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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the Quarterly Period Ended June 30, 2010

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of 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   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

As of July 31, 2010, there were 88,008,066 Class A Shares and 274,666,921 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 June 30, 2010 and December 31, 2009    2
   Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009    3
   Consolidated Statement of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2010    4
   Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009    5
   Notes to Consolidated Financial Statements    6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    25
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.    [Reserved]    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, a Delaware limited partnership, which 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 other than the Ziffs and our intermediate holding companies, including our founder, Mr. Daniel Och, except where the context requires otherwise. References to the “Ziffs” refer collectively to Ziff Investors Partnership, L.P. II, Ziff Investors Partnership, L.P. II A 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. References to our “IPO” refer to our initial public offering of 36.0 million Class A Shares that occurred in November 2007. References to the “Offerings” refer collectively to our IPO and the concurrent private offering of approximately 38.1 million Class A Shares to DIC Sahir Limited, a wholly-owned subsidiary of Dubai International Capital LLC.

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 “Part II–Item 1A. Risk Factors” 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 increase assets under management, generate positive returns, preserve capital, identify investment opportunities and enhance our investment platforms. We generally identify forward-looking statements by terminology such as “outlook,” “believe,” “expect,” “potential,” “continue,” “may,” “will,” “should,” “could,” “seek,” “approximately,” “predict,” “intend,” “plan,” “estimate,” “anticipate,” “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, business and market conditions, the conditions impacting the hedge fund industry, our ability to successfully compete for fund investors, professional investment talent and investment opportunities, our successful formulation and execution of business and growth strategies, 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. 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, 2009 filed with the Securities and Exchange Commission on March 4, 2010, 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 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

 

     June 30, 2010     December 31, 2009  
     (dollars in thousands)  

Assets

    

Cash and cash equivalents

   $ 121,205      $ 73,732   

Income and fees receivable

     23,228        368,300   

Due from affiliates

     3,854        1,934   

Deferred balances, at fair value

     3,461        404,666   

Deferred income tax assets

     985,436        953,604   

Other assets, net (includes investments in Och-Ziff Funds of $2,234 and $10,889, respectively)

     85,837        103,584   

Assets of consolidated Och-Ziff funds:

    

Investments, at fair value

     346,403        300,231   

Other assets of Och-Ziff funds

     365        373   
                

Total Assets

   $ 1,569,789      $ 2,206,424   
                

Liabilities and Shareholders’ Equity

    

Liabilities

    

Due to affiliates

   $ 786,301      $ 1,166,295   

Debt obligations

     643,237        652,414   

Compensation payable

     6,266        143,780   

Profit sharing payable

     109        11,047   

Other liabilities

     50,517        43,178   

Liabilities of consolidated Och-Ziff funds:

    

Other liabilities of Och-Ziff funds

     28        29   
                

Total Liabilities

     1,486,458        2,016,743   
                

Commitments and Contingencies (Note 12)

    

Shareholders’ Equity

    

Class A Shares, no par value, 1,000,000,000 shares authorized, 87,973,809 and 81,823,915 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively

     —          —     

Class B Shares, no par value, 750,000,000 shares authorized, 274,666,921 and 277,946,526 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively

     —          —     

Paid-in capital

     1,705,325        1,505,496   

Retained deficit

     (2,114,573     (1,879,761

Accumulated other comprehensive loss

     (52     (47
                

Shareholders’ deficit attributable to Class A shareholders

     (409,300     (374,312

Partners’ and others’ interests in consolidated subsidiaries

     492,631        563,993   
                

Total Shareholders’ Equity

     83,331        189,681   
                

Total Liabilities and Shareholders’ Equity

   $ 1,569,789      $ 2,206,424   
                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  
     (dollars in thousands, except per share amounts)  

Revenues

        

Management fees

   $ 110,214      $ 86,166      $ 211,956      $ 180,471   

Incentive income

     5,536        265        5,722        265   

Other revenues

     720        285        1,111        553   

Income of consolidated Och-Ziff funds

     7,454        8,887        14,570        11,502   
                                

Total Revenues

     123,924        95,603        233,359        192,791   
                                

Expenses

        

Compensation and benefits

     51,729        76,025        104,921        127,901   

Allocations to non-equity partner interests

     —          4,915        —          4,575   

Reorganization expenses

     411,789        424,736        836,595        844,685   

Profit sharing

     —          308        —          291   

Interest expense

     1,936        4,060        3,893        8,655   

General, administrative and other

     23,538        21,132        46,130        43,382   

Expenses of consolidated Och-Ziff funds

     4,297        1,142        5,379        1,896   
                                

Total Expenses

     493,289        532,318        996,918        1,031,385   
                                

Other Income

        

Net earnings on deferred balances

     —          14,723        —          3,430   

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

     (602     560        (549     306   

Net gain on early retirement of debt

     —          2,013        —          2,013   

Net gains (losses) of consolidated Och-Ziff funds

     16,151        (375     22,342        (98
                                

Total Other Income

     15,549        16,921        21,793        5,651   
                                

Loss Before Income Taxes

     (353,816     (419,794     (741,766     (832,943

Income taxes

     7,744        449        16,543        3,278   
                                

Consolidated Net Loss

   $ (361,560   $ (420,243   $ (758,309   $ (836,221
                                

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

   $ (272,139   $ (331,930   $ (580,249   $ (666,054
                                

Net Loss Allocated to Class A Shareholders

   $ (89,421   $ (88,313   $ (178,060   $ (170,167
                                

Net Loss Per Class A Share

        

Basic and Diluted

   $ (1.05   $ (1.15   $ (2.12   $ (2.22
                                

Weighted-Average Class A Shares Outstanding

        

Basic and Diluted

     85,432,135        76,804,771        84,078,032        76,676,699   
                                

Dividends Paid per Class A Share

   $ 0.09      $ 0.05      $ 0.67      $ 0.10   
                                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY — UNAUDITED

 

     Och-Ziff Capital Management Group LLC Shareholders              
                           Accumulated
Other
Comprehensive
Loss
             
     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'
Equity
 
                     (dollars in thousands)              

As of December 31, 2009

   81,823,915    277,946,526      $ 1,505,496    $ (1,879,761   $ (47   $ 563,993      $ 189,681   

Capital contributions

   —      —          —        —          —          66,643        66,643   

Capital distributions

   —      —          —        —          —          (290,667     (290,667

Cash dividends declared on Class A Shares

   —      —          —        (54,910     —          —          (54,910

Dividend equivalents on Class A restricted share units

   —      —          1,842      (1,842     —          (a     —     

Equity-based compensation

   1,014,649    —          10,765      —          —          43,032        53,797   

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

   5,135,245    (3,279,605     2,679      —          —          21,748        24,427   

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

   —      —          2,380      —          —          13,718        16,098   

Impact of amortization of Reorganization charges to capital

   —      —          182,163      —          —          654,432        836,595   

Comprehensive loss:

                

Consolidated net loss

   —      —          —        (178,060     —          (580,249     (758,309

Foreign currency translation adjustment

   —      —          —        —          (5     (19     (24
                      

Total comprehensive loss

                   (758,333
                                                  

As of June 30, 2010

   87,973,809    274,666,921      $ 1,705,325    $ (2,114,573   $ (52   $ 492,631      $ 83,331   
                                                  

 

(a) The dividend equivalents on Class A 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 $6.8 million.

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

 

     Six Months Ended June 30,  
     2010     2009  
     (dollars in thousands)  

Cash Flows from Operating Activities

    

Consolidated net loss

   $ (758,309   $ (836,221

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

    

Reorganization expenses

     836,595        844,685   

Amortization of equity-based compensation

     59,372        52,524   

Amortization of deferred compensation

     —          3,427   

Depreciation, amortization and loss on sale of fixed assets

     4,571        4,008   

Net gain on early retirement of debt

     —          (2,013

Deferred income taxes

     1,079        1,041   

Operating cash flows due to changes in:

    

Income and fees receivable

     345,072        16,428   

Due from affiliates

     (1,920     77   

Deferred balances, at fair value

     231,553        204,572   

Other assets, net

     11,612        20,267   

Assets of consolidated Och-Ziff funds

     (46,164     (35,882

Due to affiliates

     (81,262     (69,269

Compensation payable

     (137,514     29,835   

Profit sharing payable

     (5,769     (6,317

Other liabilities

     5,170        (12,167

Liabilities of consolidated Och-Ziff funds

     (1     508   
                

Net Cash Provided by Operating Activities

     464,085        215,503   
                

Cash Flows from Investing Activities

    

Loan to joint venture partners

     (114     (2,151

Investments in joint ventures

     (2,433     (3,562

Return of investments in joint ventures

     2,043        1,475   

Collateral deposit on aircraft loan

     —          (2,009

Proceeds from sales of fixed assets

     14        —     

Purchases of fixed assets

     —          (793
                

Net Cash Used in Investing Activities

     (490     (7,040
                

Cash Flows from Financing Activities

    

Withholding taxes paid on vested Class A restricted share units

     (5,700     (280

Repayments of debt obligations

     (7,151     (6,712

Och-Ziff Operating Group capital distributions declared prior to Reorganization

     (129,470     (122,422

Dividends on Class A Shares

     (54,910     (7,633

Partners’ and others’ interests in consolidated subsidiaries contributions

     66,643        44,625   

Partners’ and others’ interests in consolidated subsidiaries distributions

     (285,534     (62,902
                

Net Cash Used in Financing Activities

     (416,122     (155,324
                

Net Increase in Cash and Cash Equivalents

     47,473        53,139   

Cash and Cash Equivalents, Beginning of Period

     73,732        81,403   
                

Cash and Cash Equivalents, End of Period

   $ 121,205      $ 134,542   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period:

    

Interest

   $ 3,480      $ 8,187   
                

Income taxes

   $ 14,478      $ 1,740   
                

Non-cash transactions:

    

In-kind distribution of deferred balances

   $ 169,652      $ —     
                

Collateral deposit on aircraft loan applied against principal balance, including interest thereon

   $ 2,026      $ —     
                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

1. BUSINESS

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, Mumbai and Beijing. The Company provides investment management and advisory services through its various hedge funds (the “Och-Ziff funds” or the “funds”) and separately managed accounts to a diversified institutional investor base. The Och-Ziff funds seek to create value for fund investors by generating consistent, positive risk-adjusted returns while protecting investor capital.

The Company’s primary sources of revenues are management fees, which are based on the amount of the Company’s assets under management, and incentive income, which is based on the investment performance the Company generates for its fund investors. Accordingly, for any given period, the Company’s revenues will be driven by the combination of assets under management and the investment performance of the Och-Ziff funds and managed accounts.

The Company conducts substantially all of its operations through its one reportable segment, the Och-Ziff Funds segment, which provides investment management and advisory services to the Company’s hedge funds and separately managed accounts. The primary investment strategies the Company employs in its funds include long/short equity special situations, convertible and derivative arbitrage, structured credit, other credit, private investments and merger arbitrage. The Company’s Other Operations are currently comprised of its real estate business, which manages and provides advisory services to its real estate funds, and 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 generates substantially all of its revenues in the United States. 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”), other than Ziff Investors Partnership, L.P. II and certain of its affiliates and control persons (collectively, the “Ziffs”) and intermediate holding companies, including the Company’s founder, Mr. Daniel Och, except where the context requires otherwise.

On November 19, 2007, the Company completed its initial public offering (“IPO”) of 36.0 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 partners at the time of the IPO and 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. As of June 30, 2010, the Company’s interest in the Och-Ziff Operating Group had increased to approximately 22.4%.

Prior to the Offerings, the Company completed a reorganization of its business (“Reorganization”). As part of the Reorganization, interests in the Och-Ziff Operating Group held by the partners and the Ziffs were reclassified as Och-Ziff Operating Group A Units, resulting in significant non-cash charges that are recorded within Reorganization expenses in the consolidated statements of operations.

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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, 2009. 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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

Recently Adopted Accounting Pronouncements

In February 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-10, Amendments to Statement 167 for Certain Investment Funds. ASU 2010-10 defers the effective date of ASU 2009-17 (see below) for certain investment entities to allow the FASB to work with the International Accounting Standards Board (“IASB”) in developing consistent consolidation guidance. The deferral applies to a reporting entity’s (i.e. investment manager’s) interest in an entity (i) that has the attributes of an investment company or (ii) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The deferral in ASU 2010-10 does not apply in situations in which a reporting entity has the explicit or implicit obligation to fund actual losses of an entity that could potentially be significant to the entity. ASU 2010-10 is effective for annual reporting periods beginning on or after November 15, 2009, and for interim periods within that first annual reporting period. The adoption of ASU 2010-10 did not have any impact on the Company’s financial position or results of operations, as adoption of the deferral resulted in the Company continuing to apply consolidation and disclosure requirements in effect during prior periods.

In February 2010, the FASB issued ASU 2010-09, Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09 amends subsequent events guidance to address certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures. The ASU, among other items, exempts SEC filers from disclosing the date through which subsequent events have been evaluated. ASU 2010-09 was effective immediately upon issuance. The adoption of ASU 2010-09 did not have any impact on our financial position or results of operations at the date of adoption, as the changes in ASU 2010-09 affect disclosure requirements and have no impact on the accounting for subsequent events.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends fair value disclosure requirements by requiring an entity to: (i) disclose separately the amounts of significant transfers in and out of Level I and Level II fair value measurements and describe the reasons for the transfers; and (ii) present separately information about purchases, sales, issuances and settlements of Level III fair value measurements (i.e. gross presentation). Additionally, ASU 2010-06 clarifies existing disclosure requirements related to the level of disaggregation for each class of assets and liabilities and disclosures about inputs and valuation techniques for fair value measurements classified as either Level II or Level III. The new disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures requiring separate presentation of information about purchases, sales, issuances and settlements in the roll forward of activity in Level III fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of the new disclosure requirements in ASU 2010-06 did not have any impact on our financial position or results of operations at the date of adoption, and the adoption of gross presentation in the roll forward of activity in Level III fair value measurements in 2011 is not expected to have any impact on our financial position or results of operations at the date of adoption, as each of these changes affects disclosure requirements and has no impact on the accounting for items at fair value.

In June 2009, the FASB issued amended guidance on accounting for transfers of financial assets (originally issued as SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140, and subsequently reissued as ASU 2009-16, Accounting for Transfers of Financial Assets). The amendments were 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. The amendments eliminate 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. The amendments are effective for reporting periods beginning on or after November 15, 2009. The adoption of ASU 2009-16 did not have any impact on the Company’s financial position or results of operations.

In June 2009, the FASB issued amended guidance on accounting for variable interest entities (“VIEs”) (originally issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), and subsequently reissued as ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities). The amendments were issued to address the effects of the removal of the concept of qualifying special purpose entities from U.S. GAAP and to address concerns regarding the consolidation of VIEs. ASU 2009-17 requires a qualitative approach rather than a quantitative approach when determining the primary beneficiary of a VIE and also changes the criteria by which an enterprise determines whether it is the primary beneficiary of an entity. In addition, the amended interpretation no longer considers removal rights when determining whether an entity is a VIE and whether to consolidate a VIE as the primary beneficiary unless those rights are held by a single party. ASU 2009-17 is effective for reporting periods beginning on or after November 15, 2009. The adoption of ASU 2009-17 did not have any impact on the Company’s financial position or results of operations, as substantially all of the entities in which the Company holds variable interests qualify for the scope deferral included in ASU 2010-10.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

Future Adoption of Accounting Pronouncements

As of June 30, 2010, none of the changes to the Codification issued by the FASB that are not yet effective were expected to have an impact on the Company’s financial position or results of operations.

3. OCH-ZIFF OPERATING GROUP OWNERSHIP

The Company’s ownership percentage in the Och-Ziff Operating Group increased to 22.4% as of June 30, 2010 from 20.9% as of December 31, 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, primarily upon the vesting of Class A restricted share units (“RSUs”) or exchanges of Och-Ziff Operating Group A Units.

The increase in the Company’s ownership percentage in the Och-Ziff Operating Group was driven primarily by a portion of Och-Ziff Operating Group A Units forfeited by former partners subsequently reallocated as non-equity profits interests to certain other partners and 5,135,245 Och-Ziff Operating Group A Units exchanged for Class A Shares, resulting in the following:

 

     Paid-in
Capital
    Partners’  and
Others’ Interests in
Consolidated
Subsidiaries
     (dollars in thousands)

Deferred income tax assets and liabilities resulting from exchange of Och-Ziff Operating Group A Units for Class A Shares

   $ 8,737      $
 
 
15,690

Deficit capital reallocated from partners’ and others’ interests in consolidated subsidiaries to the Company related to:

    

Exchange of Och-Ziff Operating Group A Units

     (6,039     6,039

Forfeiture of Och-Ziff Operating Group A Units not subsequently reallocated

     (19     19
              
   $ 2,679      $ 21,748
              

In addition, the increase in the Company’s ownership percentage in the Och-Ziff Operating Group was also driven by the issuance of Class A Shares under the Company’s Amended and Restated 2007 Equity Incentive Plan, primarily related to the vesting of RSUs, which resulted in the reallocation of deficit capital from partners’ and others’ interests in consolidated subsidiaries to the Company’s paid-in capital of $982 thousand.

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 as of the measurement date (i.e., 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

JUNE 30, 2010

 

As of June 30, 2010 and December 31, 2009, the Company did not have any liabilities carried at fair value. The following table summarizes the Company’s assets measured at fair value on a recurring basis within the fair value hierarchy:

 

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

As of June 30, 2010

  

Investments, at fair value:

           

Real estate investments

   $ —      $ —      $ 307,857    $ 307,857

Other investments

     —        —        38,546      38,546
                           

Total Investments, at Fair Value

   $ —      $ —      $ 346,403    $ 346,403
                           

Deferred Balances, at Fair Value

   $ —      $ —      $ 3,461    $ 3,461
                           

As of December 31, 2009

  

Investments, at fair value:

           

Real estate investments

   $ —      $ —      $ 285,744    $ 285,744

Other investments

     —        —        14,487      14,487
                           

Total Investments, at Fair Value

   $ —      $ —      $ 300,231    $ 300,231
                           

Deferred Balances, at Fair Value

   $ —      $ —      $ 404,666    $ 404,666
                           

Investments, which are primarily related to real estate investments of the Och-Ziff real estate funds, include equity, preferred equity, mezzanine debt, and participating debt in entities domiciled primarily in the United States. Real estate investments of the consolidated Och-Ziff funds are initially valued at transaction price and subsequently valued based primarily upon discounting the expected cash flows from the investment or on a multiple of earnings. Recent sales as well as offers on investments that are deemed likely to close in the near future are also considered. In reaching the determination of fair value for investments, the Company considers many factors including, but not limited to, the operating cash flows and financial performance of the real estate investments relative to budget projections, property types and geographic locations, expected exit timing and strategy and any specific rights or terms associated with the investment.

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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

The following table summarizes the changes in the Company’s Level III assets for the three months ended June 30, 2010:

 

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

As of March 31, 2010

   $ 15,357      $ 333,342      $ 348,699   

Net gains of consolidated Och-Ziff funds

     —          16,151        16,151   

Collection of deferred balances

     (11,896     —          (11,896

Investment sales, net

     —          (3,090     (3,090
                        

As of June 30, 2010

   $ 3,461      $ 346,403      $ 349,864   
                        

Amounts related to assets that continue to be held as of June 30, 2010:

      

Net gains of consolidated Och-Ziff funds

   $ —        $ 15,847      $ 15,847   
                        

Total

   $ —        $ 15,847      $ 15,847   
                        

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

 

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

As of March 31, 2009

   $ 349,630      $ 223,385      $ 573,015   

Net earnings on deferred balances

     14,723        —          14,723   

Net losses of consolidated Och-Ziff funds

     —          (375     (375

Collection of deferred balances

     (10,395     —          (10,395

Investment purchases, net

     —          21,875        21,875   
                        

As of June 30, 2009

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

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

      

Net earnings on deferred balances

   $ 14,723      $ —        $ 14,723   

Net losses of consolidated Och-Ziff funds

     —          (375     (375
                        

Total

   $ 14,723      $ (375   $ 14,348   
                        

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

The following table summarizes the changes in the Company’s Level III assets for the six months ended June 30, 2010:

 

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

As of December 31, 2009

   $ 404,666      $ 300,231    $ 704,897   

Net gains of consolidated Och-Ziff funds

     —          22,342      22,342   

Collection of deferred balances

     (401,205     —        (401,205

Investment purchases, net

     —          23,830      23,830   
                       

As of June 30, 2010

   $ 3,461      $ 346,403    $ 349,864   
                       

Amounts related to assets that continue to be held as of June 30, 2010:

       

Net gains of consolidated Och-Ziff funds

   $ —        $ 19,376    $ 19,376   
                       

Total

   $ —        $ 19,376    $ 19,376   
                       

The following table summarizes the changes in the Company’s Level III assets for the six months ended June 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

     3,430        —          3,430   

Net losses of consolidated Och-Ziff funds

     —          (98     (98

Collection of deferred balances

     (208,002     —          (208,002

Investment purchases, net

     —          36,475        36,475   
                        

As of June 30, 2009

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

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

      

Net earnings on deferred balances

   $ 3,430      $ —        $ 3,430   

Net losses of consolidated Och-Ziff funds

     —          (98     (98
                        

Total

   $ 3,430      $ (98   $ 3,332   
                        

Management estimates that the fair value of its term loan is approximately 80% of its carrying value as of June 30, 2010. 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 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 deemed not to be substantive.

The Company’s involvement with funds that are VIEs and not consolidated is limited to providing investment management services. The Company’s exposure to loss from these entities is limited to a decrease in the management fees and incentive income that may be earned in future periods. The net assets of these VIEs were $24.3 billion and $22.2 billion as of June 30, 2010 and December 31, 2009, respectively. The Company does not provide, nor is it required to provide, any type of financial or other support to these entities.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

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 June 30, 2010 and December 31, 2009, the only assets related to these variable interests amounted to $14.8 million and $251.4 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 $3.8 million as of June 30, 2010 and December 31, 2009, 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.

As substantially all of the funds managed by the Company qualify for the deferral under ASU 2010-10, the Company’s determination of whether it is the primary beneficiary of a VIE is generally 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% annually of assets under management) and incentive income (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.

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

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Assets

     

Assets of consolidated Och-Ziff funds:

     

Investments, at fair value

   $ 79,962    $ 51,394

Other assets of consolidated Och-Ziff funds

     72      1,713
             

Total Assets

   $ 80,034    $ 53,107
             

Liabilities

     

Liabilities of consolidated Och-Ziff funds:

     

Other liabilities of consolidated Och-Ziff funds

   $ 28    $ 30
             

Total Liabilities

   $ 28    $ 30
             

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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

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:

 

     June 30,
2010
    December 31,
2009
 
     (dollars in thousands)  

Fixed Assets:

  

Corporate aircraft

   $ 22,600      $ 22,600   

Leasehold improvements

     20,470        20,736   

Computer hardware and software

     17,374        17,579   

Furniture, fixtures and equipment

     2,985        3,046   

Accumulated depreciation and amortization

     (28,874     (25,192
                

Fixed assets, net

     34,555        38,769   

Goodwill

     22,691        22,691   

Prepaid expenses

     5,025        9,273   

Refundable security deposits

     4,755        6,785   

Intangible assets, net

     4,735        5,106   

Investments in joint ventures

     3,849        3,799   

Investments in Och-Ziff funds

     2,234        10,889   

Other

     7,993        6,272   
                

Total Other Assets, Net

   $ 85,837      $ 103,584   
                

Other Liabilities

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

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Unearned revenues

   $ 18,116    $ 12,876

Deferred rent credit

     11,704      10,887

Deferred income tax liabilities

     6,628      9,590

Current income taxes payable

     6,140      5,070

Other

     7,929      4,755
             

Total Other Liabilities

   $ 50,517    $ 43,178
             

7. DEBT OBLIGATIONS

On June 21, 2010, the Och-Ziff real estate funds entered into a $50.0 million syndicated credit facility which will mature on June 20, 2011. The outstanding loans under the credit facility are secured by the unfunded capital commitments by one of the Company’s consolidated subsidiaries (as general partner) and the investors in the Och-Ziff real estate funds. The Och-Ziff real estate funds are jointly and severally liable for the indebtedness. For each borrowing under the new credit facility, the Och-Ziff real estate funds have the option of borrowing at an interest rate equal to LIBOR plus 2.75% or the greater of (i) the prime rate and (ii) the federal funds rate plus 0.50%. For each letter of credit drawn under the new credit facility, the Och-Ziff real estate funds pay interest at a rate equal to 2.875%. In addition, the Och-Ziff real estate funds pay a minimum usage fee of 0.50% on the average daily amount of the unused portion of the credit facility.

Borrowings under the credit facility are recorded as liabilities by the investment subsidiaries of the Och-Ziff real estate funds using the facility. In accordance with U.S. GAAP, investment subsidiaries of the Company’s consolidated funds are generally not consolidated, but are carried at fair value within other investments, at fair value. Accordingly, such borrowings are not included within debt obligations in the Company’s consolidated balance sheets. As of June 30, 2010, there was $42.8 million in outstanding borrowings.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

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
June 30,
   Six Months Ended
June 30,
 
     2010    2009    2010     2009  
     (dollars in thousands)  

Occupancy and equipment

   $ 7,388    $ 6,926    $ 14,557      $ 13,746   

Professional services

     5,421      4,353      10,115        9,701   

Information processing and communications

     3,553      3,206      6,690        6,888   

Business development

     2,041      1,701      4,150        3,468   

Insurance

     1,977      3,185      3,903        6,346   

Other expenses

     3,034      1,761      6,855        4,017   
                              
     23,414      21,132      46,270        44,166   

Changes in tax receivable agreement liability

     124      —        (140     (784
                              

Total General, Administrative and Other

   $ 23,538    $ 21,132    $ 46,130      $ 43,382   
                              

9. LOSS PER CLASS A SHARE

Basic net loss per Class A Share is computed by dividing the net loss allocated to Class A shareholders by the weighted-average number of Class A Shares outstanding for the period. In addition, 283,085 and 97,021 RSUs that have vested but have not been settled in Class A Shares as of June 30, 2010 and 2009, respectively, are included in weighted-average Class A Shares outstanding in the calculation of basic and diluted net loss per Class A Share.

The following table presents the computation of basic and diluted net loss per Class A Shares for the three months ended June 30, 2010 and 2009:

 

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

Three Months Ended June 30, 2010

  

Basic

   $ (89,421   85,432,135    $ (1.05  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —        —        303,900,879

Class A Restricted Share Units

     —        —        13,921,349
                       

Diluted

   $ (89,421   85,432,135    $ (1.05  
                       

Three Months Ended June 30, 2009

         

Basic

   $ (88,313   76,804,771    $ (1.15  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —        —        309,056,479

Class A Restricted Share Units

     —        —        15,264,076
                       

Diluted

   $ (88,313   76,804,771    $ (1.15  
                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

The following table presents the computation of basic and diluted net loss per Class A Share for the six months ended June 30, 2010 and 2009:

 

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

Six Months Ended June 30, 2010

  

Basic

   $ (178,060   84,078,032    $ (2.12  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —        —        303,900,879

Class A Restricted Share Units

     —        —        13,921,349
                       

Diluted

   $ (178,060   84,078,032    $ (2.12  
                       

Six Months Ended June 30, 2009

         

Basic

   $ (170,167   76,676,699    $ (2.22  
                       

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —        —        309,056,479

Class A Restricted Share Units

     —        —        15,264,076
                       

Diluted

   $ (170,167   76,676,699    $ (2.22  
                       

10. INCOME TAXES

The computation of the effective tax rate and provision at each interim period requires the 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 June 30, 2010. The estimates used to compute the provision for income taxes may change as new events 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 each of 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 United States and in foreign jurisdictions. The provision for income taxes includes federal, state and local taxes in the United States and foreign taxes at an approximate effective tax rate of -2.2% and -0.1% for the three months ended June 30, 2010 and 2009, respectively, and -2.2% and -0.4% for the six months ended June 30, 2010 and 2009, 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 federal, state and local corporate income taxes in the United States; (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 partners’ and the Ziffs’ interests as Och-Ziff Operating Group A Units are not deductible for tax purposes.

As of June 30, 2010 and December 31, 2009, the Company was not required to establish a liability for uncertain tax positions.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

11. RELATED PARTY TRANSACTIONS

Due to Affiliates

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

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Amounts payable under tax receivable agreement

   $ 780,612    $ 785,530

Och-Ziff Operating Group distributions declared prior to Reorganization

     1,620      248,111

Allocations to non-equity partner interests payable

     4,069      132,654
             

Total Due To Affiliates

   $ 786,301    $ 1,166,295
             

As of June 30, 2010 and December 31, 2009, 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 partners’ distributions prior to the Reorganization 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 partners and the Ziffs prior to the Offerings 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 June 30,    Six Months Ended June 30,
     2010    2009    2010    2009
     (dollars in thousands)

Management fees

   $ 107,047    $ 83,372    $ 206,280    $ 174,935

Incentive income

   $ 5,536    $ 265    $ 5,722    $ 265

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

Management Fees and Incentive Income Earned from Affiliates and Waived Fees

Prior to the Offerings, the Company did not charge management fees or earn incentive income on investments made by the Company’s partners, employees and other related parties. Following the Offerings, the Company began charging management fees and earning incentive income on new investments made in the funds by the partners and certain other related parties, including the partners’ reinvestment of the after-tax proceeds from the Offerings, other than their reinvestment of deferred balances. The Company continues to waive fees for employee investments in the funds. The following table presents management fees and incentive income charged on investments held by related parties and amounts waived by the Company for related parties:

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009
     (dollars in thousands)

Fees charged on investments held by related parties

           

Management fees

   $ 5,380    $ 5,403    $ 10,678    $ 10,772

Incentive income

   $ 611    $ —      $ 611    $ —  

Fees waived on investments held by related parties

           

Management fees

   $ 3,206    $ 3,339    $ 6,416    $ 6,661

Incentive income

   $ —      $ —      $ —      $ —  

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 $216 thousand and $119 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 June 30, 2010 and 2009, respectively and $306 thousand and $200 thousand for the six months ended June 30, 2010 and 2009, respectively.

12. COMMITMENTS AND CONTINGENCIES

Tax Receivable Agreement

The purchase of Och-Ziff Operating Group A Units from the 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 its future tax liability 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, the right to receive payments under the tax receivable agreement by such former partners was contributed to the Och-Ziff Operating Group. As a result, the Company now expects to pay to the remaining partners and the Ziffs approximately 78% (from 85% at the time of the Offerings) of the amount of cash savings, if any, in federal, state and local income taxes in the United States that the Company actually realizes as a result of the increases in tax basis discussed above. In connection with the former partners’ contributions, the Company recorded a decrease in the liability for amounts payable under the tax receivable agreement of $17.4 million, a decrease of deferred income tax assets of $1.3 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 $2.4 million and an increase to partners’ and others’ interests in consolidated subsidiaries of $13.7 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 Holding

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

Corporation, a wholly-owned corporate-tax paying subsidiary of the Company, 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 these and a number of other factors.

Lease Obligations

The Company has non-cancelable operating leases for its headquarters in New York and its offices in London, Hong Kong, Mumbai and Beijing, in addition to operating leases on computer hardware. The related lease commitments have not changed materially since December 31, 2009.

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 June 30, 2010, an Och-Ziff fund consolidated by the Company had a commitment to fund investments in an amount of up to $170.5 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 4.5 years.

The Company has committed to fund a portion of the annual operating budget for a joint venture, and this portion currently totals approximately $4.7 million for 2010, of which $2.3 million has been funded through June 30, 2010. The joint venture periodically returns substantially all of the cash that is contributed by the Company, 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 material 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 is currently the Company’s only reportable segment and represents the Company’s core business, as substantially all of the Company’s operations are conducted through this segment. The Och-Ziff Funds segment provides investment 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, and 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. GAAP.

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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

Och-Ziff Funds Segment

Management uses Economic Income to evaluate the financial performance of and make resource allocation and other operating decisions for the Och-Ziff Funds segment. Economic Income is a pre-tax measure of performance that:

 

   

presents the results of operations without the impact of eliminations resulting from the consolidation of any of the Och-Ziff funds;

 

   

presents management fees net of recurring placement and related service fees on assets under management;

 

   

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

 

   

excludes the following: Reorganization expenses, equity-based compensation expense, allocations to non-equity partner interests, profit sharing, net earnings on deferred balances, net gains (losses) on investments in the Och-Ziff funds, depreciation and amortization, changes in the tax receivable agreement liability, net gain on early retirement of debt and amounts allocated to the partners and the Ziffs on their ownership interests in the Och-Ziff Operating Group.

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.

The following table presents Economic Income of the Och-Ziff Funds segment for the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010     2009
     (dollars in thousands)

Economic Income Revenues

          

Management fees

   $ 107,035    $ 84,523    $ 206,609      $ 176,947

Incentive income

     5,536      265      5,722        265

Other revenues

     448      231      732        445
                            

Total Economic Income Revenues

     113,019      85,019      213,063        177,657
                            

Economic Income Expenses

          

Compensation and benefits

     16,739      42,587      34,770        62,963

Non-compensation expenses

     21,704      21,801      41,335        45,894
                            

Total Economic Income Expenses

     38,443      64,388      76,105        108,857
                            

Net losses on joint ventures

     —        —        (235     —  
                            

Economic Income

   $ 74,576    $ 20,631    $ 136,723      $ 68,800
                            

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

The tables below present Economic Income of the Och-Ziff Funds segment, the U.S. GAAP results of the Company’s 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:

 

                Reconciling Adjustments        
Three Months Ended June 30, 2010    Economic
Income -
Och-Ziff
Funds
   Other
Operations
U.S. GAAP Basis
    Funds
Consolidation
    Other
Adjustments
    Total
Company
U.S.  GAAP

Basis
 
     (dollars in thousands)  

Revenues

           

Management fees

   $ 107,035    $ 999      $ (60   $ 2,240 (a)    $ 110,214   

Incentive income

     5,536      —          —          —          5,536   

Other revenues

     448      272        —          —          720   

Income of consolidated Och-Ziff funds

     —        7,454        —          —          7,454   
                                       

Total Revenues

     113,019      8,725        (60     2,240        123,924   
                                       

Expenses

           

Compensation and benefits

     16,739      8,411        —          26,579 (b)(c)      51,729   

Allocations to non-equity partner interests

     —        —          —          —          —     

Reorganization expenses

     —        —          —          411,789 (e)      411,789   

Profit sharing

     —        —          —          —          —     

Interest expense

     1,936      —          —          —          1,936   

General, administrative and other

     19,768      (689     —          4,459 (a)(g)      23,538   

Expenses of consolidated Och-Ziff funds

     —        4,272        25        —          4,297   
                                       

Total Expenses

     38,443      11,994        25        442,827        493,289   
                                       

Other Income (Loss)

           

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

     —        9        —          (611 )(h)      (602

Net gains of consolidated Och-Ziff funds

     —        16,695        (544     —          16,151   
                                       

Total Other Income (Loss)

     —        16,704        (544     (611     15,549   
                                       

Income (Loss) Before Income Taxes

     74,576      13,435        (629     (441,198     (353,816

Income taxes

     —        1,170        —          6,574 (g)      7,744   
                                       

Consolidated Net Income (Loss)

   $ 74,576    $ 12,265      $ (629   $ (447,772   $ (361,560
                                       

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

   $ —      $ 20,218      $ (629   $ (291,728 )(g)    $ (272,139
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 74,576    $ (7,953   $ —        $ (156,044   $ (89,421
                                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

                Reconciling Adjustments        
Three Months Ended June 30, 2009    Economic
Income -
Och-Ziff
Funds
   Other
Operations
U.S. GAAP Basis
    Funds
Consolidation
    Other
Adjustments
    Total
Company
U.S. GAAP
Basis
 
     (dollars in thousands)  

Revenues

           

Management fees

   $ 84,523    $ 1,311      $ (55   $ 387 (a)    $ 86,166   

Incentive income

     265      —          —          —          265   

Other revenues

     231      54        —          —          285   

Income of consolidated Och-Ziff funds

     —        8,887        —          —          8,887   
                                       

Total Revenues

     85,019      10,252        (55     387        95,603   
                                       

Expenses

           

Compensation and benefits

     42,587      10,784        —          22,654 (b)(c)      76,025   

Allocations to non-equity partner interests

     —        —          —          4,915 (d)      4,915   

Reorganization expenses

     —        —          —          424,736 (e)      424,736   

Profit sharing

     —        —          —          308 (f)      308   

Interest expense

     4,060      —          —          —          4,060   

General, administrative and other

     17,741      1,072        —          2,319 (a)(g)      21,132   

Expenses of consolidated Och-Ziff funds

     —        1,134        8        —          1,142   
                                       

Total Expenses

     64,388      12,990        8        454,932        532,318   
                                       

Other Income (Loss)

           

Net earnings on deferred balances

     —        —          —          14,723 (h)      14,723   

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

     —        (444     —          1,004 (h)      560   

Net gain on early retirement of debt

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

Net gains (losses) of consolidated Och-Ziff funds

     —        20        (395     —          (375
                                       

Total Other Income (Loss)

     —        (424     (395     17,740        16,921   
                                       

Income (Loss) Before Income Taxes

     20,631      (3,162     (458     (436,805     (419,794

Income taxes

     —        62        —          387 (g)      449   
                                       

Consolidated Net Income (Loss)

   $ 20,631    $ (3,224   $ (458   $ (437,192   $ (420,243
                                       

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

   $ —      $ 7,803      $ (458   $ (339,275 )(g)    $ (331,930
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 20,631    $ (11,027   $ —        $ (97,917   $ (88,313
                                       

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

                 Reconciling Adjustments        
Six Months Ended June 30, 2010    Economic
Income -
Och-Ziff
Funds
    Other
Operations
U.S. GAAP Basis
    Funds
Consolidation
    Other
Adjustments
    Total
Company
U.S. GAAP
Basis
 
     (dollars in thousands)  

Revenues

          

Management fees

   $ 206,609      $ 1,876      $ (120   $ 3,591 (a)    $ 211,956   

Incentive income

     5,722        —          —          —          5,722   

Other revenues

     732        379        —          —          1,111   

Income of consolidated Och-Ziff funds

     —          14,570        —          —          14,570   
                                        

Total Revenues

     213,063        16,825        (120     3,591        233,359   
                                        

Expenses

          

Compensation and benefits

     34,770        15,998        —          54,153 (b)(c)      104,921   

Allocations to non-equity partner interests

     —          —          —          —          —     

Reorganization expenses

     —          —          —          836,595 (e)      836,595   

Profit sharing

     —          —          —          —          —     

Interest expense

     3,893        —          —          —          3,893   

General, administrative and other

     37,442        1,042        —          7,646 (a)(g)      46,130   

Expenses of consolidated Och-Ziff funds

     —          5,348        31        —          5,379   
                                        

Total Expenses

     76,105        22,388        31        898,394        996,918   
                                        

Other Income (Loss)

          

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

     (235     (81     —          (233 )(h)      (549

Net gains of consolidated Och-Ziff funds

     —          22,183        159        —          22,342   
                                        

Total Other Income (Loss)

     (235     22,102        159        (233     21,793   
                                        

Income (Loss) Before Income Taxes

     136,723        16,539        8        (895,036     (741,766

Income taxes

     —          2,417        —          14,126 (g)      16,543   
                                        

Consolidated Net Income (Loss)

   $ 136,723      $ 14,122      $ 8      $ (909,162   $ (758,309
                                        

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

   $ —        $ 31,472      $ 8      $ (611,729 )(g)    $ (580,249
                                        

Net Income (Loss) Allocated to Class A Shareholders

   $ 136,723      $ (17,350   $ —        $ (297,433   $ (178,060
                                        

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

                Reconciling Adjustments        
Six Months Ended June 30, 2009    Economic
Income -
Och-Ziff
Funds
   Other
Operations
U.S. GAAP Basis
    Funds
Consolidation
    Other
Adjustments
    Total
Company
U.S. GAAP
Basis
 
     (dollars in thousands)  

Revenues

           

Management fees

   $ 176,947    $ 2,622      $ (111   $ 1,013 (a)    $ 180,471   

Incentive income

     265      —          —          —          265   

Other revenues

     445      108        —          —          553   

Income of consolidated Och-Ziff funds

     —        11,502        —          —          11,502   
                                       

Total Revenues

     177,657      14,232        (111     1,013        192,791   
                                       

Expenses

           

Compensation and benefits

     62,963      19,470        —          45,468 (b)(c)      127,901   

Allocations to non-equity partner interests

     —        —          —          4,575 (d)      4,575   

Reorganization expenses

     —        —          —          844,685 (e)      844,685   

Profit sharing

     —        —          —          291 (f)      291   

Interest expense

     8,655      —          —          —          8,655   

General, administrative and other

     37,239      2,277        —          3,866 (a)(g)      43,382   

Expenses of consolidated Och-Ziff funds

     —        1,888        8        —          1,896   
                                       

Total Expenses

     108,857      23,635        8        898,885        1,031,385   
                                       

Other Income (Loss)

           

Net earnings on deferred balances

     —        —          —          3,430 (h)      3,430   

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

     —        (992     —          1,298 (h)      306   

Net gain on early retirement of debt

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

Net gains (losses) of consolidated Och-Ziff funds

     —        1,589        (1,687     —          (98
                                       

Total Other Income (Loss)

     —        597        (1,687     6,741        5,651   
                                       

Income (Loss) Before Income Taxes

     68,800      (8,806     (1,806     (891,131     (832,943

Income taxes

     —        103        —          3,175 (g)      3,278   
                                       

Consolidated Net Income (Loss)

   $ 68,800    $ (8,909   $ (1,806   $ (894,306   $ (836,221
                                       

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

   $ —      $ 11,236      $ (1,806   $ (675,484 )(g)    $ (666,054
                                       

Net Income (Loss) Allocated to Class A Shareholders

   $ 68,800    $ (20,145   $ —        $ (218,822   $ (170,167
                                       

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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2010

 

  (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 partners for periods prior to the Reorganization. For these periods, allocations to the partners, other than Mr. Och, were treated as expenses for U.S. GAAP purposes. Following the Reorganization, only allocations to the partners, other than Mr. Och, that are 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 partners and the Ziffs prior to the Reorganization as Och-Ziff Operating Group A Units and any subsequent reallocations of such 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 expenses 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, net gain on early retirement of debt and amounts allocated to partners’ and others’ interests in 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 on deferred balances and net gains (losses) on investments in Och-Ziff funds, as these amounts primarily relate to amounts due to affiliates for deferred balances, and 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 June 30, 2010, the Company recorded revenues of $43.5 million, $18.3 million and $16.9 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 three months ended June 30, 2009, the Company recorded revenues of $26.0 million, $12.0 million and $10.2 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 six months ended June 30, 2010, the Company recorded revenues of $80.9 million, $34.3 million and $33.2 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 six months ended June 30, 2009, the Company recorded revenues of $52.4 million, $29.4 million and $20.1 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.

 

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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, 2009, 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.

OVERVIEW

During the second quarter of 2010, assets under management increased $647.2 million, or 3%, from $24.8 billion as of March 31, 2010, resulting from capital net inflows of $1.0 billion, which were partially offset by performance-related depreciation of $388.2 million. Consistent with what we have seen over the last several quarters, our second quarter capital net inflows came from a well-diversified mix of existing and new fund investors. We have seen particular interest from pension funds, private banks, corporate and other institutions, including international pools of capital. Our assets under management increased $3.6 billion, or 16%, year-over-year to $25.5 billion as of June 30, 2010 from $21.9 billion as of June 30, 2009. This increase was driven by the performance-related appreciation experienced by our funds during 2009 and the first half of 2010 and capital net inflows during the same period.

Market conditions during the second quarter of 2010 were generally more challenging than at any time in the last 18 months, resulting in higher volatility. In this environment, we continued to generate strong, risk-adjusted returns. Our performance benefitted from our consistent, disciplined investment and risk management processes, our low use of leverage and our emphasis on diversification through our multi-strategy approach and international capabilities. Because we seek to capitalize on opportunities in various asset classes and geographies, and are not dependent on a specific capital allocation to a strategy or on trying to predict market direction, we were able to continue our history of generating returns for our fund investors even when market conditions are challenging.

Our year-to-date performance was driven by our structured and distressed credit strategies, convertible arbitrage and private investments. Our performance during the second quarter of 2010 reflects the benefit to our fund investors of our active risk management process. In light of the sharp decline in global equity markets and the resultant increase in volatility during the quarter, we reduced our equity exposures and increased our allocation to cash. We are continuing to see attractive ideas in all of our strategies, although we are being more selective and disciplined in terms of entering and exiting investment disciplines and geographic regions.

For the second quarter of 2010, we reported a U.S. GAAP net loss allocated to Class A shareholders of $89.4 million, or $1.05 per basic and diluted Class A Share, compared to a net loss of $88.3 million, or $1.15 per basic and diluted Class A Share for the second quarter of 2009. For the first half of 2010, we reported a U.S. GAAP net loss allocated to Class A shareholders of $178.1 million, or $2.12 per basic and diluted Class A Share, compared to a net loss of $170.2 million, or $2.22 per basic and diluted Class A Share for the first half of 2009. We continued to report a U.S. GAAP net loss due to the significant non-cash Reorganization charges associated with the Offerings.

We reported Economic Income for the Company1 of $71.6 million for the second quarter of 2010, compared with $15.8 million in the second quarter of 2009. We reported Economic Income for the Company of $129.5 million for the first half of 2010, compared with $60.3 million in the first half of 2009. The year-over-year increases were principally attributable to the Och-Ziff Funds segment. Within the segment, the increases resulted primarily from increased management fees due to higher assets under management compared to the prior-year period, and lower compensation and benefits expenses, as the accrual for discretionary cash bonuses taken in the second quarter of 2009 did not recur in the second quarter of 2010.

MARKET FACTORS AFFECTING OUR BUSINESS

Our investment strategies in any given quarter are influenced by a combination of factors, including global economic and market conditions, the opportunities we see in specific asset classes or industry sectors and our risk management processes.

During the second quarter of 2010, growing concerns over the European sovereign debt crisis and resultant weakness in the Euro, regulatory uncertainty and weaker economic data led to broad-based risk aversion, causing volatility to increase sharply and equity and debt markets to decline globally. In the United States, employment growth fell below expectations, consumer and business confidence declined and a number of other economic data suggested a deterioration in the pace and magnitude of the economic recovery. Simultaneously, global and monetary policies in most countries, particularly in Europe, started to emphasize contraction as certain governments became more focused on controlling budget deficits. As a result, most global equity indices experienced sharp declines and a corresponding increase in volatility. Strong corporate profits, however, and low interest rates and inflation countered these negative developments to a degree.

 

1

Economic Income for the Company is a non-GAAP measure. For additional information regarding non-GAAP measures, see “—Economic Income Analysis.”

 

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During the second quarter of 2010, U.S. credit markets continued their positive trend from the first quarter through April and then abruptly reversed course in May. After setting a record for primary issuance in the first quarter, activity in the U.S. high-yield bond primary market slowed appreciably. In Europe, the positive momentum evident in the credit markets during the first quarter of 2010 came to a halt as uncertainties around the outlook for European sovereigns became a key factor. Additionally, primary issuance declined substantially when compared to first-quarter levels. Asian credit markets experienced volatile conditions as the European sovereign debt crisis had follow-through effects in every asset class.

U.S. structured credit markets experienced substantial volatility in a pattern similar to the first quarter of 2010. U.S. securitized products began the second quarter with positive momentum, only to experience a substantial reversal amid the broader pullback in the global markets during May and a widening of spreads.

ASSETS UNDER MANAGEMENT AND FUND PERFORMANCE

Consistent, positive investment performance and preservation of fund investor capital are the key determinants of the long-term success of our business because they enable us to attract additional assets under management from both existing and new fund investors, as well as minimize redemptions of capital from our funds. Growth in assets under management in turn drives growth in our revenues and earnings. Conversely, poor investment performance slows our growth by decreasing our assets under management and increasing the potential for redemptions from our funds.

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. Incentive income is directly impacted by our funds’ investment performance and indirectly impacted by increases and decreases in assets under management; therefore, 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 subject to a 2% management fee would generally increase or decrease annual management fees by $20 million. If net profits attributable to a fee-paying fund investor were $10 million, we generally would earn incentive income equal to $2 million, assuming a one-year incentive income measurement period, no change in current incentive income rates, no hurdle rate and no high-water marks from prior years.

Assets Under Management

Our assets under management are a function of the capital that is placed with us by fund investors globally, which we invest on their behalf based on the focus of the fund or funds they have selected. We typically accept capital from new and existing investors into our funds on a monthly basis on the first day of each month. Investors in our funds (other than investors in private 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. However, upon the payment of a redemption fee to the funds and upon giving 30 days prior written notice and subject to limitations, 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. With respect to investors with quarterly redemption rights, requests for redemptions submitted during a quarter generally are paid on the first day 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. With respect to investors with annual redemption rights, redemptions paid prior to the end of a quarter impact assets under management in the quarter in which they are paid, and therefore impact management fees for that quarter.

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. Both of these factors directly impact the revenues we earn from management fees and incentive income.

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 by our partners and the Ziffs prior to our IPO, and investments by us, our partners, employees and certain other related parties. Prior to our 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, employees and certain other related parties, including the reinvestment by our partners of the after-tax proceeds from the Offerings, other than the

 

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reinvestment by our partners of deferred balances. As of June 30, 2010, approximately 9% of our assets under management represented investments by us, our partners and certain other related parties in our funds. As of this date, approximately 37% 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 pre-IPO investments by our partners as well as other related parties.

As further discussed below in “—Understanding Our Results—Revenues,” we generally calculate management fees based on assets under management as of the beginning of each quarter. The assets under management in the tables below are presented net of management fees and incentive income and are as of the end of the period. Accordingly, the assets under management presented in the tables below are not the amounts used to calculate management fees for the respective periods.

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

 

     June 30,
     2010    2009
     (dollars in thousands)

OZ Master Fund

   $ 18,360,337    $ 14,447,472

OZ Europe Master Fund

   $ 2,891,561    $ 2,960,415

OZ Asia Master Fund

   $ 1,330,726    $ 1,392,700

OZ Global Special Investments Master Fund

   $ 1,183,853    $ 1,939,872

Assets under management presented in the table above 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 that are not material, which collectively were approximately $1.7 billion and $1.2 billion as of June 30, 2010 and 2009, respectively.

During the first quarter of 2010, our partners re-allocated $713.9 million of their $1.5 billion of after-tax proceeds from the Offerings invested in the OZ Global Special Investments Master Fund primarily to the OZ Master Fund. As the majority of our fund investors’ capital is in the OZ Master Fund, this change further aligns the partners’ interests with theirs. The change also reflects the fact that our fund investors have become more selective in their appetite for exposure to private investments in favor of the broader investment opportunities available on a multi-strategy basis. The full amount of our partners’ capital continues to be subject to the original 5-year lock-up from the time of our IPO, and the amount remaining in the OZ Global Special Investments Master Fund will continue to be used to invest in our private investments platforms.

The $3.9 billion year-over-year increase in assets under management for the OZ Master Fund was driven primarily by capital net inflows in the fourth quarter of 2009 and first half of 2010, and the positive investment performance of the OZ Master Fund in the second half of 2009 and the first quarter of 2010. Also contributing to the increase was the reallocation of capital by our partners from OZ Global Special Investments Master Fund as discussed above. These inflows were partially offset by capital net outflows experienced in the third quarter of 2009 and performance-related depreciation in the second quarter of 2010.

The $68.9 million and $62.0 million year-over-year decreases in assets under management for the OZ Europe Master Fund and OZ Asia Master Fund, respectively, were primarily as a result of capital net outflows experienced in the second half of 2009, and performance-related depreciation in the second quarter of 2010. These decreases were partially offset by the positive investment performance of these funds in the second half of 2009 and the first quarter of 2010, in addition to capital net inflows in the second quarter of 2010. The OZ Europe Master Fund experienced capital net outflows in the first quarter of 2010.

The $756.0 million year-over-year decrease in the assets under management for the OZ Global Special Investments Master Fund was driven by capital net outflows, primarily in the first quarter of 2010 due to the reallocation of capital by our partners to our other funds as discussed above, partially offset by positive investment performance in the second half of 2009 and the first quarter of 2010.

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

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010    2009  
     (dollars in thousands)  

Balance-beginning of period

   $ 24,849,771      $ 22,601,156      $ 23,079,796    $ 26,954,606   

Net flows

     1,035,333        (2,135,924     2,060,957      (7,222,046

Appreciation (Depreciation)

     (388,164     1,454,329        356,187      2,187,001   
                               

Balance-end of period

   $ 25,496,940      $ 21,919,561      $ 25,496,940    $ 21,919,561   
                               

Weighted-average assets under management

   $ 25,643,056      $ 20,422,890      $ 24,708,370    $ 21,224,255   

 

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Our assets under management increased $3.6 billion, or 16%, year-over-year as a result of positive investment performance of approximately $2.4 billion and capital net inflows of approximately $1.2 billion from June 30, 2009 to June 30, 2010.

In the first half of 2010, our funds experienced performance-related appreciation of $356.2 million and capital net inflows of $2.1 billion, which were comprised of $3.7 billion of gross inflows and $1.6 billion of gross outflows. The inflows were driven by increased institutional investor confidence in placing capital with alternative asset managers and, in turn with us, in order to enhance the yield and diversification of their investments. The outflows were driven by quarterly redemption requests, which we believe have normalized to levels seen prior to 2008.

In the first half of 2009, our funds experienced performance-related appreciation of $2.2 billion and capital net outflows of $7.2 billion, which were comprised of $423.5 million of gross inflows and $7.6 billion of gross outflows. The outflows were driven principally by fourth quarter 2008 redemption requests paid on January 1, 2009 of $5.0 billion and first quarter 2009 redemption requests paid on April 1, 2009 of $2.3 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 of 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 imposed or maintained constraints on investor redemptions.

Estimated assets under management as of August 1, 2010 were $25.9 billion, an increase of approximately $400 million from June 30, 2010, as a result of capital net inflows of $100 million from July 1, 2010 to August 1, 2010, and performance-related appreciation of approximately $300 million.

Fund Performance

Annual fund investment performance, as generally earned on a calendar-year basis, determines the amount of incentive income we will earn in a given year. Incentive income is generally 20% of the net realized and unrealized profits attributable to each of our fund investors, excluding unrealized profits on private investments and subject to any high-water marks.

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.

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, as noted above, 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 June 30,
    Net Return for the
Six Months Ended June 30,
 
     2010     2009     2010     2009  

OZ Master Fund

   -1.4   7.6   1.3   12.3

OZ Europe Master Fund

   -2.8   7.2   1.5   7.0

OZ Asia Master Fund

   -2.0   8.5   3.0   13.2

OZ Global Special Investments Master Fund

   -0.2   2.9   3.6   3.6

OZ Master Fund

For the first half of 2010, the return of the OZ Master Fund was driven primarily by investment opportunities in structured and distressed credit, primarily in the United States and Europe.

For the first half of 2009, the return of the OZ Master Fund was driven primarily by investment opportunities in the following strategies: long/short equity special situations, primarily in the United States and Asia, which contributed approximately 46% of the return before management fees and incentive income; convertible and derivative arbitrage, primarily in the United States, which contributed approximately 30%; and structured and distressed credit, primarily in the United States and Europe, which contributed approximately 26%. The positive investment performance of these strategies was partially offset by losses in our private investments strategy.

 

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OZ Europe Master Fund

For the first half of 2010, the return of the OZ Europe Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, which contributed approximately 76% of the return before management fees and incentive income; private investments, which contributed approximately 22%; and convertible and derivative arbitrage, which contributed approximately 11%. The positive investment performance of these strategies was partially offset by losses in our long/short equity special situations strategy.

For the first half of 2009, the return of the OZ Europe Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, which contributed approximately 57% of the return before management fees and incentive income; convertible and derivative arbitrage, which contributed approximately 37%; and long/short equity special situations, which contributed approximately 15%. The positive investment performance of these strategies was partially offset by losses in our private investments strategy.

OZ Asia Master Fund

For the first half of 2010, the return of the OZ Asia Master Fund was driven primarily by investment opportunities in the following strategies: convertible and derivative arbitrage, which contributed approximately 78% of the return before management fees and incentive income; and private investments, which contributed approximately 38%. The positive investment performance of these strategies was partially offset by losses related to bankruptcy claims.

For the first half of 2009, the return of the OZ Asia Master Fund was driven primarily by investment opportunities in the following strategies: long/short equity special situations, which contributed approximately 89% of the return before management fees and incentive income; convertible and derivative arbitrage, which contributed approximately 14%; and distressed credit, which contributed approximately 13%. The positive investment performance of these strategies was partially offset by losses in our private investments strategy.

OZ Global Special Investments Master Fund

For the first half of 2010, the return of the OZ Global Special Investments Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, primarily in the United States and Europe, which contributed approximately 83% of the return before management fees and incentive income; and private investments, which contributed approximately 23%. The positive investment performance of these strategies was partially offset by losses in our long/short equity special situations strategy.

For the first half of 2009, substantially all of the return before management fees and incentive income of the OZ Global Special Investments Master Fund was driven by investment opportunities in long/short equity special situations, primarily in the United States and Asia, partially offset by losses in our private investments strategy.

UNDERSTANDING OUR RESULTS

Revenues

Our operations have been financed primarily by cash flows generated by our business. Our principal sources of revenues are management fees and incentive income.

 

   

Management Fees. We earn management fees as follows:

Hedge Funds and Managed Accounts. Management fees typically range from 1.5% to 2.5% annually of assets under management and currently average approximately 1.7%. This average rate takes into account the effect of non-fee paying assets under management, the management fee charged on capital contributed and the management fee on capital redeemed. Management fees are generally calculated and 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 from quarter to quarter are driven by changes in the quarterly 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.

Real Estate Funds. Management fees from the Och-Ziff real estate funds are generally charged at an annual rate of 0.75% to 1.5% of the total capital commitments during the original investment period and 0.75% to 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.

 

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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 attributable to each fund investor, but excludes unrealized profits on private investments. We do not recognize incentive income until the end of the measurement period when the amounts are contractually payable, or “crystallized.” The measurement period for most of our assets under management is on a calendar-year basis, and therefore we generally crystallize incentive income annually on December 31st. The measurement periods, however, with respect to approximately 10% of our assets under management as of June 30, 2010, are based on longer time periods and the calculations of incentive income for these assets are subject to hurdle rates. Generally, any incentive income recorded during the first three quarters of the year is related to fund investor redemptions or amounts earned from fund investors with measurement periods longer than one-year. Furthermore, incentive income on private investments is earned in the year of the sale or on realization of the private investment.

As of January 1, 2010, all of our funds are subject to a perpetual loss carry forward, or perpetual “high-water mark,” meaning we will not be able to earn incentive income with respect to a fund investor’s investment loss in the year or years following negative investment performance until that loss is recouped, at which point a fund investor’s investment surpasses the high-water mark. We earn incentive income on any net profits in excess of the high-water mark. Prior to January 1, 2010, most of our funds had a one-year high-water mark. Since our inception, we have surpassed essentially all of our high-water marks in the year following negative investment performance, including the losses experienced by our funds in 2008. Accordingly, high-water marks have not affected incentive income in any year other than the year immediately following a loss. The impact of the change from a one-year high-water mark to a perpetual high-water mark on future incentive income is dependent on our ability to recover any losses in the year following such losses. As of December 31, 2009, we had surpassed virtually all of the high-water marks in our funds.

For any given fiscal period, our revenues will be influenced by the combination of assets under management and the investment performance of our funds. For the first three quarters of each year, our revenues will be primarily comprised of the management fees we have earned for each respective quarter. In the fourth quarter, our revenues will be primarily comprised of the management fees we have earned for the quarter, as well as incentive income related to the full-year investment performance generated for the majority of our fund investors.

Income of Consolidated Och-Ziff Funds. Revenues recorded as income of consolidated Och-Ziff funds consist of interest income, dividend income and other miscellaneous items.

Expenses

Our operating expenses consist of the following:

 

   

Compensation and Benefits. Compensation and benefits in the first three quarters is comprised of salaries and benefits, guaranteed bonus accruals and equity-based compensation primarily in the form of Class A restricted share units, or “RSUs”. On an annual basis, compensation and benefits comprise the most significant portion of total expenses, with discretionary cash bonuses comprising the majority of total compensation and benefits. These cash bonuses are funded by total annual revenues, which are significantly influenced by the incentive income we earn for the year. Annual discretionary cash bonuses in a year with no high-water marks in effect are generally determined and expensed in the fourth quarter each year. In the second quarter of 2009, however, we began to accrue for the estimated 2009 discretionary cash bonuses that we expected to pay our employees shortly after year-end 2009. We did this in order to provide a competitive compensation structure in a year in which we generated strong investment performance while at the same time having the high-water marks in our funds, which if not recovered would have precluded us from earning any incentive income in 2009. For the six months ended June 30, 2010, we did not accrue for any discretionary cash bonuses.

 

   

Interest Expense. Amounts included within interest expense relate primarily to interest expense on our term loan and the note payable on our corporate aircraft, both of which are LIBOR-based, variable rate borrowings.

 

   

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.

In addition, the following expenses also impact our U.S. GAAP results:

Reorganization Expenses. Prior to the Offerings, we completed a reorganization of our business, which we refer to as the “Reorganization.” As part of the Reorganization, interests in the Och-Ziff Operating Group held by our partners and the Ziffs 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.

 

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Allocations to Non-Equity Partner Interests and Profit Sharing. Prior to the Reorganization, income allocations to our partners, other than Mr. Och, and to the Ziffs on their interests in our business were recorded as expenses within allocations to non-equity partner interests and profit sharing, respectively, in the consolidated statements of operations. For periods following the Reorganization, only allocations to the partners, other than Mr. Och, and the Ziffs related to earnings on deferred balances are incurred. Allocations to Och-Ziff Operating Group A Units held by our partners and the Ziffs subsequent to the Reorganization are recorded within net loss allocated to partners’ and others’ interests in consolidated subsidiaries in the consolidated statements of operations, as these are equity interests held directly in the Och-Ziff Operating Group.

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

Other Income

Our other income consists of:

 

   

Net Earnings on Deferred Balances. Net earnings on deferred balances represent the changes in fair value of the deferred balances owed to our partners and the Ziffs. Earnings on deferred balances impact the amounts ultimately paid to our partners and the Ziffs, and therefore do not impact our Class A shareholders. For more information, see “—Liquidity and Capital Resources—Other Future Liquidity and Capital Needs—Deferred Balances Distributions.”

 

   

Net Gains (Losses) on Investments in Och-Ziff Funds and Joint Ventures. Net gains (losses) on investments in Och-Ziff funds and joint ventures primarily consists of net gains (losses) on investments in our funds made by us to economically hedge certain deferred compensation plans indexed to fund performance, and net losses on investments in joint ventures established to expand our private investment platforms.

 

   

Net Gain on Early Retirement of Debt. Net gain on early retirement of debt consists of the gain realized upon the early retirement of $5 million of our term loan that occurred in 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

Income taxes consist of our provision for federal, state, local and foreign income taxes, including provisions for deferred income taxes resulting from temporary differences between the tax and U.S. GAAP basis. The computation of the provision requires certain estimates and significant judgment including, but not limited to, the expected taxable income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent differences between the tax and U.S. GAAP basis and the likelihood of being able to fully utilize deferred tax assets existing as of the end of the period. In addition, the amount of incentive income we earn, the resultant flow of revenues and expenses through our legal entity structure, the effect that changes in our Class A Share price may have on the ultimate deduction we are able to take related to the vesting of RSUs, and any changes in future enacted income tax rates may have a significant impact on our income tax provision and effective tax rate.

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

Partners’ and others’ interests in consolidated subsidiaries represents ownership interests in the Company’s subsidiaries held by parties other than us and is primarily made up of: (i) Och-Ziff Operating Group A Units held by our 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. 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.

 

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RESULTS OF OPERATIONS

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Revenues

        

Management fees

   $ 110,214      $ 86,166      $ 211,956      $ 180,471   

Incentive income

     5,536        265        5,722        265   

Other revenues

     720        285        1,111        553   

Income of consolidated Och-Ziff funds

     7,454        8,887        14,570        11,502   
                                

Total Revenues

     123,924        95,603        233,359        192,791   
                                

Expenses

        

Compensation and benefits

     51,729        76,025        104,921        127,901   

Allocations to non-equity partner interests

     —          4,915        —          4,575   

Reorganization expenses

     411,789        424,736        836,595        844,685   

Profit sharing

     —          308        —          291   

Interest expense

     1,936        4,060        3,893        8,655   

General, administrative and other

     23,538        21,132        46,130        43,382   

Expenses of consolidated Och-Ziff funds

     4,297        1,142        5,379        1,896   
                                

Total Expenses

     493,289        532,318        996,918        1,031,385   
                                

Other Income

        

Net earnings on deferred balances

     —          14,723        —          3,430   

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

     (602     560        (549     306   

Net gain on early retirement of debt

     —          2,013        —          2,013   

Net gains (losses) of consolidated Och-Ziff funds

     16,151        (375     22,342        (98
                                

Total Other Income

     15,549        16,921        21,793        5,651   
                                

Loss Before Income Taxes

     (353,816     (419,794     (741,766     (832,943

Income taxes

     7,744        449        16,543        3,278   
                                

Consolidated Net Loss

   $ (361,560   $ (420,243   $ (758,309   $ (836,221
                                

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

   $ (272,139   $ (331,930   $ (580,249   $ (666,054
                                

Net Loss Allocated to Class A Shareholders

   $ (89,421   $ (88,313   $ (178,060   $ (170,167
                                

Revenues

Management Fees. The following table sets forth the components of our management fees:

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009
     (dollars in thousands)

Och-Ziff Funds segment:

           

Hedge funds

   $ 104,867    $ 83,041    $ 202,809    $ 174,034

Managed accounts

     2,168      1,482      3,800      2,913

Och-Ziff real estate funds

     999      1,311      1,876      2,622

Eliminated in consolidation and recurring placement and related service fees netted against management fees above

     2,180      332      3,471      902
                           

Total

   $ 110,214    $ 86,166    $ 211,956    $ 180,471
                           

 

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Management fees increased by $24.0 million and $31.5 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods, due to the year-over-year increase in average assets under management driven by a combination of capital net inflows and performance-related appreciation.

Our management fees, before the impact of eliminations, were 1.7% (annualized) of our weighted-average assets under management for the three and six months ended June 30, 2010 and 2009. See “—Segment Analysis” for a discussion of management fees earned by the Och-Ziff Funds segment before the impact of eliminations in consolidation.

Incentive Income. Incentive income increased by $5.3 million and $5.5 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These amounts were primarily related to fund investor redemptions.

Income of Consolidated Och-Ziff Funds. Income of consolidated Och-Ziff funds decreased by $1.4 million and increased by $3.1 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Expenses

Compensation and Benefits. Compensation and benefits expenses decreased by $24.3 million and $23.0 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily related to a $25.4 million accrual for discretionary cash bonuses in the second quarter of 2009. In the second quarter of 2009 we began to accrue for the estimated 2009 discretionary cash bonuses that we expected to pay our employees shortly after year end 2009. We did this in order to provide a competitive compensation structure in a year in which we generated strong investment performance while at the same time having the high-water marks in our funds, which if not recovered would have precluded us from earning any incentive income in 2009. For the six months ended June 30, 2010, we did not accrue for any discretionary cash bonuses. Annual discretionary cash bonuses in a year with no high-water marks in effect are generally determined and expensed in the fourth quarter each year. Our worldwide headcount increased from 358 at June 30, 2009 to 384 at June 30, 2010.

Allocations to Non-Equity Partners. Allocations to non-equity partners in 2009 were related to earnings on deferred balances allocated to our partners, other than Mr. Och. For more information, see “—Liquidity and Capital Resources—Other Future Liquidity and Capital Needs—Deferred Balances Distributions.”

Reorganization Expenses. Reorganization expenses decreased by $12.9 million and $8.1 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These expenses represent the amortization of the fair value of unvested Och-Ziff Operating Group A Units held by our partners after the Offerings. The decrease in Reorganization expenses was primarily attributable to the decrease in the amortization on certain units forfeited by former partners in the first half of 2009 and the first quarter of 2010 and subsequently reallocated to the remaining partners. The grant-date fair value of the reallocated units was lower than the original grant-date fair value, and therefore the Reorganization expenses associated with the reallocated units decreased. Assuming no material forfeitures or reallocations, the estimated future Reorganization expenses related to the amortization of Och-Ziff Operating Group A Units held by our partners are expected to be approximately $824.5 million for the remainder of 2010, $1.7 billion in 2011 and $1.5 billion in 2012.

Interest Expense. Interest expense decreased by $2.1 million and $4.8 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily due to the decrease in LIBOR, to which both our term loan obligation and the note payable on our corporate aircraft are indexed. Additionally, interest expense decreased as a result of the early retirement of an aggregate of $105 million of our term loan in 2009. 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. The following table sets forth the components of our general, administrative and other expenses:

 

     Three Months Ended June 30,    Six Months Ended June 30,  
     2010    2009    2010     2009  
     (dollars in thousands)  

Occupancy and equipment

   $ 7,388    $ 6,926    $ 14,557      $ 13,746   

Professional services

     5,421      4,353      10,115        9,701   

Information processing and communications

     3,553      3,206      6,690        6,888   

Business development

     2,041      1,701      4,150        3,468   

Insurance

     1,977      3,185      3,903        6,346   

Other expenses

     3,034      1,761      6,855        4,017   
                              
     23,414      21,132      46,270        44,166   

Changes in tax receivable agreement liability

     124      —        (140     (784
                              

Total General, Administrative and Other

   $ 23,538    $ 21,132    $ 46,130      $ 43,382   
                              

General, administrative and other expenses increased by $2.4 million and $2.7 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These increases were primarily driven by higher recurring placement and related service fees on assets under management (included within other expenses in the table above), occupancy and equipment, and professional services, partially offset by lower insurance costs.

Expenses of Consolidated Och-Ziff Funds. Expenses of consolidated Och-Ziff funds increased by $3.2 million and $3.5 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Other Income

Net Earnings on Deferred Balances. There were no earnings on deferred balances in the first half of 2010 as substantially all of the deferred balances were collected from the offshore funds and distributed to our partners and the Ziffs at the beginning of the year. We expect the remaining balances to be collected and distributed to our partners and the Ziffs in 2010. See “—Liquidity and Capital Resources—Other Future Liquidity and Capital Needs—Deferred Balances Distributions” for additional information.

Net Gain on Early Retirement of Debt. Net gain on early retirement of debt represents 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 of consolidated Och-Ziff funds increased by $16.5 million and $22.4 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Income Taxes

Income tax expense increased by $7.3 million and $13.3 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. The increases were primarily driven by higher profitability in the Och-Ziff Operating Group and certain of its foreign subsidiaries. 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, only 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 -2.2% for the three and six months ended June 30, 2010, compared to an effective tax rate of -0.1% and -0.4% for the three and six months ended June 30, 2009, respectively. 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 federal, state and local corporate income taxes in the United States; (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 six months ended June 30, 2010 and 2009, we were not required to establish a liability for uncertain tax positions. In addition, as of June 30, 2010, we had net operating loss carryforwards of $95.3 million for federal income taxes and $12.8 million for state and local income taxes that will expire by December 31, 2029 and 2030, respectively.

 

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

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

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Och-Ziff Operating Group A Units

   $ (291,728   $ (348,355   $ (611,729   $ (674,501

Consolidated Och-Ziff funds

     19,053        7,232        31,098        9,261   

Other

     536        9,193        382        (814
                                

Total

   $ (272,139   $ (331,930   $ (580,249   $ (666,054
                                

Net loss allocated to partners’ and others’ interests in consolidated subsidiaries decreased by $59.8 million and $85.8 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. The decrease in net loss allocated to the Och-Ziff Operating Group A Units was primarily due to a larger share of losses of the Och-Ziff Operating Group being allocated to us. The partners’ and the Ziffs’ interests in the Och-Ziff Operating Group in the form of Och-Ziff Operating Group A Units declined from 79.8% as of June 30, 2009 to 77.6% as of June 30, 2010 as a result of the vesting of RSUs and the exchange of Och-Ziff Operating Group A Units for Class A Shares. The Och-Ziff Operating Group A Units are expected to continue to significantly reduce our net loss in future periods as losses of the Och-Ziff Operating Group are allocated to these interests.

ECONOMIC INCOME ANALYSIS

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Economic Income:

        

Och-Ziff Funds segment

   $ 74,576      $ 20,631      $ 136,723      $ 68,800   

Other Operations - Non-GAAP

     (2,936     (4,833     (7,201     (8,491
                                

Total Company - Non-GAAP

   $ 71,640      $ 15,798      $ 129,522      $ 60,309   
                                

We conduct substantially all of our operations through our only reportable segment under U.S. GAAP, the Och-Ziff Funds segment, which provides investment management and advisory services to our hedge funds and separately managed accounts. Our Other Operations are currently comprised of our real estate business, which manages and provides advisory services to our real estate funds, and investments in new businesses established to expand our private investment platforms.

In addition to analyzing our results on a U.S. GAAP basis, management also reviews our results on an “Economic Income basis.” Economic Income for the Company, the Och-Ziff Funds segment and our Other Operations excludes the adjustments described below that are required for presentation of our results on a U.S. GAAP basis, but that management does not consider when evaluating operating performance in any given period. Management, therefore, uses Economic Income as the basis on which it evaluates our financial performance and makes resource allocation and other operating decisions. In addition, management believes that Economic Income provides a more comparable view of our operating performance from period to period. Management considers it important that investors review the same operating information that it uses.

Economic Income is a measure of pre-tax operating performance that excludes the following from our results on a U.S. GAAP basis:

 

   

Income allocations to our partners and the Ziffs on their direct interests in the Och-Ziff Operating Group. Management reviews operating performance at the Och-Ziff Operating Group level, where substantially all of our operations are performed, prior to making any income allocations;

 

   

Reorganization expenses related to the Offerings, equity-based compensation expenses and depreciation and amortization expenses, as management does not consider these non-cash expenses to be reflective of operating performance;

 

   

Changes in the tax receivable agreement liability and net gain on early retirement of debt, as management does not consider these to be reflective of operating performance;

 

   

Net earnings on the deferred balances and net gains on investments in Och-Ziff funds, as these amounts primarily relate to amounts due to our partners and the Ziffs for pre-IPO deferred incentive income, and amounts due to employees under deferred cash compensation arrangements, as management does not consider these items to be reflective of operating performance; and

 

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Amounts related to the consolidated Och-Ziff funds, including the related eliminations of management fees and incentive income, as management reviews the total amount of management fees and incentive income earned from all of the Och-Ziff funds in relation to total assets under management and fund performance.

In addition, deferred cash compensation expense is recognized in full in the period in which it is awarded, as management determines the total amount of compensation based on our performance in the year of the award.

For a reconciliation of Economic Income of the Och-Ziff Funds segment and its components to the respective U.S. GAAP basis 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.

Economic Income for our Other Operations is a non-GAAP measure that is calculated on the same basis as the methodology that is used to calculate Economic Income for the Och-Ziff Funds segment. Management also evaluates Economic Income for the Company, which is a non-GAAP measure that equals the sum of Economic Income for the Och-Ziff Funds segment and for our Other Operations. Our non-GAAP financial measures should not be considered as alternatives to our U.S. GAAP net loss or cash flow from operations, or as indicative of liquidity or the cash available to fund operations. Our non-GAAP measures may not be comparable to similarly-titled measures used by other companies. For reconciliations of these non-GAAP measures to the respective U.S. GAAP measures, see “—Economic Income Reconciliations” at the end of this management’s discussion and analysis of financial condition and results of operations.

Och-Ziff Funds Segment—Economic Income Analysis

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010     2009
     (dollars in thousands)

Economic Income Revenues

          

Management fees

   $ 107,035    $ 84,523    $ 206,609      $ 176,947

Incentive income

     5,536      265      5,722        265

Other revenues

     448      231      732        445
                            

Total Economic Income Revenues

     113,019      85,019      213,063        177,657
                            

Economic Income Expenses

          

Compensation and benefits

     16,739      42,587      34,770        62,963

Non-compensation expenses

     21,704      21,801      41,335        45,894
                            

Total Economic Income Expenses

     38,443      64,388      76,105        108,857
                            

Net losses on joint ventures

     —        —        (235     —  
                            

Economic Income

   $ 74,576    $ 20,631    $ 136,723      $ 68,800
                            

Economic Income for the Och-Ziff Funds segment increased by $53.9 million and $67.9 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These increases were driven primarily by an increase in assets under management on which we earned management fees and the decrease in compensation and benefits due to the accrual for year-end discretionary cash bonuses in the second quarter of 2009.

Economic Income Revenues

Management Fees. Management fees for the segment increased by $22.5 million and $29.7 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods, due to the year-over-year increase in average assets under management driven by a combination of capital net inflows and performance-related appreciation.

Incentive Income. Incentive income increased by $5.3 million and $5.5 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These amounts were primarily related to fund investor redemptions.

Economic Income Expenses

Compensation and Benefits. Compensation and benefits expenses decreased by $25.8 million and $28.2 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily related to a $24.6 million accrual for discretionary cash bonuses in the second quarter of 2009. In the second quarter of 2009 we began to accrue for the

 

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estimated 2009 discretionary cash bonuses that we expected to pay our employees shortly after year end 2009. We did this in order to provide a competitive compensation structure in a year in which we generated strong investment performance while at the same time having the high-water marks in our funds, which if not recovered would have precluded us from earning any incentive income in 2009. For the six months ended June 30, 2010, we did not accrue for any discretionary cash bonuses. Annual discretionary cash bonuses in a year with no high-water marks in effect are generally determined and expensed in the fourth quarter each year.

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

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    2009    2010    2009
     (dollars in thousands)

Occupancy and equipment

   $ 6,125    $ 5,844    $ 12,035    $ 11,823

Professional services

     5,364      3,864      9,990      8,324

Information processing and communications

     2,617      2,299      4,847      5,064

Business development

     2,028      1,647      4,114      3,374

Insurance

     1,977      3,185      3,903      6,346

Interest expense

     1,936      4,060      3,893      8,655

Other expenses

     1,657      902      2,553      2,308
                           

Total Non-Compensation Expenses

   $ 21,704    $ 21,801    $ 41,335    $ 45,894
                           

Non-compensation expenses decreased by $97 thousand and $4.6 million for the three and six months ended June 30, 2010, compared to the corresponding 2009 periods. These decreases were driven primarily by decreases in interest expense and insurance costs, offset in part by increases in professional services fees. The decreases in interest expense were due to the decrease in LIBOR, to which both our term loan and the note payable on our corporate aircraft are indexed. Additionally, interest expense decreased as a result of the early retirement of an aggregate of $105 million of our term loan in 2009. 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.

Other Operations – Economic Income Analysis (Non-GAAP)

Our Other Operations are comprised of our real estate business, which manages and provides advisory services to our real estate funds, and investments in new businesses established to expand certain of our private investment platforms. The businesses within our Other Operations are currently in their early development stages, and are not included in the results of the Och-Ziff Funds segment.

Economic Income for our Other Operations was a net loss of $2.9 million for the three months ended June 30, 2010, compared with a net loss of $4.8 million for the three months ended June 30, 2009. Economic Income for our Other Operations was a net loss of $7.2 million for the six months ended June 30, 2010, compared with a net loss of $8.5 million for the six months ended June 30, 2009. The decrease in the Economic Income net loss for both periods was principally the result of lower non-compensation expenses due to the reimbursement of organization expenses related to our new real estate fund.

Economic Income for our Other Operations as discussed above is a non-GAAP measure. For reconciliations of Economic Income of our Other Operations to the respective U.S. GAAP net loss for the periods described above, see “—Economic Income Reconciliations” following “—Critical Accounting Policies and Estimates” below.

The Company – Economic Income Analysis (Non-GAAP)

Economic Income for the Company was $71.6 million for the three months ended June 30, 2010, a $55.8 million increase from Economic Income for the Company of $15.8 million for the three months ended June 30, 2009. Economic Income for the Company was $129.5 million for the six months ended June 30, 2010, a $69.2 million increase from Economic Income for the Company of $60.3 million for the six months ended June 30, 2009. The primary drivers for the increases were higher management fees and lower compensation and benefits expenses in the Och-Ziff Funds segment.

Economic Income for the Company as discussed above is a non-GAAP measure. For reconciliations of Economic Income for the Company to the respective U.S. GAAP net loss for the periods described above, see “—Economic Income Reconciliations” following “—Critical Accounting Policies and Estimates” below.

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

 

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not incur any indebtedness to fund our ongoing 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 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 non-compensation expenses;

 

   

repay borrowings and interest thereon;

 

   

provide capital to facilitate the growth of our business;

 

   

pay income taxes and amounts to our partners and the Ziffs with respect to the tax receivable agreement as discussed below under “—Tax Receivable Agreement”; and

 

   

make cash distributions in accordance with our distribution policy as discussed below under “—Distributions.”

Historically, management fees have been more than sufficient to cover our all of our “fixed” operating expenses, which we define as salaries and benefits and most of our non-compensation costs. As explained above under “—Understanding Our Results—Revenues—Incentive Income,” we generally do not recognize incentive income during the first three quarters of the year other than amounts earned as a result of fund investor redemptions during the period or amounts earned from fund investors with measurement periods longer than one year (approximately 10% of our assets under management as of June 30, 2010). Furthermore, we cannot predict the amount of incentive income, if any, which we may earn at year end. Accordingly, we do not rely on incentive income to meet our fixed operating expenses. Total annual revenues, which typically have been significantly influenced by the amount of annual incentive income we earn, historically have been sufficient to fund all of our other working capital needs, including annual discretionary cash bonuses. These cash bonuses, which historically have comprised our largest operating expense, are variable such that, in any year where total annual revenues are greater or less than the prior year, cash bonuses may be adjusted accordingly. Our ability to scale this significant operating expense to our total annual revenues helps us manage our cash flow and liquidity position from period to period.

Based on our past results, management’s experience and our current level of assets under management, we believe that our existing cash resources, together with the cash generated from management fees, will be sufficient to meet our anticipated fixed operating expenses and capital expenditure requirements for at least the next 12 months. As we have done historically, we will determine the actual amount of discretionary cash bonuses for this year during the fourth quarter and intend to fund this amount through management fees and any incentive income we may earn at the end of the fourth quarter. Although we cannot predict the amount, if any, of incentive income we may earn, we are able to regularly monitor expected management fees and we believe that we will be able to adjust our expense infrastructure, including discretionary cash bonuses, as needed to meet the requirements of our business and in order to maintain positive operating cash flows. 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.

Our term loan, discussed below under “—Debt Obligations—Term Loan,” matures in July 2012 and the balance on our aircraft loan, discussed below under “—Debt Obligations—Aircraft Loan,” is payable in May 2011. To date, we have used cash on hand to repurchase and retire $105 million of the outstanding principal amount of our term loan. In addition, as of June 30, 2010, we had repaid an additional $13.1 million of the outstanding balance on our term loan from cash on hand, as we are required to make quarterly payments in an aggregate annual amount equal to 1% of the original loan balance. We may continue to use cash on hand to repay the term loan and the aircraft loan in part or in full prior to their maturity dates, which would reduce amounts available to distribute to our Class A shareholders. For any amounts unpaid as of those dates, we will be required to either refinance the obligations by entering into new facilities, which could result in higher borrowing costs, or raise cash by issuing equity or other securities, which would dilute existing shareholders. No assurance can be given that we will be able to enter into new facilities or issue equity or other securities in the future on attractive terms or at all. Any new facilities that we may be able to enter into may have covenants that impose additional limitations on us, including with respect to making distributions, entering into business transactions or other matters, and may result in increased interest expense. If we are unable to meet our debt obligations on terms that are favorable to us, our business may be adversely impacted.

For our other longer-term liquidity requirements, we expect to continue to fund our fixed operating costs through management fees and to fund discretionary cash bonuses and repayment of our debt obligations through a combination of management fees and incentive income. We may also decide to meet these requirements by issuing new debt or additional equity or other securities. Over the long term, we believe we will be able to grow our assets under management and generate positive investment performance in our funds, which we expect will allow us to grow our management fees and incentive income in amounts sufficient to cover our long-term liquidity requirements.

 

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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, issue additional equity or borrow additional funds to:

 

   

support the future growth in our business;

 

   

create new or enhance existing products and investment platforms;

 

   

repay borrowings;

 

   

pursue new investment opportunities; and

 

   

develop new distribution channels.

Market and other factors 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.

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, and in December 2009, we repurchased and retired an additional $100.0 million of the outstanding balance for $80.0 million. As of June 30, 2010, the total outstanding amount of the term loan was $631.9 million.

The term loan includes provisions that restrict our ability to further encumber our assets and make certain distributions. Specifically, 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 of 3.0 to 1.0 of EBITDA (as defined in the credit agreement) and no default or event of default has occurred and is continuing. As of June 30, 2010, 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 June 30, 2010, distributions from the Och-Ziff Operating Group were in compliance with the free cash flow covenant.

Aircraft Loan. On May 30, 2008, we refinanced the remaining principal balance on the original note on our corporate aircraft. 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 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. During the second quarter of 2010, we paid $3.4 million of the note payable and applied $2.0 million of collateral previously posted with the lender against the remaining principal balance. As of June 30, 2010, the remaining principal balance of the note payable was $11.3 million.

 

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The terms of the amended note payable also 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 and interest payments due on all direct or indirect indebtedness of the Och-Ziff Operating Group, tested quarterly; and

 

   

Average cash, unrestricted marketable securities and other liquid investments that may be converted to cash within 90 days must be 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.

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 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 expenses 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 federal, state and local income tax in the United States that these entities actually realize related to their units as a result of such increases in tax basis. In connection with the departure of certain former partners, the right to receive payments under the tax receivable agreement by such partners was contributed to the Och-Ziff Operating Group. As a result, we expect to pay to our remaining partners and the Ziffs approximately 78% (from 85% at the time of the Offerings) of the overall cash savings, if any, in federal, state and local income tax in the United States that we actually realize as a result of such increases in tax basis. To the extent that we do not realize any cash savings in federal, state and local income tax in the United States, we would not be required to make corresponding payments under the tax receivable agreement.

Payments under the tax receivable agreement are anticipated to increase the tax basis adjustment of 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 of 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.

As of June 30, 2010, 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, we expect to pay our partners and the Ziffs approximately $780.6 million over the next 13 to 15 years as a result of 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. 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 payments 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.

 

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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.

Other Future Liquidity and Capital Needs

Restricted Share Units (RSUs). Substantially all of the RSUs that we have awarded to date 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 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. All remaining deferred balances, which as of June 30, 2010 were $3.5 million, are expected to be paid to us in 2010. Such amounts, in turn, will be distributed to our partners and the Ziffs, and therefore will not benefit our Class A shareholders.

Distributions

The following table presents the cash dividends declared on our Class A Shares and the related cash distributions to our partners and the Ziffs with respect to their direct ownership 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)

August 19, 2010

   August 12, 2010    $ 0.11    $ 45,103

May 11, 2010

   April 1, 2010    $ 0.09    $ 34,315

February 18, 2010

   December 31, 2009    $ 0.58    $ 198,852

Our intention is to distribute to our Class A shareholders substantially all of their pro rata share of annual Economic Income (as described above under “—Economic Income Analysis”) in excess of amounts determined by us to be necessary or appropriate to provide

 

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for the conduct of our business, to pay income taxes, to pay any amounts owed under the tax receivable agreement, to make appropriate investments in our business and our funds, and to make payments on any of our debt obligations, including our term loan and aircraft loan. When we pay dividends on our Class A Shares, subject to the terms of the limited partnership agreements of the Och-Ziff Operating Group entities, we intend to make corresponding distributions to our partners and the Ziffs on their interests in the Och-Ziff Operating Group.

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; the impact of tax and other regulatory factors relevant to our structure and operations; 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.

The declaration and payment of future distributions will be at the sole discretion of our Board of Directors, which may change our distribution policy at any time. In determining the amount