807

Income taxes

     —        188        —          (21,077 ) (g)      (20,889
                                       

Consolidated Net Income (Loss)

   $ 43,807    $ (2,103   $ (124   $ (431,498   $ (389,918
                                       

Net Income (Loss) Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ —      $ 9,009      $ (124   $ (318,776 ) (g)    $ (309,891
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 43,807    $ (11,112   $ —        $ (112,722   $ (80,027
                                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

     Economic
Income -
Och-Ziff
Funds
   Other
Operations
    Reconciling Adjustments     Total
Company
U.S. GAAP
Basis
 

Three Months Ended September 30, 2008

        Funds
Consolidation
    Other
Adjustments
   
     (dollars in thousands)  

Revenues

           

Management fees

   $ 147,747    $ 1,312      $ (83   $ —        $ 148,976   

Incentive income

     4,373      —          —          —          4,373   

Other revenues

     919      6        —          —          925   

Income of consolidated Och-Ziff funds

     —        2,696        72        —          2,768   
                                       

Total Revenues

     153,039      4,014        (11     —          157,042   
                                       

Expenses

           

Compensation and benefits

     28,813      1,878        —          19,686  (b)(c)      50,377   

Allocations to non-equity partner interests

     —        —          —          (3,039 )(d)      (3,039

Reorganization expenses

     —        —          —          425,585  (e)      425,585   

Profit sharing

     —        —          —          (305 )(f)      (305

Interest expense

     7,118      —          —          —          7,118   

General, administrative and other

     23,345      472        —          915  (g)      24,732   

Expenses of consolidated Och-Ziff funds

     —        897        146        —          1,043   
                                       

Total Expenses

     59,276      3,247        146        442,842        505,511   
                                       

Other Income (Loss)

           

Net losses on deferred balances and investments in Och-Ziff funds and joint ventures

     —        (1,544     —          (19,281 )(h)      (20,825

Net gains (losses) of consolidated Och-Ziff funds

     —        1,859        (569     —          1,290   
                                       

Total Other Income (Loss)

     —        315        (569     (19,281     (19,535
                                       

Income (Loss) Before Income Taxes

     93,763      1,082        (726     (462,123     (368,004

Income taxes

     —        19        —          14,716  (g)      14,735   
                                       

Consolidated Net Income (Loss)

   $ 93,763    $ 1,063      $ (726   $ (476,839   $ (382,739
                                       

Net Income (Loss) Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ —      $ 3,876      $ (726   $ (316,445 )(g)    $ (313,295
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 93,763    $ (2,813   $ —        $ (160,394   $ (69,444
                                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

     Economic
Income -
Och-Ziff
Funds
   Other
Operations
    Reconciling Adjustments     Total
Company
U.S. GAAP
Basis
 

Nine Months Ended September 30, 2009

        Funds
Consolidation
    Other
Adjustments
   
     (dollars in thousands)  

Revenues

           

Management fees

   $ 263,209    $ 3,934      $ (167   $ 1,622  (a)    $ 268,598   

Incentive income

     3,336      —          —          —           3,336   

Other revenues

     713      195        —          —           908   

Income of consolidated Och-Ziff funds

     —        21,629        —          —          21,629   
                                       

Total Revenues

     267,258      25,758        (167     1,622        294,471   
                                       

Expenses

           

Compensation and benefits

     86,502      30,808        —          74,665  (b)(c)      191,975   

Allocations to non-equity partner interests

     —        —          —          12,627  (d)      12,627   

Reorganization expenses

     —        —          —          1,262,171  (e)      1,262,171   

Profit sharing

     —        —          —          954  (f)      954   

Interest expense

     10,823      —          —          —           10,823   

General, administrative and other

     57,326      3,277        —          23,466  (a)(g)      84,069   

Expenses of consolidated Och-Ziff funds

     —        2,757        19        —           2,776   
                                       

Total Expenses

     154,651      36,842        19        1,373,883         1,565,395   
                                       

Other Income (Loss)

           

Net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures

     —        (1,236     —          26,542  (h)      25,306   

Gain on early retirement of debt

     —        —          —          2,013  (g)      2,013   

Net gains (losses) of consolidated Och-Ziff funds

     —        1,599        (1,744     —           (145
                                       

Total Other Income (Loss)

     —        363        (1,744     28,555         27,174   
                                       

Income (Loss) Before Income Taxes

     112,607      (10,721     (1,930     (1,343,706     (1,243,750

Income taxes

     —        291        —          (17,902 )(g)      (17,611
                                       

Consolidated Net Income (Loss)

   $ 112,607    $ (11,012   $ (1,930   $ (1,325,804   $ (1,226,139
                                       

Net Income (Loss) Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ —      $ 20,245      $ (1,930   $ (994,260 )(g)    $ (975,945
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 112,607    $ (31,257   $ —        $ (331,544   $ (250,194
                                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

     Economic
Income -
Och-Ziff
Funds
   Other
Operations
    Reconciling Adjustments     Total
Company
U.S. GAAP
Basis
 

Nine Months Ended September 30, 2008

        Funds
Consolidation
    Other
Adjustments
   
     (dollars in thousands)  

Revenues

           

Management fees

   $ 438,034    $ 3,934      $ (198   $ —         $ 441,770   

Incentive income

     5,483      —          —          —           5,483   

Other revenues

     3,149      30        —          —           3,179   

Income of consolidated Och-Ziff funds

     —        7,548        106        —           7,654   
                                       

Total Revenues

     446,666      11,512        (92     —           458,086   
                                       

Expenses

           

Compensation and benefits

     76,989      2,969        —          75,430  (b)(c)      155,388   

Allocations to non-equity partner interests

     —        —          —          (865 )(d)      (865

Reorganization expenses

     —        —          —          1,276,753  (e)      1,276,753   

Profit sharing

     —        —          —          (1,736 )(f)      (1,736

Interest expense

     24,791      —          —          —           24,791   

General, administrative and other

     70,176      1,194        —          12,401  (g)      83,771   

Expenses of consolidated Och-Ziff funds

     —        1,891        509        —           2,400   
                                       

Total Expenses

     171,956      6,054        509        1,361,983         1,540,502   
                                       

Other Loss

           

Net losses on deferred balances and investments in Och-Ziff funds and joint ventures

     —        (6,144     —          (18,851 )(h)      (24,995

Net gains (losses) of consolidated Och-Ziff funds

     —        2,761        (1,974     —           787   
                                       

Total Other Loss

     —        (3,383     (1,974     (18,851     (24,208
                                       

Income (Loss) Before Income Taxes

     274,710      2,075        (2,575     (1,380,834     (1,106,624

Income taxes

     —        226        —          22,470  (g)      22,696   
                                       

Consolidated Net Income (Loss)

   $ 274,710    $ 1,849      $ (2,575   $ (1,403,304   $ (1,129,320
                                       

Net Income (Loss) Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ —      $ 9,455      $ (2,575   $ (737,837 )(g)    $ (730,957
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 274,710    $ (7,606   $ —        $ (665,467   $ (398,363
                                       

The following is a summary of the adjustments made to the U.S. GAAP net loss for the Och-Ziff Funds segment to arrive at Economic Income for the segment:

Funds Consolidation. Economic Income for the Och-Ziff Funds segment reflects management fees and incentive income earned from each of the Company’s hedge funds and separately managed accounts, excluding the Company’s domestic real estate funds which are included within the Company’s other operations. The impacts of consolidation and the related eliminations of the Och-Ziff funds are not included in Economic Income.

Other Adjustments. Economic Income is calculated by:

 

  (a) presenting management fees net of recurring placement and related service fees on assets under management, as management considers these fees a reduction in management fees, not an expense.

 

  (b) recognizing deferred cash compensation expense in full in the period in which it is awarded, as management determines the total amount of compensation based on the Company’s performance in the year of the award.

 

  (c) excluding equity-based compensation expense, as management does not consider these non-cash expenses when evaluating Economic Income for the Och-Ziff Funds segment.

 

  (d)

excluding allocations to non-equity partner interests. Management reviewed the performance of the Och-Ziff Funds segment before it made any allocations to the Company’s non-equity founding partners for periods prior to the Reorganization. For these periods, allocations to the founding partners, other than Mr. Och, were treated as

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2009

 

 

expenses for U.S. GAAP purposes. Following the Reorganization, only allocations to the founding partners, other than Mr. Och, related to earnings on deferred balances are incurred and these allocations are excluded from Economic Income.

 

  (e) excluding Reorganization expenses, which are non-cash expenses directly attributable to the reclassification of interests held by the founding partners and the Ziffs prior to the Reorganization into Och-Ziff Operating Group A Units.

 

  (f) excluding the profit sharing expenses related to the Ziffs’ interest in the Company. Management reviewed the performance of the Och-Ziff Funds segment before it made any allocations to the Ziffs for periods prior to the Reorganization. Following the Reorganization, only profit sharing expense related to the allocation of earnings on deferred balances are incurred and these allocations are excluded from Economic Income.

 

  (g) excluding depreciation, changes in the tax receivable agreement liability, gain on early retirement of debt and amounts allocated to partners’ and others’ interests in income of consolidated subsidiaries, as management does not consider these items when evaluating the performance of the Och-Ziff Funds segment. Economic Income also excludes income taxes as it is a measure of pre-tax performance.

 

  (h) excluding the net earnings (losses) on deferred balances and investments in Och-Ziff funds, as these amounts primarily relate to earnings (losses) on amounts due to affiliates for deferred balances, and earnings (losses) on amounts due to employees under deferred cash compensation arrangements that are indexed to the returns of certain funds.

Substantially all of the Company’s revenues are earned from the Och-Ziff funds. For the three months ended September 30, 2009, the Company recorded revenues of $15.7 million from an individual feeder fund managed by the Och-Ziff Funds segment, which represented more than 10% of the Company’s total revenues. For the three months ended September 30, 2008, the Company recorded revenues of $42.9 million, $27.0 million, $20.0 million and $15.9 million from four individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues. For the nine months ended September 30, 2009, the Company recorded revenues of $82.7 million, $45.1 million and $32.0 million from three individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues. For the nine months ended September 30, 2008, the Company recorded revenues of $120.2 million, $79.6 million, $58.1 million and $49.2 million from four individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues.

14. SUBSEQUENT EVENTS

The Company has evaluated events that have occurred since September 30, 2009 and through November 4, 2009 (the date of this filing), and it has determined that no events have occurred that would require recognition or additional disclosures in these interim unaudited consolidated financial statements to prevent them from being misleading.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in “Part I—Item 1A. Risk Factors” of our annual report filed with the U.S. Securities and Exchange Commission on Form 10-K for the year ended December 31, 2008, which we refer to as our “Annual Report.” Actual results may differ materially from those contained in any forward-looking statements. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report. An investment in our Class A Shares is not an investment in any of our funds.

BUSINESS OVERVIEW

We are a leading global alternative asset management firm with offices in New York, London, Hong Kong, Tokyo, Bangalore and Beijing. We provide investment management services to our various hedge funds and separately managed accounts on behalf of a diverse group of institutional investors worldwide, including funds-of-funds, pension and profit-sharing funds, foundations, university endowments and other financial institutions. We were founded in 1994 by Daniel Och in partnership with the Ziffs with the goal of building an enduring, world class investment management business. Since our inception, we have managed our business with a global perspective, taking advantage of investment opportunities wherever they arise. We have been among the pioneers of the hedge fund industry in building out a global investment platform, with 362 employees, including 135 investment professionals, worldwide as of September 30, 2009.

In November 2007, we completed our initial public offering, or “IPO,” of 36 million Class A Shares and a private offering of approximately 38.1 million Class A Shares to DIC Sahir, a wholly-owned subsidiary of Dubai International Capital LLC. We refer to the IPO and the private share sale to DIC Sahir collectively as the “Offerings.” The Offerings strengthened our brand visibility globally while also providing us with the added capital to pursue growth opportunities. Our founding partners, including Daniel Och, and the Ziffs reinvested substantially all of their $1.6 billion in after-tax proceeds from the Offerings into the Och-Ziff funds, primarily OZ Global Special Investments Master Fund, the main vehicle by which we expect to grow our private investments business.

FACTORS AFFECTING OUR BUSINESS

As a global alternative asset manager, our business is affected by several factors, including: economic conditions in the United States, Western Europe, Asia and elsewhere in the world; the strength and liquidity of the U.S. and global capital markets; the strength of the alternative asset management industry, including the amount of capital invested in, and withdrawn from, alternative investments; and our investment performance on both an absolute and relative basis and the related impact on our ability to attract new capital.

During the third quarter, equity and credit markets continued to rally globally, further advancing the rally that began in the first half of 2009. While economic data was mixed, corporate earnings results were generally favorable relative to expectations. Credit spreads continued to tighten as capital markets issuance remained strong, with issuers taking advantage of favorable market conditions to repair their balance sheets through debt and equity issuance. Monetary policy remained extremely accommodative.

Fundamentals in the hedge fund industry improved further during the 2009 third quarter. Investment performance was generally strong in response to the more favorable market environment and lower volatility in the equity markets globally. Redemptions appeared to have normalized to historical levels for the industry as a whole as market conditions have further improved and investor confidence has increased. New capital flows are slowly beginning to return to the industry, with the 2009 third quarter being the second consecutive quarter in which there was a net increase in capital. It may still take some time, however, for those inflows to become meaningful as institutional investors continue to assess how they will re-balance their portfolios and re-invest their capital. We continue to believe that investors have substantial capital to invest, that they will allocate a portion of it to alternative asset managers, and that this allocation will grow over time.

During the third quarter of 2009, our funds delivered strong absolute returns in every month of the quarter. Our investment performance benefitted from our multi-strategy approach, which gives us the ability to capitalize on investment opportunities in a number of asset classes globally. Our redemptions declined substantially from second quarter levels, and we believe that, consistent with the experience for the hedge fund industry more broadly, our redemptions have returned to historical levels. We believe that the most important factor about future capital inflows is not the exact timing of when they begin, but rather the aggregate size of those flows over time and the corresponding market share we are able to attract. We remain confident that as investors re-deploy capital to alternative investments, we will be a leading beneficiary of those flows because of our track record, infrastructure, transparency and the consistency of our model.

 

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Our ability to grow revenues and expand our business is dependent upon attracting new assets under management from existing and new investors. The current environment presents unique opportunities because the market dislocation affected such a broad range of asset classes around the world. We also believe that the competitive landscape has changed in important ways due to the consolidation and contraction that have occurred both within the hedge fund industry and in the financial services industry since the beginning of 2008. Both the expanding opportunity set and the more fragmented competitive landscape are positive factors for our business. Finally, we believe investors place a premium on global institutional asset managers like us that have a long, positive track record, a strong business infrastructure, a multi-strategy approach, provide transparency to fund investors and have significant capital to deploy when the right opportunities arise.

There are several elements which are integral to our business that we believe are differentiating competitive strengths. As such, we view these elements as important to our ability to attract new assets under management over time:

 

   

Well established investment performance track record and strong investment returns. We are a leading, global alternative asset manager with a track record spanning fifteen years. We have demonstrated our ability to generate consistent, positive, absolute returns and preserve fund investor capital across market cycles. We believe our investment performance record positions us to gain a greater share of capital inflows as institutional investors increase their demand for hedge fund products. Historically, this demand has been driven by several factors, including the pursuit of higher returns compared to those generated by traditional equity and fixed income strategies, the desire to increase diversification and selecting asset managers who generate investment returns with low volatility and that have a low correlation to the broader equity markets.

 

   

Multi-strategy approach. We have a highly-diversified business model and pursue five core investment strategies globally. Within each of our portfolios we allocate capital dynamically amongst these strategies based on where we see the best investment opportunities. Our investment strategies are not dependent on large directional moves in the markets broadly or in any one sector or strategy. Moreover, we do not invest capital based on pre-determined allocations by geography, asset class or industry sector, but rather by where we see the best opportunities. Our approach seeks to ensure that investments are diverse and sized appropriately relative to risk/return.

 

   

Disciplined investment and risk management processes. We maintain a disciplined focus on the investment and risk management processes that have been central to our business since inception. We generally make investments where our analytical processes lead us to believe that we have expertise and a competitive advantage, and then only in positions for which we believe the risks are reasonable and manageable. Our risk management principles and practices are a key element of our daily investment processes, and we focus significant attention to actively managing the risk in our portfolios.

 

   

Low use of leverage. Historically, we have generated investment returns without the extensive use of leverage, and we will continue to manage our business with a consistent and disciplined focus on generating consistent, positive, absolute returns and preserving investor capital.

 

   

Infrastructure and transparency. We provide fund investors with the infrastructure and transparency that they consider important in their determination of alternative asset managers with which to invest.

 

   

Global presence. We have a diversified global alternative investment platform. Our global presence, respected brand name and financial and intellectual capital enable us to identify and quickly respond to investment opportunities. As markets continue to stabilize, we believe that there is significant potential for us to further develop our private investment platforms to capitalize on emerging markets, real estate, energy and alternative energy. We believe that these asset classes will be drivers of long-term growth in our assets under management.

UNDERSTANDING OUR RESULTS

Assets under Management and Fund Performance

Our results are primarily driven by the combination of assets under management and the investment performance of our funds. Positive investment performance and preservation of fund investor capital are the principal determinants of the long-term success of our business because they enable us to grow assets under management organically as well as attract new capital and minimize redemptions by our fund investors. Conversely, poor investment performance slows our growth, decreases our assets under management and can result in investor redemptions from our funds.

We typically accept new investors and additional investments from existing investors into our funds on a monthly basis on the first day of each month. Investors in our funds (other than investors in special investments, certain real estate funds and other new businesses) have the right to redeem their interests in a fund following an initial lock-up period of one to three years. Following the expiration of these lock-up periods, investors may redeem capital generally on a quarterly or annual basis upon giving 30 to 45 days prior written notice; provided however, that upon the payment of a redemption fee and upon giving 30 days

 

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prior written notice, investors with quarterly redemption rights may redeem capital during the lock-up period. The lock-up requirements for the funds may generally be waived or modified in the sole discretion of the fund’s general partner or board of directors, as applicable. The ability of investors to contribute capital to and redeem capital from our funds causes our assets under management to fluctuate from period to period. Fluctuations in assets under management also result from our funds’ investment performance due to the reinvestment of fund profits and impact of fund losses. Fluctuations in assets under management due to investor contributions and redemptions, and resulting from fund performance, directly impact the revenues we earn from management fees and incentive income.

As our assets under management fluctuate, our revenues from management fees fluctuate. Management fee rates typically range from 1.5% to 2.5% of assets under management annually and currently average approximately 1.7%, taking into account non-fee paying assets under management. Management fees are calculated on a quarterly basis, based on assets under management as of the first day of each quarter. Capital contributions made during a quarter are charged a pro rata management fee. Requests for redemptions submitted during a quarter generally are paid at the beginning of the following quarter. Accordingly, quarterly redemptions generally will have no impact on management fees during the quarter in which they are submitted. Instead, these redemptions will decrease assets under management as of the first day of the following quarter, which reduces management fees for that quarter. In addition, annual fund investment performance determines the amount of incentive income we will earn, because generally we earn 20% of any net profits earned by the funds on an annual basis.

Accordingly, our revenues are directly impacted by the value of our assets under management. Management fees are directly impacted by any increase or decrease in our assets under management, whether due to investor capital flows or fund investment performance, while incentive income is directly impacted by our funds’ performance and indirectly impacted by increases and decreases in assets under management. To the extent that our assets under management change, our total revenues will change. For example, a $1 billion increase or decrease in assets under management would generally increase or decrease annual management fees by approximately $17 million, assuming no material changes in current average management fee rates and taking into account non-fee paying assets under management. If net profits attributable to a fee-paying fund investor were $1 billion, we generally would earn incentive income equal to $200 million, assuming no change in current incentive income rates. For most of our funds, there is a one-year high-water mark in years when our funds experience negative investment performance. Generally, if the high-water mark is not recouped during the year following the loss, the high-water mark is eliminated, allowing us to earn incentive income during the second year following the loss, even if the full amount of the investor’s prior year’s loss had not been recouped. If the high-water mark is recouped during the year, we would then be able to earn incentive income during that year on net profits in excess of the high-water mark.

Information with respect to our assets under management throughout this quarterly report, including the tables set forth in this discussion and analysis, includes deferred balances, which are made up of incentive income receivables from our offshore funds that were deferred prior to the Offerings, and investments by us, our partners and certain other affiliated parties. Prior to the IPO, we did not charge management fees or earn incentive income on these investments. Following our IPO, we began charging management fees and earning incentive income on new investments made in our funds by our partners and certain other affiliated parties, including the reinvestment by our founding partners of the after-tax proceeds from the Offerings, other than the reinvestment by our founding partners of deferred balances. As of September 30, 2009, approximately 11% of our assets under management represented investments by us, our partners and certain other affiliated parties in our funds and the deferred balances. As of this date, approximately 40% of these affiliated assets under management are not charged management fees and are not subject to an incentive income allocation, as they relate primarily to deferred balances and pre-IPO investments by our founding partners and other related parties.

Revenues

We generate revenue through two principal sources: management fees and incentive income. The amount of revenues earned from those sources is directly related to the amount of our assets under management and the investment performance of our funds. Management fees are directly impacted by any increase or decrease in our assets under management, while incentive income is impacted by our funds’ performance and any increase or decrease in assets under management.

 

   

Management fees. We earn management fees as follows:

Hedge Funds and Managed Accounts. Management fees range from 1.5% to 2.5% annually of assets under management. Management fees are generally paid to us on a quarterly basis, at the beginning of the quarter, based on assets under management at the beginning of the quarter. Management fees are prorated for capital inflows and redemptions during the quarter. Accordingly, changes in our management fee revenues each quarter are influenced by changes in the opening balances of assets under management, the management fee rates charged on new capital compared with the rates on capital that is redeemed, and the relative magnitude and timing of inflows and redemptions during the respective quarter.

 

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Real Estate Funds. Management fees from the Och-Ziff real estate funds are generally charged at an annual rate of 1.5% of the total capital commitments during the original investment period (through October 31, 2009) and 1.5% of invested capital thereafter. Management fees are generally paid to us on a quarterly basis, at the beginning of the quarter, and are prorated for changes in capital commitments throughout the original investment period and invested capital thereafter.

 

   

Incentive Income. We earn incentive income based on the performance of the Och-Ziff funds and managed accounts. Incentive income is typically equal to 20% of the net realized and unrealized profits earned for the full year that are attributable to each investor, but excludes unrealized profits on certain private investments. Incentive income on private investments is earned in the year of the sale or realization of the private investment. Generally, for most of our funds, there is a one-year high-water mark, except for the OZ Global Special Investments Master Fund, which has a perpetual high-water mark. Substantially all of our incentive income is recorded at the end of the fourth quarter of each year, when all contingencies have been resolved. Generally, incentive income recorded during the first three quarters of the year is related to fund investor redemptions.

Revenues recorded as income of consolidated Och-Ziff funds consists of interest income, dividend income and other revenues related to the lending of securities and other miscellaneous items.

Expenses

Our operating expenses consist of compensation and benefits; interest expense; and general, administrative and other expenses.

 

   

Compensation and benefits. Compensation and benefits is comprised of salaries and benefits, guaranteed and discretionary cash bonuses and equity-based compensation primarily in the form of Class A restricted share units, or “RSUs”. Generally, compensation and benefits comprise a significant portion of total expenses, with discretionary cash bonuses comprising a large portion of total compensation and benefits expense. These cash bonuses are funded by total annual revenues, which are significantly influenced by incentive income earned by us at the end of the year.

In the second quarter of 2009, we began to accrue for the estimated discretionary cash bonuses that we expected to pay our employees at year end. We did this in order to provide a competitive compensation structure taking into account the high-water marks in our funds, which if not recovered could preclude us from earning any incentive income, and the fact that our funds had generated strong year-to-date investment performance due to the efforts of the firm’s employees. In the third quarter of 2009, management revised its annual discretionary bonus compensation methodology for years in which high-water marks are in effect. During the second and third quarter, we accrued a total of $31.5 million. Any remaining amount will be expensed in the fourth quarter. The actual cash bonuses paid in the 2009 fourth quarter may vary materially from management’s current estimate as discretionary cash bonuses are based on total annual revenues, including any year-end incentive income, which is influenced by, among other things, our funds’ investment performance, the level of assets under management, the ability of our funds to continue to satisfy the high-water marks at the end of the year and global economic and market conditions. As we have done historically, we will determine the actual amount of annual discretionary cash bonuses in the fourth quarter of this year. Accordingly, the amounts accrued as of September 30, 2009 may not be indicative of the actual cash bonuses paid in the 2009 fourth quarter.

 

   

Interest expense. Amounts included within interest expense relate primarily to interest expense on our term loan and on the note payable on our corporate aircraft.

 

   

General, administrative and other. General, administrative and other expenses are related to professional services, occupancy and equipment, business development expenses, information processing and communications, insurance, changes in the tax receivable agreement liability and other miscellaneous expenses.

Prior to the Reorganization, income allocations to our founding partners, other than Mr. Och, and the Ziffs on their interests in our business were recorded as allocations to non-equity partners and profit sharing expenses, respectively. As part of the Reorganization, these interests were reclassified as Och-Ziff Operating Group A Units, resulting in significant non-cash charges that we have recorded within Reorganization expenses in our consolidated statements of operations. The estimated future Reorganization expenses related to the amortization of Och-Ziff Operating Group A Units held by our founding partners are expected to be approximately $1.7 billion per year from 2009 through 2011 and $1.5 billion in 2012.

Expenses recorded as expenses of consolidated Och-Ziff funds consist of interest expense, dividend expense, stock loan fees and other expenses.

 

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Other Income (Loss)

Our other income (loss) consists of (i) net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures, (ii) gain on early retirement of debt; and (iii) net gains (losses) of consolidated Och-Ziff funds.

 

   

Net Earnings (Losses) on Deferred Balances and Investments in Och-Ziff Funds and Joint Ventures. Net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures primarily consists of the following: (i) net earnings (losses) on deferred balances; (ii) net earnings (losses) on investments in our funds made by us to economically hedge certain deferred compensation plans indexed to fund performance; and (iii) net losses on investments in joint ventures.

 

   

Gain on Early Retirement of Debt. Gain on early retirement of debt consists of the gain realized upon the early retirement of $5 million of our term loan that occurred during the second quarter of 2009.

 

   

Net Gains (Losses) of Consolidated Och-Ziff Funds. Net gains (losses) of consolidated Och-Ziff funds consist of realized and unrealized gains and losses on investments held by the consolidated Och-Ziff funds.

Income Taxes

The computation of the effective tax rate and provision for each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent differences, and the likelihood of recovering deferred tax assets existing as of September 30, 2009. The estimates and judgments used to compute the provision for income taxes may change as new events occur, additional information is obtained or the tax laws and regulations change.

Members of the United States Congress have introduced legislation in the current session of Congress that would, if enacted, preclude us from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly-traded partnership rules. In addition, other tax legislation has been proposed that may negatively impact our business, such as taxing the incentive income we derive from our interests in certain funds as ordinary income. See “Item 1A. Risk Factors—Risks Related to Taxation—Members of the United States Congress have introduced legislation that would, if enacted, preclude us from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly-traded partnership rules and treat certain of our offshore funds as domestic corporations. Our structure also is subject to potential judicial or administrative change and differing interpretations, possibly on a retroactive basis.” in our Annual Report for information on other legislation, including legislation introduced in the previous session of Congress addressing these issues.

Net Loss Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

Partners’ and others’ interests in income of consolidated subsidiaries represents ownership interests held by parties other than us and is primarily made up of: (i) Och-Ziff Operating Group A Units held by our founding partners and the Ziffs; and (ii) fund investors’ interests in the consolidated Och-Ziff funds. Increases or decreases in this item related to the Och-Ziff Operating Group A Units are driven by the earnings or losses of the Och-Ziff Operating Group, and prior to the adoption of the Financial Accounting Standards Board’s (“FASB”) new accounting treatment of noncontrolling interests (formerly Statement of Financial Accounting Standards (“SFAS”) No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS 160”)) on January 1, 2009, losses were allocated to such units to the extent that cumulative losses did not reduce partners’ and others’ interests in consolidated subsidiaries to a deficit position. Subsequent to January 1, 2009, we no longer absorb losses when cumulative losses reduce partners’ and others’ interests in consolidated subsidiaries to a deficit position. See “—Recently Adopted Accounting Pronouncements” for additional information regarding the adoption of SFAS 160. Increases or decreases in this item related to fund investors’ interests in consolidated Och-Ziff funds are driven by the earnings or losses of the consolidated Och-Ziff funds.

ASSETS UNDER MANAGEMENT AND FUND PERFORMANCE

Assets Under Management

Our assets under management include deferred balances, amounts invested by us and certain amounts invested by our founding partners and other affiliated parties for which we charge no management fees and receive no incentive income. As of September 30, 2009, approximately 11% of our assets under management represented investments by us, our partners and certain other affiliated parties in our funds and the deferred balances. As of this date, approximately 40% of these affiliated assets under management are not charged management fees and are not subject to an incentive income allocation, as they relate primarily to deferred balances and pre-IPO investments by our founding partners and other related parties. In addition, we calculate management fees based on a quarterly basis, based on assets under management as of the first day of each quarter. Capital contributions made during a quarter are charged a pro rata management fee. The amounts presented below are net of management fees and incentive income, and are presented as of the end of the period. Accordingly, the assets under management presented in the table below are not the amounts used to calculate management fees for the respective periods.

 

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The following table sets forth assets under management of our most significant funds (by asset size):

 

     September 30,
     2009    2008
     (dollars in thousands)

OZ Master Fund

   $ 14,772,543    $ 18,832,375

OZ Europe Master Fund

   $ 2,958,346    $ 5,784,214

OZ Asia Master Fund

   $ 1,327,226    $ 3,247,272

OZ Global Special Investments Master Fund

   $ 1,980,060    $ 2,023,214

Assets under management presented in this table do not include assets under management related to our real estate funds, the separate accounts we manage on behalf of certain institutions or certain other funds, which collectively were approximately $1.2 billion and $1.4 billion as of September 30, 2009 and 2008, respectively.

The table below sets forth the changes to our assets under management and weighted-average assets under management. The weighted-average assets under management excludes the impact of third-quarter performance-related appreciation (depreciation) for the periods presented, as these amounts do not impact management fees calculated for such periods.

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
     (dollars in thousands)  

Balance-beginning of period

   $ 21,919,561      $ 33,618,372      $ 26,954,606      $ 33,387,455   

Net flows

     (1,134,670     73,482        (8,357,716     305,210   

Appreciation (depreciation)

     1,493,604        (2,452,579     3,680,605        (2,453,390
                                

Balance-end of period

   $ 22,278,495      $ 31,239,275      $ 22,278,495      $ 31,239,275   
                                

Weighted-average assets under management

   $ 20,821,794      $ 33,503,575      $ 20,523,347      $ 33,202,476   

Our assets under management declined substantially year-over-year due to redemptions of fund investor capital, investment losses and write-downs in our private investments, which were driven by the extremely difficult global capital market conditions during 2008, particularly during the second half of the year.

In the first nine months of 2009, our funds experienced performance-related appreciation of $3.7 billion and net investor outflows of $8.4 billion, which were comprised of $913.8 million of inflows and $9.3 billion of outflows. The outflows were driven principally by fourth quarter 2008 redemption requests paid on January 1, 2009 of $5.0 billion, first quarter 2009 redemption requests paid on April 1, 2009 of $2.3 billion and second quarter 2009 redemption requests paid on July 1, 2009 of $1.3 billion. Our fund investors, primarily our fund-of-fund investors, continued to re-balance, reduce or eliminate their exposures to hedge funds and the capital markets generally in response to challenging market conditions in January and February 2009, and to meet liquidity requirements resulting from investment losses they sustained in the second half of 2008. In addition, our redemptions were adversely impacted because we provided liquidity in accordance with the pre-defined terms of our funds in an environment where many other hedge funds maintained or imposed new constraints on investor redemptions. In the first nine months of 2008, our funds experienced performance-related depreciation of $2.5 billion and net investor inflows of $305.2 million, which were comprised of $4.3 billion of inflows and $4.0 billion of outflows.

Estimated assets under management as of November 1, 2009 were $22.6 billion, an increase of approximately $300 million from September 30, 2009, as a result of net investor inflows of $200 million from October 1, 2009 to November 1, 2009, and performance-related appreciation of approximately $100 million.

Fund Performance

Performance information for our most significant master funds is included throughout this discussion and analysis to facilitate an understanding of our results of operations for the periods presented. The performance information reflected in this discussion and analysis is not indicative of the performance of our Class A Shares and is also not necessarily indicative of the future results of any particular fund. An investment in our Class A Shares is not an investment in any of our funds. There can be no assurance that any of our master funds or our other existing and future funds will achieve similar results.

 

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The table below sets forth performance information for our most significant master funds (by asset size). These net returns represent a composite of the average net returns of the feeder funds that comprise each of the master funds presented and are presented on a total return basis, net of all fees and expenses (except incentive income earned on certain unrealized private investments that could reduce returns at the time of realization) and include the reinvestment of all dividends and income. These net returns also include realized and unrealized gains and losses attributable to certain private and IPO investments that are not allocated to all investors in the funds.

 

     Net Return for the
Three Months Ended September 30,
    Net Return for the
Nine Months Ended September 30,
 
     2009     2008     2009     2008  

OZ Master Fund

   7.3   -6.5   20.5   -5.8

OZ Europe Master Fund

   7.9   -8.8   15.5   -8.4

OZ Asia Master Fund

   11.6   -12.4   26.4   -16.9

OZ Global Special Investments Master Fund

   3.4   -3.1   7.1   -3.0

For the first nine months of 2009, performance-related appreciation was due primarily to improved investment opportunities globally in long/short equities, convertible arbitrage, and credit and structured credit, all of which are core strategies in our master funds.

 

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RESULTS OF OPERATIONS

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
     (dollars in thousands)  

Revenues

        

Management fees

   $ 88,127      $ 148,976      $ 268,598      $ 441,770   

Incentive income

     3,071        4,373        3,336        5,483   

Other revenues

     355        925        908        3,179   

Income of consolidated Och-Ziff funds

     10,127        2,768        21,629        7,654   
                                

Total Revenues

     101,680        157,042        294,471        458,086   
                                

Expenses

        

Compensation and benefits

     64,074        50,377        191,975        155,388   

Allocations to non-equity partner interests

     8,052        (3,039     12,627        (865

Reorganization expenses

     417,486        425,585        1,262,171        1,276,753   

Profit sharing

     663        (305     954        (1,736

Interest expense

     2,168        7,118        10,823        24,791   

General, administrative and other

     40,687        24,732        84,069        83,771   

Expenses of consolidated Och-Ziff funds

     880        1,043        2,776        2,400   
                                

Total Expenses

     534,010        505,511        1,565,395        1,540,502   
                                

Other Income (Loss)

        

Net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures

     21,570        (20,825     25,306        (24,995

Gain on early retirement of debt

     —          —          2,013        —     

Net gains (losses) of consolidated Och-Ziff funds

     (47     1,290        (145     787   
                                

Total Other Income (Loss)

     21,523        (19,535     27,174        (24,208
                                

Loss Before Income Taxes

     (410,807     (368,004     (1,243,750     (1,106,624

Income taxes

     (20,889     14,735        (17,611     22,696   
                                

Consolidated Net Loss

   $ (389,918   $ (382,739   $ (1,226,139   $ (1,129,320
                                

Net Loss Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

   $ (309,891   $ (313,295   $ (975,945   $ (730,957
                                

Net Loss Allocated to Class A Shareholders

   $ (80,027   $ (69,444   $ (250,194   $ (398,363
                                

Revenues

Management fees and Incentive income. The following table sets forth the components of our management fees:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009    2008     2009    2008  
     (dollars in thousands)  

Management Fees

  

Och-Ziff Funds segment:

          

Hedge funds

   $ 84,619    $ 144,765      $ 258,653    $ 428,879   

Managed accounts

     1,643      2,982        4,556      9,155   

Och-Ziff real estate funds

     1,312      1,312        3,934      3,934   

Eliminated in consolidation and other Economic Income adjustments

     553      (83     1,455      (198
                              

Total

   $ 88,127    $ 148,976      $ 268,598    $ 441,770   
                              

Management fees decreased by $60.8 million and $173.2 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods, primarily due to the decrease in average assets under management.

Our management fees, before the impact of eliminations, were 1.7% (annualized) of our weighted-average assets under management for the three and nine months ended September 30, 2009, compared to 1.8% for the three and nine months ended September 30, 2008, respectively. See “—Och-Ziff Funds Segment Analysis” for a discussion of management fees earned by the Och-Ziff Funds segment before the impact of eliminations in consolidation.

 

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Incentive income is generally recorded during the fourth quarter each year. Generally, incentive income recorded during the first three quarters of the year is related to fund investor redemptions.

Income of consolidated Och-Ziff funds. Income of consolidated Och-Ziff funds increased by $7.4 million and $14.0 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. This income is primarily related to our domestic real estate funds.

Expenses

Compensation and benefits. Compensation and benefits expenses increased by $13.7 million and $36.6 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These increases were driven primarily by an increase in share-based compensation expenses (primarily RSUs), an increase related to the discretionary bonus accrual discussed below, offset by lower bonus payments and guaranteed bonus accruals due to lower hiring activity and a reduction in our global headcount from 458 at September 30, 2008 to 362 at September 30, 2009.

In the second quarter of 2009, we began to accrue for the estimated discretionary cash bonuses that we expected to pay our employees at year end. We did this in order to provide a competitive compensation structure taking into account the high-water marks in our funds, which if not recovered could preclude us from earning any incentive income, and the fact that our funds had generated strong year-to-date investment performance due to the efforts of the firm’s employees. In the third quarter of 2009, management revised its annual discretionary bonus compensation methodology for years in which high-water marks are in effect. During the second and third quarter, we accrued a total of $31.5 million. Any remaining amount will be expensed in the fourth quarter. The actual cash bonuses paid in the 2009 fourth quarter may vary materially from management’s current estimate as discretionary cash bonuses are based on total annual revenues, including any year-end incentive income, which is influenced by, among other things, our funds’ investment performance, the level of assets under management, the ability of our funds to continue to satisfy the high-water marks at the end of the year and global economic and market conditions. As we have done historically, we will determine the actual amount of annual discretionary cash bonuses in the fourth quarter of this year. Accordingly, the amounts accrued as of September 30, 2009 may not be indicative of the actual cash bonuses paid in the 2009 fourth quarter.

Allocations to non-equity partner interests. Allocations to non-equity partner interests increased by $11.1 million and $13.5 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods as a result of an increase in the net earnings on deferred balances, net of taxes, allocated to the pre-Reorganization non-equity partner interests. Only allocations of earnings and losses on deferred balances, net of taxes, are treated as expenses following the Reorganization.

Reorganization expenses. Reorganization expenses decreased by $8.1 million and $14.6 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These expenses represent the amortization of the fair value of unvested Och-Ziff Operating Group A Units held by our founding partners after the Offerings. The decrease in Reorganization expense was primarily attributable to the forfeitures of Och-Ziff Group A Units by former partners and subsequent reallocations of those units to the remaining partners in the fourth quarter of 2008 and first half of 2009. The grant-date fair-value of the reallocated units was lower than the original grant-date fair value, and therefore, the Reorganization expense associated with these units decreased. The estimated future Reorganization expenses related to the amortization of the fair value of the remaining unvested Och-Ziff Operating Group A Units held by our founding partners is expected to be approximately $1.7 billion per year from 2009 through 2011 and $1.5 billion in 2012. Accordingly, we expect to continue to report a U.S. GAAP net loss allocated to Class A shareholders in each of these years.

Profit sharing. Profit sharing expense increased by $1.0 million and $2.7 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods as a result of an increase in the earnings on deferred balances, net of taxes, allocated to the Ziffs’ pre-Reorganization profit sharing interest in our business. Only allocations of earnings and losses on deferred balances, net of taxes, are treated as expenses following the Reorganization.

Interest expense. Interest expense decreased by $5.0 million and $14.0 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These decreases were primarily due to the decrease in LIBOR, to which both our term loan obligation and note payable on our corporate aircraft are indexed. The LIBOR interest rate on our term loan resets every one, two, three or six months (at our option), two business days prior to the start of each interest period. The LIBOR interest rate on the note payable on our corporate aircraft resets on a monthly basis, three business days prior to the start of each month.

 

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General, administrative and other expenses. The following table sets forth the components of our general, administrative and other expenses:

 

     Three Months Ended September 30,     Nine Months Ended September 30,
     2009    2008     2009    2008
     (dollars in thousands)

Occupancy and equipment

   $ 7,214    $ 5,165      $ 20,960    $ 13,271

Professional services

     3,998      8,841        13,699      30,125

Information processing and communications

     3,403      4,207        10,291      11,811

Insurance

     3,238      1,537        9,584      4,654

Business development

     1,492      3,562        4,960      9,926

Other expenses

     4,425      2,102        8,442      5,839
                            
     23,770      25,414        67,936      75,626

Changes in tax receivable agreement liability

     16,917      (682     16,133      8,145
                            

Total General, Administrative and Other

   $ 40,687    $ 24,732      $ 84,069    $ 83,771
                            

General, administrative and other expenses increased by $16.0 million and $298 thousand for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These increases were primarily driven by an increase in the tax receivable agreement liability as further discussed below, higher insurance costs, and increased occupancy and equipment costs related to the expansion of leased office space in New York and London, offset in part by a reduction in professional services and business development expenses.

The changes in tax receivable agreement liability in 2009 and 2008 were driven by changes to the future enacted tax rates at the state and local level, resulting in a change in the estimated future tax savings related to the sale of interests in the Och-Ziff Operating Group by our founding partners and the Ziffs at the time of the Offerings in addition to subsequent exchanges of Och-Ziff Operating Group A Units for Class A Shares. See “—Liquidity and Capital Resources—Dividends, Distributions, Future Liquidity and Capital Needs—Tax receivable agreement” for additional information.

Expenses of consolidated Och-Ziff funds. Expenses of consolidated Och-Ziff funds decreased by $163 thousand and increased by $376 thousand for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These expenses are primarily related to our domestic real estate funds.

Other Income (Loss)

Net Earnings (Losses) on Deferred Balances and Investments in Och-Ziff Funds and Joint Ventures. The following table sets forth: (i) net earnings (losses) on deferred balances; (ii) net gains (losses) on investments in Och-Ziff funds; (iii) net losses on joint ventures; and (iv) amounts eliminated in consolidation:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
     (dollars in thousands)  

Net earnings (losses) on deferred balances

   $ 20,840      $ (18,776   $ 24,270      $ (18,975

Net gains (losses) on investments in Och-Ziff funds

     1,073        (469     2,488        208   

Net losses on joint ventures

     (244     (1,544     (1,236     (6,144

Eliminated in consolidation

     (99     (36     (216     (84
                                

Total

   $ 21,570      $ (20,825   $ 25,306      $ (24,995
                                

Net earnings on deferred balances and investments in Och-Ziff funds and joint ventures increased by $42.4 million and $50.3 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods, primarily as a result of the increased earnings on deferred balances due to improved performance of the underlying investments of the funds to which the deferred balances are indexed. In addition, net losses on joint ventures decreased year-over-year primarily as a result of one-time start-up costs in our African joint venture in 2008, especially during the first quarter of 2008.

 

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Gain on Early Retirement of Debt. Gain on early retirement of debt consists of the gain realized upon the early retirement of debt that occurred during the second quarter of 2009. In June 2009, we repurchased and retired $5.0 million of our outstanding term loan for $3.0 million, which resulted in the recognition of a gain on early retirement of debt in the amount of $2.0 million in the consolidated statements of operations.

Net gains (losses) of consolidated Och-Ziff funds. Net gains (losses) of consolidated Och-Ziff funds decreased by $1.3 million and $932 thousand for the three and nine months ended September 30, 2009. These net gains (losses) are primarily related to our domestic real estate funds.

Income Taxes

Income tax expense decreased by $35.6 million and $40.3 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These decreases were primarily due to an increase in deferred tax assets resulting from a change in future enacted tax rates at the state and local level, in addition to a decrease in the profitability of the Och-Ziff Operating Group entities.

The Registrant and the Och-Ziff Operating Group entities are partnerships for U.S. federal income tax purposes. As a result of our legal structure, a portion of the income we earn is subject to corporate level tax rates in the U.S. and foreign jurisdictions. The provision for income taxes includes U.S. federal, state, local and foreign taxes at an effective tax rate of 20.7% and 6.6% for the three and nine months ended September 30, 2009, compared to an effective tax rate of -26.9% and -6.0% for the three and nine months ended September 30, 2008. The reconciling items between our statutory rate and our effective tax rate were due to the following: (i) only a portion of the income we earn is subject to U.S. federal, state and local corporate income taxes; (ii) a portion of the income we earn is subject to the New York City unincorporated business tax; (iii) certain foreign subsidiaries are subject to foreign corporate income taxes; and (iv) the Reorganization expenses are non-deductible for income tax purposes.

As of and for the three and nine months ended September 30, 2009 and 2008, we were not required to establish a liability for uncertain tax positions.

Net Loss Allocated to Partners’ and Others’ Interests in Income of Consolidated Subsidiaries

The following table sets forth the components of the net loss allocated to partners’ and others’ interests in income of consolidated subsidiaries:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2009     2008     2009     2008  
     (dollars in thousands)  

Och-Ziff Operating Group A Units

   $ (330,307   $ (301,555   $ (1,004,808   $ (720,439

Consolidated Och-Ziff funds

     9,046        2,897        18,307        5,759   

Other

     11,370        (14,637     10,556        (16,277
                                

Total

   $ (309,891   $ (313,295   $ (975,945   $ (730,957
                                

Net loss allocated to partners’ and others’ interests in income of consolidated subsidiaries decreased by $3.4 million and increased by $245.0 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. The increase in the year-to-date period was primarily related to the increase in net loss allocated to the Och-Ziff Operating Group A Units. As a result of the adoption of SFAS 160, we were not limited in the amount of loss that could be allocated to the Och-Ziff Operating Group A Units. The partners’ and the Ziffs’ interests in the Och-Ziff Operating Group in the form of Och-Ziff Operating Group A Units, which represent an approximately 79.5% economic interest in our business, is expected to continue to significantly reduce our net loss in future periods as losses of the Och-Ziff Operating Group are allocated to such interests.

OCH-ZIFF FUNDS SEGMENT ANALYSIS

We conduct substantially all of our operations through the Och-Ziff Funds segment, our only reportable segment. Management uses Economic Income to evaluate the financial performance of and make resource allocations and other operating decisions for the segment. In addition, management believes that Economic Income provides a more comparable view of our segments’ operating performance from period to period. Accordingly, management believes that investors should review the same performance measure that it uses to analyze the segment’s performance.

Economic Income is a pre-tax measure that (i) presents the results of operations without the impact of eliminations resulting from the consolidation of any of the Och-Ziff funds; (ii) presents management fees net of recurring placement and related service fees on assets under management; (iii) recognizes the full amount of deferred cash compensation expense on the

 

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date it is paid irrespective of any requisite service period or deferral; and (iv) excludes the following: Reorganization expenses, equity-based compensation expense, allocation to non-equity partner interests, profit sharing, net earnings (losses) on deferred balances and investments in Och-Ziff funds and joint ventures, gain on early retirement of debt, depreciation, changes in the tax receivable agreement liability and amounts allocated to the partners and the Ziffs on their ownership interests in the Och-Ziff Operating Group (primarily Och-Ziff Operating Group A Units). For a reconciliation of Economic Income to our U.S. GAAP net loss for the periods presented and additional information regarding the reconciling adjustments discussed above, see Note 13 to our consolidated financial statements included in this quarterly report.

Och-Ziff Funds Segment—Economic Income

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008
     (dollars in thousands)

Economic Income Revenues

           

Management fees

   $ 86,262    $ 147,747    $ 263,209    $ 438,034

Incentive income

     3,071      4,373      3,336      5,483

Other revenues

     268      919      713      3,149
                           

Total Economic Income Revenues

     89,601      153,039      267,258      446,666
                           

Economic Income Expenses

           

Compensation and benefits

     23,539      28,813      86,502      76,989

Non-compensation expenses

     22,255      30,463      68,149      94,967
                           

Total Economic Income Expenses

     45,794      59,276      154,651      171,956
                           

Economic Income

   $ 43,807    $ 93,763    $ 112,607    $ 274,710
                           

Economic Income Analysis

Economic Income for the Och-Ziff Funds segment decreased by $50.0 million and $162.1 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These decreases were driven primarily by lower assets under management on which we earned management fees and the accrual for year-end discretionary incentive compensation in the second and third quarters of 2009.

Economic Income Revenues

Management fees and Incentive income. Management fees for the segment decreased by $61.5 million and $174.8 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods, primarily driven by the year-over-year decrease in average assets under management.

Incentive income is generally recorded during the fourth quarter of each year. Generally, incentive income recorded during the first three quarters of the year is related to fund investor redemptions.

Economic Income Expenses

Compensation and benefits. Compensation and benefits expenses decreased by $5.3 million and increased by $9.5 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. The decrease for the quarter-to-date period was primarily related to decreases in salaries, benefits, bonus payments and guaranteed bonus accruals due to lower headcount that occurred primarily during the first half of 2009, and lower hiring activity, offset in part by the discretionary bonus accrual discussed below. The increase for the year-to-date period was primarily related to the discretionary bonus accrual discussed below, offset in part by decreases in salaries, benefits, bonus payments and guaranteed bonus accruals due to lower headcount and hiring activity.

In the second quarter of 2009, we began to accrue for the estimated discretionary cash bonuses that we expected to pay our employees at year end. We did this in order to provide a competitive compensation structure taking into account the high-water marks in our funds, which if not recovered could preclude us from earning any incentive income, and the fact that our funds had generated strong year-to-date investment performance due to the efforts of the firm’s employees. In the third quarter of 2009, management revised its annual discretionary bonus compensation methodology for years in which high-water marks are in effect. During the second and third quarter, we accrued a total of $30.5 million in the Och-Ziff Funds segment. Any remaining amount will be expensed in the fourth quarter. The actual cash bonuses paid in the 2009 fourth quarter may vary materially from management’s current estimate as discretionary cash bonuses are based on total annual revenues, including any year-end incentive income, which is influenced by, among other things, our funds’ investment performance, the level of assets under management,

 

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the ability of our funds to continue to satisfy the high-water marks at the end of the year and global economic and market conditions. As we have done historically, we will determine the actual amount of annual discretionary cash bonuses in the fourth quarter of this year. Accordingly, the amounts accrued as of September 30, 2009 may not be indicative of the actual cash bonuses paid in the 2009 fourth quarter.

Non-Compensation Expenses. The following table presents the components of our non-compensation expenses:

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2009    2008    2009    2008
     (dollars in thousands)

Occupancy and equipment

   $ 5,977    $ 4,338    $ 17,800    $ 10,839

Professional services

     3,808      8,789      12,132      30,020

Insurance

     3,238      1,537      9,584      4,654

Information processing and communications

     2,452      3,417      7,516      9,968

Interest expense

     2,168      7,118      10,823      24,791

Business development

     1,455      3,541      4,829      9,905

Other expenses

     3,157      1,723      5,465      4,790
                           

Total Non-Compensation Expenses

   $ 22,255    $ 30,463    $ 68,149    $ 94,967
                           

Non-compensation expenses decreased by $8.2 million and $26.8 million for the three and nine months ended September 30, 2009, compared to the corresponding 2008 periods. These decreases were driven primarily by a reduction in professional services, interest expense and business development, offset by higher insurance costs, as well increased occupancy and equipment costs related to the expansion of leased office space in New York and London. The decrease in interest expense was due to the decrease in LIBOR, to which both our term loan obligation and the note payable on our corporate aircraft are indexed. The LIBOR interest rate on our term loan resets every one, two, three or six months (at our option), two business days prior to the start of each interest period. The LIBOR interest rate on the note payable on our corporate aircraft resets on a monthly basis, three business days prior to the start of each month.

LIQUIDITY AND CAPITAL RESOURCES

The working capital needs of our business have historically been met and continue to be met through cash generated from management fees and incentive income earned by the Och-Ziff Operating Group from our funds and managed accounts. We currently do not incur any indebtedness to fund our on-going operations, but have outstanding indebtedness that was incurred in connection with the Reorganization and to refinance the note payable on our corporate aircraft. We expect that our primary working capital liquidity needs over the next 12 months will be to:

 

   

pay our operating expenses, primarily consisting of compensation and benefits, as well as any related tax withholding obligations, and general and administrative expenses;

 

   

repay borrowings and related interest expense;

 

   

provide capital to facilitate the growth of our existing business;

 

   

pay income taxes and amounts to our partners and the Ziffs with respect to the tax receivable agreement as discussed below;

 

   

make cash distributions to our partners and the Ziffs on their direct interests in the Och-Ziff Operating Group and pay dividends to our Class A shareholders; and

 

   

make planned distributions of the deferred balances to our founding partners and the Ziffs as discussed below.

Our funds’ assets under management and investment performance directly impact our ability to generate management fees and earn incentive income. Management fees earned from our funds have historically been an important source of cash for our operating expenses and payments to our partners and the Ziffs with respect to their interests in our business. Management fees generally range from 1.5% to 2.5% annually of assets under management. Management fees are paid to us at the beginning of each quarter, based on the amount of assets under management at the beginning of the quarter. Accordingly, changes in the quarterly beginning balances of fee-paying assets under management, whether due to fund investment performance or capital inflows and redemptions, together with any changes in management fee rates will generally result in changes to our management fee revenues from quarter to quarter. Net capital flows during the quarter may also impact management fees during the quarter, although the magnitude of this impact is dependent on the timing and size of the net flows and on the management fee rate associated with the capital inflows as compared to the rate associated with the capital redeemed.

 

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In addition, the amount of assets under management and our funds’ investment performance drive how much incentive income we earn, which has been another important source of liquidity. Incentive income is typically equal to 20% of the net realized and unrealized profits earned for the calendar year that is attributable to each investor, but excludes unrealized profits on certain private investments. The only incentive income that is recognized during the first three quarters of any year relates to profits earned on fund investor redemptions during a particular quarter.

Accordingly, our revenues, and therefore cash available to fund operations, are directly impacted by the amount of our assets under management, which is determined by our funds’ investment performance and fund investor capital inflows and redemptions. To the extent our assets under management change, our total revenues will change. For example, as to management fees, a $1 billion change in assets under management would generally increase or decrease annual management fees and cash to fund operations by approximately $17 million, assuming no material changes in current management fee rates and taking into account non-fee paying assets under management. As to incentive income, if net profits attributable to a fee-paying fund investor were $1 billion, we generally would earn incentive income equal to $200 million, assuming no change in current incentive income rates. Most of our funds have a one-year high-water mark in any year when the fund experiences negative investment performance. This means that if an investor were to lose money in our fund in a current year, we would have to recoup that loss before incentive income could be earned in the following year. Even if the loss is not recouped up to the high-water mark during the year following the loss, the high-water mark is eliminated, allowing us to earn incentive income during the second year following the loss.

Investors in our funds as of December 31, 2008 generally experienced losses in 2008 resulting in a high-water mark for those investors in 2009. Accordingly, our funds’ investment performance in 2009 will have to exceed the high-water mark for each such investor in order for us to earn incentive income with respect to each such investor’s existing capital account balance in 2009. We are not required to meet any high-water marks for investors who experienced losses and subsequently redeemed all of their capital. Furthermore, any contributions from new or existing fund investors in 2009 would not be subject to any existing high-water marks in 2009.

As discussed in “Understanding Our Results—Revenues—Management Fees” and “—Our Funds’ Liquidity and Capital Resources,” we believe that we are able to monitor expected management fees and manage expenses in order to meet our operating needs. Our largest core operating expense historically has been annual incentive compensation, which is variable and discretionary based on our annual revenues and our funds’ annual investment performance. Accordingly, as our cash flow varies, we believe we have the flexibility to adjust this significant expense as needed to maintain sufficient liquidity.

Based on our historical results, management’s experience, our current business strategy and current assets under management, we believe that our existing cash resources together with cash generated from management fees will be sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next 12 months. In addition, as necessary, we believe that we will be able to adjust our expense infrastructure in order to maintain positive operating cash flow. Nevertheless, if we generate insufficient cash flows from operations to meet our short-term liquidity needs, we may have to borrow funds or sell assets, subject to existing contractual arrangements.

We expect to meet our longer-term liquidity requirements, including the repayment of our debt obligations, through the generation of management fees and incentive income. Over the long term, we believe we will be able to increase our assets under management and realize positive fund investment performance, which we expect will allow us to generate greater management fees and incentive income.

To maintain maximum flexibility to meet demands and opportunities both in the short and long term, and subject to existing contractual arrangements, we may want to retain cash, or raise or borrow additional funds to:

 

   

support the future growth in our business;

 

   

create new or enhance existing products and investment platforms in our private investments business;

 

   

repay borrowings;

 

   

pursue new investment opportunities; and

 

   

develop new distribution channels.

We may also incur additional indebtedness or raise capital under certain circumstances in order for us to maximize our growth potential and flexibility in responding to opportunities and challenges. Current market conditions may make it more difficult or costly to raise or borrow additional funds. Excessive costs or other significant market barriers may limit or prevent us from maximizing our growth potential and flexibility.

 

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Debt Obligations

Term Loan. On July 2, 2007, we entered into a $750 million term loan bearing an interest rate of LIBOR plus 0.75%. The term loan will mature in July 2012 and is secured by a first priority lien on substantially all of our assets. The term loan is payable in equal quarterly installments, which began on December 31, 2008, in an aggregate annual amount equal to 1% of the original principal amount borrowed under the term loan, and the balance will be payable upon maturity. In June 2009, we repurchased and retired $5.0 million of the outstanding balance for $3.0 million, which resulted in the recognition of a gain on early retirement of debt in the amount of $2.0 million in the consolidated statements of operations.

The term loan includes provisions that restrict our ability to further encumber our assets and make certain distributions. Specifically, subject to certain exceptions and without the prior consent of a majority of the lenders, we generally are prohibited from:

 

   

incurring further secured indebtedness;

 

   

engaging in certain transactions with shareholders or affiliates;

 

   

engaging in a substantially different line of business; and

 

   

amending our organizational documents in a manner materially adverse to the lenders.

The term loan permits us to incur up to $150 million of unsecured indebtedness and additional unsecured indebtedness so long as, after giving effect to the incurrence of such indebtedness, we are in compliance with a leverage ratio (as defined in the credit agreement) of 3.0 to 1.0 and no default or event of default has occurred and is continuing. As of September 30, 2009, we have not incurred any unsecured indebtedness. The term loan does not include any financial maintenance covenants, such as minimum requirements relating to assets under management or profitability. We will not be permitted to make distributions from the Och-Ziff Operating Group to our Class A shareholders or the holders of Och-Ziff Operating Group A Units if we are in default under the term loan.

The term loan also limits the amount of distributions we can pay in a 12-month period to our “free cash flow.” Free cash flow for any period includes the combined net income or loss of the Och-Ziff Operating Group entities, excluding certain subsidiaries, subject to certain additions and deductions for taxes, interest, depreciation, amortization and other non-cash charges for such period, less total interest paid, expenses in connection with the purchase of property and equipment, distributions to equity holders to pay taxes, realized gains or losses on investments and dividends and interest from investments. As of September 30, 2009, distributions from the Och-Ziff Operating Group were in compliance with the free cash flow covenant.

Aircraft Loan. On March 30, 2009, we amended the terms of the note payable on our corporate aircraft. The principal amount borrowed under the amended note is approximately $16.8 million, bears an annual interest rate of LIBOR plus 2.35%, is due in full at maturity on May 31, 2011 and is secured by a first priority lien on the aircraft. The terms of the amended note payable require us to comply with the following financial maintenance covenants in order for us to avoid an event of default:

 

   

The minimum amount of assets under management is $17 billion, tested quarterly;

 

   

Annual management fees earned by the Och-Ziff Operating Group must not fall below $286.1 million, tested annually;

 

   

All revenues earned by the Och-Ziff Operating Group less compensation expenses and all other cash operating expenses must exceed three times the annual principal payments and interest payments due on all direct or indirect indebtedness of the Och-Ziff Operating Group, tested quarterly; and

 

   

Maintain average cash, unrestricted marketable securities and other liquid investments that may be converted to cash within 90 days equal to an amount greater than the outstanding principal balance of the note, tested quarterly.

Upon an event of default, subject to certain cure periods set forth in the note, the lender may declare all amounts outstanding under the note to be due and payable. The terms of the amended note also require us to make one or more prepayments of the note or post cash collateral with the lender in the event that the outstanding principal balance of the loan at any time exceeds an amount equal to 65% of the fair market value of the aircraft, as determined by the lender pursuant to an appraisal obtained by the lender that may not be exercised more than once every 12 months.

 

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Distributions, Future Liquidity and Capital Needs

The following table presents the cash dividends paid on our Class A Shares and the related cash distributions made to our partners and the Ziffs on their direct interests in the Och-Ziff Operating Group:

 

Class A Shares

    

Payment Date

  

Record Date

   Dividend
per Share
   Related Distributions
to the Partners and the Ziffs
(dollars in thousands)

November 10, 2009 (Expected)

   October 1, 2009    $ 0.07    $ 27,965

August 11, 2009

   July 1, 2009    $ 0.02    $ 8,654

May 11, 2009

   April 1, 2009    $ 0.05    $ 29,554

February 19, 2009

   December 31, 2008    $ 0.05    $ 15,555

Our ability to make cash distributions to our partners and the Ziffs and pay dividends to our Class A shareholders depends on a number of factors that our Board of Directors takes into account as it may deem relevant. These factors include: revenues earned and profits generated by the Och-Ziff Operating Group; general economic and business conditions; our strategic plans and prospects; our business and investment opportunities; our financial condition and operating results; our working capital requirements and anticipated cash needs; the ability of the Och-Ziff Operating Group to secure additional sources of liquidity; and contractual obligations, including payment obligations pursuant to the tax receivable agreement and our term loan. If we generate insufficient cash flows from operations to make such distributions or payments, we may need to borrow funds or sell assets, subject to existing contractual obligations. In addition, we may not be able to obtain additional financing on terms that are acceptable, if at all.

Restricted Share Units (RSUs). Substantially all of the RSUs that we have awarded to date to our employees and independent members of our Board of Directors accrue dividend equivalents equal to the dividend amounts paid on our Class A Shares. To date, these dividend equivalents have been awarded in the form of additional RSUs, which accrue additional dividends. The dividend equivalents will be paid if and when the related RSUs vest. Our Board of Directors has the right to determine whether the RSUs and any related dividend equivalents will be settled in Class A Shares or in cash. We may withhold shares to satisfy the tax withholding obligations of holders of vested RSUs and dividend equivalents, which may result in the use of cash from operations or borrowings to satisfy these tax withholding payments.

Tax Receivable Agreement. We have made and may in the future be required to make additional payments under the tax receivable agreement that we entered into with our partners and the Ziffs. The purchase by the Och-Ziff Operating Group of Och-Ziff Operating Group A Units from our founding partners and the Ziffs with proceeds from the Offerings, and subsequent taxable exchanges by our partners and the Ziffs of Och-Ziff Operating Group A Units for our Class A Shares on a one-for-one basis (or, at our option, a cash equivalent), resulted, and, in the case of future exchanges, are anticipated to result, in an increase in the tax basis of the assets of the Och-Ziff Operating Group that would not otherwise have been available. We anticipate that any such tax basis adjustment resulting from an exchange will be allocated principally to certain intangible assets of the Och-Ziff Operating Group, and we will derive our tax benefits principally through amortization of these intangibles over a 15-year period. Consequently, these tax basis adjustments will increase, for tax purposes, our depreciation and amortization expense and will therefore reduce the amount of tax that Och-Ziff Corp and any other future intermediate corporate taxpaying entities that acquire Och-Ziff Operating Group B Units in connection with an exchange, if any, would otherwise be required to pay in the future. Accordingly, pursuant to the tax receivable agreement, such corporate taxpaying entities (including Och-Ziff Capital Management Group LLC if it is treated as a corporate taxpayer) have agreed to pay our partners and the Ziffs 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that these entities actually realize as a result of such increases in tax basis. In connection with the departure of certain former partners, such partners contributed their right to receive payments under the tax receivable agreement to the Och-Ziff Operating Group. As a result, we expect to pay to our remaining founding partners and the Ziffs approximately 82% (from 85%) of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of such increases in tax basis.

Payments under the tax receivable agreement are anticipated to increase the tax basis adjustment to intangible assets resulting from a prior exchange, with such increase being amortized over the remainder of the amortization period applicable to the original basis adjustment to such intangible assets resulting from such prior exchange. It is anticipated that this will result in increasing annual amortization deductions in the taxable years of and after such increases to the original basis adjustments, and potentially will give rise to increasing tax savings with respect to such years and correspondingly increasing payments under the tax receivable agreement.

 

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As of September 30, 2009, assuming no material changes in the relevant tax law and that we generate sufficient taxable income to realize the full tax benefit of the increased amortization resulting from the increase in tax basis of our assets, the cash savings to our intermediate holding companies from the purchase of Och-Ziff Operating Group B Units in the Offerings and the exchange of Och-Ziff Operating Group A Units for Class A Shares by certain former partners would aggregate approximately $1.0 billion over the next 13 to 15 years, resulting in payments to our founding partners and the Ziffs of approximately $854.1 million over the same period of time. Future cash savings and related payments to our partners under the tax receivable agreement in respect of subsequent exchanges would be in addition to these amounts. The obligation to make payment under the tax receivable agreement is an obligation of the intermediate corporate taxpaying entities and not of the Och-Ziff Operating Group entities. We may need to incur debt to finance payments under the tax receivable agreement to the extent the entities within the Och-Ziff Operating Group do not distribute cash to our intermediate corporate tax paying entities in an amount sufficient to meet our obligations under the tax receivable agreement. The actual increase in tax basis of the Och-Ziff Operating Group assets resulting from an exchange or from payments under the tax receivable agreement, as well as the amortization thereof and the timing and amount of payments under the tax receivable agreement, will vary based upon a number of factors, including those described below:

 

   

The amount and timing of the income of Och-Ziff Corp will impact the payments to be made under the tax receivable agreement. To the extent that Och-Ziff Corp does not have sufficient taxable income to utilize the amortization deductions available as a result of the increased tax basis in the Och-Ziff Operating Group assets, payments required under the tax receivable agreement would be reduced.

 

   

The price of our Class A Shares at the time of any exchange will determine the actual increase in tax basis of the Och-Ziff Operating Group assets resulting from such exchange; payments under the tax receivable agreement resulting from future exchanges, if any, will be dependent in part upon such actual increase in tax basis.

 

   

The composition of the Och-Ziff Operating Group’s assets at the time of any exchange will determine the extent to which Och-Ziff Corp may benefit from amortizing its increased tax basis in such assets and thus will impact the amount of future payments under the tax receivable agreement resulting from any future exchanges.

 

   

The extent to which future exchanges are taxable will impact the extent to which Och-Ziff Corp will receive an increase in tax basis of the Och-Ziff Operating Group assets as a result of such exchanges, and thus will impact the benefit derived by Och-Ziff Corp and the resulting payments, if any, to be made under the tax receivable agreement.

Depending upon the outcome of these factors, payments that we may be obligated to make to our partners and the Ziffs under the tax receivable agreement in respect of exchanges could be substantial. In light of the numerous factors affecting our obligation to make payments under the tax receivable agreement, the timing and amounts of any such actual payments are not reasonably ascertainable.

Tax Liability Distributions. In accordance with the Och-Ziff Operating Group entities’ limited partnership agreements, we may cause the applicable Och-Ziff Operating Group entities to distribute cash to the intermediate holding companies, the partners and the Ziffs in an amount at least equal to the presumed maximum tax liabilities arising from their direct ownership in these entities. The presumed maximum tax liabilities are based upon the presumed maximum income allocable to any such unit holder at the maximum combined U.S. federal, New York State and New York City tax rates. Holders of our Class A Shares may not always receive distributions at a time when our partners and the Ziffs are receiving distributions on their interests, as distributions to our intermediate holding companies may be used to settle tax liabilities, if any, or other obligations. Such tax distributions will take into account the disproportionate income allocation (but not a disproportionate cash allocation) to the unit holders with respect to “built-in gain assets,” if any, at the time of the Offerings. Consequently, Och-Ziff Operating Group tax distributions may be greater than if such assets had a tax basis equal to their value at the time of the Offerings.

Deferred Balances Distributions. Through 2006, we deferred collection of a certain portion of incentive income receivable from our offshore funds. As a result of a change in the method of accounting used for U.S. income tax purposes by certain of our subsidiaries, we no longer defer the collection of such receivables. We expect that all deferred balances, which as of September 30, 2009, were $374.8 million, will be paid to us over the next year. In 2008, we collected and paid 50% of the deferred balances that were outstanding as of December 31, 2006, plus the 2007 earnings on the deferred balances. In the first three quarters of 2009, we collected and paid an amount equal to 25% of the deferred balances that were outstanding as of December 31, 2006, net of any changes in the value of the deferred balances experienced in 2008. We expect to collect and pay any remaining deferred balances in 2010. Ninety-five percent of the amount due each year is payable in January, while the

 

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remaining five percent is required to be paid upon completion of the audited financial statements of the relevant funds for the previous year. Such amounts, in turn, will be distributed to our founding partners and the Ziffs and, therefore, will not benefit our Class A shareholders.

Our Funds’ Liquidity and Capital Resources

Our funds have access to liquidity from our prime brokers and other counterparties. Additionally, our funds may have committed facilities in addition to regular financing from our counterparties. These sources of liquidity provide our funds with additional financing resources, allowing them to take advantage of opportunities in the global marketplace.

Our funds’ current liquidity position could be adversely impacted by any substantial, unanticipated investor redemptions from our funds that are made within a short time period. Capital contributions from investors in our funds generally are subject to initial lock-up periods of one to three years. Following the expiration of these lock-up periods, investors may redeem capital generally on a quarterly or annual basis upon giving 30 to 45 days prior written notice; provided however, that upon the payment of a redemption fee and upon giving 30 days prior written notice, investors with quarterly redemption rights may redeem capital during the lock-up period. These lock-ups and redemption notice periods help us to manage our liquidity position.

We also follow a diligent risk management process and regularly monitor the liquidity of our funds’ portfolios in relation to economic and market factors and the timing of potential investor redemptions. As a result of this process, we may determine to reduce exposure or increase the liquidity of our funds’ portfolios at any time, whether in response to global economic and market conditions, redemption requests or otherwise. For these reasons, we believe we will be well prepared to address market conditions and redemption requests, as well as any other events, with limited impact on our funds’ liquidity position. Nevertheless, significant redemptions made during a single quarter could adversely affect our funds’ liquidity position, as we may determine to meet redemptions by using our funds’ available cash or selling assets (possibly at a loss). Such actions would result in lower assets under management, which would reduce the amount of management fees and incentive income we may earn. Our funds could also meet redemptions by increasing leverage, provided we are able to obtain financing on reasonable terms, if at all. We believe our funds have sufficient liquidity to meet any anticipated redemptions for the foreseeable future.

Cash Flows Analysis

Operating Activities. Net cash provided by operating activities was $245.8 million and $755.9 million for the nine months ended September 30, 2009 and 2008, respectively. For the nine months ended September 30, 2009 and 2008, net cash flows from operating activities were primarily related to the collection of prior year incentive income and current year management fees, less interest expense and other operating expenses. In addition, we collected $529.7 million of deferred balances in December 2007 and $343.9 million in the first half of 2008. These amounts were distributed to our founding partners and the Ziffs, net of taxes, in the first half of 2008; however, deferred balances, net of taxes, distributed to Mr. Och in the amount of $577.2 million are included within cash flows from financing activities. During the first nine months of 2009, we collected an additional $208.0 million of deferred balances, which we in turn distributed to our founding partners and the Ziffs, net of taxes. The deferred balances distributed to Mr. Och, net of taxes, in the first nine months of 2009 in the amount of $122.4 million were also recorded within cash flows from financing activities.

Investing Activities. There were no significant changes in the net cash used in investing activities for the periods presented, as investment-related cash flows of the consolidated Och-Ziff funds are classified within operating activities in our consolidated statements of cash flows.

Financing Activities. Net cash used in financing activities was $136.1 million and $1.2 billion for the nine months ended September 30, 2009 and 2008, respectively. For the nine months ended September 30, 2009 and 2008, net cash flows from financing activities are primarily related to the dividends paid of $9.2 million and $103.1 million, respectively, to our Class A shareholders and distributions to our founding partners and the Ziffs of $53.8 million and $500.0 million, respectively, on their Och-Ziff Operating Group A Units. In addition, as discussed above, deferred balances distributed to Mr. Och, net of taxes, in the amount of $122.4 million and $577.2 million in the first nine months of 2009 and 2008, respectively, and distributions of 2007 pre-Reorganization income in the amount of $83.6 million in the first quarter of 2008 reduced net cash from financing activities.

CONTRACTUAL OBLIGATIONS

There have been no significant changes to our contractual obligations reported in our Annual Report.

OFF-BALANCE SHEET ARRANGEMENTS

As of September 30, 2009, we did not have any off-balance sheet arrangements.

 

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are those that require us to make significant judgments, estimates or assumptions that affect amounts reported in our financial statements or the notes thereto. We base our judgments, estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable and prudent. Actual results may differ materially from these estimates. See Note 2 to our audited consolidated and combined financial statements included in our Annual Report for a description of our accounting policies. The following is a summary of what we believe to be our most critical accounting policies and estimates:

Annual Discretionary Cash Bonuses

Generally, compensation and benefits comprise a significant portion of total expenses, with discretionary cash bonuses comprising a large portion of total compensation and benefits expense. These cash bonuses are funded by total annual revenues, which are significantly influenced by incentive income earned by us at the end of the year. In the second quarter of 2009, we began to accrue for the estimated discretionary cash bonuses that we expected to pay our employees at year end. We did this in order to provide a competitive compensation structure taking into account the high-water marks in our funds, which if not recovered could preclude us from earning any incentive income, and the fact that our funds had generated strong year-to-date investment performance due to the efforts of the firm’s employees. In the third quarter of 2009, management revised its annual discretionary bonus compensation methodology for years in which high-water marks are in effect. During the second and third quarter, we accrued a total of $31.5 million. Any remaining amount will be expensed in the fourth quarter. The actual cash bonuses paid in the 2009 fourth quarter may vary materially from management’s current estimate as discretionary cash bonuses are based on total annual revenues, including any year-end incentive income, which is influenced by, among other things, our funds’ investment performance, the level of assets under management, the ability of our funds to continue to satisfy the high-water marks at the end of the year and global economic and market conditions. As we have done historically, we will determine the actual amount of annual discretionary cash bonuses in the fourth quarter of this year. Accordingly, the amounts accrued as of September 30, 2009 may not be indicative of the actual cash bonuses paid in the 2009 fourth quarter.

Fair Value of Investments

The valuation of investments held by our funds is the most critical estimate made by management impacting our results. The Och-Ziff funds are considered investment companies for U.S. GAAP purposes. Pursuant to specialized accounting for investment companies under U.S. GAAP, investments of these funds are carried at their estimated fair values. The valuation of investments in our funds has significant impacts on our results, as our management fees and incentive income are determined based on the fair value of the investments held by the funds.

Fair value represents the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Assets and liabilities measured at fair value are classified into one of the following categories:

 

   

Level I – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Assets and liabilities included in this category include listed equities and listed derivatives. As required by SFAS 157, we do not adjust the quoted price for these assets or liabilities, even in situations where we may hold a large position and a sale could reasonably impact the quoted market price. While our funds may hold Level I assets and liabilities in their portfolios, as of September 30, 2009, we did not hold any Level I assets or liabilities directly or indirectly through the consolidated funds.

 

   

Level II – Fair value is determined through the use of models or other valuation methodologies based on pricing inputs that are either directly or indirectly observable as of the reporting date. Assets and liabilities generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives. While our funds may hold Level II assets and liabilities in their portfolios, as of September 30, 2009, we did not hold any Level II assets or liabilities directly or indirectly through the consolidated funds.

 

   

Level III – Fair value is determined based on pricing inputs that are unobservable and includes situations where there is little, if any, market activity for the asset or liability. The determination of fair value for assets and liabilities in this category requires significant management judgment or estimation. Assets and liabilities that are included in this category generally include general and limited partnership interests in private equity and real estate. In addition, funds not consolidated by us may hold additional types of Level III assets and liabilities, such as mezzanine funds, distressed debt and non-investment grade residual interests in securitizations and

 

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collateralized debt obligations. As of September 30, 2009, the investments held by our consolidated funds and the deferred balances, the only assets we carry at fair value in our consolidated balance sheets, were Level III assets. While our funds may hold Level III liabilities in their portfolios, as of September 30, 2009, we did not hold any Level III liabilities directly or indirectly through the consolidated funds.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

Valuation of Investments. Fair value generally represents the amount at which an investment could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The fair value of our funds’ investments is based on observable market prices when available. Such values are based on our internal policies which may require that prices are determined based on the last sales price, the “bid,” “ask” or the “mid,” depending on the type of security. Futures and options contracts are valued based on closing market prices. Forward and swap contracts are valued based on market rates or prices obtained from recognized financial data service providers.

We, as the investment manager of the Och-Ziff funds, determine the fair value of investments that are not actively traded on a recognized securities exchange or otherwise lack a readily ascertainable market value. Such investments may be valued based on: (i) amounts invested in these investments; (ii) financial information provided by the management of these investments; (iii) information provided by third parties; (iv) the last round of financing in which new investors have participated; (v) performing comparisons with prices of comparable or similar securities; (vi) obtaining valuation-related information from issuers; (vii) assessing other analytical data and indicators of value; and/or (viii) calculating the present value of future cash flows.

Significant judgment and estimation goes into the assumptions that drive our valuation methodologies and procedures for assets that are not actively traded on a recognized securities exchange or otherwise lack a readily ascertainable market value and the actual amounts ultimately realized could differ materially from the values estimated based on the use of these methodologies.

We have established an internal control infrastructure over the valuation of financial instruments that requires ongoing independent oversight by our financial control group as well as periodic audits by our internal audit function. These management control functions are independent of the trading and investing functions. We have also established a valuation committee, comprised of individuals who are independent of our investment professionals, that is responsible for overseeing the pricing of our funds’ investments.

We employ resources to help ensure that the financial control and internal audit groups are able to function at an appropriate quality level. We believe our internal control infrastructure utilizes an effective and appropriate level of segregation of duties. Specifically, the financial control group is responsible for establishing and monitoring compliance with valuation policies, as well as reporting compliance with these policies to our Audit Committee. Our internal audit group employs a risk-based program of audit coverage that is designed to provide an independent assessment of the design and effectiveness of key controls over our operations, regulatory compliance, valuation of financial instruments and reporting. Additionally, internal audit meets with management to evaluate and provide guidance on the existing risk framework and control environment assessments. Within the trading and investing functions, we have established policies and procedures that relate to approval of all new transaction types, transaction pricing sources, and fair valuation hierarchy coding within our financial reporting system. The appropriate internal and external resources with technical expertise and product, market and industry knowledge, perform independent verification of prices, profit and loss review, and validation of the valuation models used in our valuation process.

The analysis used in measuring the fair value of financial instruments is generally related to the level of observable pricing inputs. For Level III inputs that are less observable, to the extent possible, procedures have been established to discuss the valuation methodology, including pricing techniques, with senior management of the trading and investing functions, to compare the inputs to observable inputs for similar positions, to review subsequent secondary market activities, and to perform comparison of actual versus projected cash flows.

As of September 30, 2009 and December 31, 2008, our only assets carried at fair value are the deferred balances and the investment holdings of consolidated Och-Ziff funds. The deferred balances and the investments held by the consolidated Och-Ziff funds are predominately valued using sources other than observable market data, which are considered to be within Level III of the fair value hierarchy.

 

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The following table sets forth the fair values of assets classified as Level III within the fair value hierarchy and a brief description of the valuation technique for each type of asset:

 

Assets Recorded at Fair Value

   September 30, 2009    

Valuation Technique

     (dollars in thousands)      

Deferred balances, at fair value

   $ 374,798      Deferred balances are valued based on net asset value information provided by the underlying Och- Ziff funds. The underlying investments within these funds are carried at fair value and are comprised of Levels I, II, and III financial instruments.

Investments, at fair value (assets of consolidated Och-Ziff funds)

     284,398      Investments, which are primarily related to holdings of the real estate funds, are initially valued at transaction price and subsequently valued based on third-party investments, pending transactions or changes in financial ratios (e.g., earnings multiples) and discounted cash flow models.
          

Total Level III assets, at fair value

     659,196     

Level III assets for which we do not bear economic exposure

     (659,114  
          

Net Economic Exposure to Level III Assets

   $ 82     
          

Level III assets for which we do not bear economic exposure include: (i) deferred balances, as changes in the fair value of such receivables are offset by changes in a corresponding liability to our founding partners and the Ziffs; and (ii) substantially all of the investments of consolidated Och-Ziff funds, as substantially all of the changes in the fair values of these investments are absorbed by fund investors in these consolidated funds (i.e., partners’ and others’ interests in consolidated subsidiaries).

Impact of fair value measurement on our results. A 10% change in the fair value of the investments held by our funds would have the following effects on our results:

 

    

Och-Ziff Funds
(excluding real estate funds)

  

Och-Ziff Real Estate Funds

Management fees    Generally, a 10% change in the period subsequent to the change in fair value.    None, as management fees are currently based on committed capital.
Incentive income    Generally, an immediate 10% impact if the change in fair value continues at the end of the measurement period, at which time incentive income is recognized.    None, as incentive income is based on realized profits, subject to clawback.

Net earnings (losses) on deferred balances and investments in Och-Ziff funds

   Generally insignificant, as substantially all of such earnings (losses) are related to amounts owed to our founding partners and employees under deferred compensation arrangements; therefore, an offsetting liability is generally accrued.    None, as such amounts are eliminated in consolidation.

Net gains (losses) of consolidated Och-Ziff funds

   Insignificant, as substantially all of such funds were deconsolidated in 2007.    Immediate impact, as such funds continue to be consolidated. Impact is insignificant as substantially all of the impact is offset by a corresponding change in partners' and others' interest in income of consolidated subsidiaries.

 

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As management fees are charged based on the fair value of assets under management subject to fees at the beginning of the period, a 10% change in the fair value of the investments held by the Och-Ziff funds as of September 30, 2009 would impact management fees calculated on October 1, 2009 by approximately $8.7 million.

Our results are not expected to be significantly impacted by changes in fair value that impact the net gains (losses) of consolidated Och-Ziff funds in the foreseeable future as a result of the deconsolidation of substantially all of our funds in 2007 and that substantially all of these impacts are absorbed by fund investors’ interests in these funds (i.e. partners’ and others’ interests in consolidated subsidiaries).

Variable Interest Entities

The determination of whether or not to consolidate a variable interest entity under U.S. GAAP requires a significant amount of judgment concerning the degree of control over an entity by its holders of variable interests. To make these judgments, management has conducted an analysis, on a case-by-case basis, of the relation of the holders of variable interests to each other, the design of the entity, the expected operations of the entity, which holder of variable interests is most “closely associated” to the entity and which holder of variable interests is the primary beneficiary required to consolidate the entity. Upon the occurrence of certain events, such as redemptions by all unaffiliated investors in any fund and modifications to fund organization documents and investment management agreements, management reviews and reconsiders its previous conclusion regarding the status of an entity as a variable interest entity and whether we are deemed to be the primary beneficiary who consolidates such entity.

Income Taxes

We use the asset and liability method of accounting for deferred income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, a valuation allowance is established when management believes it is more likely than not that a deferred tax asset will not be realized.

Substantially all of our deferred tax asset relates to the goodwill and other intangible assets deductible for tax purposes by Och-Ziff Corp that arose in connection with the purchase of Och-Ziff Operating Group A Units from our founding partners and the Ziffs with proceeds from the Offerings and from subsequent payments to our founding partners and the Ziffs made under the tax receivable agreement. In accordance with relevant provisions of the Internal Revenue Code, we expect to take these goodwill and other intangible deductions over the 15-year period following the Offerings and the additional 20-year loss carryforward period available to us. Our analysis of whether we expect to have sufficient future taxable income to realize these deductions is based solely on estimates over this period.

We generated taxable income in the amount of $17.3 million in the first three quarters of 2009 before taking into account deductions related to the amortization of the goodwill and other intangible assets. We determined that we would need to generate taxable income of at least $2.2 billion over the remaining 13-year weighted-average amortization period and the additional 20-year loss carryforward period available to us in order to fully realize the deferred tax asset. In this regard, Reorganization expenses, allocations to non-equity partners and profit sharing expenses are considered permanent book to tax differences, and therefore, do not impact taxable income. Accordingly, while we reported net losses on a U.S. GAAP basis, and expect to continue to report a U.S. GAAP net loss through 2012, we generated income on a tax basis over these prior periods and, as of September 30, 2009, using the estimates and assumptions discussed below, we expect to generate sufficient taxable income on a tax basis through 2012 and over the period for which estimates have been prepared in order to fully realize this deferred tax asset.

To generate $2.2 billion in taxable income over the remaining amortization and loss carryforward periods available to us, we estimated that, based on assets under management of $22.1 billion as of October 1, 2009, we would need to generate a minimum compound annual growth rate in assets under management of approximately 1% over the period for which the taxable income estimate relates to fully realize the deferred tax asset, assuming no performance-related growth and therefore no incentive income. The assumed nature and amount of this estimated growth rate are not based on historical results or current expectations of future growth; however, the other assumptions underlying the taxable income estimate, such as general maintenance of current expense ratios and cost allocation percentages among the Och-Ziff Operating Group entities, which impact the amount of taxable income flowing through our legal structure, are based on our near-term operating budget. If our actual growth rate in assets under management falls below this minimum threshold for any extended time during the period for which these estimates relate and we do not otherwise experience offsetting growth rates in other periods, we may not generate taxable income sufficient to realize the deferred tax asset and may need to record a valuation allowance. Management regularly reviews the model used to generate the estimates, including the underlying assumptions. If it determines that a valuation allowance is required for any reason, the amount would be determined based on the relevant circumstances at that time. To the extent we record a valuation allowance against our deferred tax asset related to the goodwill and other intangible assets, we would record a corresponding decrease in the liability to our remaining founding partners and the Ziffs under the tax receivable agreement equal to approximately 82% of such amount; therefore, net earnings would only be impacted by 18% of any valuation allowance recorded against the deferred tax asset.

 

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Actual taxable income may be different than the estimate described above, which was prepared solely for the purpose of determining whether we currently expect to have sufficient future taxable income to realize the deferred tax asset. Furthermore, actual or estimated future taxable income may be materially impacted by significant changes in assets under management, whether as a result of fund investment performance or fund investor contributions or redemptions, significant changes to the assumptions underlying our estimates, future changes in income tax law, state income tax apportionment or other factors.

Based on the analysis set forth above, we have determined that it is not necessary to record a valuation allowance with respect to our deferred tax asset related to the goodwill and other intangible assets deductible for tax purposes as of September 30, 2009. We have, however, determined that we may not realize certain deferred tax credits related to our state income taxes. Accordingly, a valuation allowance in the amount of $2.8 million has been established for these credits.

Recently Adopted Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“SFAS 168”) (subsequently codified into FASB Accounting Standards Codification (“FASB ASC” or the “Codification”) Topic 105). SFAS 168 was issued to establish the Codification as the single source of authoritative accounting principles for U.S. GAAP issued by the FASB. SFAS 168 was effective for reporting periods ending on or after September 15, 2009. The adoption of SFAS 168 did not have any impact on our financial position or results of operations at the date of adoption.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS 165”) (subsequently codified into FASB ASC Topic 855). SFAS 165 addresses the accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. In addition, SFAS 165 requires an entity to disclose the date through which an entity has evaluated subsequent events. SFAS 165 was effective for interim or annual periods ending after June 15, 2009. The adoption of SFAS 165 did not have any impact on our financial position or results of operations at the date of adoption.

In April 2009, the FASB issued FASB Staff Position 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP 157-4”) (subsequently codified into FASB ASC Topic 820). FSP 157-4 provides additional guidance to expand on the factors that should be considered in estimating fair value when there has been a significant decrease in market activity for an asset or liability. FSP 157-4 was effective for interim and annual periods ending after June 15, 2009. The adoption of FSP 157-4 did not have any impact on our financial position or results of operations at the date of adoption.

In April 2009, the FASB issued FASB Staff Position SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP 115-2”) (subsequently codified into FASB ASC Topic 320). FSP 115-2 establishes a new method of recognizing and reporting other-than-temporary impairments for debt securities. An entity will be required to record in current period earnings an other-than-temporary impairment for debt securities if it (i) intends to sell the security, (ii) will more likely than not be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis. Additionally, if an other-than-temporary impairment exists but an entity does not intend to sell the impaired debt security and it is not more likely than not that the entity is not required to sell the security before recovery of its cost, only the credit loss component is recognized in current period earnings and the remainder of the impairment amount is recognized in accumulated other comprehensive income. FSP 115-2 was effective for interim and annual periods ending after June 15, 2009. The adoption of FSP 115-2 did not have any impact on our financial position or results of operations at the date of adoption.

In April 2009, the FASB issued FASB Staff Position SFAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”) (subsequently codified into FASB ASC Topic 825). FSP 107-1 provides that the disclosures required annually under FASB ASC Topic 825 (formerly, SFAS No. 107, Disclosure about Fair Value of Financial Instruments), also be disclosed in interim periods. FSP 107-1 was effective for interim periods ending after June 15, 2009. The adoption of FSP 107-1 did not have any impact on our financial position or results of operations at the date of adoption.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141(R)”) (subsequently codified into FASB ASC Topic 805). SFAS 141(R) requires assets acquired, liabilities assumed and determinable contingent consideration to be measured at their fair values at the acquisition date. In addition, SFAS 141(R) requires subsequent adjustments to any acquisition-related tax reserves to be recognized in net income rather than as an adjustment to the purchase price. SFAS 141(R) was effective for business combinations completed in periods beginning on or after December 15, 2008. The adoption of SFAS 141(R) did not have any impact on our financial position or results of operations at the date of adoption.

 

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In December 2007, the FASB issued SFAS 160 (subsequently codified into FASB ASC Topic 810). SFAS 160 requires a company to clearly identify and present ownership interests in subsidiaries held by parties other than the company within the equity section of the consolidated financial statements. SFAS 160 also requires (i) the amount of consolidated net income attributable to the controlling and the noncontrolling interests to be clearly identified and presented on the face of the consolidated statement of operations; (ii) acquisitions of noncontrolling interest to be accounted for as equity transactions with no step-up to fair value; (iii) when a subsidiary is deconsolidated, any retained noncontrolling interest and the gain or loss upon deconsolidation to be measured at fair value; and (iv) losses to be allocated to noncontrolling interest regardless of whether cumulative losses have exceeded the