XNYS:OZM Och-Ziff Capital Management Group LLC Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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, 2012

OR

 

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

Commission File Number 001-33805

 

 

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  x    No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
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 25, 2012, there were 141,618,443 Class A Shares and 274,286,008 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)

     3   
 

Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011

     3   
 

Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2012 and 2011

     4   
 

Consolidated Statement of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2012

     5   
 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011

     6   
 

Notes to Consolidated Financial Statements

     7   
Item 2.  

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

     26   
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     55   
Item 4.  

Controls and Procedures

     56   

PART II — OTHER INFORMATION

  
Item 1.  

Legal Proceedings

     58   
Item 1A.  

Risk Factors

     58   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     58   
Item 3.  

Defaults upon Senior Securities

     58   
Item 4.  

Mine Safety Disclosures

     58   
Item 5.  

Other Information

     58   
Item 6.  

Exhibits

     58   

Signatures

     59   

 

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Table of Contents

In this quarterly report, references to “Och-Ziff,” “our Company,” “the Company,” “the firm,” “we,” “us,” or “our” refer, unless the 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 “executive managing directors” refer to the current limited partners of the Och-Ziff Operating Group entities other than the Ziffs and our intermediate holding companies, and include our founder, Mr. Daniel S. Och, except where the context requires otherwise. References to the “Ziffs” refer collectively to Ziff Investors Partnership, L.P. II and certain of its affiliates and control persons.

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 executive managing directors 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 “2007 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. References to the “2011 Offering” refer to the public offering of 33.3 million Class A Shares that occurred in November 2011.

References to “our funds” or the “Och-Ziff funds” refer to the hedge funds and other alternative investment vehicles for which we provide asset management services. References to “Special Investments” refer to investments that we, as investment manager, believe lack a readily ascertainable market value, are illiquid or should be held until the resolution of a special event or circumstance.

No statements herein, available on our website or in any of the materials we file with the Securities and Exchange Commission, which we refer to as the “SEC,” constitute or should be viewed as constituting an offer of any Och-Ziff fund.

 

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Table of Contents

Forward-Looking Statements

Some of the statements under “Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Part I — Item 3. Quantitative and Qualitative Disclosures About Market Risk,” and “Part II — Item 1A. Risk Factors” and elsewhere in this quarterly report may contain 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. 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,” “comfortable,” “assume,” “remain,” “maintain,” “sustain,” “achieve,” “see,” “think,” “position” or the negative version of those words or other comparable words.

Any forward-looking statements contained herein are based upon historical information and on our current plans, estimates and expectations. The inclusion of this or 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. We caution that forward-looking statements are subject to numerous assumptions, estimates, risks and uncertainties, including but not limited to the following: global economic, business, market and geopolitical conditions, including Euro-zone sovereign debt issues; U.S. and foreign regulatory developments relating to, among other things, financial institutions and markets, government oversight and taxation; conditions impacting the alternative asset management industry; our ability to successfully compete for fund investors, assets, professional talent and investment opportunities; our ability to retain our executive managing directors, managing directors and other investment professionals; our successful formulation and execution of our business and growth strategies; our ability to appropriately manage conflicts of interest and tax and other regulatory factors relevant to our business; and assumptions relating to our operations, investment performance, 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 assumptions or estimates prove to be incorrect, our actual results may vary materially from those indicated in these statements. These factors are not and should not be construed as exhaustive and should be read in conjunction with the other cautionary statements and risks that are included in our filings with the SEC, including but not limited to our annual report on Form 10-K for the year ended December 31, 2011 filed on February 27, 2012, which we refer to as our “Annual Report.”

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 contained in this quarterly report are made only as of the date of this report. We do not undertake to update any forward-looking statement, whether because of new information, future developments or otherwise.

 

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Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS — UNAUDITED

 

     June 30, 2012     December 31, 2011  
     (dollars in thousands)  

Assets

    

Cash and cash equivalents

   $ 171,207      $ 149,011   

Income and fees receivable

     37,017        74,640   

Due from related parties

     2,036        2,135   

Deferred income tax assets

     951,045        965,520   

Other assets, net

     72,169        79,840   

Assets of consolidated Och-Ziff funds:

    

Investments, at fair value

     1,083,345        729,152   

Other assets of Och-Ziff funds

     23,360        43,805   
  

 

 

   

 

 

 

Total Assets

   $ 2,340,179      $ 2,044,103   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Liabilities

    

Due to related parties

   $ 764,276      $ 759,056   

Debt obligations

     389,990        383,685   

Compensation payable

     7,681        107,384   

Other liabilities

     74,768        58,510   

Liabilities of consolidated Och-Ziff funds:

    

Securities sold under agreements to repurchase

     140,925        101,563   

Other liabilities of Och-Ziff funds

     42,924        1,540   
  

 

 

   

 

 

 

Total Liabilities

   $ 1,420,564      $ 1,411,738   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 12)

    

Shareholders’ Equity

    

Class A Shares, no par value, 1,000,000,000 shares authorized, 141,538,557 and 139,341,965 shares issued and outstanding as of June 30, 2012 and December 31, 2011, respectively

     —          —     

Class B Shares, no par value, 750,000,000 shares authorized, 274,286,008 shares issued and outstanding as of June 30, 2012 and December 31, 2011

     —          —     

Paid-in capital

     2,686,861        2,419,287   

Accumulated deficit

     (3,035,650     (2,776,374

Accumulated other comprehensive loss

     —          (49
  

 

 

   

 

 

 

Shareholders’ deficit attributable to Class A Shareholders

     (348,789     (357,136

Shareholders’ equity attributable to noncontrolling interests

     1,268,404        989,501   
  

 

 

   

 

 

 

Total Shareholders’ Equity

   $ 919,615      $ 632,365   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 2,340,179      $ 2,044,103   
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS — UNAUDITED

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Revenues

        

Management fees

   $ 127,492      $ 128,344      $ 249,574      $ 249,690   

Incentive income

     18,414        6,867        19,635        13,833   

Other revenues

     220        678        584        1,036   

Income of consolidated Och-Ziff funds

     32,296        11,396        49,553        21,134   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenues

     178,422        147,285        319,346        285,693   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Compensation and benefits

     41,321        61,243        82,191        120,448   

Reorganization expenses

     398,416        399,312        796,832        805,167   

Interest expense

     1,212        1,843        2,455        3,891   

General, administrative and other

     32,252        27,319        61,200        52,424   

Expenses of consolidated Och-Ziff funds

     2,939        2,480        5,051        3,930   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Expenses

     476,140        492,197        947,729        985,860   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Income

        

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

     (382     36        (288     212   

Change in deferred income of consolidated Och-Ziff funds

     (7,055     (649     (22,427     (2,975

Net gains of consolidated Och-Ziff funds

     8,864        2,912        85,276        11,199   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income

     1,427        2,299        62,561        8,436   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss Before Income Taxes

     (296,291     (342,613     (565,822     (691,731

Income taxes

     12,491        9,413        26,895        18,039   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Net Loss

     (308,782     (352,026     (592,717     (709,770
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Comprehensive Income, Net of Tax

        

Foreign currency translation adjustment

     192        1        229        19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Comprehensive Loss

   $ (308,590   $ (352,025   $ (592,488   $ (709,751
  

 

 

   

 

 

   

 

 

   

 

 

 

Allocation of Consolidated Net Loss

        

Class A Shareholders

   $ (116,242   $ (93,362   $ (238,986   $ (188,826

Noncontrolling interests

     (192,540     (258,664     (353,731     (520,944
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (308,782   $ (352,026   $ (592,717   $ (709,770
  

 

 

   

 

 

   

 

 

   

 

 

 

Allocation of Total Comprehensive Loss

        

Class A Shareholders

   $ (116,205   $ (93,361   $ (238,937   $ (188,821

Noncontrolling interests

     (192,385     (258,664     (353,551     (520,930
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (308,590   $ (352,025   $ (592,488   $ (709,751
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss Per Class A Share

        

Basic and Diluted

   $ (0.82   $ (0.96   $ (1.69   $ (1.94

Weighted-Average Class A Shares Outstanding

        

Basic and Diluted

     141,722,881        97,705,327        141,308,533        97,261,490   

Dividends Paid per Class A Share

   $ 0.10      $ 0.13      $ 0.14      $ 0.84   

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              
    Number of
Class A
Shares
    Number of
Class B
Shares
    Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Shareholders’
Deficit
Attributable
to Class A
Shareholders
    Shareholders’
Equity
Attributable to
Noncontrolling
Interests
    Total
Shareholders’
Equity
 
            Foreign
Currency
Translation
Adjustment
       
                            (dollars in thousands)              

As of December 31, 2011

    139,341,965        274,286,008      $ 2,419,287      $ (2,776,374   $ (49   $ (357,136   $ 989,501      $ 632,365   

Capital contributions

    —          —          —          —          —          —          202,197        202,197   

Capital distributions

    —          —          —          —          —          —          (132,624     (132,624

Cash dividends declared on Class A Shares

    —          —          —          (19,589     —          (19,589     —          (19,589

Dividend equivalents on Class A restricted share units

    —          —          701        (701     —          —               (a)      —     

Equity-based compensation

    641,094        —          10,111        —          —          10,111        21,881        31,992   

Och-Ziff Operating Group A Units exchanged for Class A Shares

    1,555,498        —          289        —          —          289        641        930   

Impact of amortization of Reorganization charges on capital

    —          —          256,473        —          —          256,473        540,359        796,832   

Total comprehensive loss

    —          —          —          (238,986     49        (238,937     (353,551     (592,488
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of June 30, 2012

    141,538,557        274,286,008      $ 2,686,861      $ (3,035,650   $ —        $ (348,789   $ 1,268,404      $ 919,615   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) The dividend equivalents on Class A restricted share units impacted noncontrolling interests by increasing the paid-in capital component and increasing the accumulated deficit component of noncontrolling interests each by $1.5 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,  
     2012     2011  
     (dollars in thousands)  

Cash Flows from Operating Activities

    

Consolidated net loss

   $ (592,717   $ (709,770

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

    

Reorganization expenses

     796,832        805,167   

Amortization of equity-based compensation

     34,075        69,303   

Depreciation and amortization

     4,679        4,864   

Deferred income taxes

     20,674        9,372   

Operating cash flows due to changes in:

    

Income and fees receivable

     37,623        437,284   

Due from related parties

     99        (1,110

Other assets, net

     4,561        5,047   

Assets of consolidated Och-Ziff funds

     (333,748     (161,081

Due to related parties

     (51     (937

Compensation payable

     (99,703     (135,187

Other liabilities

     16,675        (8,186

Liabilities of consolidated Och-Ziff funds

     80,685        38,186   
  

 

 

   

 

 

 

Net Cash Provided by (Used in) Operating Activities

     (30,316     352,952   
  

 

 

   

 

 

 

Cash Flows from Investing Activities

    

Investments in joint ventures

     (2,351     (1,140

Return of investments in joint ventures

     1,324        —     

Repayment of loan to joint venture partners

     —          1,750   

Purchases of fixed assets

     (312     (1,088
  

 

 

   

 

 

 

Net Cash Used in Investing Activities

     (1,339     (478
  

 

 

   

 

 

 

Cash Flows from Financing Activities

    

Proceeds from Delayed Draw Term Loan

     384,500        —     

Repayments of debt obligations

     (378,195     (4,406

Contributions from noncontrolling interests

     202,259        141,298   

Distributions to noncontrolling interests

     (132,624     (351,874

Distribution of deferred balances and related taxes to Mr. Och

     —          (1,583

Dividends on Class A Shares

     (19,589     (81,211

Withholding taxes paid on vested Class A restricted share units

     (2,083     (3,656

Principal payments under capital lease obligations

     (417     (422
  

 

 

   

 

 

 

Net Cash Provided by (Used in) Financing Activities

     53,851        (301,854
  

 

 

   

 

 

 

Net Change in Cash and Cash Equivalents

     22,196        50,620   

Cash and Cash Equivalents, Beginning of Period

     149,011        117,577   
  

 

 

   

 

 

 

Cash and Cash Equivalents, End of Period

   $ 171,207      $ 168,197   
  

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information

    

Cash paid during the period:

    

Interest

   $ 2,102      $ 3,466   

Income taxes

   $ 8,124      $ 13,010   

Non-cash transactions:

    

Capital lease additions

   $ —        $ 2,471   

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

1. OVERVIEW

Och-Ziff Capital Management Group LLC (the “Registrant”), a Delaware limited liability company, together with its consolidated subsidiaries (collectively, the “Company”), is a global alternative asset management firm with offices in New York, London, Hong Kong, Beijing and Mumbai. The Company provides asset management services to its investment funds (the “Och-Ziff funds” or the “funds”), which pursue diverse investment opportunities globally. The Och-Ziff funds seek to generate consistent, positive, absolute returns across market cycles, generally with low volatility compared to the equity markets.

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 of the funds. 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.

The Company conducts substantially all of its operations through its one reportable segment, the Och-Ziff Funds segment, which provides asset management services to its hedge funds and other alternative investment vehicles. The Company’s assets under management are generally invested on a multi-strategy basis, across multiple geographies, although certain of the Company’s funds are focused on specific sectors, strategies or geographies. The primary investment strategies the Company employs in its funds are convertible and derivative arbitrage, corporate credit, long/short equity special situations, merger arbitrage, private investments and structured credit.

The Company’s Other Operations are primarily comprised of its real estate business, which provides asset management services to its real estate funds. The businesses included in the Company’s Other Operations do not meet the thresholds of reportable business segments under U.S. generally accepted accounting principles (“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 “executive managing directors” refer to the current limited partners of OZ Management LP, OZ Advisors LP and OZ Advisors II LP (collectively with their consolidated subsidiaries, the “Och-Ziff Operating Group”) other than the Ziffs and the Company’s intermediate holding companies, and include the Company’s founder, Mr. Daniel S. Och, except where the context requires otherwise. References to the “Ziffs” refer collectively to Ziff Investors Partnership, L.P. II and certain of its affiliates and control persons. The Company conducts substantially all of its operations through the Och-Ziff Operating Group.

 

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

These unaudited, interim, consolidated financial statements are prepared in accordance with GAAP as set forth in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”), and should be read in conjunction with the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2011. 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 because of the majority of incentive income and discretionary cash bonuses being recorded in the fourth quarter each year. All significant intercompany transactions and balances have been eliminated in consolidation.

Recently Adopted Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update (“ASU”) 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and IFRSs. ASU 2011-04 provides clarifying guidance on how to measure fair value and requires additional disclosures regarding fair value measurements. The amendments, among other

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

things, prohibit the use of blockage factors at all levels of the fair value hierarchy, provide guidance on measuring financial instruments that are managed on a net portfolio basis, and clarify guidance on the application of premiums and discounts in measuring fair value. Additional disclosure requirements include the disclosure of transfers between Level I and Level II, a description of the valuation processes for Level III fair value measurements, as well as additional information regarding unobservable inputs affecting Level III measurements. The amendments were effective for the Company beginning in the first quarter of 2012. The adoption of the new requirements in ASU 2011-04 did not have a material impact on the Company’s financial position or results of operations.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires entities to present the components of net income, the components of other comprehensive income and the total of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Regardless of the option chosen, the entity is required to present items that are reclassified between net income and other comprehensive income on the face of the financial statements where the components of net income and the components of other comprehensive income are presented. This amendment eliminates the option to present the components of other comprehensive income solely within the statement of changes in stockholders’ equity. In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, to defer the effective date for the requirement to present reclassification of items out of other comprehensive income on the face of the income statement. Because of the deferral, entities would continue to report reclassifications out of accumulated other comprehensive income consistent with the requirements in effect before adoption of ASU 2011-05. The requirements of ASU 2011-05 and the deferral provided in ASU 2011-12 were effective for the Company beginning in the first quarter of 2012. The adoption of ASU 2011-05 did not have any impact on the Company’s financial position or results of operations, as ASU 2011-05 only changes the presentation of other comprehensive income and total comprehensive income. No changes were made to the existing guidance regarding which items are reported in other comprehensive income.

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment. ASU 2011-08 simplifies how entities test goodwill for impairment by permitting an entity to assess qualitative factors in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test required under GAAP. ASU 2011-08 was effective for the Company beginning in the first quarter of 2012. The adoption of ASU 2011-08 did not have any impact on the Company’s financial position or results of operations.

Future Adoption of Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 requires entities to disclose both gross and net information about financial instruments and derivative instruments that are either (i) offset in the balance sheet or (ii) subject to an enforceable master netting arrangement or similar arrangement, irrespective of whether they are offset in the balance sheet. In addition, ASU 2011-11 requires disclosure of collateral received and posted in connection with master netting agreements or similar arrangements. The requirements of ASU 2011-11 are effective for the Company beginning in the first quarter of 2013. The adoption of ASU 2011-11 will not have any impact on the Company’s financial position or results of operations, as ASU 2011-11 only affects disclosures about offsetting. No changes were made to the existing guidance on the offsetting of assets and liabilities in the Company’s balance sheet.

 

3. REORGANIZATION EXPENSES AND OCH-ZIFF OPERATING GROUP OWNERSHIP

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 “2007 Offerings”). The Company used the net proceeds from the 2007 Offerings to acquire a 19.2% interest in the Och-Ziff Operating Group from the executive managing directors and the Ziffs, who collectively held all of the interests in the Och-Ziff Operating Group prior to the 2007 Offerings.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Prior to the 2007 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 executive managing directors and the Ziffs were reclassified as Och-Ziff Operating Group A Units and accounted for as a share-based payment. The Och-Ziff Operating Group A Units granted to the Ziffs and those units sold by the executive managing directors at the time of the 2007 Offerings were not subject to any substantive service or performance requirements; therefore, the fair value related to those units were recognized as a one-time charge at the time of the 2007 Offerings. The fair value of the Och-Ziff Operating Group A Units that continue to be held by the executive managing directors after the 2007 Offerings is being amortized on a straight-line basis over the requisite five-year service period following the 2007 Offerings. Once vested, these units may be exchanged for Class A Shares of the Registrant on a one-for-one basis, subject to certain transfer restrictions for the five years following the 2007 Offerings.

As of June 30, 2012, the Company’s interest in the Och-Ziff Operating Group had increased to approximately 32.4%. Increases in the Company’s interest in the Och-Ziff Operating Group were driven by the issuance of Class A Shares in the November 2011 public offering of 33,333,333 Class A Shares (the “2011 Offering”). Additionally, the exchange of Och-Ziff Operating Group A Units for an equal number of Class A Shares and the issuance of Class A Shares under the Company’s Amended and Restated 2007 Equity Incentive Plan, primarily related to the vesting of Class A restricted share units (“RSUs”), also increased the Company’s interest in the Och-Ziff Operating Group since the IPO. The Company’s interest in the Och-Ziff Operating Group is expected to continue to increase over time as additional Class A Shares are issued upon the exchanges of Och-Ziff Operating Group A Units and vesting of RSUs.

 

4. FAIR VALUE DISCLOSURES

Fair value represents the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date (i.e., an exit price). Due to the inherent uncertainty of valuations of investments that are determined to be illiquid or do not have readily ascertainable fair values, the estimates of fair value may differ from the values ultimately realized, and those differences can be material.

GAAP prioritizes the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is impacted by a number of factors, including the type of assets and liabilities and the specific characteristics of the assets and liabilities. Assets and liabilities with readily available, actively quoted prices or for which fair value can be measured from actively-quoted prices generally will have a higher degree of market price observability and lesser degree of judgment used in measuring fair value.

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

 

   

Level I — Fair value is determined using quoted prices that are available in active markets for identical assets or liabilities. The types of assets and liabilities that would generally be included in this category are certain listed equities, sovereign debt of developed nations and listed derivatives.

 

   

Level II — Fair value is determined using quotations received from dealers making a market for these assets or liabilities (“broker quotes”), valuations obtained from independent third-party pricing services, the use of models or other valuation methodologies based on pricing inputs that are either directly or indirectly market observable as of the measurement date. Consideration is given to the nature of the broker quotes (e.g., indicative or executable). Assets and liabilities for which executable broker quotes are significant inputs in determining the fair value of an asset or liability are included within Level II. The types of assets and liabilities that would generally be included in this category are certain corporate bonds, certain credit default swap contracts, certain bank debt securities, certain commercial real estate debt securities, less liquid and restricted equity securities, forward contracts and certain over-the-counter (“OTC”) derivatives.

 

   

Level III — Fair value is determined using pricing inputs that are unobservable in the market and includes situations where there is little, if any, market activity for the asset or liability. The fair value of assets and liabilities in this category may require significant judgment or estimation in determining fair value of the assets or liabilities. The fair value of these assets and liabilities may be estimated using a

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

 

combination of observed transaction prices, independent pricing services, relevant broker quotes, models or other valuation methodologies based on pricing inputs that are neither directly or indirectly market observable. Assets and liabilities for which indicative broker quotes are significant inputs in determining the fair value of an asset or liability are included within Level III. The types of assets and liabilities that would generally be included in this category include equity and debt securities issued by private entities, limited partnerships, certain corporate bonds, certain credit default swap contracts, certain bank debt securities, certain commercial real estate debt securities, certain OTC derivatives, residential and commercial mortgage-backed securities, collateralized debt obligations and other asset-backed securities.

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 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.

Fair Value Measurements Categorized within the Fair Value Hierarchy

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy:

 

     As of June 30, 2012  
     Level I      Level II      Level III      Counterparty Netting
of Derivative Contracts
    Total  
     (dollars in thousands)  

Real estate investments

   $ —         $ —         $ 440,824       $ —        $ 440,824   

Residential mortgage backed securities

     46         —           177,236         —          177,282   

Energy and natural resources limited partnerships

     —           —           141,172         —          141,172   

Collateralized debt obligations

     —           —           132,212         —          132,212   

Commercial mortgage backed securities

     —           —           49,047         —          49,047   

Commercial real estate debt securities

     —           —           46,469         —          46,469   

Investment in affiliated credit fund

     —           —           33,707         —          33,707   

Preferred stock

     —           —           29,964         —          29,964   

United States government obligations

     25,529         —           —           —          25,529   

Other investments

     28         28         7,113         (30     7,139   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Financial Assets, at Fair Value, Included Within Investments, at Fair Value

   $ 25,603       $ 28       $ 1,057,744       $ (30   $ 1,083,345   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Financial Liabilities, at Fair Value, Included Within Other Liabilities of Och-Ziff Funds

   $ 844       $ 190       $ 2,164       $ (30   $ 3,168   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
     As of December 31, 2011  
     Level I      Level II      Level III      Counterparty Netting
of Derivative Contracts
    Total  
     (dollars in thousands)  

Real estate investments

   $ —         $ —         $ 352,218       $ —        $ 352,218   

Residential mortgage backed securities

     291         —           147,426         —          147,717   

Energy and natural resources limited partnerships

     —           —           100,827         —          100,827   

Collateralized debt obligations

     —           —           44,060         —          44,060   

Commercial real estate debt securities

     —           —           38,240         —          38,240   

Commercial mortgage backed securities

     —           —           27,256         —          27,256   

United States government obligations

     15,069         —           —           —          15,069   

Other investments

     95         361         3,542         (233     3,765   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Financial Assets, at Fair Value, Included Within Investments, at Fair Value

   $ 15,455       $ 361       $ 713,569       $ (233   $ 729,152   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Financial Liabilities, at Fair Value, Included Within Other Liabilities of Och-Ziff Funds

   $ 362       $ 4       $ 657       $ (233   $ 790   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

The Company assumes that any transfers between Level I, Level II or Level III during the period occur at the beginning of the period. For the three and six months ended June 30, 2012 and 2011, there were no transfers between Level I, Level II or Level III assets or liabilities.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Reconciliation of Fair Value Measurements Categorized within Level III

The following table summarizes the changes in the Company’s Level III assets and liabilities for the three months ended June 30, 2012:

 

     Balance as of
March 31, 2012
     Investment
Purchases
     Investment Sales     Derivative Settlements     Net Gains (Losses)
of Consolidated
Och-Ziff Funds
    Balance as of
June 30, 2012
 
     (dollars in thousands)  

Real estate investments

   $ 381,181       $ 78,890       $ (14,096   $ —        $ (5,151   $ 440,824   

Residential mortgage backed securities

     151,515         105,701         (79,533     —          (447     177,236   

Energy and natural resources limited partnerships

     135,023         773         —          —          5,376        141,172   

Collateralized debt obligations

     99,983         44,567         (18,760     —          6,422        132,212   

Commercial mortgage backed securities

     36,428         19,981         (7,394     —          32        49,047   

Commercial real estate debt securities

     45,053         16,143         (16,175     —          1,448        46,469   

Investment in affiliated credit fund

     31,939         1,340         —          —          428        33,707   

Preferred stock

     —           29,575         —          —          389        29,964   

Other investments (including derivatives, net)

     2,845         4,205         —          (3,234     1,133        4,949   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total, at Fair Value

   $ 883,967       $ 301,175       $ (135,958   $ (3,234   $ 9,630      $ 1,055,580   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The following table summarizes the changes in the Company’s Level III assets and liabilities for the three months ended June 30, 2011:

 

     Balance as of
March 31, 2011
     Investment
Purchases
     Investment Sales     Derivative Settlements      Net Gains (Losses)
of Consolidated
Och-Ziff Funds
    Balance as of
June 30, 2011
 
     (dollars in thousands)  

Real estate investments

   $ 289,008       $ 18,802       $ (9,800     —         $ (2,425   $ 295,585   

Residential mortgage backed securities

     102,309         11,692         (26,286     —           (1,240     86,475   

Energy and natural resources limited partnerships

     50,884         40,627         —          —           (1,243     90,268   

Collateralized debt obligations

     26,564         14,736         (2,921     —           (53     38,326   

Commercial mortgage backed securities

     18,859         14,246         (5,425     —           (581     27,099   

Commercial real estate debt securities

     29,516         —           (10,074     —           9,180        28,622   

Other investments (including derivatives, net)

     1,481         1,589         —          524         197        3,791   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total, at Fair Value

   $ 518,621       $ 101,692       $ (54,506   $ 524       $ 3,835      $ 570,166   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Deferred Balances, at Fair Value

   $ 2,892       $ —         $ —        $ —         $ —        $ 2,892   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

The following table summarizes the changes in the Company’s Level III assets and liabilities for the six months ended June 30, 2012:

 

     Balance as of
December 31, 2011
     Investment
Purchases
     Investment Sales     Derivative Settlements     Net Gains (Losses)
of Consolidated
Och-Ziff Funds
     Balance as of
June 30, 2012
 
     (dollars in thousands)  

Real estate investments

   $ 352,218       $ 100,058       $ (21,337   $ —        $ 9,885       $ 440,824   

Residential mortgage backed securities

     147,426         175,663         (159,220     —          13,367         177,236   

Energy and natural resources limited partnerships

     100,827         1,878         (3,777     —          42,244         141,172   

Collateralized debt obligations

     44,060         97,149         (23,344     —          14,347         132,212   

Commercial mortgage backed securities

     27,256         31,221         (11,098     —          1,668         49,047   

Commercial real estate debt securities

     38,240         21,635         (16,197     —          2,791         46,469   

Investment in affiliated credit fund

     —           31,525         —          —          2,182         33,707   

Preferred stock

     —           29,575         —          —          389         29,964   

Other investments (including derivatives, net)

     2,885         4,205         —          (2,963     822         4,949   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total, at Fair Value

   $ 712,912       $ 492,909       $ (234,973   $ (2,963   $ 87,695       $ 1,055,580   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

The following table summarizes the changes in the Company’s Level III assets and liabilities for the six months ended June 30, 2011:

 

     Balance as of
December 31, 2010
     Investment
Purchases
     Investment Sales and
Collection of
Deferred Balances
    Derivative Settlements      Net Gains (Losses)
of Consolidated
Och-Ziff Funds
    Balance as of
June 30, 2011
 
     (dollars in thousands)  

Real estate investments

   $ 288,444       $ 24,061       $ (17,900     —         $ 980      $ 295,585   

Residential mortgage backed securities

     40,707         99,914         (53,901     —           (245     86,475   

Energy and natural resources limited partnerships

     49,870         42,729         —          —           (2,331     90,268   

Collateralized debt obligations

     10,405         39,550         (13,267     —           1,638        38,326   

Commercial mortgage backed securities

     15,604         21,424         (11,755     —           1,826        27,099   

Commercial real estate debt securities

     13,516         14,975         (10,074     —           10,205        28,622   

Other investments (including derivatives, net)

     478         3,089         (500     450         274        3,791   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total, at Fair Value

   $ 419,024       $ 245,742       $ (107,397   $ 450       $ 12,347      $ 570,166   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Deferred Balances, at Fair Value

   $ 2,913       $ —         $ (21   $ —         $ —        $ 2,892   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

The table below summarizes the net change in unrealized gains (losses) on the Company’s Level III investments held as of the reporting date. These gains and losses are included within net gains of consolidated Och-Ziff funds in the Company’s consolidated statements of comprehensive loss.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Real estate investments

   $ (356   $ (2,425   $ 13,782      $ 4,301   

Residential mortgage backed securities

     (3,738     (3,153     3,852        (4,206

Energy and natural resources limited partnerships

     5,376        (1,243     41,217        (2,331

Collateralized debt obligations

     (3,909     (524     3,205        184   

Commercial mortgage backed securities

     (165     (634     1,453        1,349   

Commercial real estate debt securities

     (6,283     4,807        (5,050     5,832   

Investment in affiliated credit fund

     (1,057     —          849        —     

Preferred stock

     389        —          389        —     

Other investments (including derivatives, net)

     949        59        739        43   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (8,794   $ (3,113   $ 60,436      $ 5,172   
  

 

 

   

 

 

   

 

 

   

 

 

 

Valuation Methodologies for Fair Value Measurements Categorized within Levels II and III

Real Estate Investments

Real estate investments include equity, preferred equity, mezzanine debt, and participating debt in entities domiciled primarily in the United States. The fair values of these investments are generally based upon discounting the expected cash flows from the investment or a cash flow multiple. 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 budgets or projections, property types, geographic locations, the physical condition of the asset, prevailing market capitalization rates, prevailing market discount rates, general economic conditions, economic conditions specific to the market in which the assets are located, the prevailing interest rate environment, the prevailing state of the debt markets, comparable public company trading multiples, independent third-party appraisals, available pricing data on comparable properties in the specific market in which the asset is located, expected exit timing and strategy and any specific rights or terms associated with the investment.

The significant unobservable inputs used in the fair value measurement of the Company’s real estate investments are discount rates, cash flow growth rates, exit capitalization rates, absorption percentage per year, loss factor and inflation factor. Significant increases (decreases) in the discount rates, exit capitalization rates and loss factor in isolation would result in a significantly lower (higher) fair value measurement. Significant increases (decreases) in the cash flow growth rates, absorption percentage per year, inflation factor and cash flow multiple in isolation would result in a significantly higher (lower) fair value measurement.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Residential and Commercial Mortgage Backed Securities; Collateralized Debt Obligations; Preferred Stock

The fair value of investments in residential and commercial mortgage-backed securities, collateralized debt obligations, other asset-backed securities and preferred stock that do not have readily ascertainable fair values is generally determined using broker quotes, or at cost for recent transactions. If broker quotes are not available or deemed unreliable, fair value may be determined using independent pricing services or cash flow models. Market data is used to the extent that it is observable and considered reliable.

Energy and Natural Resources Limited Partnerships

The fair value of energy and natural resources limited partnerships are generally determined using discounted cash flows when assets are producing oil or gas, or when it is reasonably certain that an asset will be capable of producing oil or gas. Acreage with proven undeveloped, probable or possible reserves are valued using prevailing prices of comparable properties, and may include adjustments for other assets or liabilities such as seismic data, equipment, or cash on hand. Additionally, certain natural resource assets may be valued based on recent financings or based on the fair value of certain underlying publicly traded securities held by an investee, adjusted for lack of marketability.

The significant unobservable inputs used in the fair value measurement of the Company’s energy and natural resources limited partnerships are discount rates, discounts to commodity strip prices and differentials, probability of reserves, discount for lack of marketability and capital investments, including acreage values. Significant increases (decreases) in the discount rates, discounts to commodity strip prices and differentials, and discount for lack of marketability in isolation would result in a lower (higher) fair value measurement. Significant increases (decreases) in probability of reserves or per acre values in isolation would result in a significantly higher (lower) fair value measurement.

Commercial Real Estate Debt Securities

The fair value of commercial real estate debt securities is generally determined using broker quotes or as determined in good faith with observable market inputs or other third party inputs, where available. The methods and procedures to value these investments may include, but are not limited to: (i) performing comparisons with prices of comparable or similar securities; (ii) obtaining valuation-related information from the issuers; (iii) calculating the present value of future cash flows; (iv) assessing other analytical data and information relating to the investment that is an indication of value; (v) obtaining information provided by third parties; (vi) reviewing the amounts invested in these investments; and (vii) evaluating financial information provided by the management of these investments. Inputs utilized to determine fair value when the above methods are used include, but are not limited to, the following: broker quotes, discount rates, loan-to-value ratios, revenue growth rates, comparability adjustments and correlations of certain of these inputs.

Significant increases (decreases) in discount rates and loan-to-value ratios in isolation would result in a significantly lower (higher) fair value measurement. Significant increases (decreases) in revenue growth rates, and comparability adjustments in isolation would result in a significantly higher (lower) fair value measurement. Generally, a change in the assumptions used for discount rates is accompanied by a directionally similar change in loan-to-value ratios.

Investment in Affiliated Credit Fund

The fair value of the Company’s investment in affiliated credit fund relates to a consolidated feeder fund’s investment into a related master fund. The Company is not an investor of the feeder fund or the master fund. The fair value of this investment is based on the consolidated feeder fund’s proportionate share of the master fund’s net asset value. The master fund invests primarily in credit-related strategies.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Information about Significant Inputs Used in Fair Value Measurements Categorized within Level III

The table below summarizes information about the significant unobservable inputs used in determining the fair value of the Company’s Level III assets and liabilities.

 

Type of Investment

   Fair Value at
June 30, 2012
(in thousands)(1)
    

Valuation Technique

  

Unobservable Input

   Range

Real estate investments

   $ 379,574       Discounted cash flow    Discount rate    8% - 40%
         Cash flow growth rate    0% - 7%
         Capitalization rate    7.7% - 9.5%
         Absorption percentage per year    6% - 13%
         Loss factor    0% - 15%
         Inflation factor    0% - 3%
  

 

 

 

61,250

 

  

  

 

Comparable companies

  

Cash flow multiple

  

 

15.4x

  

 

 

          
   $ 440,824            

Energy and natural resources limited partnerships

   $ 2,020       Discounted cash flow    Discount rate    15%
         Discount to commodity strip prices    0% - 17.5%
         Probability of reserves    0% - 100%
         Discount to differentials    10%
     88,031       Analysis of publicly traded securities held by investee company    Discount for lack of marketability    0% - 20%
     51,121       Recent financings and cash held by investee    n/a    n/a
  

 

 

          
   $ 141,172            

 

Commercial real estate debt securities

   $ 8,434      

Comparable companies

  

Loan-to-value ratio

   50% - 70%
         Revenue growth rate    2% - 6%
         Comparability adjustment    0% - 30%
  

 

 

 

38,035

 

  

  

 

Broker quotes or at cost for recent transactions

  

 

n/a

  

 

n/a

  

 

 

          
   $ 46,469            

 

(1) 

The remaining Level III investments are valued primarily using broker quotes, at cost for recent transactions or net asset value for the investment in affiliated credit fund.

Valuation Process for Fair Value Measurements Categorized within Level III

The Company has established an internal control infrastructure over the valuation of financial instruments that requires ongoing oversight by its Financial Control Group, as well as periodic audits by the Company’s Internal Audit Group. These management control functions are segregated from the trading and investing functions. The Company has also established a Valuation Committee, comprised of non-investment professionals, that is responsible for overseeing and monitoring the pricing of the funds’ investments and performing periodic due diligence reviews of independent pricing services. The Valuation Committee may obtain input from investment professionals for consideration in carrying out its responsibilities.

The Company employs resources to help ensure that its Financial Control and Internal Audit Groups are able to function at an appropriate quality level. The Company considers the segregation of duties within its internal control infrastructure. Specifically, the Financial Control Group is responsible for establishing and monitoring compliance with valuation policies. The Internal Audit Group employs a risk-based program of audit coverage that is designed to provide an independent assessment of the design and effectiveness of controls over the Company’s operations, regulatory compliance, valuation of financial instruments and reporting, as well as reporting compliance with these controls to the Company’s Audit Committee. Additionally, the Internal Audit Group meets with management periodically to evaluate and provide guidance on the existing risk framework and control environment assessments. Within the trading and investing functions, the Company has established policies and procedures that relate to the approval of all new transaction types, transaction pricing sources and fair value hierarchy coding within the financial reporting system.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

The analysis used in measuring the fair value of financial instruments is generally related to the level of observable pricing inputs. For Level III inputs that are less observable, to the extent possible, procedures have been established to discuss the valuation methodology, including pricing techniques, with senior management of the trading and investing functions, to compare the inputs to observable inputs for similar positions, to review subsequent secondary market activities and to perform comparisons of actual versus projected cash flows. The Company reviews a daily profit and loss report, as well as other periodic reports, and analyzes material changes from period-to-period in the valuation of investments. The Company also performs back testing on a regular basis by comparing prices observed in executed transactions to previous valuations. Pricing services may be used regularly to verify that the Company’s internal valuations are reasonable.

Fair Value of Other Financial Instruments

Management estimates that the fair value of the Delayed Draw Term Loan (as defined in Note 7) was approximately 89% of its carrying value as of June 30, 2012, based on an analysis of comparable issuers. Management believes that the carrying values of all other financial instruments presented in the consolidated balance sheets approximate their fair value generally due to their short-term nature and generally negligible credit risk. These fair value measurements would be categorized as Level III within the fair value hierarchy.

 

5. VARIABLE INTEREST ENTITIES

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

The Company’s involvement with funds that are VIEs that are not consolidated is generally limited to providing asset 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 $26.1 billion and $25.6 billion as of June 30, 2012 and December 31, 2011, respectively. The Company does not provide, nor is it required to provide, any type of financial or other support to these entities. The Company’s variable interests related to these VIEs relate primarily to management fees and incentive income earned from the VIEs. As of June 30, 2012 and December 31, 2011, the only assets related to these variable interests related to income and fees receivable of $28.1 million and $45.6 million, respectively.

In addition, the Company holds variable interests in certain joint ventures that are VIEs. The Company’s exposure to loss for these joint ventures is limited to its investments in these entities, which totaled $5.6 million and $4.8 million as of June 30, 2012 and December 31, 2011, respectively, and are recorded within other assets in the Company’s consolidated balance sheets. The Company has not recorded any liabilities with respect to VIEs not consolidated.

Substantially all of the funds managed by the Company qualify for the deferral under ASU 2010-10, Amendments to Statement 167 for Certain Investment Funds. Accordingly, 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 substantially all of the economics of these VIEs with the exception of the management fee and incentive income, if any, earned by the Company. Accordingly, the Company’s determination of the primary beneficiary is not impacted by changes in the underlying assumptions made regarding future results or expected cash flows of these VIEs.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

The following table presents the assets and liabilities of funds that are VIEs and consolidated by the Company:

 

     June 30, 2012      December 31, 2011  
     (dollars in thousands)  

Assets

     

Assets of consolidated Och-Ziff funds:

     

Investments, at fair value

   $ 449,667       $ 313,345   

Other assets of Och-Ziff funds

     5,289         9,321   
  

 

 

    

 

 

 

Total Assets

   $ 454,956       $ 322,666   
  

 

 

    

 

 

 

Liabilities

     

Liabilities of consolidated Och-Ziff funds:

     

Securities sold under agreements to repurchase

   $ 59,673       $ 57,763   

Other liabilities of Och-Ziff funds

     13,208         909   
  

 

 

    

 

 

 

Total Liabilities

   $ 72,881       $ 58,672   
  

 

 

    

 

 

 

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 to the general credit of the Company with respect to any liability. The Company also consolidates funds that are not VIEs, and therefore the assets and liabilities of those funds are not included in the table above.

 

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, 2012     December 31, 2011  
     (dollars in thousands)  

Fixed Assets:

    

Corporate aircraft

   $ 22,600      $ 22,600   

Leasehold improvements

     20,325        20,325   

Computer hardware and software

     19,536        21,125   

Furniture, fixtures and equipment

     2,724        2,814   

Accumulated depreciation and amortization

     (42,587     (40,272
  

 

 

   

 

 

 

Fixed assets, net

     22,598        26,592   

Goodwill

     22,691        22,691   

Prepaid expenses

     6,823        9,878   

Investments in joint ventures

     5,574        4,848   

Refundable security deposits

     5,177        5,165   

Intangible assets, net

     3,236        3,609   

Current income tax receivable

     2,979        3,467   

Investments in Och-Ziff funds

     594        552   

Other

     2,497        3,038   
  

 

 

   

 

 

 

Total Other Assets, Net

   $ 72,169      $ 79,840   
  

 

 

   

 

 

 

 

16


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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Other Liabilities

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

 

     June 30, 2012      December 31, 2011  
     (dollars in thousands)  

Deferred income of consolidated Och-Ziff funds

   $ 49,162       $ 26,735   

Deferred rent credit

     14,149         14,538   

Accrued expenses

     9,403         12,009   

Obligation under capital leases

     1,226         1,643   

Current income taxes payable

     268         2,720   

Other

     560         865   
  

 

 

    

 

 

 

Total Other Liabilities

   $ 74,768       $ 58,510   
  

 

 

    

 

 

 

 

7. DEBT OBLIGATIONS

The following table presents the Company’s indebtedness outstanding as reported in its consolidated balance sheets:

 

     June 30, 2012      December 31, 2011  
     (dollars in thousands)  

Delayed Draw Term Loan

   $ 389,990       $ 6,484   

2007 Term Loan

     —           366,519   

Aircraft loan

     —           10,682   
  

 

 

    

 

 

 

Total Debt Obligations

   $ 389,990       $ 383,685   
  

 

 

    

 

 

 

The following table presents the Company’s scheduled principal repayments and maturities for its indebtedness outstanding as of June 30, 2012:

 

     Principal
Repayments
 
     (dollars in thousands)  

Remainder of 2012

   $ 1,948   

2013

     3,866   

2014

     3,827   

2015

     3,789   

2016

     376,560   
  

 

 

 

Total Principal Repayments

   $ 389,990   
  

 

 

 

In June 2012, the Company refinanced the indebtedness outstanding under its term loan entered into in connection with the 2007 Offerings ( the “2007 Term Loan”), as well as the indebtedness outstanding under its aircraft loan. These refinancings were funded through a borrowing under a delayed draw term loan agreement entered into in November 2011 (the “Delayed Draw Term Loan”). A $6.5 million borrowing under the facility was made in November 2011 to fund a portion of the 2007 Term Loan repurchased and retired in connection with the 2011 Offering that was not funded by the net proceeds from the offering. An additional $384.5 million borrowing was made in June 2012 to refinance the remaining indebtedness outstanding under the 2007 Term Loan and the indebtedness outstanding under the aircraft loan.

Borrowings under the Delayed Draw Term Loan are payable in quarterly installments equal to 0.25% of the amount outstanding on the last day of each quarter, and the balance will be payable upon maturity on November 23, 2016. Any amounts borrowed under the facility and subsequently repaid may not be re-borrowed. Amounts borrowed bear interest at a rate of LIBOR plus 1.50%, or a base rate plus 0.50%, and are secured by a first priority lien on substantially all assets of the Och-Ziff Operating Group.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

The Delayed Draw Term Loan includes two financial maintenance covenants. The first prohibits total assets under management as of the last day of any fiscal quarter to be less than $17.5 billion for two successive quarters, and the second prohibits the “economic income leverage ratio” (as defined in the credit agreement) as of the last day of any fiscal quarter from exceeding 4.0 to 1.0. The Delayed Draw Term Loan allows a limited right to cure an event of default resulting from noncompliance with the economic income leverage ratio test with an equity contribution made to the borrower, OZ Management. Such cure right may not be used more than two times in any four-quarter period or more than three times during the term of the facility. As of June 30, 2012, the Company was in compliance with these covenants.

The Delayed Draw Term Loan includes provisions that restrict or limit the ability of the Och-Ziff Operating Group from:

 

   

Incurring further secured indebtedness or issuing certain equity interests.

 

   

Creating liens.

 

   

Paying dividends in excess of free cash flow (as defined below) or making certain other payments.

 

   

Merging, consolidating, selling or otherwise disposing of all or part of its assets.

 

   

Engaging in certain transactions with shareholders or affiliates.

 

   

Engaging in a substantially different line of business.

 

   

Amending its organizational documents in a manner materially adverse to the lenders.

The Delayed Draw Term Loan permits the Och-Ziff Operating Group 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, it is in compliance with an economic income leverage ratio (as defined in the credit agreement) of 4.0 to 1.0 and no default or event of default has occurred and is continuing. As of June 30, 2012, the Och-Ziff Operating Group had not incurred any unsecured indebtedness. The Company will not be permitted to make distributions from the Och-Ziff Operating Group to its Class A Shareholders or the holders of Och-Ziff Operating Group A Units if it is in default under the Delayed Draw Term Loan.

The Delayed Draw Term Loan also limits the amount of distributions the Och-Ziff Operating Group can pay in a 12-month period to its “free cash flow.” Free cash flow for any period includes the combined net income or loss of the Och-Ziff Operating Group, 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, plus (or minus) realized gains (or losses) on investments and dividends and interest from investments. As of June 30, 2012, distributions from the Och-Ziff Operating Group were in compliance with the free cash flow covenant.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

8. GENERAL, ADMINISTRATIVE AND OTHER

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

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012     2011  
     (dollars in thousands)  

Occupancy and equipment

   $ 7,043       $ 7,001       $ 13,751      $ 14,102   

Professional services

     6,813         5,829         11,630        10,806   

Information processing and communications

     5,189         4,140         9,885        8,185   

Business development

     2,733         2,352         4,715        4,101   

Insurance

     1,912         1,776         3,819        3,512   

Other expenses

     8,539         6,178         17,451        11,563   
  

 

 

    

 

 

    

 

 

   

 

 

 
     32,229         27,276         61,251        52,269   

Changes in tax receivable agreement liability

     23         43         (51     155   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total General, Administrative and Other

   $ 32,252       $ 27,319       $ 61,200      $ 52,424   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

9. 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 the balance sheet date. 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 records the majority of its incentive income and discretionary cash bonuses in the fourth quarter each year. 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. Due to 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 -4.2% and -2.7% for the three months ended June 30, 2012 and 2011, respectively, and -4.8% and -2.6% for the six months ended June 30, 2012 and 2011, 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 not 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 executive managing directors’ and the Ziffs’ interests as Och-Ziff Operating Group A Units are not deductible for tax purposes.

As of June 30, 2012 and December 31, 2011, the Company was not required to establish a liability for uncertain tax positions.

 

10. NET 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. For the three months ended June 30, 2012 and 2011, the Company included RSUs of 952,982 and 857,821, respectively, that have vested but have not been settled in Class A Shares in the weighted-average Class A Shares outstanding used in the calculation of basic and diluted net loss per Class A Share. For the six months ended June 30, 2012 and 2011, the Company included RSUs of 1,059,747 and 917,866, respectively, that have vested but have not been settled in Class A Shares in the weighted-average Class A Shares outstanding used in the calculation of basic and diluted net loss per Class A Share.

 

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Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

The following tables present the computation of basic and diluted net loss per Class A Share:

 

     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
 
Three Months Ended June 30, 2012    (dollars in thousands, except per share amounts)  

Basic

   $ (116,242     141,722,881       $ (0.82  
  

 

 

   

 

 

    

 

 

   

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —          —             295,742,476   

Class A Restricted Share Units

     —          —             8,553,594   
  

 

 

   

 

 

      

Diluted

   $ (116,242     141,722,881       $ (0.82  
  

 

 

   

 

 

    

 

 

   
     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
 
Three Months Ended June 30, 2011    (dollars in thousands, except per share amounts)  

Basic

   $ (93,362     97,705,327       $ (0.96  
  

 

 

   

 

 

    

 

 

   

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —          —             300,872,397   

Class A Restricted Share Units

     —          —             13,077,759   
  

 

 

   

 

 

      

Diluted

   $ (93,362     97,705,327       $ (0.96  
  

 

 

   

 

 

    

 

 

   
     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
 
Six Months Ended June 30, 2012    (dollars in thousands, except per share amounts)  

Basic

   $ (238,986     141,308,533       $ (1.69  
  

 

 

   

 

 

    

 

 

   

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —          —             295,742,476   

Class A Restricted Share Units

     —          —             8,553,594   
  

 

 

   

 

 

      

Diluted

   $ (238,986     141,308,533       $ (1.69  
  

 

 

   

 

 

    

 

 

   
     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
 
Six Months Ended June 30, 2011    (dollars in thousands, except per share amounts)  

Basic

   $ (188,826     97,261,490       $ (1.94  
  

 

 

   

 

 

    

 

 

   

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —          —             300,872,397   

Class A Restricted Share Units

     —          —             13,077,759   
  

 

 

   

 

 

      

Diluted

   $ (188,826     97,261,490       $ (1.94  
  

 

 

   

 

 

    

 

 

   

 

20


Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

11. RELATED PARTY TRANSACTIONS

Due to Related Parties

Amounts due to related parties relate to future payments owed to the Company’s executive managing directors and the Ziffs under the tax receivable agreement. As further discussed in Note 12, the Company entered into an agreement with the executive managing directors and the Ziffs, whereby the Company would pay them a portion of any tax savings resulting from the purchase of Och-Ziff Operating Group A Units at the time of the 2007 Offerings or as a result of any subsequent exchanges of their interests for Class A Shares.

Management Fees and Incentive Income Earned from the 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.

Management Fees and Incentive Income Earned from Related Parties and Waived Fees

Prior to the 2007 Offerings, the Company did not charge management fees or earn incentive income on investments made by the Company’s executive managing directors, employees and other related parties. Following the 2007 Offerings, the Company began charging management fees and earning incentive income on new investments made in the funds by executive managing directors and certain other related parties, including the reinvestment by executive managing directors of the after-tax proceeds from the 2007 Offerings. 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,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Fees charged on investments held by related parties:

           

Management fees

   $ 6,346       $ 7,034       $ 12,401       $ 12,753   

Incentive income

   $ 591       $ 970       $ 638       $ 1,343   

Fees waived on investments held by related parties:

           

Management fees

   $ 3,303       $ 3,473       $ 6,449       $ 6,818   

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. For the three months ended June 30, 2012 and 2011, the Company charged Mr. Och $80 thousand and $433 thousand, respectively, based on market rates for his personal use of the aircraft. For the six months ended June 30, 2012 and 2011, the Company charged Mr. Och $210 thousand and $563 thousand, respectively, for his personal use of the aircraft.

 

12. COMMITMENTS AND CONTINGENCIES

Tax Receivable Agreement

The purchase of Och-Ziff Operating Group A Units from the executive managing directors and the Ziffs with the proceeds from the 2007 Offerings, and subsequent taxable exchanges by them 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-

 

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Table of Contents

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

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 executive managing directors and the Ziffs, the Company has agreed to pay to the executive managing directors 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 related parties 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 comprehensive loss.

In connection with the departure of certain former executive managing directors since the 2007 Offerings, the right to receive payments under the tax receivable agreement by such former executive managing directors was contributed to the Och-Ziff Operating Group. As a result, the Company now expects to pay to the remaining executive managing directors and the Ziffs approximately 77% (from 85% at the time of the 2007 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.

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 Corporation, a wholly owned 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, Beijing and Mumbai. The Company also has operating leases for other locations, as well as operating and capital leases on computer hardware. The Company recognizes expense related to its operating leases on a straight-line basis over the lease term. The related lease commitments have not changed materially since December 31, 2011.

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 to extensive scrutiny by regulatory agencies globally that have or may in the future have regulatory authority over the Company and its business activities. This has resulted or may in the future result in regulatory agency investigations, litigation and subpoenas and costs related to each. 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 consolidated financial statements.

Investment Commitments

From time to time, certain funds consolidated by the Company may have commitments to fund investments. These commitments are funded through contributions from investors in those funds. The Company generally only manages these funds and is not an investor in the funds.

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 annually. 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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Other Contingencies

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

 

13. SEGMENT INFORMATION

The Och-Ziff Funds segment 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 asset management services to the Company’s funds. The Company’s Other Operations are primarily comprised of its real estate business, which provides asset management services to the Company’s real estate funds.

In addition to analyzing the Company’s results on a GAAP basis, management also reviews its results on an “Economic Income” basis. Economic Income excludes the adjustments described below that are required for presentation of the Company’s results on a 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 the Company’s financial performance and makes resource allocation and other operating decisions. 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 the Company’s results on a GAAP basis:

 

   

Income allocations to the Company’s executive managing directors 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 the Company’s operations are performed, prior to making any income allocations.

 

   

Reorganization expenses related to the 2007 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 gains (losses) on investments in Och-Ziff funds, as management does not consider these to be reflective of operating performance.

 

   

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 in relation to total assets under management and fund performance.

In addition, the full amount of deferred cash compensation and expenses related to compensation arrangements based on annual investment performance are recognized on the date they are determined (generally in the fourth quarter of each year), as management determines the total amount of compensation based on the Company’s performance in the year of the award. Finally, management reviews Economic Income revenues by presenting management fees net of recurring placement and related service fees, rather than considering these fees an expense, and by excluding the impact of the consolidated Och-Ziff funds.

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. All interest expense related to outstanding indebtedness is allocated to the Och-Ziff Funds segment.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

Och-Ziff Funds Segment Results

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Och-Ziff Funds Segment:

           

Economic Income Revenues

   $ 139,493       $ 127,996       $ 256,471       $ 248,951   

Economic Income

   $ 93,248       $ 84,453       $ 168,649       $ 163,512   

Reconciliation of Och-Ziff Funds Segment Revenues to Consolidated Revenues

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Economic Income Revenues - Och-Ziff Funds segment

   $ 139,493       $ 127,996       $ 256,471       $ 248,951   

Adjustment to management fees(1)

     4,271         3,018         8,473         6,391   

Other Operations revenues

     2,362         4,875         4,849         9,217   

Income of consolidated Och-Ziff funds

     32,296         11,396         49,553         21,134   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Consolidated Revenues

   $ 178,422       $ 147,285       $ 319,346       $ 285,693   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Adjustment to present management fees net of recurring placement and related service fees, as management considers these fees a reduction in management fees, not an expense. The impact of eliminations related to the consolidated Och-Ziff funds is also removed.

Reconciliation of Och-Ziff Funds Economic Income to Net Loss Allocated to Class A Shareholders

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Economic Income - Och-Ziff Funds segment

   $ 93,248      $ 84,453      $ 168,649      $ 163,512   

Reorganization expenses

     (398,416     (399,312     (796,832     (805,167

Net Loss Allocated to the Och-Ziff Operating Group A Units

     222,241        269,652        458,649        546,640   

Equity-based compensation

     (16,267     (35,805     (34,075     (69,303

Income taxes

     (12,491     (9,413     (26,895     (18,039

Depreciation and amortization

     (2,321     (2,390     (4,679     (4,864

Amortization of deferred cash compensation and expenses related to compensation arrangements based on annual fund performance

     (1,685     (1,535     (2,965     (3,224

Other Operations

     727        1,944        1,220        3,375   

Other adjustments

     (1,278     (956     (2,058     (1,756
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Loss Allocated to Class A Shareholders

   $ (116,242   $ (93,362   $ (238,986   $ (188,826
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

JUNE 30, 2012

 

14. SUBSEQUENT EVENTS

In August 2012, upon the recommendation and approval of the Compensation Committee of the Company’s Board of Directors (the “Board”), the Board approved The Och-Ziff Capital Management Group LLC 2012 Partner Incentive Plan (the “PIP”) in order to retain and further motivate its executive managing directors, including those executive managing directors who were limited partners of the Och-Ziff Operating Group entities at the time of the Company’s IPO (collectively, the “Pre-IPO Partners”) as described in more detail below.

Transfer Restrictions

In August 2012, the Company’s executive managing directors approved new transfer restrictions that will generally limit the executive managing directors’ ability to transfer or exchange their Och-Ziff Operating Group A Units over a five-year period commencing in 2013. In consideration of the executive managing directors becoming subject to these transfer restrictions and reflective of the Pre-IPO Partners’ commitment to the Company, the Board adopted the PIP.

Summary of the Partner Incentive Plan

Under the terms of the PIP, participating Pre-IPO Partners (the “Eligible Pre-IPO Partners”) will be eligible to receive grants of discretionary annual performance awards (“Performance Awards”), which may be satisfied in Och-Ziff Operating Group D Units (“Performance Unit Awards”) and may also be satisfied in cash (“Performance Cash Awards”). All Performance Awards will be conditionally granted subject to compliance with each participating executive managing director’s non-compete obligations under the Och-Ziff Operating Group Limited Partnership Agreements and related agreements, and may be clawed back pursuant to the terms of the PIP. Mr. Daniel S. Och has determined not to participate in the PIP and will continue to participate in the Company’s profits solely through distributions made in respect of his existing equity ownership stake.

Whether any Performance Awards are made in a particular year, and the amount of any such awards, shall be determined by the Compensation Committee of the Board in its sole discretion, based on recommendations from Mr. Och for such year pursuant to the terms of the PIP. If an Eligible Pre-IPO Partner ceases, for any reason, to be a limited partner of the Och-Ziff Operating Group entities prior to the end of any year, such Eligible Pre-IPO Partner will not be eligible to receive any Performance Awards with respect to such year or any subsequent year.

If one of the Eligible Pre-IPO Partners currently on the Partner Management Committee ceases to be a limited partner of the Och-Ziff Operating Group entities, the amounts of cash and Och-Ziff Operating Group D Units that such Eligible Pre-IPO Partner would otherwise have been able to receive shall not be available for reallocation to the remaining Eligible Pre-IPO Partners. As a result, the maximum aggregate amounts of cash and Och-Ziff Operating Group D Units that are available for Performance Cash Awards and Performance Unit Awards as described below shall be reduced accordingly. If one of the Eligible Pre-IPO Partners not currently on the Partner Management Committee ceases to be a limited partner of the Och-Ziff Operating Group entities for any reason, the amounts of cash and Och-Ziff Operating Group D Units that such Eligible Pre-IPO Partner would otherwise have been eligible to receive shall be available for reallocation to the remaining Eligible Pre-IPO Partners not currently on the Partner Management Committee.

Performance Units Awards

The Eligible Pre-IPO Partners may be granted, collectively, an aggregate of up to 3,628,907 Och-Ziff Operating Group D Units each year over a five-year period commencing in 2013. Any such awards of Och-Ziff Operating Group D Units will be made pursuant to the Och-Ziff Capital Management Group LLC Amended and Restated 2007 Equity Incentive Plan or a successor plan.

Och-Ziff Operating Group D Units are not considered equity for GAAP purposes, and therefore distributions made to holders of these units are recognized within compensation and benefits in the consolidated statements of comprehensive loss. Och-Ziff Operating Group D Units receive distributions on a pro rata basis with the Och-Ziff Operating Group A Units, which are held by the executive managing directors and the Ziffs, and the Och-Ziff Operating Group B Units, which are held by the Company’s intermediate holding companies. As discussed in the Company’s Annual Report, an Och-Ziff Operating Group D Unit automatically converts into an Och-Ziff Operating Group A Unit to the extent the Company determines that it has become economically equivalent to an Och-Ziff Operating Group A Unit, at which point it is considered a grant of equity-based compensation for GAAP purposes.

Performance Cash Awards

The Eligible Pre-IPO Partners, collectively, may also be eligible to receive discretionary annual cash awards if the Company earns incentive income in the relevant year. For each year during the five-year period commencing in 2013, an amount equal to up to 10% of the incentive income earned by the Och-Ziff Operating Group during such year, not to exceed $52.4 million, will be available for discretionary cash awards to be distributed to the Eligible Pre-IPO Partners.

 

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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. 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

Our Business

We are one of the largest institutional alternative asset managers in the world, with approximately $30.3 billion in assets under management as of August 1, 2012. We provide asset management services globally through our hedge funds and other alternative investment vehicles. Our funds seek to generate consistent, positive, absolute returns across market cycles, with low volatility compared to the equity markets. We have always limited our use of leverage to generate investment performance with an emphasis on preservation of capital. Our assets under management are generally invested on a multi-strategy basis, across multiple geographies, although certain of our funds are focused on specific sectors, strategies and geographies. Our primary investment strategies are convertible and derivative arbitrage, corporate credit, long/short equity special situations, merger arbitrage, private investments and structured credit. Our fund investors value our funds’ consistent performance history, our global investing expertise, and our diverse investment strategies, combined with our strong focus on risk management and sustaining a robust operational infrastructure.

Overview of Our 2012 Second Quarter Results

As of June 30, 2012, our assets under management were $29.9 billion, compared with $29.8 billion as of June 30, 2011. The year-over-year increase was driven by performance-related appreciation of $218.0 million, partially offset by capital net outflows of $57.8 million. Institutional investors continue to indicate a strong interest in allocating to hedge funds as they seek to enhance returns and reduce volatility. However, capital inflows to the hedge fund industry slowed during the second quarter of this year as concerns about the ongoing issues in Europe, as well as a weaker economic backdrop in the U.S. and China continued to weigh on near-term investor confidence.

For the second quarter of 2012, we reported a GAAP net loss allocated to Class A Shareholders of $116.2 million, compared to a net loss of $93.4 million for the second quarter of 2011, and $239.0 million for the first half of 2012, compared to a net loss of $188.8 million for the first half of 2011. The GAAP net losses primarily resulted from non-cash Reorganization expenses associated with our 2007 Offerings of $398.4 million and $399.3 million for the three months ended June 30, 2012 and 2011, respectively, and $796.8 million and $805.2 million for the six months ended June 30, 2012 and 2011, respectively.

We reported Economic Income for the Company1 of $94.0 million for the second quarter of 2012, compared to $86.4 million for the second quarter of 2011, and $169.9 million for the first half of 2012, compared to $166.9 million for the first half of 2011. The increase for both periods was driven by an increase in incentive income and a decrease in compensation and benefits expenses, partially offset by an increase in non-compensation expenses and a decrease in management fees. For a discussion of these drivers, please see “—Economic Income Analysis.”

Refinancing of 2007 Term Loan and Aircraft Loan

In June 2012, we refinanced the indebtedness outstanding under the term loan entered into in connection with the 2007 Offerings (the “2007 Term Loan”), as well as the indebtedness outstanding under our aircraft loan. A $384.5 million borrowing under a delayed draw term loan agreement entered into in November 2011 (the “Delayed Draw Term Loan”) was used to fund these refinancings, with the balance being used for general corporate purposes. See “—Liquidity and Capital Resources” for additional information.

 

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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Overview of 2012 Second Quarter Fund Performance

During the 2012 second quarter, we continued to deliver strong absolute returns for our fund investors, with approximately 11% of the volatility of the S&P 500 Index on a weighted-average basis for our four main funds. Our investment performance reflected our ability to protect investor capital in the difficult and often volatile market conditions that characterized May and June. Our performance was a function of our consistent and disciplined approach to investing and actively managing risk with limited use of leverage. We adjusted our exposures in response to weaker macroeconomic conditions globally. We increased cash in the OZ Master Fund in the second quarter to approximately 7% as of July 1, 2012, from 0% on April 1, 2012, and reallocated capital to those asset classes that offered more compelling investment opportunities, principally in credit and equities.

During the second quarter of 2012, the OZ Master Fund generated a net return of +0.2%, the OZ Europe Master Fund a net return of -1.4%, the OZ Asia Master Fund a net return of -3.4% and the OZ Global Special Investments Master Fund a net return of -0.1%1.

During the first half of 2012, the OZ Master Fund generated a net return of +4.9%, the OZ Europe Master Fund a net return of +3.4%, the OZ Asia Master Fund a net return of +2.3% and the OZ Global Special Investments Master Fund a net return of +5.0%. For the 2012 first half, performance was driven primarily by structured credit, corporate credit and long/short equity special situations strategies.

Financial Market and Capital Flow Environment

Our ability to generate management fees and incentive income is impacted by the financial markets, which influences our ability to generate returns for our fund investors, and by the amount of capital flowing into and out of the hedge fund industry, which impacts our ability to retain existing investor capital and the amount of new assets we attract.

Financial Market Environment

Our ability to successfully generate consistent, positive, absolute returns is dependent on our ability to execute each fund’s investment strategy or strategies. Each investment strategy may be materially affected by conditions in the financial markets, and by global economic and business conditions.

The second quarter of 2012 was characterized by increased market volatility and heightened investor concerns about the ongoing European sovereign debt crisis and slowing global economic growth. While the Greek elections and the European leaders’ summit in the second half of June lifted markets globally and resulted in improved investor sentiment, the gains achieved in the global equity markets during the 2012 first quarter were eliminated. Global equity indices posted negative returns for the quarter, while volatility reached a six-month high in early June.

U.S. corporate credit markets also experienced increased volatility during the second quarter as a variety of technical and fundamental factors weighed on credit spreads. However, U.S. high-yield bonds and leveraged loans generated positive returns during the period. European credit markets experienced high levels of volatility due to increased economic weakness and renewed uncertainty about issues in Greece and Spain. The European primary markets showed very little activity for new high-yield and leveraged loans. The Asian credit markets were strong, despite higher levels of intra-quarter volatility, and were positively impacted by more accommodative monetary conditions in China.

Capital Flow Environment

Capital inflows to the hedge fund industry slowed sharply in the 2012 second quarter from the 2012 first quarter and year-ago levels, and were the weakest since the 2011 fourth quarter when flows were essentially flat. We believe this was attributable to declining investor confidence, as the sovereign debt crisis in Europe persisted and economic conditions weakened globally.

However, institutional investors continue to indicate a strong interest in allocation to hedge funds as they seek to enhance their investment returns. Despite a more difficult environment for flows in the second quarter, we remain confident that capital allocations to the hedge fund industry will increase as markets stabilize globally.

 

1  For important information about our fund performance data, please see “—Fund Performance Summary.”

 

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Assets Under Management

Our financial results are primarily driven by the combination of assets under management and the investment performance of our funds. Both of these factors directly impact the revenues we earn from management fees and incentive income. Growth in assets under management due to capital placed with us by investors in our funds and positive investment performance of our funds drive 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, which would have a negative effect on our revenues and earnings.

We typically accept capital from new and existing investors in our funds on a monthly basis on the first day of each month. Investors in our funds (other than investors in our real estate funds, certain credit funds and certain other alternative investment vehicles we manage and other than with respect to capital invested in Special Investments) typically 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, subject to certain limitations, 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 applicable fund and upon giving 30 days prior written notice, certain investors may redeem capital during the lock-up period. The lock-up requirements for our funds may generally be waived or modified at the sole discretion of each fund’s general partner or board of directors, as applicable. The after-tax proceeds from the 2007 Offerings reinvested by our executive managing directors in our funds are subject to a five-year lock-up that expires in December 2012.

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.

Information with respect to our assets under management throughout this report, including the tables set forth in this discussion and analysis, includes investments by us, our executive managing directors, 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 executive managing directors and certain other related parties, including the reinvestment by our executive managing directors of their after-tax proceeds from the 2007 Offerings. As of June 30, 2012, approximately 9% of our assets under management represented investments by us, our executive managing directors, employees and certain other related parties in our funds. As of that date, approximately 32% of these affiliated assets under management are not charged management fees and are not subject to an incentive income calculation.

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.

Summary of Changes in Assets Under Management

The table below presents the changes to our assets under management and our weighted-average assets under management for the respective period. Weighted-average assets under management exclude the impact of second quarter investment performance for the periods presented, as these amounts do not impact management fees calculated for that period.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Balance-beginning of period

   $ 30,116,849      $ 29,030,215      $ 28,766,340      $ 27,934,696   

Net flows

     (185,516     774,697        (248,651     925,633   

Appreciation (Depreciation)

     (3,603     (37,350     1,410,041        907,233   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance-end of period

   $ 29,927,730      $ 29,767,562      $ 29,927,730      $ 29,767,562   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average assets under management

   $ 29,763,232      $ 29,420,746      $ 29,164,976      $ 28,668,682   

 

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In the first half of 2012, our funds experienced performance-related appreciation of $1.4 billion and capital net outflows of $248.7 million, which were comprised of $1.4 billion of gross inflows and $1.7 billion of gross outflows. Direct allocations from pension funds continue to be the largest driver of our inflows, while redemptions from fund-of-funds were the largest driver of our outflows. We continue to have an active dialog with current and prospective fund investors globally. While the broader market and industry backdrop affects the amount and timing of flows, interest in both our hedge funds and dedicated credit platforms remains strong.

In the first half of 2011, our funds experienced performance-related appreciation of $907.2 million and capital net inflows of $925.6 million, which were comprised of $2.7 billion of gross inflows and $1.8 billion of gross outflows. The inflows came from a diverse mix of investors globally. Additionally, our real estate funds and various other assets that we manage with longer than one-year measurement periods comprised a meaningful portion of gross inflows in the first half of 2011 (see “—Understanding our Results—Revenues—Incentive Income”). The outflows were driven by a variety of factors influencing our fund investors.

Assets Under Management by Fund

 

     June 30,  
     2012      2011  
     (dollars in thousands)  

OZ Master Fund

   $ 20,807,573       $ 20,716,749   

OZ Europe Master Fund

     2,057,464         2,675,954   

OZ Asia Master Fund

     1,577,092         1,658,295   

OZ Global Special Investments Master Fund

     1,020,931         1,088,882   

Other(1)

     4,464,670         3,627,682   
  

 

 

    

 

 

 

Total

   $ 29,927,730       $ 29,767,562   
  

 

 

    

 

 

 

 

(1) Includes real estate funds, credit funds and other alternative investment vehicles we manage.

OZ Master Fund

The $90.8 million year-over-year increase in assets under management for the OZ Master Fund was driven by capital net inflows in the second half of 2011, as well as positive investment performance during the fourth quarter of 2011 and first half of 2012. These increases were partially offset by performance-related depreciation in the third quarter of 2011, as well as capital net outflows experienced in the first half of 2012.

OZ Europe Master Fund

The $618.5 million year-over-year decrease in assets under management for the OZ Europe Master Fund was driven by capital net outflows experienced in the second half of 2011 and the first half of 2012, and performance-related depreciation in the second half of 2011 and the second quarter of 2012. These decreases were partially offset by positive investment performance in the first quarter of 2012.

OZ Asia Master Fund

The $81.2 million year-over-year decrease in assets under management for the OZ Asia Master Fund was driven by performance-related depreciation in the second half of 2011 and the second quarter of 2012, as well as capital net outflows experienced in the first half of 2012. These increases were partially offset by capital net inflows in the second half of 2011, as well as positive investment performance during the first quarter of 2012.

OZ Global Special Investments Master Fund

The $68.0 million year-over-year decrease in the assets under management for the OZ Global Special Investments Master Fund was driven by capital net outflows in the second half of 2011 and the first half of 2012, and performance-related depreciation in the third quarter of 2011 and second quarter of 2012, partially offset by positive investment performance in the fourth quarter of 2011 and the first quarter of 2012.

 

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Other

The $837.0 million year-over-year increase in the assets under management in our other funds was primarily due to the growth in our dedicated credit platforms, several of which were launched in 2011 and early 2012. These platforms generally have a lower management fee rate and longer lock-ups, but still maintain a 20% incentive income structure. The remaining growth came from various other alternative investment vehicles we formed to meet the needs of our fund investors.

Fund Performance Summary

Fund investment performance, as generally measured 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 gains and losses attributable to Special 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 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.

Performance by Fund

The table below presents the performance information for our most significant master funds (by asset size). The net returns shown represent the composite performance of all feeder funds that comprise each of the master funds presented. The net return is calculated using the total return of all feeder funds, net of all fees and expenses of such feeder funds and master funds (except, as noted above, incentive income on unrealized gains attributable to Special Investments that could reduce returns in these investments at the time of realization) and the returns of each feeder fund include the reinvestment of all dividends and other income. The net returns also include realized and unrealized gains and losses attributable to Special Investments and initial public offering investments that are not allocated to all investors in the feeder funds. Investors that were not allocated Special Investments and initial public offering investments may experience materially different returns.

 

     Net Return for the
Three Months Ended June 30,
    Net Return for  the
Six Months Ended June 30,
 
     2012     2011     2012     2011  

OZ Master Fund

     0.2     0.0     4.9     3.3

OZ Europe Master Fund

     -1.4     -1.6     3.4     1.9

OZ Asia Master Fund

     -3.4     -0.1     2.3     1.3

OZ Global Special Investments Master Fund

     -0.1     1.8     5.0     6.5

OZ Master Fund

The table below presents a summary of each investment strategy’s contribution to the OZ Master Fund’s return before management fees and incentive income:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

Convertible and Derivative Arbitrage

     30     5     7     10

Corporate Credit

     39     37     23     21

Long/Short Equity Special Situations

     -118     59     25     27

Merger Arbitrage

     17     -27     3     3

Private Investments

     -1     2     3     4

Structured Credit

     136     41     40     37

Other

     -3     -17     -1     -2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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OZ Europe Master Fund

The table below presents a summary of each investment strategy’s contribution to the OZ Europe Master Fund’s return before management fees and incentive income:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

Convertible and Derivative Arbitrage

     -17     3     3     15

Corporate Credit

     -6     -30     35     42

Long/Short Equity Special Situations

     84     66     35     -5

Merger Arbitrage

     -33     -10     7     12

Private Investments

     117     37     -22     20

Structured Credit

     -49     16     43     31

Other

     4     18     -1     -15
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

OZ Asia Master Fund

The table below presents a summary of each investment strategy’s contribution to the OZ Asia Master Fund’s return before management fees and incentive income:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

Convertible and Derivative Arbitrage

     -2     -24     14     13

Corporate Credit

     -17     30     40     30

Long/Short Equity Special Situations

     92     -22     59     16

Merger Arbitrage

     1     51     -4     5

Private Investments

     20     130     -6     58

Other

     6     -65     -3     -22
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

OZ Global Special Investments Master Fund

The table below presents a summary of each investment strategy’s contribution to the OZ Global Special Investments Master Fund’s return before management fees and incentive income:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  

Corporate Credit

     141     14     13     8

Long/Short Equity Special Situations

     -190     4     12     9

Merger Arbitrage

     18     -3     1     1

Private Investments

     -105     80     23     39

Structured Credit

     239     12     53     48

Other

     -3     -7     -2     -5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

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. For any given fiscal period, our revenues are influenced by the amount of our assets under management, the investment performance of our funds and the timing of when we recognize incentive income for certain assets under management as discussed below.

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’

 

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investment performance. Both of these factors directly impact the revenues we earn from management fees and incentive income. 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 20% incentive income rate, a one-year performance measurement period, no hurdle rate and no high-water marks from prior years.

For any given quarter, 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 on assets under management that are subject to annual measurement periods, or for other assets under management for which the measurement period expired in that quarter.

Management Fees. Management fees typically range from 1.5% to 2.5% annually of assets under management in our hedge funds. In our real estate funds and credit funds, management fees typically range from 0.75% to 1.5% based on the amount of capital committed to these platforms by our fund investors. Our average management fee rate is approximately 1.7%. This average rate takes into account the effect of non-fee paying assets under management, as well as our dedicated credit platforms and other alternative investment vehicles. Management fees are generally calculated and paid to us on a quarterly basis at the beginning of the quarter, based on the amount of 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 relative magnitude and timing of inflows and redemptions during the respective quarter, as well as the impact of differing management fee rates charged on those inflows and redemptions.

Incentive Income. We earn incentive income based on the performance of our funds. Incentive income is typically equal to 20% of the net realized and unrealized profits attributable to each fund investor, but it excludes unrealized gains and losses attributable to Special Investments. We do not recognize incentive income until the end of the performance measurement period when the amounts are contractually payable, or “crystallized.” Additionally, all of our hedge 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.

The performance 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 31. We may recognize incentive income during the first three quarters of the year related to assets subject to three-year performance measurement periods, as well as assets in our real estate funds, credit funds and certain other funds we manage. Additionally, we may recognize incentive income for tax distributions related to these assets. Tax distributions are amounts distributed to us to cover tax liabilities related to incentive income that has been accrued at the fund level but will not be recognized by us until the end of the relevant performance measurement period (if at all). Finally, we may also recognize incentive income related to fund investor redemptions during the first three quarters of the year.

The performance measurement periods with respect to approximately 20.1% of our assets under management as of June 30, 2012 are longer than one year. Approximately 42% of these assets are in the OZ Master Fund and subject to three-year performance measurement periods. The three-year performance measurement period with respect to approximately 53% of these assets will begin to expire in 2012, virtually all in the fourth quarter. Incentive income related to assets subject to three-year performance measurement periods is generally not earned until the end of the three-year period and is based on the cumulative performance over the three-year period. The remaining assets under management with performance measurement periods longer than one year are related to our real estate funds, credit funds and certain other alternative investment vehicles we manage. Incentive income related to these funds is generally not earned until it is no longer subject to repayment to the respective fund. Our ability to earn incentive income on these assets, as well as those with three-year performance measurement periods, is also subject to hurdle rates whereby we do not earn any incentive income until the investment returns exceed an agreed upon benchmark.

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.

 

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Expenses

Our operating expenses consist of the following:

 

   

Compensation and Benefits. Compensation and benefits is comprised of salaries, benefits, payroll taxes, discretionary and guaranteed cash bonus expense and equity-based compensation, primarily in the form of RSUs and Och-Ziff Operating Group A Units granted to executive managing directors subsequent to the 2007 Offerings. On an annual basis, compensation and benefits comprise a significant portion of total expenses, with discretionary cash bonuses generally 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 significant high-water marks in effect are generally determined and expensed in the fourth quarter each year.

 

   

Interest Expense. Amounts included within interest expense relate primarily to interest expense on our Delayed Draw Term Loan, which is a LIBOR-based, variable-rate borrowing. The LIBOR interest rate on our Delayed Draw Term Loan resets every one, two, three or six months (at our option), two business days prior to the start of each interest period. Prior to the repayment of our 2007 Term Loan and aircraft loan in June 2012, interest expense also included interest on those borrowings.

 

   

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

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

Reorganization Expenses. Prior to the 2007 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 executive managing directors and the Ziffs were reclassified as Och-Ziff Operating Group A Units, resulting in significant non-cash Reorganization expenses. These expenses are generally being amortized through 2012 on a straight-line basis over a five-year vesting period following the 2007 Offerings. 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 executive managing directors are expected to be approximately $600.1 million for the remainder of 2012.

Expenses of Consolidated Och-Ziff Funds. Expenses recorded as expenses of consolidated Och-Ziff funds consist of interest expense and other miscellaneous expenses.

Other Income

Our other income consists of the following:

 

   

Net Gains on Investments in Och-Ziff Funds and Joint Ventures. Net gains on investments in Och-Ziff funds and joint ventures primarily consists of net gains (losses) on investments in our funds made by us and net gains (losses) on investments in joint ventures established to expand our private investment platforms.

 

   

Change in Deferred Income of Consolidated Och-Ziff Funds. Incentive income allocations from funds that we consolidate are recognized through a greater share of these funds’ net earnings being allocated to us, and a correspondingly reduced share of these earnings allocated to investors in the funds (noncontrolling interests). To the extent we are allocated incentive income by a consolidated fund that could be subject to repayment in the event of future losses, we defer the recognition of our share of income through change in deferred income of consolidated Och-Ziff funds in the consolidated statements of comprehensive loss and record a corresponding liability within other liabilities in the consolidated balance sheets. The liability is reversed and recognized in earnings when these amounts are no longer subject to repayment.

 

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Net Gains of Consolidated Och-Ziff Funds. Net gains 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 and local income taxes in the United States and foreign income taxes, including provisions for deferred income taxes resulting from temporary differences between the tax and 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 GAAP basis and the likelihood of being able to fully utilize deferred income 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 Noncontrolling Interests

Noncontrolling interests represent ownership interests in our subsidiaries held by parties other than us and are primarily made up of: (i) Och-Ziff Operating Group A Units held by our executive managing directors and the Ziffs; and (ii) fund investors’ interests in the consolidated Och-Ziff funds. Increases or decreases in net income (loss) allocated 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 the net income (loss) allocated to fund investors’ interests in consolidated Och-Ziff funds are driven by the earnings or losses of those funds.

Results of Operations

Revenues

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Management fees

   $ 127,492       $ 128,344       $ 249,574       $ 249,690   

Incentive income

     18,414         6,867         19,635         13,833   

Other revenues

     220         678         584         1,036   

Income of consolidated Och-Ziff funds

     32,296         11,396         49,553         21,134   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenues

   $ 178,422       $ 147,285       $ 319,346       $ 285,693   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues for the quarter-to-date period increased $31.1 million primarily due to the following:

 

   

A $20.9 million increase in income of consolidated Och-Ziff funds. The majority of this income is allocated to noncontrolling interests, as we only have minimal ownership interest, if any, in each of these funds. A portion of this income may be allocated to us as an incentive income allocation; however, these amounts are deferred until the end of the performance measurement periods for the relevant fund.

 

   

An $11.5 million increase in incentive income driven primarily by $11.3 million of incentive income recognized in the second quarter of 2012 related to assets under management subject to three-year performance measurement periods.

Total revenues for the year-to-date period increased $33.7 million primarily due to the following:

 

   

A $28.4 million increase in income of consolidated Och-Ziff funds. The majority of this income is allocated to noncontrolling interests, as we only have minimal ownership interest, if any, in each of these funds. A portion of this income may be allocated to us as an incentive income allocation; however, these amounts are deferred until the end of the performance measurement periods for the relevant fund.

 

   

A $5.8 million increase in incentive income driven by $11.3 million of incentive income recognized in the second quarter of 2012 related to assets under management subject to three-year performance measurement periods. Partially offsetting this increase was a $6.0 million decrease related to tax distributions taken in 2011 that did not recur in 2012.

 

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Our average management fee rate remained at approximately 1.7% in the second quarter of 2012 and 2011.

Expenses

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Compensation and benefits

   $ 41,321       $ 61,243       $ 82,191       $ 120,448   

Reorganization expenses

     398,416         399,312         796,832         805,167   

Interest expense

     1,212         1,843         2,455         3,891   

General, administrative and other

     32,252         27,319         61,200         52,424   

Expenses of consolidated Och-Ziff funds

     2,939         2,480         5,051         3,930   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Expenses

   $ 476,140       $ 492,197       $ 947,729       $ 985,860   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses for the quarter-to-date period decreased by $16.1 million primarily due to the following:

 

   

A $19.9 million decrease in compensation and benefits primarily due to the following: (i) a $19.5 million decrease in equity-based compensation expenses primarily due to the vesting of a large number of RSUs in November 2011. These RSUs were mostly granted in connection with our IPO and were subject to a four-year vesting period; (ii) a $2.3 million decrease in bonus expense driven by lower guaranteed bonus accruals; and (iii) a $1.1 million offsetting increase in salaries and benefits due in part to the increase in our worldwide headcount from 421 as of June 30, 2011 to 448 as of June 30, 2012.

 

   

A $4.9 million offsetting increase in general, administrative and other expenses primarily due to a $1.4 million increase in recurring placement and related service fees and a $1.0 million increase in information processing and communication costs. The remaining increase was driven by a net increase in other miscellaneous expenses.

Total expenses for the year-to-date period decreased by $38.1 million primarily due to the following:

 

   

A $38.3 million decrease in compensation and benefits primarily due to the following: (i) a $35.2 million decrease in equity-based compensation expenses primarily due to the vesting of a large number of RSUs in November 2011. These RSUs were mostly granted in connection with our IPO and were subject to a four-year vesting period; (ii) a $6.9 million decrease in bonus expense driven by lower guaranteed bonus accruals; and (iii) a $2.9 million offsetting increase in salaries and benefits due in part to the increase in our worldwide headcount as discussed above.

 

   

An $8.3 million decrease in Reorganization expenses primarily due to lower amortization of Och-Ziff Operating Group A Units that were forfeited by former executive managing directors and subsequently reallocated to the remaining executive managing directors generally at a lower grant-date fair value. Partially offsetting this decrease was a reversal of $6.1 million in the second quarter of 2011 related to the forfeiture of Och-Ziff Operating Group A Units by a former executive managing director.

 

   

An $8.8 million offsetting increase in general, administrative and other expenses primarily due to a $3.1 million increase in recurring placement and related service fees, a $1.7 million increase in information processing and communication costs and $1.4 million of commitment fees recognized in 2012 related to the undrawn portion of our Delayed Draw Term Loan that were incurred prior to the drawdown made in June 2012. The remaining increase was driven by a net increase in other miscellaneous expenses.

 

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Other Income

 

                                           
     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

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

   $ (382   $ 36      $ (288   $ 212   

Change in deferred income of consolidated Och-Ziff funds

     (7,055     (649     (22,427     (2,975

Net gains of consolidated Och-Ziff funds

     8,864        2,912        85,276        11,199   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Income

   $ 1,427      $ 2,299      $ 62,561      $ 8,436   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income for the quarter-to-date period decreased by $872 thousand primarily due to the following:

 

   

A $6.4 million decrease in other income resulting from the change in deferred income of consolidated funds. This change was driven by the increase in income and net gains of consolidated Och-Ziff funds discussed above. We defer our incentive income allocation from these funds until the performance measurement period ends and any incentive income allocated to us is no longer subject to repayment.

 

   

A $6.0 million offsetting increase in net gains of consolidated Och-Ziff funds. The majority of these net gains are allocated to noncontrolling interests, as we only have minimal ownership interest, if any, in each of these funds. A portion of these net gains is allocated to us as an incentive income allocation; however, these amounts are deferred until the end of the performance measurement periods for the relevant fund.

Total other income for the year-to-date period increased by $54.1 million primarily due to the following:

 

   

A $74.1 million increase in net gains of consolidated Och-Ziff funds. The majority of these net gains are allocated to noncontrolling interests, as we only have minimal ownership interest, if any, in each of these funds. A portion of these net gains is allocated to us as an incentive income allocation; however, these amounts are deferred until the end of the performance measurement periods for the relevant fund.

 

   

A $19.5 million decrease in other income resulting from the change in deferred income of consolidated funds. This change was driven by the increase in income and net gains of consolidated Och-Ziff funds discussed above. We defer our incentive income allocation from these funds until the performance measurement period ends and any incentive income allocated to us is no longer subject to repayment.

Income Taxes

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (dollars in thousands)  

Income taxes

   $ 12,491       $ 9,413       $ 26,895       $ 18,039   

Income tax expense increased by $3.1 million for the quarter-to-date period and $8.9 million for the year-to-date period. The increase in both periods was primarily due to higher profitability and an increase in ownership in the Och-Ziff Operating Group, resulting in an increase in income tax expense of $3.1 million and $5.6 million for the quarter- and year-to-date periods, respectively. An additional increase of $1.2 million for the quarter-to-date period and $3.1 million for the year-to-date period was driven by lower deferred tax assets related to RSU amortization and write-offs of deferred tax assets relating to the vesting of RSUs. Also contributing to the increase for the year-to-date period was a $1.9 million true-up related to the tax treatment of prior net gains on early retirement of debt. These increases were partially offset by a decrease of $1.3 million and $2.2 million for the quarter- and year-to-date periods, respectively, due to lower foreign income taxes.

The Registrant and the Och-Ziff Operating Group entities are partnerships for U.S. federal income tax purposes. Due to our legal structure, only a portion of the income we earn is subject to corporate-level tax rates in the United States and foreign jurisdictions. The provision for income taxes includes federal, state and local income taxes in the United States and foreign income taxes at an effective tax rate of -4.2% and -2.7% for the three months ended June 30, 2012 and 2011, respectively, compared to an effective tax rate of -4.8% and -2.6% for the six months ended June 30, 2012 and 2011, respectively.

 

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The reconciling items between our statutory rate and our effective tax rate were due to the following: (i) a portion of the income we earn is not 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) Reorganization expenses are non-deductible for income tax purposes.

As of and for the three and six months ended June 30, 2012 and 2011, we were not required to establish a liability for uncertain tax positions.

Net Loss Allocated to Noncontrolling Interests

The following table presents the components of the net loss allocated to noncontrolling interests:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Och-Ziff Operating Group A Units

   $ (222,241   $ (269,652   $ (458,649   $ (546,640

Consolidated Och-Ziff funds

     29,333        9,620        104,136        23,482   

Other

     368        1,368        782        2,214   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (192,540   $ (258,664   $ (353,731   $ (520,944
  

 

 

   

 

 

   

 

 

   

 

 

 

The amount of net loss allocated to noncontrolling interests for the quarter-to-date period decreased $66.1 million primarily due to a $47.4 million decrease in the amount of net loss allocated to the Och-Ziff Operating Group A Units and a $19.7 million increase in the amount of net income allocated to the consolidated Och-Ziff funds. The amount of net loss allocated to noncontrolling interests for the year-to-date period decreased $167.2 million primarily due to an $88.0 million decrease in the amount of net loss allocated to the Och-Ziff Operating Group A Units and an $80.7 million increase in the amount of net income allocated to the consolidated Och-Ziff funds.

The decrease in net loss allocated to the Och-Ziff Operating Group A Units was driven by a decrease in the executive managing directors’ and the Ziffs’ interests in the Och-Ziff Operating Group in the form of Och-Ziff Operating Group A Units from 75.6% as of June 30, 2011 to 67.6% as of June 30, 2012. As a result, a larger share of losses of the Och-Ziff Operating Group was allocated to us rather than the Och-Ziff Operating Group A Units. Also contributing to the decrease in net loss allocated to the Och-Ziff Operating Group A Units was higher profitability in the Och-Ziff Operating Group driven by lower operating expenses and higher incentive income as discussed above. The Och-Ziff Operating Group A Units are expected to continue to significantly reduce our net income (loss) in future periods as income (losses) of the Och-Ziff Operating Group are allocated to these interests. The increases in net income allocated to the consolidated Och-Ziff funds was driven primarily by the increase in income and net gains of consolidated Och-Ziff funds discussed above.

Net Loss Allocated to Class A Shareholders

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (dollars in thousands)  

Net Loss Allocated to Class A Shareholders

   $ (116,242   $ (93,362   $ (238,986   $ (188,826

The amount of net loss allocated to Class A Shareholders increased by $22.9 million for the quarter-to-date period and $50.2 million for the year-to-date period, primarily due to an increase in our ownership interest in the Och-Ziff Operating Group. The increase in ownership interest was driven by the 2011 Offering, the issuance of Class A Shares for vested RSUs and the exchange of Och-Ziff Operating Group A Units for Class A Shares. As a result, a larger share of the losses of the Och-Ziff Operating Group was allocated to us. Partially offsetting the increase in net loss allocated to Class A Shareholders was higher profitability in the Och-Ziff Operating Group driven by lower operating expenses and higher incentive income as discussed above.

Economic Income Analysis

In addition to analyzing our results on a GAAP basis, management also reviews our results on an “Economic Income” basis. Economic Income excludes the adjustments described below that are required for presentation of our results on a GAAP basis, but that management does not consider when evaluating operating performance in any given

 

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period. Management, therefore, uses Economic Income as the basis on which it evaluates our financial performance and makes resource allocation and other operating decisions. 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 GAAP basis:

 

   

Income allocations to our executive managing directors 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 2007 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 gains (losses) on investments in Och-Ziff funds, as management does not consider these to be reflective of operating performance.

 

   

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 in relation to total assets under management and fund performance.

In addition, the full amount of deferred cash compensation and expenses related to compensation arrangements based on annual investment performance are recognized on the date they are determined (generally in the fourth quarter of each year), as management determines the total amount of compensation based on our performance in the year of the award.

As a result of the adjustments described above, as well as an adjustment to present management fees net of recurring placement and related service fees (rather than considering these fees an expense), management fees, compensation and benefits, non-compensation expenses and net loss (income) allocated to noncontrolling interests as presented on an Economic Income basis are also non-GAAP measures. No adjustments to the GAAP basis have been made for incentive income, other revenues and net gains (losses) on joint ventures. For reconciliations of our non-GAAP measures to the respective GAAP measures, please see “—Economic Income Reconciliations” following “—Critical Accounting Policies and Estimates” below.

Our non-GAAP financial measures should not be considered as alternatives to our GAAP net loss allocated to Class A Shareholders 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.

We conduct substantially all of our operations through our only reportable segment under GAAP, the Och-Ziff Funds segment, which provides asset management services to our hedge funds and other alternative investment vehicles. Other Operations are primarily comprised of our real estate business, which provides asset management services to our real estate funds.

Economic Income Revenues (Non-GAAP)

 

     Three Months Ended June 30, 2012      Three Months Ended June 30, 2011  
     Och-Ziff
Funds Segment
     Other
Operations
     Total
Company
     Och-Ziff
Funds Segment
     Other
Operations
     Total
Company
 
     (dollars in thousands)  

Economic Income Basis

                 

Management fees

   $ 120,862       $ 2,359       $ 123,221       $ 120,539       $ 4,787       $ 125,326   

Incentive Income

     18,414         —           18,414         6,867         —           6,867   

Other revenues

     217         3         220         590         88         678   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Economic Income Revenues

   $ 139,493       $ 2,362       $ 141,855       $ 127,996       $ 4,875       $ 132,871   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Economic Income revenues for the quarter-to-date period increased $9.0 million due to an $11.5 million increase in incentive income, partially offset by a $2.1 million decrease in management fees. The increase in incentive income was driven primarily by $11.3 million of incentive income recognized in the Och-Ziff Funds segment during the second quarter of 2012 related to assets under management subject to three-year performance measurement periods. The

 

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decrease in management fees was primarily due to a $2.4 million decrease in Other Operations, which was driven by a catch-up in the second quarter of 2011 for additional investors in our second domestic real estate fund. These investors were charged management fees retroactively to the initial closing of the fund.

Our average management fee rate remained at approximately 1.7% in the second quarter of 2012 and 2011.

 

     Six Months Ended June 30, 2012      Six Months Ended June 30, 2011  
     Och-Ziff
Funds  Segment
     Other
Operations
     Total
Company
     Och-Ziff
Funds  Segment
     Other
Operations
     Total
Company
 
     (dollars in thousands)  

Economic Income Basis

                 

Management fees

   $ 236,355       $ 4,746       $ 241,101       $ 234,226       $ 9,073       $ 243,299   

Incentive Income

     19,635         —           19,635         13,833         —           13,833   

Other revenues

     481         103         584         892         144         1,036   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Economic Income Revenues

   $ 256,471       $ 4,849       $ 261,320       $ 248,951       $ 9,217       $ 258,168   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Economic Income revenues for the year-to-date period increased $3.2 million due to increases of $5.8 million in incentive income, partially offset by a $2.2 million decrease in management fees. The increase in incentive income was driven by $11.3 million of incentive income recognized in the second quarter of 2012 related to assets under management subject to three-year performance measurement periods. Partially offsetting this increase was a $6.0 million decrease related to tax distributions taken in 2011 that did not recur in 2012. The decrease in management fees was due to a $4.3 million decrease in Other Operations, which was driven by a catch-up in the first half of 2011 for additional investors in our second domestic real estate fund. These investors were charged management fees retroactively to the initial closing of the fund. These decreases were partially offset by a $2.1 million increase in management fees in the Och-Ziff Funds segment.

Economic Income Expenses (Non-GAAP)

 

     Three Months Ended June 30, 2012      Three Months Ended June 30, 2011  
     Och-Ziff
Funds Segment
     Other
Operations
     Total
Company
     Och-Ziff
Funds Segment
     Other
Operations
     Total
Company
 
     (dollars in thousands)  

Economic Income Basis

                 

Compensation and benefits

   $ 21,058       $ 941       $ 21,999       $ 22,245       $ 1,081       $ 23,326   

Non-compensation expenses

     24,804         375         25,179         21,333         890         22,223   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Economic Income Expenses

   $ 45,862       $ 1,316       $ 47,178       $ 43,578       $ 1,971       $ 45,549   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Economic Income expenses for the quarter-to-date period increased $1.6 million primarily due to the following:

 

   

A $3.0 million increase in non-compensation expenses, as a $3.6 million increase in general, administrative and other expenses, primarily in the Och-Ziff Funds segment, was partially offset by a $631 thousand decrease in interest expense. The ratio of non-compensation expenses to management fees increased from 18% in the second quarter of 2011 to 20% in the second quarter of 2012 as non-compensation expenses increased year-over-year while management fees decreased.

 

   

A $1.3 million decrease in compensation and benefits, primarily in the Och-Ziff Funds segment, which was driven by a $2.5 million decrease in bonus expense, partially offset by an increase of $1.1 million in salaries and benefits. The decline in bonus expense was primarily due to lower guaranteed bonus accruals. The increase in salaries and benefits was due in part to the increase in our worldwide headcount from 421 as of June 30, 2011 to 448 as of June 30, 2012. The ratio of salaries and benefits to management fees increased from 15% in the second quarter of 2011 to 16% in the second quarter of 2012 as salaries and benefits increased year-over-year while management fees decreased.

 

     Six Months Ended June 30, 2012      Six Months Ended June 30, 2011  
     Och-Ziff
Funds  Segment
     Other
Operations
     Total
Company
     Och-Ziff
Funds Segment
     Other
Operations
     Total
Company
 
     (dollars in thousands)  

Economic Income Basis

                 

Compensation and benefits

   $ 40,801       $ 1,917       $ 42,718       $ 44,672       $ 1,836       $ 46,508   

Non-compensation expenses

     46,800         926         47,726         40,971         2,171         43,142   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Economic Income Expenses

   $ 87,601       $ 2,843       $ 90,444       $ 85,643       $ 4,007       $ 89,650   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Economic Income expenses for the year-to-date period increased $794 thousand primarily due to the following:

 

   

A $4.6 million increase in non-compensation expenses, as a $6.0 million increase in general, administrative and other expenses, primarily in the Och-Ziff Funds segment, was partially offset by a $1.4 million decrease in interest expense. The ratio of non-compensation expenses to management fees increased from 18% in the second quarter of 2011 to 20% in the second quarter of 2012 as non-compensation expenses increased year-over-year while management fees decreased.

 

   

A $3.8 million decrease in compensation and benefits, primarily in the Och-Ziff Funds segment, which was driven by a $6.7 million decrease in bonus expense, partially offset by an increase of $2.9 million in salaries and benefits. The decline in bonus expense was primarily due to lower guaranteed bonus accruals. The increase in salaries and benefits was due in part to the increase in our worldwide headcount. The ratio of salaries and benefits to management fees increased from 15% in the first half of 2011 to 16% in the first half of 2012 as salaries and benefits increased year-over-year while management fees decreased.

Other Economic Income Items (Non-GAAP)

 

     Three Months Ended June 30, 2012     Three Months Ended June 30, 2011  
     Och-Ziff
Funds Segment
    Other
Operations
    Total
Company
    Och-Ziff
Funds Segment
     Other
Operations
    Total
Company
 
     (dollars in thousands)  

Economic Income Basis

             

Net gains (losses) on joint ventures

   $ (383   $ —        $ (383   $