10-Q 1 d10q.htm FORM 10-Q Form 10-Q
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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 September 30, 2010

OR

 

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

Commission File Number 1-33805

OCH-ZIFF CAPITAL MANAGEMENT

GROUP LLC

(Exact Name of Registrant as Specified in its Charter)

 

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

9 West 57th Street, New York, New York, 10019

(Address of Principal Executive Offices)

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

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

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

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

 

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

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

As of October 31, 2010, there were 90,757,461 Class A Shares and 274,666,921 Class B Shares outstanding.

 

 

 


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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

TABLE OF CONTENTS

 

          Page  

PART I — FINANCIAL INFORMATION

  
Item 1.    Financial Statements (Unaudited)      2   
   Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009      2   
   Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009      3   
   Consolidated Statement of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2010      4   
   Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009      5   
   Notes to Consolidated Financial Statements      6   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      25   
Item 3.    Quantitative and Qualitative Disclosures about Market Risk      49   
Item 4.    Controls and Procedures      50   
PART II — OTHER INFORMATION   
Item 1.    Legal Proceedings      52   
Item 1A.    Risk Factors      52   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      52   
Item 3.    Defaults upon Senior Securities      52   
Item 4.    [Reserved]      52   
Item 5.    Other Information      52   
Item 6.    Exhibits      52   

Signatures

     53   

 

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In this quarterly report, references to “Och-Ziff,” “our Company,” “the Company,” “we,” “us,” or “our” refer, unless context requires otherwise, to Och-Ziff Capital Management Group LLC, a Delaware limited liability company, and its consolidated subsidiaries, including the Och-Ziff Operating Group. References to the “Och-Ziff Operating Group” refer, collectively, to OZ Management LP, a Delaware limited partnership, which we refer to as “OZ Management,” OZ Advisors LP, a Delaware limited partnership, which we refer to as “OZ Advisors I,” OZ Advisors II LP, a Delaware limited partnership, which we refer to as “OZ Advisors II,” and their consolidated subsidiaries. References to our “intermediate holding companies” refer, collectively, to Och-Ziff Holding Corporation, a Delaware corporation, which we refer to as “Och-Ziff Corp,” and Och-Ziff Holding LLC, a Delaware limited liability company, which we refer to as “Och-Ziff Holding,” both of which are wholly-owned subsidiaries of Och-Ziff Capital Management Group LLC. References to our “partners” refer to the current limited partners of the Och-Ziff Operating Group entities other than the Ziffs and our intermediate holding companies, including our founder, Mr. Daniel S. Och, except where the context requires otherwise. References to the “Ziffs” refer collectively to Ziff Investors Partnership, L.P. II, Ziff Investors Partnership, L.P. II A and certain of its affiliates and control persons, which, together with Mr. Och, founded our business in 1994. References to “Class A Shares” refer to our Class A Shares, representing Class A limited liability company interests of Och-Ziff Capital Management Group LLC, which are publicly traded and listed on the New York Stock Exchange. References to “Class B Shares” refer to Class B Shares of Och-Ziff Capital Management Group LLC, which are not publicly traded, are currently held solely by our partners and have no economic rights but entitle the holders thereof to one vote per share together with the holders of our Class A Shares. References to our “IPO” refer to our initial public offering of 36.0 million Class A Shares that occurred in November 2007. References to the “Offerings” refer collectively to our IPO and the concurrent private offering of approximately 38.1 million Class A Shares to DIC Sahir Limited, a wholly-owned subsidiary of Dubai International Capital LLC.

Forward-Looking Statements

Some of the statements under “Part 1–Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II–Item 1A. Risk Factors” and elsewhere in this quarterly report may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to as the “Securities Act,” and Section 21E of the Securities Exchange Act of 1934, as amended, which we refer to as the “Exchange Act,” that reflect our current views with respect to, among other things, future events and financial performance, strategies and expectations, including but not limited to statements regarding our financial performance and results, including our ability to increase assets under management, generate positive returns, preserve capital, identify investment opportunities and enhance our investment platforms. We generally identify forward-looking statements by terminology such as “outlook,” “believe,” “expect,” “potential,” “continue,” “may,” “will,” “should,” “could,” “seek,” “approximately,” “predict,” “intend,” “plan,” “estimate,” “anticipate,” “opportunity,” “pipeline,” “comfortable,” “assume,” “remain,” “maintain,” “sustain,” “achieve” or the negative version of those words or other comparable words.

Any forward-looking statements contained in this quarterly report are based upon historical information and on our current plans, estimates and expectations. The inclusion of this or any other forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Such forward-looking statements are subject to various risks and uncertainties and assumptions, including but not limited to global economic, business and market conditions, the conditions impacting the hedge fund industry, our ability to successfully compete for fund investors, professional investment talent and investment opportunities, our successful formulation and execution of business and growth strategies, our ability to appropriately manage conflicts of interest and tax and other regulatory factors relevant to our business, as well as assumptions relating to our operations, financial results, financial condition, business prospects, growth strategy and liquidity.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from those indicated in these statements. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this quarterly report. The most significant of these risks, uncertainties and other factors are described in our annual report on Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission on March 4, 2010, including the factors described in “Item 1A. Risk Factors.” Other risks may be described from time to time in our news releases and other filings made under the securities laws, including our quarterly reports on Form 10-Q and our current reports on Form 8-K. There may be additional risks, uncertainties and factors that we do not currently view as material or that are not known. The forward-looking statements included in this document are made only as of the date of this document and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED BALANCE SHEETS — UNAUDITED

 

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

Assets

    

Cash and cash equivalents

   $ 127,502      $ 73,732   

Income and fees receivable

     25,046        368,300   

Due from related parties

     2,835        1,934   

Deferred balances, at fair value

     2,917        404,666   

Deferred income tax assets

     985,360        953,604   

Other assets, net (includes investments in Och-Ziff Funds of $1,938 and $10,889, respectively)

     89,120        103,584   

Assets of consolidated Och-Ziff funds:

    

Investments, at fair value

     370,559        300,231   

Other assets of Och-Ziff funds

     7,283        373   
                

Total Assets

   $ 1,610,622      $ 2,206,424   
                

Liabilities and Shareholders’ Equity

    

Liabilities

    

Due to related parties

   $ 795,724      $ 1,166,295   

Debt obligations

     641,362        652,414   

Compensation payable

     12,048        143,780   

Profit sharing payable

     108        11,047   

Other liabilities

     46,484        43,178   

Liabilities of consolidated Och-Ziff funds:

    

Other liabilities of Och-Ziff funds

     44        29   
                

Total Liabilities

     1,495,770        2,016,743   
                

Commitments and Contingencies (Note 12)

    

Shareholders’ Equity

    

Class A Shares, no par value, 1,000,000,000 shares authorized, 90,525,165 and 81,823,915 shares issued and outstanding as of September 30, 2010 and December 31, 2009, respectively

     —          —     

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

     —          —     

Paid-in capital

     1,806,494        1,505,496   

Retained deficit

     (2,218,284     (1,879,761

Accumulated other comprehensive loss

     (51     (47
                

Shareholders’ deficit attributable to Class A shareholders

     (411,841     (374,312

Partners’ and others’ interests in consolidated subsidiaries

     526,693        563,993   
                

Total Shareholders’ Equity

     114,852        189,681   
                

Total Liabilities and Shareholders’ Equity

   $ 1,610,622      $ 2,206,424   
                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED

 

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

Revenues

        

Management fees

   $ 110,035      $ 88,127      $ 321,991      $ 268,598   

Incentive income

     5,561        3,071        11,283        3,336   

Other revenues

     401        355        1,512        908   

Income of consolidated Och-Ziff funds

     6,473        10,127        21,043        21,629   
                                

Total Revenues

     122,470        101,680        355,829        294,471   
                                

Expenses

        

Compensation and benefits

     59,186        64,074        164,107        191,975   

Allocations to non-equity partner interests

     —          8,052        —          12,627   

Reorganization expenses

     411,828        417,486        1,248,423        1,262,171   

Profit sharing

     —          663        —          954   

Interest expense

     1,916        2,168        5,809        10,823   

General, administrative and other

     23,994        40,687        70,124        84,069   

Expenses of consolidated Och-Ziff funds

     1,540        880        6,919        2,776   
                                

Total Expenses

     498,464        534,010        1,495,382        1,565,395   
                                

Other Income

        

Net earnings on deferred balances

     —          20,840        —          24,270   

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

     453        730        (96     1,036   

Net gain on early retirement of debt

     —          —          —          2,013   

Net gains (losses) of consolidated Och-Ziff funds

     4,767        (47     27,109        (145
                                

Total Other Income

     5,220        21,523        27,013        27,174   
                                

Loss Before Income Taxes

     (370,774     (410,807     (1,112,540     (1,243,750

Income taxes

     7,054        (20,889     23,597        (17,611
                                

Consolidated Net Loss

   $ (377,828   $ (389,918   $ (1,136,137   $ (1,226,139
                                

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

   $ (284,298   $ (309,891   $ (864,547   $ (975,945
                                

Net Loss Allocated to Class A Shareholders

   $ (93,530   $ (80,027   $ (271,590   $ (250,194
                                

Net Loss Per Class A Share

        

Basic

   $ (1.04   $ (1.02   $ (3.16   $ (3.23
                                

Diluted

   $ (1.05   $ (1.06   $ (3.16   $ (3.25
                                

Weighted-Average Class A Shares Outstanding

        

Basic

     89,862,493        78,818,314        86,027,375        77,398,416   
                                

Diluted

     392,799,640        387,874,793        86,027,375        387,719,637   
                                

Dividends Paid per Class A Share

   $ 0.11      $ 0.02      $ 0.78      $ 0.12   
                                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY — UNAUDITED

 

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

As of December 31, 2009

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

Capital contributions

     —           —          —           —          —          124,772        124,772   

Capital distributions

     —           —          —           —          —          (371,791     (371,791

Cash dividends declared on Class A Shares

     —           —          —           (64,810     —          —          (64,810

Dividend equivalents on Class A restricted share units

     —           —          2,123         (2,123     —          (a     —     

Equity-based compensation

     2,010,507         —          16,478         —          —          66,036        82,514   

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

     6,690,743         (3,279,605     2,961         —          —          23,159        26,120   

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

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

Impact of amortization of Reorganization charges to capital

     —           —          277,056         —          —          971,367        1,248,423   

Comprehensive loss:

                

Consolidated net loss

     —           —          —           (271,590     —          (864,547     (1,136,137

Foreign currency translation adjustment

     —           —          —           —          (4     (14     (18
                      

Total comprehensive loss

                   (1,136,155
                                                          

As of September 30, 2010

     90,525,165         274,666,921      $ 1,806,494       $ (2,218,284   $ (51   $ 526,693      $ 114,852   
                                                          

 

(a) The dividend equivalents on Class A restricted share units impacted partners’ and others’ interests in consolidated subsidiaries by increasing the paid-in capital component and increasing the retained deficit component of partners’ and others’ interests in consolidated subsidiaries each by $9.9 million.

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED

 

     Nine Months Ended September 30,  
     2010     2009  
     (dollars in thousands)  

Cash Flows from Operating Activities

    

Consolidated net loss

   $ (1,136,137   $ (1,226,139

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

    

Reorganization expenses

     1,248,423        1,262,171   

Amortization of equity-based compensation

     92,028        86,069   

Amortization of deferred compensation

     —          5,470   

Depreciation, amortization and loss on sale of fixed assets

     6,893        6,272   

Net gain on early retirement of debt

     —          (2,013

Deferred income taxes

     9,601        (25,235

Operating cash flows due to changes in:

    

Income and fees receivable

     343,254        10,385   

Due from related parties

     (901     469   

Deferred balances, at fair value

     232,097        183,734   

Other assets, net

     7,254        35,370   

Assets of consolidated Och-Ziff funds

     (77,238     (75,430

Due to related parties

     (81,436     (44,302

Compensation payable

     (131,732     41,987   

Profit sharing payable

     (5,770     (5,654

Other liabilities

     3,365        (7,418

Liabilities of consolidated Och-Ziff funds

     15        16   
                

Net Cash Provided by Operating Activities

     509,716        245,752   
                

Cash Flows from Investing Activities

    

Loan to joint venture partners

     —          (2,351

Repayment of loan to joint venture partners

     250        —     

Investments in joint ventures

     (3,768     (4,808

Return of investments in joint ventures

     2,043        3,730   

Collateral deposit on aircraft loan

     —          (2,009

Proceeds from sales of fixed assets

     14        —     

Purchases of fixed assets

     (285     (1,123
                

Net Cash Used in Investing Activities

     (1,746     (6,561
                

Cash Flows from Financing Activities

    

Withholding taxes paid on vested Class A restricted share units

     (9,753     (649

Repayments of debt obligations

     (9,026     (8,587

Och-Ziff Operating Group capital distributions declared prior to Reorganization

     (129,470     (122,422

Dividends on Class A Shares

     (64,810     (9,203

Partners’ and others’ interests in consolidated subsidiaries contributions

     124,772        88,456   

Partners’ and others’ interests in consolidated subsidiaries distributions

     (365,913     (83,700
                

Net Cash Used in Financing Activities

     (454,200     (136,105
                

Net Increase in Cash and Cash Equivalents

     53,770        103,086   

Cash and Cash Equivalents, Beginning of Period

     73,732        81,403   
                

Cash and Cash Equivalents, End of Period

   $ 127,502      $ 184,489   
                

Supplemental Disclosure of Cash Flow Information

    

Cash paid (received) during the period:

    

Interest

   $ 5,347      $ 10,307   
                

Income taxes

   $ 21,081      $ (5,833
                

Non-cash transactions:

    

In-kind distribution of deferred balances

   $ 169,652      $ —     
                

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

   $ 2,026      $ —     
                

See notes to consolidated financial statements.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

1. BUSINESS

Och-Ziff Capital Management Group LLC (the “Registrant”), a Delaware limited liability company, together with its consolidated subsidiaries (collectively, the “Company”), is a global alternative asset management firm with offices in New York, London, Hong Kong, Mumbai and Beijing. The Company provides investment management and advisory services 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 risk-adjusted returns throughout market cycles with minimal use of leverage.

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

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

The Company generates substantially all of its revenues in the United States. The liability of the Company’s Class A shareholders is limited to the extent of their capital contributions.

References to the Company’s “partners” refer to the current limited partners of OZ Management LP, OZ Advisors LP and OZ Advisors II LP (collectively, the “Och-Ziff Operating Group”), other than Ziff Investors Partnership, L.P. II and certain of its affiliates and control persons (collectively, the “Ziffs”) and the Company’s intermediate holding companies, including the Company’s founder, Mr. Daniel S. Och, except where the context requires otherwise. The Company conducts substantially all of its operations through the Och-Ziff Operating Group.

On November 19, 2007, the Company completed its initial public offering (“IPO”) of 36.0 million Class A Shares and a private offering of approximately 38.1 million Class A Shares to DIC Sahir, a wholly-owned subsidiary of Dubai International Capital LLC (collectively, the “Offerings”). The Company used the net proceeds from the Offerings to acquire a 19.2% interest in the Och-Ziff Operating Group from the partners at the time of the IPO and the Ziffs, who collectively held all of the interests in the Och-Ziff Operating Group prior to the Offerings. As of September 30, 2010, the Company’s interest in the Och-Ziff Operating Group had increased to approximately 23.0%.

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

2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

These unaudited, interim, consolidated financial statements are prepared in accordance with U.S. GAAP and should be read in conjunction with the audited financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2009. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company’s unaudited, interim, consolidated financial statements have been included and are of a normal and recurring nature. The results of operations presented for the interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year, primarily as a result of incentive income being recorded in the fourth quarter each year. All significant intercompany transactions and balances have been eliminated in consolidation.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

Recently Adopted Accounting Pronouncements

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

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

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

In June 2009, the FASB issued amended guidance on accounting for transfers of financial assets (originally issued as SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140, and subsequently reissued as ASU 2009-16, Accounting for Transfers of Financial Assets). The amendments were issued to improve the information that a reporting entity provides in its financial statements about transfers of financial assets, the effects of transfers on its financial statements and a transferor’s continuing involvement, if any, in transferred financial assets. The amendments eliminate the concept of qualifying special purpose entities from U.S. GAAP. These entities will now be evaluated for consolidation in accordance with the applicable consolidation criteria. The amendments are effective for reporting periods beginning on or after November 15, 2009. The adoption of ASU 2009-16 did not have any impact on the Company’s financial position or results of operations.

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

Future Adoption of Accounting Pronouncements

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

3. OCH-ZIFF OPERATING GROUP OWNERSHIP

The Company’s ownership percentage in the Och-Ziff Operating Group increased to 23.0% as of September 30, 2010 from 20.9% as of December 31, 2009 and 19.2% at the time of the Offerings. The increase in the Company’s ownership percentage in the Och-Ziff Operating Group was driven by the following: (i) the exchange of 6,690,743 Och-Ziff Operating Group A Units for an equal number of Class A Shares; (ii) 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”); and (iii) the forfeiture of a portion of Och-Ziff Operating Group A Units by former partners that were subsequently reallocated as non-equity profits interests to certain other partners. The Company’s interest in the Och-Ziff Operating Group is expected to continue to increase over time as additional Class A Shares are issued, primarily upon the vesting of RSUs or exchanges of Och-Ziff Operating Group A Units.

Och-Ziff Operating Group A Unit Transactions

In connection with the exchange of Och-Ziff Operating Group A Units for Class A Shares and the forfeiture of a portion of Och-Ziff Operating Group A Units by former partners that were subsequently reallocated as non-equity profits interests to certain other partners, the Company recorded the following changes to shareholders’ equity for the nine months ended September 30, 2010:

 

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

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

   $ 10,430      $ 15,690   

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

    

Exchange of Och-Ziff Operating Group A Units

     (7,450     7,450   

Forfeiture of Och-Ziff Operating Group A Units subsequently reallocated as non-equity profits interests

     (19     19   
                
   $ 2,961      $ 23,159   
                

Vesting of Class A Restricted Share Units

In connection with the issuance of Class A Shares related to the vesting of RSUs, the Company reallocated $1.9 million of deficit capital from partners’ and others’ interests in consolidated subsidiaries to the Company’s paid-in capital in the nine months ended September 30, 2010.

4. FAIR VALUE DISCLOSURES

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

 

   

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

   

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

 

   

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

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

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

 

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

As of September 30, 2010

  

Investments, at fair value:

           

Domestic real estate investments

   $ —         $ —         $ 324,902       $ 324,902   

Other investments

     —           —           45,657         45,657   
                                   

Total Investments, at Fair Value

   $ —         $ —         $ 370,559       $ 370,559   
                                   

Deferred Balances, at Fair Value

   $ —         $ —         $ 2,917       $ 2,917   
                                   

As of December 31, 2009

  

Investments, at fair value:

           

Domestic real estate investments

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

Other investments

     —           —           14,487         14,487   
                                   

Total Investments, at Fair Value

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

Deferred Balances, at Fair Value

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

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

Deferred balances are made up of deferred incentive income receivable from the Company’s offshore funds. Deferred balances are valued based on net asset value information provided by the Och-Ziff funds. The investments within these funds are carried at fair value and are categorized as Level I, II, and III financial instruments, as appropriate.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

 

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

As of June 30, 2010

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

Net gains of consolidated Och-Ziff funds

     —          4,767         4,767   

Collection of deferred balances

     (544     —           (544

Investment purchases, net

     —          19,389         19,389   
                         

As of September 30, 2010

   $ 2,917      $ 370,559       $ 373,476   
                         

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

       

Net gains of consolidated Och-Ziff funds

   $ —        $ 4,539       $ 4,539   
                         

Total

   $ —        $ 4,539       $ 4,539   
                         

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

 

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

As of June 30, 2009

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

Net earnings on deferred balances

     20,840         —          20,840   

Net losses of consolidated Och-Ziff funds

     —           (47     (47

Investment purchases, net

     —           39,560        39,560   
                         

As of September 30, 2009

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

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

       

Net earnings on deferred balances

   $ 20,840       $ —        $ 20,840   

Net losses of consolidated Och-Ziff funds

     —           (47     (47
                         

Total

   $ 20,840       $ (47   $ 20,793   
                         

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

 

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

As of December 31, 2009

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

Net gains of consolidated Och-Ziff funds

     —          27,109         27,109   

Collection of deferred balances

     (401,749     —           (401,749

Investment purchases, net

     —          43,219         43,219   
                         

As of September 30, 2010

   $ 2,917      $ 370,559       $ 373,476   
                         

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

       

Net gains of consolidated Och-Ziff funds

   $ —        $ 23,915       $ 23,915   
                         

Total

   $ —        $ 23,915       $ 23,915   
                         

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

 

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

As of December 31, 2008

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

Net earnings on deferred balances

     24,270        —          24,270   

Net losses of consolidated Och-Ziff funds

     —          (145     (145

Collection of deferred balances

     (208,002     —          (208,002

Investment purchases, net

     —          76,035        76,035   
                        

As of September 30, 2009

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

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

      

Net earnings on deferred balances

   $ 24,270      $ —        $ 24,270   

Net losses of consolidated Och-Ziff funds

     —          (145     (145
                        

Total

   $ 24,270      $ (145   $ 24,125   
                        

Management estimates that the fair value of its term loan is approximately 85% of its carrying value as of September 30, 2010 based on an analysis of comparable issuers. Management believes that the carrying values of all other financial instruments presented on the consolidated balance sheets approximate their fair values.

5. VARIABLE INTEREST ENTITIES

In the ordinary course of business, the Company sponsors the formation of various entities considered to be VIEs. These VIEs are primarily funds in which the Company serves as the general partner or the investment manager with decision making rights. VIEs consolidated by the Company are primarily funds in which kick-out or liquidation rights, if any, were deemed not to be substantive.

The Company’s involvement with funds that are VIEs and not consolidated is limited to providing investment management services. The Company’s exposure to loss from these entities is limited to a decrease in the management fees and incentive income that may be earned in future periods. The net assets of these VIEs were $25.3 billion and $22.2 billion as of September 30, 2010 and December 31, 2009, respectively. The Company does not provide, nor is it required to provide, any type of financial or other support to these entities.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

The Company’s variable interests in funds determined to be VIEs that are not consolidated relate primarily to management fees and incentive income earned from those VIEs. As of September 30, 2010 and December 31, 2009, the only assets related to these variable interests amounted to $13.9 million and $251.4 million, respectively, which are included within income and fees receivable in the Company’s consolidated balance sheets.

In addition, the Company holds variable interests in certain joint ventures determined to be VIEs. The Company’s exposure to loss for these joint ventures is limited to its investments in these entities, which totaled $5.1 million and $3.8 million as of September 30, 2010 and December 31, 2009, 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.

As substantially all of the funds managed by the Company qualify for the deferral under ASU 2010-10, the Company’s determination of whether it is the primary beneficiary of a VIE is generally based on an analysis of which variable interest holder of a VIE is exposed to the majority of the expected losses or receives a majority of the expected residual returns. Fund investors are entitled to all of the economics of these VIEs with the exception of the management fee (generally 1.5% to 2.5% annually of assets under management) and incentive income (generally 20% of net appreciation in a given year), if any, earned by the Company. Accordingly, the Company’s determination of the primary beneficiary is not impacted by changes in the underlying assumptions made regarding future results or expected cash flows of these VIEs.

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

 

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

Assets

     

Assets of consolidated Och-Ziff funds:

     

Investments, at fair value

   $ 86,984       $ 51,394   

Other assets of consolidated Och-Ziff funds

     6,732         1,713   
                 

Total Assets

   $ 93,716       $ 53,107   
                 

Liabilities

     

Liabilities of consolidated Och-Ziff funds:

     

Other liabilities of consolidated Och-Ziff funds

   $ 44       $ 30   
                 

Total Liabilities

   $ 44       $ 30   
                 

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

6. OTHER ASSETS AND OTHER LIABILITIES

Other Assets, Net

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

 

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

Fixed Assets:

  

Corporate aircraft

   $ 22,600      $ 22,600   

Leasehold improvements

     20,554        20,736   

Computer hardware and software

     17,174        17,579   

Furniture, fixtures and equipment

     2,977        3,046   

Accumulated depreciation and amortization

     (30,597     (25,192
                

Fixed assets, net

     32,708        38,769   

Goodwill

     22,691        22,691   

Current income tax receivable

     6,860        484   

Investments in joint ventures

     5,100        3,799   

Intangible assets, net

     4,546        5,106   

Prepaid expenses

     4,103        9,273   

Refundable security deposits

     3,740        6,785   

Investments in Och-Ziff funds

     1,938        10,889   

Other

     7,434        5,788   
                

Total Other Assets, Net

   $ 89,120      $ 103,584   
                

Other Liabilities

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

 

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

Unearned revenues

   $ 18,909       $ 12,876   

Deferred rent credit

     12,816         10,887   

Current income taxes payable

     4,477         5,070   

Deferred income tax liabilities

     3,656         9,590   

Other

     6,626         4,755   
                 

Total Other Liabilities

   $ 46,484       $ 43,178   
                 

7. DEBT OBLIGATIONS

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

Borrowings under the credit facility are recorded as liabilities by the investment subsidiaries of the funds using the facility. In accordance with U.S. GAAP, investment subsidiaries of the Company’s consolidated funds are generally not consolidated, but are carried at fair value within other investments, at fair value in the Company’s consolidated balance sheets. Accordingly, such borrowings are not included within debt obligations in the Company’s consolidated balance sheets. As of September 30, 2010, there was $8.4 million in outstanding borrowings under the facility.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

8. GENERAL, ADMINISTRATIVE AND OTHER

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010     2009      2010     2009  
     (dollars in thousands)  

Occupancy and equipment

   $ 7,117      $ 7,214       $ 21,674      $ 20,960   

Professional services

     5,418        3,998         15,533        13,699   

Information processing and communications

     3,532        3,403         10,222        10,291   

Insurance

     1,958        3,238         5,861        9,584   

Business development

     1,429        1,492         5,579        4,960   

Other expenses

     4,565        4,425         11,420        8,442   
                                 
     24,019        23,770         70,289        67,936   

Changes in tax receivable agreement liability

     (25     16,917         (165     16,133   
                                 

Total General, Administrative and Other

   $ 23,994      $ 40,687       $ 70,124      $ 84,069   
                                 

9. 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. In addition, 960,451 and 299,272 RSUs that have vested but have not been settled in Class A Shares as of September 30, 2010 and 2009, respectively, are included in weighted-average Class A Shares outstanding in the calculation of basic and diluted net loss per Class A Share.

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

 

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

Three Months Ended September 30, 2010

         

Basic

   $ (93,530     89,862,493       $ (1.04  
                           

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     (318,809     302,937,147           —     

Class A Restricted Share Units

     —          —             13,698,490   
                           

Diluted

   $ (412,339     392,799,640       $ (1.05  
                           

Three Months Ended September 30, 2009

         

Basic

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

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     (330,405     309,056,479           —     

Class A Restricted Share Units

     —          —             15,973,252   
                           

Diluted

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

 

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

Nine Months Ended September 30, 2010

         

Basic

   $ (271,590     86,027,375       $ (3.16  
                           

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

     —          —             302,345,381   

Class A Restricted Share Units

     —          —             13,698,490   
                           

Diluted

   $ (271,590     86,027,375       $ (3.16  
                           

Nine Months Ended September 30, 2009

         

Basic

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

Effect of dilutive securities:

         

Och-Ziff Operating Group A Units

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

Class A Restricted Share Units

     —          —             15,973,252   
                           

Diluted

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

10. INCOME TAXES

The computation of the effective tax rate and provision at each interim period requires the use of certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent differences, and the likelihood of recovering deferred tax assets existing as of September 30, 2010. The estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as tax laws and regulations change. Additionally, the Company does not record incentive income in its interim financial statements, other than incentive income resulting from investor redemptions during the period. Accordingly, the effective tax rate for interim periods is not indicative of the tax rate expected for a full year.

The Registrant and each of the Och-Ziff Operating Group entities are partnerships for U.S. federal income tax purposes. As a result of the Company’s legal structure, only a portion of the income earned by the Company is subject to corporate-level tax rates in the United States and in foreign jurisdictions. The provision for income taxes includes federal, state and local taxes in the United States and foreign taxes at an approximate effective tax rate of -1.9% and 5.1% for the three months ended September 30, 2010 and 2009, respectively, and -2.1% and 1.4% for the nine months ended September 30, 2010 and 2009, respectively. The reconciling items from the Company’s statutory rate to the effective tax rate were driven primarily by the following: (i) a portion of the income earned by the Company is 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 partners’ and the Ziffs’ interests as Och-Ziff Operating Group A Units are not deductible for tax purposes.

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

11. RELATED PARTY TRANSACTIONS

Due to Related Parties

The following table presents the amounts included within due to related parties:

 

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

Amounts payable under tax receivable agreement

   $ 790,184       $ 785,530   

Och-Ziff Operating Group distributions declared prior to Reorganization

     1,621         248,111   

Allocations to non-equity partner interests payable

     3,919         132,654   
                 

Total Due To Related Parties

   $ 795,724       $ 1,166,295   
                 

As of September 30, 2010 and December 31, 2009, the amounts presented above relating to (i) Och-Ziff Operating Group distributions declared prior to the Reorganization, where Mr. Och’s distributions were treated as equity distributions, and (ii) allocations to non-equity partner interests payable, where the other partners’ distributions prior to the Reorganization were treated as operating expenses, each represent the deferred balances payable to the Company’s partners, net of taxes. These balances relate to incentive income allocated to the partners and the Ziffs prior to the Offerings and are adjusted each period for earnings and losses on deferred balances, net of taxes.

Management Fees and Incentive Income Earned from Och-Ziff Funds

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010      2009      2010      2009  
     (dollars in thousands)  

Management fees

   $ 106,253       $ 85,172       $ 312,533       $ 260,108   

Incentive income

   $ 5,561       $ 3,071       $ 11,283       $ 3,336   

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

Management Fees and Incentive Income Earned from Affiliates and Waived Fees

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010      2009      2010      2009  
     (dollars in thousands)  

Fees charged on investments held by related parties:

           

Management fees

   $ 4,996       $ 4,562       $ 15,674       $ 15,334   

Incentive income

   $ 220       $ —         $ 831       $ —     

Fees waived on investments held by related parties:

           

Management fees

   $ 3,146       $ 3,611       $ 9,562       $ 10,272   

Corporate Aircraft

The Company’s corporate aircraft is used primarily for business purposes. From time to time, Mr. Och uses the aircraft for personal use. The Company recorded revenues of $101 thousand and $186 thousand for Mr. Och’s personal use of the corporate aircraft based on market rates for the use of a private aircraft for the three months ended September 30, 2010 and 2009, respectively and $407 thousand and $386 thousand for the nine months ended September 30, 2010 and 2009, respectively.

12. COMMITMENTS AND CONTINGENCIES

Tax Receivable Agreement

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

The Company recorded its initial estimate of future payments under the tax receivable agreement by recording a decrease to paid-in capital and an increase in amounts due to 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 operations.

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

The estimate of the timing and the amount of future payments under the tax receivable agreement involves several assumptions that do not account for the significant uncertainties associated with these potential payments, including an assumption that Och-Ziff Holding

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

Corporation, a wholly-owned corporate-tax paying subsidiary of the Company, will have sufficient taxable income in the relevant tax years to utilize the tax benefits that would give rise to an obligation to make payments. The actual timing and amount of any actual payments under the tax receivable agreement will vary based upon these and a number of other factors.

Lease Obligations

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

Litigation

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

Investment Commitments

As of September 30, 2010, an Och-Ziff fund consolidated by the Company had a commitment to fund investments in an amount of up to $167.1 million. This commitment will be funded through contributions from investors in the consolidated fund, as the Company is only the investment manager and not an investor in the fund. The Company expects this commitment to be funded over the next 4 years.

The Company has committed to fund a portion of the annual operating budget for a joint venture, and this portion currently totals approximately $4.7 million for 2010, of which $3.5 million has been funded through September 30, 2010. The joint venture periodically returns substantially all of the cash that is contributed by the Company, as expenses incurred by the joint venture are generally reimbursed by the projects it manages.

Other Contingencies

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

13. SEGMENT INFORMATION

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

The Company’s Other Operations are currently comprised of its real estate business, which manages and provides advisory services to the Company’s real estate funds, and investments in new businesses established to expand the Company’s private investment platforms. The businesses and investments included in the Company’s Other Operations do not meet the thresholds of reportable business segments under U.S. GAAP.

Management does not regularly review assets by operating segment in assessing operating segment performance and the allocation of company resources; therefore, the Company does not present total assets by operating segment.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

Och-Ziff Funds Segment

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

 

   

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

 

   

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

 

   

recognizes the full amount of deferred cash compensation and expenses related to compensation arrangements indexed to annual investment performance on the date they are determined (generally in the fourth quarter of each year), irrespective of any requisite service period or deferral; and

 

   

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

See the footnotes that follow the reconciliation tables below for additional information regarding the adjustments made to arrive at Economic Income of the Och-Ziff Funds segment.

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010     2009      2010     2009  
     (dollars in thousands)  

Economic Income Revenues

         

Management fees

   $ 105,538      $ 86,262       $ 312,147      $ 263,209   

Incentive income

     5,561        3,071         11,283        3,336   

Other revenues

     298        268         1,030        713   
                                 

Total Economic Income Revenues

     111,397        89,601         324,460        267,258   
                                 

Economic Income Expenses

         

Compensation and benefits

     18,634        23,539         53,404        86,502   

Non-compensation expenses

     20,317        22,255         61,652        68,149   
                                 

Total Economic Income Expenses

     38,951        45,794         115,056        154,651   
                                 

Net losses on joint ventures

     (68     —           (303     —     
                                 

Economic Income

   $ 72,378      $ 43,807       $ 209,101      $ 112,607   
                                 

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

 

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

Revenues

          

Management fees

   $ 105,538      $ 1,898      $ (60   $ 2,659 (a)    $ 110,035   

Incentive income

     5,561        —          —          —          5,561   

Other revenues

     298        103        —          —          401   

Income of consolidated Och-Ziff funds

     —          6,473        —          —          6,473   
                                        

Total Revenues

     111,397        8,474        (60     2,659        122,470   
                                        

Expenses

          

Compensation and benefits

     18,634        9,188        —          31,364 (b)(c)      59,186   

Allocations to non-equity partner interests

     —          —          —          —          —     

Reorganization expenses

     —          —          —          411,828 (e)      411,828   

Profit sharing

     —          —          —          —          —     

Interest expense

     1,916        —          —          —          1,916   

General, administrative and other

     18,401        827        —          4,766 (a)(g)      23,994   

Expenses of consolidated Och-Ziff funds

     —          1,505        35        —          1,540   
                                        

Total Expenses

     38,951        11,520        35        447,958        498,464   
                                        

Other Income (Loss)

          

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

     (68     (21     —          542 (h)      453   

Net gains of consolidated Och-Ziff funds

     —          4,233        534        —          4,767   
                                        

Total Other Income (Loss)

     (68     4,212        534        542        5,220   
                                        

Income (Loss) Before Income Taxes

     72,378        1,166        439        (444,757     (370,774

Income taxes

     —          (367     —          7,421 (g)      7,054   
                                        

Consolidated Net Income (Loss)

   $ 72,378      $ 1,533      $ 439      $ (452,178   $ (377,828
                                        

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

   $ —        $ 9,417      $ 439      $ (294,154 )(g)    $ (284,298
                                        

Net Income (Loss) Allocated to Class A Shareholders

   $ 72,378      $ (7,884   $ —        $ (158,024   $ (93,530
                                        

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

Revenues

           

Management fees

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

Incentive income

     3,071         —          —          —          3,071   

Other revenues

     268         87        —          —          355   

Income of consolidated Och-Ziff funds

     —           10,127        —          —          10,127   
                                         

Total Revenues

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

Expenses

           

Compensation and benefits

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

Allocations to non-equity partner interests

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

Reorganization expenses

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

Profit sharing

     —           —          —          663 (f)      663   

Interest expense

     2,168         —          —          —          2,168   

General, administrative and other

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

Expenses of consolidated Och-Ziff funds

     —           869        11        —          880   
                                         

Total Expenses

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

Other Income (Loss)

           

Net earnings on deferred balances

     —           —          —          20,840 (h)      20,840   

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

     —           (244     —          974 (h)      730   

Net gains (losses) of consolidated Och-Ziff funds

     —           10        (57     —          (47
                                         

Total Other Income (Loss)

     —           (234     (57     21,814        21,523   
                                         

Income (Loss) Before Income Taxes

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

Income taxes

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

Consolidated Net Income (Loss)

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

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

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

Net Income (Loss) Allocated to Class A Shareholders

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

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

Revenues

          

Management fees

   $ 312,147      $ 3,774      $ (180   $ 6,250 (a)    $ 321,991   

Incentive income

     11,283        —          —          —          11,283   

Other revenues

     1,030        482        —          —          1,512   

Income of consolidated Och-Ziff funds

     —          21,043        —          —          21,043   
                                        

Total Revenues

     324,460        25,299        (180     6,250        355,829   
                                        

Expenses

          

Compensation and benefits

     53,404        25,186        —          85,517 (b)(c)      164,107   

Allocations to non-equity partner interests

     —          —          —          —          —     

Reorganization expenses

     —          —          —          1,248,423 (e)      1,248,423   

Profit sharing

     —          —          —          —          —     

Interest expense

     5,809        —          —          —          5,809   

General, administrative and other

     55,843        1,869        —          12,412 (a)(g)      70,124   

Expenses of consolidated Och-Ziff funds

     —          6,853        66        —          6,919   
                                        

Total Expenses

     115,056        33,908        66        1,346,352        1,495,382   
                                        

Other Income (Loss)

          

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

     (303     (102     —          309 (h)      (96

Net gains of consolidated Och-Ziff funds

     —          26,416        693        —          27,109   
                                        

Total Other Income (Loss)

     (303     26,314        693        309        27,013   
                                        

Income (Loss) Before Income Taxes

     209,101        17,705        447        (1,339,793     (1,112,540

Income taxes

     —          2,050        —          21,547 (g)      23,597   
                                        

Consolidated Net Income (Loss)

   $ 209,101      $ 15,655      $ 447      $ (1,361,340   $ (1,136,137
                                        

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

   $ —        $ 40,889      $ 447      $ (905,883 )(g)    $ (864,547
                                        

Net Income (Loss) Allocated to Class A Shareholders

   $ 209,101      $ (25,234   $ —        $ (455,457   $ (271,590
                                        

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

                  Reconciling Adjustments        
Nine Months Ended September 30, 2009    Economic
Income -
Och-Ziff
Funds
     Other
Operations

U.S. GAAP  Basis
    Funds
Consolidation
    Other
Adjustments
    Total
Company
U.S. GAAP
Basis
 
     (dollars in thousands)  

Revenues

           

Management fees

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

Incentive income

     3,336         —          —          —          3,336   

Other revenues

     713         195        —          —          908   

Income of consolidated Och-Ziff funds

     —           21,629        —          —          21,629   
                                         

Total Revenues

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

Expenses

           

Compensation and benefits

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

Allocations to non-equity partner interests

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

Reorganization expenses

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

Profit sharing

     —           —          —          954 (f)      954   

Interest expense

     10,823         —          —          —          10,823   

General, administrative and other

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

Expenses of consolidated Och-Ziff funds

     —           2,757        19        —          2,776   
                                         

Total Expenses

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

Other Income (Loss)

           

Net earnings on deferred balances

     —           —          —          24,270 (h)      24,270   

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

     —           (1,236     —          2,272 (h)      1,036   

Net gain on early retirement of debt

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

Net gains (losses) of consolidated Och-Ziff funds

     —           1,599        (1,744     —          (145
                                         

Total Other Income (Loss)

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

Income (Loss) Before Income Taxes

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

Income taxes

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

Consolidated Net Income (Loss)

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

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

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

Net Income (Loss) Allocated to Class A Shareholders

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

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

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

Other Adjustments. Economic Income is calculated by:

 

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

 

  (b) recognizing the full amount of deferred cash compensation and expenses related to compensation arrangements indexed to annual investment performance 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.

 

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OCH-ZIFF CAPITAL MANAGEMENT GROUP LLC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

SEPTEMBER 30, 2010

 

 

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

 

  (d) excluding allocations to non-equity partner interests. Management reviewed the performance of the Och-Ziff Funds segment before it made any allocations to the Company’s non-equity partners for periods prior to the Reorganization. For these periods, allocations to the partners, other than Mr. Och, were treated as expenses for U.S. GAAP purposes. Following the Reorganization, only allocations to the partners, other than Mr. Och, that are related to earnings on deferred balances are incurred and these allocations are excluded from Economic Income.

 

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

 

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

 

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

 

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

Substantially all of the Company’s revenues are earned from the Och-Ziff funds. For the three months ended September 30, 2010, the Company recorded revenues of $41.6 million, $21.1 million and $16.2 million from three individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues. For the three months ended September 30, 2009, the Company recorded revenues of $15.7 million from an individual feeder fund managed by the Och-Ziff Funds segment, which represented more than 10% of the Company’s total revenues.

For the nine months ended September 30, 2010, the Company recorded revenues of $122.5 million, $55.4 million and $49.4 million from three individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues. For the nine months ended September 30, 2009, the Company recorded revenues of $82.7 million, $45.1 million and $32.0 million from three individual feeder funds managed by the Och-Ziff Funds segment, each of which represented more than 10% of the Company’s total revenues.

 

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

This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in “Part I—Item 1A. Risk Factors” of our annual report filed with the U.S. Securities and Exchange Commission on Form 10-K for the year ended December 31, 2009, which we refer to as our “Annual Report.” Actual results may differ materially from those contained in any forward-looking statements. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report. An investment in our Class A Shares is not an investment in any of our funds.

OVERVIEW

Our Business

We are one of the world’s largest institutional alternative asset managers with offices in New York, London, Hong Kong, Mumbai and Beijing. We provide investment management and advisory services to our investment funds globally. Our funds seek to generate consistent, positive risk-adjusted returns throughout market cycles with minimal use of leverage. Our multi-strategy approach combines global investment strategies, including long/short equity special situations, convertible and derivative arbitrage, structured credit, other credit, private investments and merger arbitrage. We have implemented a strong institutional infrastructure emphasizing risk management and detailed, transparent information in our communications with our fund investors. As of November 1, 2010, we had approximately $27.2 billion in assets under management.

Overview of Our Third Quarter Results

As of September 30, 2010, our assets under management were $26.5 billion. This amount reflects an increase of $978.5 million, or 4%, from $25.5 billion as of June 30, 2010, resulting from performance-related appreciation of $756.9 million and net capital inflows of $221.6 million. From September 30, 2009 to September 30, 2010, our assets under management increased by $4.2 billion, or 19%, from $22.3 billion. This increase was driven by net capital inflows of $2.6 billion and performance-related appreciation of $1.6 billion. Consistent with what we have seen over the last several quarters, our third quarter net capital inflows came from a well-diversified mix of existing and new fund investors and the composition of our fund investor base as of September 30, 2010 remained generally consistent with the composition as of June 30, 2010.

For the third quarter of 2010, we reported a U.S. GAAP net loss allocated to Class A shareholders of $93.5 million, compared to a net loss of $80.0 million for the third quarter of 2009. For the nine months ended September 30, 2010, we reported a U.S. GAAP net loss allocated to Class A shareholders of $271.6 million, compared to a net loss of $250.2 million for the nine months ended September 30, 2009. The U.S. GAAP net loss in both periods primarily resulted from non-cash Reorganization expenses associated with our initial public offering in November 2007 of $411.8 million and $417.5 million for the third quarters of 2010 and 2009, respectively, and $1.2 billion and $1.3 billion for the nine months ended September 30, 2010 and 2009, respectively.

We reported Economic Income for the Company1 of $69.5 million for the third quarter of 2010, compared with $39.5 million for the third quarter of 2009. We reported Economic Income for the Company of $199.0 million for the nine months ended September 30, 2010, compared with $99.8 million for the nine months ended September 30, 2009. The year-over-year increases were principally attributable to the Och-Ziff Funds segment, which recorded higher management fees due to increased assets under management compared to the prior-year periods and lower compensation and benefits expenses, as the accrual for discretionary cash bonuses taken in the second and third quarters of 2009 did not recur in 2010.

Overview of Third Quarter Fund Performance

During the third quarter of 2010, our funds continued to generate positive, risk-adjusted returns with low volatility and low correlation to the markets. This performance reflected the effect of our active capital allocation and risk management processes, which enabled us to efficiently move capital based on our evaluation of the risk/return opportunities within each of our strategies and the markets overall. As market conditions improved and uncertainty in the United States and Europe declined relative to the first half of 2010, we increased investment levels in our funds due to our perception of increased opportunities in several of our strategies.

During the third quarter of 2010, the OZ Master Fund generated a net return of 2.9%, the OZ Europe Master Fund a net return of 3.3%, the OZ Asia Master Fund a net return of 2.2% and the OZ Global Special Investments Master Fund a net return of 3.6%.2 For the nine months ended September 30, 2010, the OZ Master Fund generated a net return of 4.3%, the OZ Europe Master Fund a net return of 4.9%, the OZ Asia Master Fund a net return of 5.2% and the OZ Global Special Investments Master Fund a net return of 7.3%. Our year-to-date performance was primarily driven by our credit-related strategies in the United States and Europe, long/short equity special situations and convertible arbitrage in Asia, and private investments in Europe and Asia.

 

1

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

2

For important information about our fund performance data, please see “—Assets Under Management and Fund Performance – Fund Performance” below.

 

 

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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 grow assets under management.

Financial Market Environment

Our ability to successfully generate consistent, positive, risk-adjusted 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 other global economic conditions.

During the third quarter, the global equity markets were volatile but performed strongly. In reaction to a weaker U.S. economy, the Federal Reserve indicated that it is likely to initiate further easing of monetary policy. This caused equities indices to rise and both bond yields and the dollar to decline. Additionally, merger activity increased during the third quarter of 2010 as equity and credit market conditions were strong.

The U.S. corporate credit markets were strong during the third quarter, driven by investor inflows and more favorable perceptions of economic conditions. Following a slowdown during the second quarter of 2010, primary market conditions improved and were exceptionally strong. The primary high-yield market has achieved a record year for new issuance as investors sought opportunities to increase the yields on their fixed income portfolios.

In Europe, the credit markets continued to be positive during the third quarter after substantial volatility in the first half of 2010, driven by clarification of sovereign and banking-related risks, positive economic data and the expectation of further monetary easing by Europe’s central banks. In Asia the credit markets rallied during the third quarter as volatility declined.

Capital Flow Environment

Capital flows into the hedge fund industry appeared to increase during the third quarter of 2010 compared to the second quarter of 2010. We believe that fund investor interest in the hedge fund industry remains strong, with pension funds, private banks and corporate and international pools of capital all seeking to allocate capital to the hedge fund industry during the quarter. We believe that allocations from these institutions were driven primarily by their desire to diversify their investment portfolios and to seek non-volatile returns to enhance the yield of their portfolios.

ASSETS UNDER MANAGEMENT AND FUND PERFORMANCE

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

Management fees are directly impacted by any increase or decrease in our assets under management, whether due to investor capital flows or fund investment performance. Incentive income is directly impacted by our funds’ investment performance and indirectly impacted by increases and decreases in assets under management; therefore, to the extent that our assets under management change, our total revenues will change. For example, a $1 billion increase or decrease in assets under management subject to a 2% management fee would generally increase or decrease annual management fees by $20 million. If net profits attributable to a fee-paying fund investor were $10 million, we generally would earn incentive income equal to $2 million, assuming a one-year incentive income measurement period, no change in current incentive income rates, no hurdle rate and no high-water marks from prior years.

Assets Under Management

Our assets under management are a function of the capital that is placed with us by fund investors globally, which we invest on their behalf based on the focus of the fund or funds they have selected. We typically accept capital from new and existing investors into our funds on a monthly basis on the first day of each month. Investors in our funds (other than investors in private investments, certain real estate funds and other new businesses) have the right to redeem their interests in a fund following an initial lock-up period of one to three years. Following the expiration of these lock-up periods, investors may redeem capital generally on a quarterly or annual basis upon giving 30 to 45 days prior written notice. However, upon the payment of a redemption fee to the funds and upon giving 30 days prior written notice and subject to limitations, investors with quarterly redemption rights may redeem capital during the lock-up period. The lock-up

 

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requirements for the funds may generally be waived or modified in the sole discretion of the fund’s general partner or board of directors, as applicable. With respect to investors with quarterly redemption rights, requests for redemptions submitted during a quarter generally are paid on the first day of the following quarter. Accordingly, quarterly redemptions generally will have no impact on management fees during the quarter in which they are submitted. Instead, these redemptions will decrease assets under management as of the first day of the following quarter, which reduces management fees for that quarter. With respect to investors with annual redemption rights, redemptions paid prior to the end of a quarter impact assets under management in the quarter in which they are paid, and therefore impact management fees for that quarter.

The ability of investors to contribute capital to and redeem capital from our funds causes our assets under management to fluctuate from period to period. Fluctuations in assets under management also result from our funds’ investment performance. Both of these factors directly impact the revenues we earn from management fees and incentive income.

Information with respect to our assets under management throughout this quarterly report, including the tables set forth in this discussion and analysis, includes deferred balances, which are made up of incentive income receivables from our offshore funds that were deferred by our partners and the Ziffs prior to our IPO, and investments by us, our partners, employees and certain other related parties. Prior to our IPO, we did not charge management fees or earn incentive income on these investments. Following our IPO, we began charging management fees and earning incentive income on new investments made in our funds by our partners, employees and certain other related parties, including the reinvestment by our partners of the after-tax proceeds from the Offerings, other than the reinvestment by our partners of deferred balances. As of September 30, 2010, approximately 9% of our assets under management represented investments by us, our partners and certain other related parties in our funds. As of this date, approximately 37% of these affiliated assets under management are not charged management fees and are not subject to an incentive income allocation, as they relate primarily to pre-IPO investments by our partners as well as other related parties.

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

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

 

     September 30,  
     2010      2009  
     (dollars in thousands)  

OZ Master Fund

   $ 18,611,582       $ 14,772,543   

OZ Europe Master Fund

   $ 2,957,726       $ 2,958,346   

OZ Asia Master Fund

   $ 1,418,467       $ 1,327,226   

OZ Global Special Investments Master Fund

   $ 1,197,839       $ 1,980,060   

Assets under management presented in the table above do not include assets under management related to our real estate funds, the separate accounts we manage on behalf of certain institutions or certain other funds that are not material, which collectively were approximately $2.3 billion and $1.2 billion as of September 30, 2010 and 2009, respectively.

The $3.8 billion year-over-year increase in assets under management for the OZ Master Fund was driven primarily by capital net inflows in the fourth quarter of 2009 and first six months of 2010, and positive investment performance of the OZ Master Fund in the fourth quarter of 2009 and the first and third quarters of 2010. Also contributing to the increase was the reallocation of capital by our partners from the OZ Global Special Investments Master Fund as discussed below. These increases were partially offset by capital net outflows experienced in the third quarter of 2010 and performance-related depreciation in the second quarter of 2010.

The $620 thousand year-over-year decrease in assets under management for the OZ Europe Master Fund was primarily a result of capital net outflows experienced in the fourth quarter of 2009 and the first and third quarters of 2010, and performance-related depreciation in the second quarter of 2010. These decreases were partially offset by positive investment performance in the fourth quarter of 2009 and the first and third quarters of 2010, in addition to capital net inflows in the second quarter of 2010.

The $91.2 million year-over-year increase in assets under management for the OZ Asia Master Fund was primarily a result of performance-related appreciation in the fourth quarter of 2009 and the first and third quarters of 2010, as well as capital net inflows during the first nine months of 2010. These increases were partially offset by capital net outflows in the fourth quarter of 2009 and performance-related depreciation in the second quarter of 2010.

The $782.2 million year-over-year decrease in the assets under management for the OZ Global Special Investments Master Fund was driven by capital net outflows each quarter, primarily in the first quarter of 2010 due to the reallocation of capital by our partners to our other funds as discussed below, partially offset by positive investment performance in the fourth quarter of 2009 and the first and third quarters of 2010.

 

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

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

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2010      2009     2010      2009  
     (dollars in thousands)  

Balance-beginning of period

   $ 25,496,940       $ 21,919,561      $ 23,079,796       $ 26,954,606   

Net flows

     221,582         (1,134,670     2,282,539         (8,356,716

Appreciation

     756,854         1,493,604        1,113,041         3,680,605   
                                  

Balance-end of period

   $ 26,475,376       $ 22,278,495      $ 26,475,376       $ 22,278,495   
                                  

Weighted-average assets under management

   $ 25,546,478       $ 20,821,794      $ 25,121,619       $ 20,523,347   

Our assets under management increased $4.2 billion, or 19%, year-over-year as a result of capital net inflows of approximately $2.6 billion and positive investment performance of approximately $1.6 billion from September 30, 2009 to September 30, 2010.

In the first nine months of 2010, our funds experienced performance-related appreciation of $1.1 billion and capital net inflows of $2.3 billion, which were comprised of $4.4 billion of gross inflows and $2.1 billion of gross outflows. The inflows were driven by increased institutional investor confidence in placing capital with alternative asset managers and, in turn with us, in order to enhance the yield and diversification of their investments. The outflows were driven by quarterly redemption requests, which we believe have normalized to levels seen prior to 2008.

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

Estimated assets under management as of November 1, 2010 were $27.2 billion, an increase of approximately $700 million from September 30, 2010, as a result of capital net inflows of $100 million from October 1, 2010 to November 1, 2010, and performance-related appreciation of approximately $600 million.

Fund Performance

Annual 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 profits on private investments and subject to any high-water marks.

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

 

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

 

     Net Return for the
Three Months Ended September 30,
    Net Return for the
Nine Months Ended September 30,
 
     2010     2009     2010     2009  

OZ Master Fund

     2.9     7.3     4.3     20.5

OZ Europe Master Fund

     3.3     7.9     4.9     15.5

OZ Asia Master Fund

     2.2     11.6     5.2     26.4

OZ Global Special Investments Master Fund

     3.6     3.4     7.3     7.1

OZ Master Fund

For the first nine months of 2010, the return of the OZ Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, primarily in the United States and Europe, which contributed approximately 72% of the return before management fees and incentive income; long/short equity special situations, primarily in Asia, which contributed approximately 8%; convertible and derivative arbitrage across all geographies, which contributed approximately 8%; and private investments, which contributed approximately 7%.

For the first nine months of 2009, the return of the OZ Master Fund was driven primarily by investment opportunities in the following strategies: long/short equity special situations across all geographies, which contributed approximately 36% of the return before management fees and incentive income; structured and distressed credit, primarily in the United States and Europe, which contributed approximately 33%; and convertible and derivative arbitrage, primarily in the United States, which contributed approximately 27%.

OZ Europe Master Fund

For the first nine months of 2010, the return of the OZ Europe Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, which contributed approximately 62% of the return before management fees and incentive income; private investments, which contributed approximately 17%; and convertible and derivative arbitrage, which contributed approximately 13%.

For the first nine months of 2009, the return of the OZ Europe Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, which contributed approximately 53% of the return before management fees and incentive income; convertible and derivative arbitrage, which contributed approximately 24%; and long/short equity special situations, which contributed approximately 18%.

OZ Asia Master Fund

For the first nine months of 2010, the return of the OZ Asia Master Fund was driven primarily by investment opportunities in the following strategies: convertible and derivative arbitrage, which contributed approximately 46% of the return before management fees and incentive income; long/short equity special situations, which contributed approximately 41%; and private investments, which contributed approximately 19%. The positive investment performance of these strategies was partially offset by losses related to bankruptcy claims.

For the first nine months of 2009, the return of the OZ Asia Master Fund was driven primarily by investment opportunities in long/short equity special situations, which contributed approximately 62% of the return before management fees and incentive income, and convertible and derivative arbitrage, which contributed approximately 32%.

OZ Global Special Investments Master Fund

For the first nine months of 2010, the return of the OZ Global Special Investments Master Fund was driven primarily by investment opportunities in the following strategies: structured and distressed credit, primarily in the United States, which contributed approximately 79% of the return before management fees and incentive income; and private investments, which contributed approximately 19%.

For the first nine months of 2009, substantially all of the return before management fees and incentive income of the OZ Global Special Investments Master Fund was driven by investment opportunities in the following strategies: long/short equity special situations across all geographies, which contributed approximately 74% of the return before management fees and incentive income; and structured and distressed credit, primarily in the United States, which contributed approximately 21%.

 

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UNDERSTANDING OUR RESULTS

Revenues

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

 

   

Management Fees. We earn management fees as follows:

Hedge Funds and Managed Accounts. Management fees typically range from 1.5% to 2.5% annually of assets under management and currently average approximately 1.7%. This average rate takes into account the effect of non-fee paying assets under management, the management fee charged on capital contributed and the management fee on capital redeemed. Management fees are generally calculated and paid to us on a quarterly basis, at the beginning of the quarter, based on assets under management at the beginning of the quarter. Management fees are prorated for capital inflows and redemptions during the quarter. Accordingly, changes in our management fee revenues from quarter to quarter are driven by changes in the quarterly opening balances of assets under management, the management fee rates charged on new capital compared with the rates on capital that is redeemed, and the relative magnitude and timing of inflows and redemptions during the respective quarter.

Real Estate Funds. Management fees from the Och-Ziff real estate funds are generally charged at an annual rate of 0.75% to 1.5% of the total capital commitments during the original investment period and 0.75% to 1.5% of invested capital thereafter. Management fees are generally paid to us on a quarterly basis, at the beginning of the quarter, and are prorated for changes in capital commitments throughout the original investment period and invested capital thereafter.

 

   

Incentive Income. We earn incentive income based on the performance of the Och-Ziff funds and managed accounts. Incentive income is typically equal to 20% of the net realized and unrealized profits attributable to each fund investor, but excludes unrealized profits on private investments. We do not recognize incentive income until the end of the measurement period when the amounts are contractually payable, or “crystallized.” The measurement period for most of our assets under management is on a calendar-year basis, and therefore we generally crystallize incentive income annually on December 31st. The measurement periods, however, with respect to approximately 12% of our assets under management as of September 30, 2010, are based on longer time periods and include assets subject to three-year lock-ups and assets invested in certain private platforms. The calculations of incentive income for these assets may be subject to hurdle rates. Generally, any incentive income recorded during the first three quarters of the year is related to fund investor redemptions or amounts earned from fund investors with measurement periods longer than one year. Furthermore, incentive income on private investments is earned in the year of the sale or on realization of the private investment.

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

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

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

 

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Expenses

Our operating expenses consist of the following:

 

   

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

 

   

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

 

   

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

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

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

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

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

Other Income

Our other income consists of:

 

   

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

 

   

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

 

   

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

 

   

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

 

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Income Taxes

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

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

Partners’ and others’ interests in consolidated subsidiaries represents ownership interests in the Company’s subsidiaries held by parties other than us and is primarily made up of: (i) Och-Ziff Operating Group A Units held by our partners and the Ziffs; and (ii) fund investors’ interests in the consolidated Och-Ziff funds. Increases or decreases in this item related to the Och-Ziff Operating Group A Units are driven by the earnings or losses of the Och-Ziff Operating Group. Increases or decreases in this item related to fund investors’ interests in consolidated Och-Ziff funds are driven by the earnings or losses of the consolidated Och-Ziff funds.

RESULTS OF OPERATIONS

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Revenues

        

Management fees

   $ 110,035      $ 88,127      $ 321,991      $ 268,598   

Incentive income

     5,561        3,071        11,283        3,336   

Other revenues

     401        355        1,512        908   

Income of consolidated Och-Ziff funds

     6,473        10,127        21,043        21,629   
                                

Total Revenues

     122,470        101,680        355,829        294,471   
                                

Expenses

        

Compensation and benefits

     59,186        64,074        164,107        191,975   

Allocations to non-equity partner interests

     —          8,052        —          12,627   

Reorganization expenses

     411,828        417,486        1,248,423        1,262,171   

Profit sharing

     —          663        —          954   

Interest expense

     1,916        2,168        5,809        10,823   

General, administrative and other

     23,994        40,687        70,124        84,069   

Expenses of consolidated Och-Ziff funds

     1,540        880        6,919        2,776   
                                

Total Expenses

     498,464        534,010        1,495,382        1,565,395   
                                

Other Income

        

Net earnings on deferred balances

     —          20,840        —          24,270   

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

     453        730        (96     1,036   

Net gain on early retirement of debt

     —          —          —          2,013   

Net gains (losses) of consolidated Och-Ziff funds

     4,767        (47     27,109        (145
                                

Total Other Income

     5,220        21,523        27,013        27,174   
                                

Loss Before Income Taxes

     (370,774     (410,807     (1,112,540     (1,243,750

Income taxes

     7,054        (20,889     23,597        (17,611
                                

Consolidated Net Loss

   $ (377,828   $ (389,918   $ (1,136,137   $ (1,226,139
                                

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

   $ (284,298   $ (309,891   $ (864,547   $ (975,945
                                

Net Loss Allocated to Class A Shareholders

   $ (93,530   $ (80,027   $ (271,590   $ (250,194
                                

 

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Revenues

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010      2009      2010      2009  
     (dollars in thousands)  

Och-Ziff Funds segment

   $ 105,538       $ 86,262       $ 312,147       $ 263,209   

Och-Ziff real estate funds

     1,898         1,312         3,774         3,934   

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

     2,599         553         6,070         1,455   
                                   

Total

   $ 110,035       $ 88,127       $ 321,991       $ 268,598   
                                   

Management fees increased by $21.9 million and $53.4 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods, due to the year-over-year increase in average assets under management driven by a combination of capital net inflows and performance-related appreciation.

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

Incentive Income. Incentive income increased by $2.5 million and $7.9 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These amounts were primarily related to fund investor redemptions.

Income of Consolidated Och-Ziff Funds. Income of consolidated Och-Ziff funds decreased by $3.7 million and $586 thousand for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Expenses

Compensation and Benefits. Compensation and benefits expenses decreased by $4.9 million and $27.9 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily related to the accrual for discretionary cash bonuses in the second and third quarters of 2009 in an aggregate amount of $31.5 million. In the second quarter of 2009 we began to accrue for the estimated 2009 discretionary cash bonuses that we expected to pay our employees shortly after year end 2009. We did this in order to provide a competitive compensation structure in a year in which we generated strong investment performance while at the same time having the high-water marks in our funds, which if not recovered would have precluded us from earning any incentive income in 2009. For the nine months ended September 30, 2010, we did not accrue for any discretionary cash bonuses. Annual discretionary cash bonuses in a year with no high-water marks in effect are generally determined and expensed in the fourth quarter each year. Our worldwide headcount increased from 362 at September 30, 2009 to 402 at September 30, 2010.

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

Reorganization Expenses. Reorganization expenses decreased by $5.7 million and $13.7 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These expenses represent the amortization of the fair value of unvested Och-Ziff Operating Group A Units held by our partners after the Offerings. The decrease in Reorganization expenses was primarily attributable to the decrease in the amortization on certain units forfeited by former partners in the first half of 2009 and the first quarter of 2010 and subsequently reallocated to the remaining partners. The grant-date fair value of the reallocated units was generally lower than the original grant-date fair value, and therefore the Reorganization expenses associated with the reallocated units decreased. Assuming no material forfeitures or reallocations, the estimated future Reorganization expenses related to the amortization of Och-Ziff Operating Group A Units held by our partners are expected to be approximately $394.8 million for the remainder of 2010, $1.6 billion in 2011 and $1.4 billion in 2012.

 

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Interest Expense. Interest expense decreased by $252 thousand and $5.0 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These decreases were a result of the early retirement of an aggregate of $105 million of our term loan in 2009. Additionally, for the year-to-date period, interest expense decreased due to the decrease in LIBOR, to which both our term loan obligation and the note payable on our corporate aircraft are indexed. The LIBOR interest rate on our term loan resets every one, two, three or six months (at our option), two business days prior to the start of each interest period. The LIBOR interest rate on the note payable on our corporate aircraft resets on a monthly basis, three business days prior to the start of each month.

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010     2009      2010     2009  
     (dollars in thousands)  

Occupancy and equipment

   $ 7,117      $ 7,214       $ 21,674      $ 20,960   

Professional services

     5,418        3,998         15,533        13,699   

Information processing and communications

     3,532        3,403         10,222        10,291   

Insurance

     1,958        3,238         5,861        9,584   

Business development

     1,429        1,492         5,579        4,960   

Other expenses

     4,565        4,425         11,420        8,442   
                                 
     24,019        23,770         70,289        67,936   

Changes in tax receivable agreement liability

     (25     16,917         (165     16,133   
                                 

Total General, Administrative and Other

   $ 23,994      $ 40,687       $ 70,124      $ 84,069   
                                 

General, administrative and other expenses decreased by $16.7 million and $13.9 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily due to the increase in tax receivable agreement liability recorded in the third quarter of 2009. This increase was driven by changes to the future enacted rates at the state and local level, resulting in a change in the estimated future tax savings related to the sale of interests in the Och-Ziff Operating Group by our partners and the Ziffs at the time of the Offerings, in addition to subsequent exchanges of Och-Ziff Operating Group A Units for Class A Shares. See “—Liquidity and Capital Resources—Tax Receivable Agreement.” Additionally, lower insurance costs were partially offset by an increase in recurring placement and related service fees on assets under management (included within other expenses above) and professional services.

Expenses of Consolidated Och-Ziff Funds. Expenses of consolidated Och-Ziff funds increased by $660 thousand and $4.1 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Other Income

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

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

Net Gains (Losses) of Consolidated Och-Ziff Funds. Net gains of consolidated Och-Ziff funds increased by $4.8 million and $27.3 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods, primarily due to the investment activities of our real estate funds.

Income Taxes

Income tax expense increased by $27.9 million and $41.2 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. The increases were primarily due to an increase in deferred tax assets in the third quarter of 2009 resulting from a change in future enacted tax rates at the state and local level. In addition, higher profitability in the Och-Ziff

 

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Operating Group and certain of its foreign subsidiaries also contributed to the increase. The Registrant and the Och-Ziff Operating Group entities are partnerships for U.S. federal income tax purposes. As a result of our legal structure, only a portion of the income we earn is subject to corporate level tax rates in the U.S. and foreign jurisdictions. The provision for income taxes includes U.S. federal, state, local and foreign taxes at an effective tax rate of -1.9% and 5.1% for the three months ended September 30, 2010 and 2009, respectively, and -2.1% and 1.4% for the nine months ended September 30, 2010 and 2009, respectively. 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) the Reorganization expenses are non-deductible for income tax purposes.

As of and for the three and nine months ended September 30, 2010 and 2009, we were not required to establish a liability for uncertain tax positions. In addition, as of September 30, 2010, we had net operating loss carryforwards of $82.5 million for federal income taxes and $14.2 million for state and local income taxes that will expire by December 31, 2029 and 2030, respectively.

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

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

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Och-Ziff Operating Group A Units

   $ (294,154   $ (330,307   $ (905,883   $ (1,004,808

Consolidated Och-Ziff funds

     9,531        9,046        40,629        18,307   

Other

     325        11,370        707        10,556   
                                

Total

   $ (284,298   $ (309,891   $ (864,547   $ (975,945
                                

Net loss allocated to partners’ and others’ interests in consolidated subsidiaries decreased by $25.6 million and $111.4 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. The decrease in net loss allocated to the Och-Ziff Operating Group A Units was primarily due to improved profitability of the Och-Ziff Operating Group, as well as a larger share of losses of the Och-Ziff Operating Group being allocated to us. The partners’ and the Ziffs’ interests in the Och-Ziff Operating Group in the form of Och-Ziff Operating Group A Units declined from 79.5% as of September 30, 2009 to 77.0% as of September 30, 2010 as a result of the vesting of RSUs and the exchange of Och-Ziff Operating Group A Units for Class A Shares. The Och-Ziff Operating Group A Units are expected to continue to significantly reduce our net loss in future periods as losses of the Och-Ziff Operating Group are allocated to these interests.

ECONOMIC INCOME ANALYSIS

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2010     2009     2010     2009  
     (dollars in thousands)  

Economic Income:

        

Och-Ziff Funds segment

   $ 72,378      $ 43,807      $ 209,101      $ 112,607   

Other Operations - Non-GAAP

     (2,867     (4,281     (10,068     (12,772
                                

Total Company - Non-GAAP

   $ 69,511      $ 39,526      $ 199,033      $ 99,835   
                                

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

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

 

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

In addition, the full amount of deferred cash compensation and expenses related to compensation arrangements indexed to 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.

For a reconciliation of Economic Income of the Och-Ziff Funds segment and its components to the respective U.S. GAAP basis for the periods presented and additional information regarding the reconciling adjustments discussed above, see Note 13 to our consolidated financial statements included in this quarterly report.

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

Och-Ziff Funds Segment—Economic Income Analysis

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010     2009      2010     2009  
     (dollars in thousands)  

Economic Income Revenues

         

Management fees

   $ 105,538      $ 86,262       $ 312,147      $ 263,209   

Incentive income

     5,561        3,071         11,283        3,336   

Other revenues

     298        268         1,030        713   
                                 

Total Economic Income Revenues

     111,397        89,601         324,460        267,258   
                                 

Economic Income Expenses

         

Compensation and benefits

     18,634        23,539         53,404        86,502   

Non-compensation expenses

     20,317        22,255         61,652        68,149   
                                 

Total Economic Income Expenses

     38,951        45,794         115,056        154,651   
                                 

Net losses on joint ventures

     (68     —           (303     —     
                                 

Economic Income

   $ 72,378      $ 43,807       $ 209,101      $ 112,607   
                                 

Economic Income for the Och-Ziff Funds segment increased by $28.6 million and $96.5 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These increases were driven primarily by an increase in assets under management on which we earned management fees and the decrease in compensation and benefits expenses due to the accrual for year-end discretionary cash bonuses in the second and third quarter of 2009.

 

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Economic Income Revenues

Management Fees. Management fees for the segment increased by $19.3 million and $48.9 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods, due to the year-over-year increase in average assets under management driven by a combination of capital net inflows and performance-related appreciation.

Incentive Income. Incentive income increased by $2.5 million and $7.9 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These amounts were primarily related to fund investor redemptions.

Economic Income Expenses

Compensation and Benefits. Compensation and benefits expenses decreased by $4.9 million and $33.1 million for the three and nine months ended September 30, 2010, compared to the corresponding 2009 periods. These decreases were primarily related to the accrual for discretionary cash bonuses in the second and third quarters of 2009 in an aggregate amount of $30.5 million. In the second quarter of 2009 we began to accrue for the estimated 2009 discretionary cash bonuses that we expected to pay our employees shortly after year end 2009. We did this in order to provide a competitive compensation structure in a year in which we generated strong investment performance while at the same time having the high-water marks in our funds, which if not recovered would have precluded us from earning any incentive income in 2009. For the nine months ended September 30, 2010, we did not accrue for any discretionary cash bonuses. Annual discretionary cash bonuses in a year with no high-water marks in effect are generally determined and expensed in the fourth quarter each year.

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

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2010      2009      2010      2009  
     (dollars in thousands)  

Occupancy and equipment

   $ 5,785       $ 5,977       $ 17,820       $ 17,800   

Professional services

     5,247         3,808         15,237         12,132   

Information processing and communications

     2,635         2,452         7,482         7,516   

Insurance

     1,958         3,238         5,861         9,584   

Interest expense

     1,916         2,168         5,809         10,823   

Business development

     1,399         1,455         5,513         4,829   

Other expenses

     1,377         3,157         3,930         5,465   
                                   

Total Non-Compensation Expenses

   $ 20,317       $ 22,255       $ 61,652       $ 68,149   
                                   

Non-compensation expenses decreased by $1.9 million and $6.5 million for the three and nine months ended September 30, 2010, respectively, compared to the corresponding 2009 periods. These decreases were driven primarily by decreases in interest expense, insurance costs and other expenses, partially offset by an increase in professional services. The decreases in interest expense were a result of the early retirement of an aggregate of $105 million of our term loan in 2009. Additionally, for the year-to-date period, interest expense decreased due to the decrease in LIBOR, to which both our term loan and the note payable on our corporate aircraft are indexed. The LIBOR interest rate on our term loan resets every one, two, three or six months (at our option), two business days prior to the start of each interest period. The LIBOR interest rate on the note payable on our corporate aircraft resets on a monthly basis, three business days prior to the start of each month.

Other Operations – Economic Income Analysis (Non-GAAP)

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

Economic Income for our Other Operations was a net loss of $2.9 million and $4.3 million for the three months ended September 30, 2010 and 2009, and a net loss of $10.1 million and $12.8 million for the nine months ended September 30, 2010 and 2009, respectively. The decrease in the Economic Income net loss for the three month period was principally the result of lower expenses related to our Asia real estate business and increased management fees related to the launch of our new real estate fund. The decrease in the Economic Income net loss for the nine month period was the result of lower non-compensation expenses due to the reimbursement of organization expenses related to our new real estate fund in 2010, a decrease in our share of the net losses of our African joint venture, as well as a decrease in expenses related to our Asia real estate business.

 

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

The Company – Economic Income Analysis (Non-GAAP)

Economic Income for the Company for the three months ended September 30, 2010 was $69.5 million, a $30.0 million increase from Economic Income for the Company for the three months ended September 30, 2009 of $39.5 million. Economic Income for the Company for the nine months ended September 30, 2010 was $199.0 million, a $99.2 million increase from Economic Income for the Company for the nine months ended September 30, 2009 of $99.8 million. The primary drivers for the increases were higher management fees and lower compensation and benefits expenses in the Och-Ziff Funds segment.

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

LIQUIDITY AND CAPITAL RESOURCES

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

 

   

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

 

   

repay borrowings and interest thereon;

 

   

provide capital to facilitate the growth of our business;

 

   

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

 

   

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

Historically, management fees have been more than sufficient to cover all of our “fixed” operating expenses, which we define as salaries and benefits and most of our non-compensation costs. As explained above under “—Understanding Our Results—Revenues—Incentive Income,” we generally do not recognize incentive income during the first three quarters of the year other than amounts earned as a result of fund investor redemptions during the period or amounts earned from fund investors with measurement periods longer than one year (approximately 12% of our assets under management as of September 30, 2010). Furthermore, we cannot predict the amount of incentive income, if any, which we may earn at year end. Accordingly, we do not rely on incentive income to meet our fixed operating expenses. Total annual revenues, which typically have been significantly influenced by the amount of annual incentive income we earn, historically have been sufficient to fund all of our other working capital needs, including annual discretionary cash bonuses. These cash bonuses, which historically have comprised our largest operating expense, are variable such that, in any year where total annual revenues are greater or less than the prior year, cash bonuses may be adjusted accordingly. Our ability to scale this significant operating expense to our total annual revenues helps us manage our cash flow and liquidity position from period to period.

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

 

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Our term loan, discussed below under “—Debt Obligations—Term Loan,” matures in July 2012 and the balance on our aircraft loan, discussed below under “—Debt Obligations—Aircraft Loan,” is payable in May 2011. To date, we have used cash on hand to repurchase and retire $105 million of the outstanding principal amount of our term loan. In addition, as of September 30, 2010, we had repaid an additional $15.0 million of the outstanding balance on our term loan from cash on hand, as we are required to make quarterly payments in an aggregate annual amount equal to 1% of the original loan balance. We may continue to use cash on hand to repay the term loan and the aircraft loan in part or in full prior to their maturity dates, which would reduce amounts available to distribute to our Class A shareholders. For any amounts unpaid as of those dates, we will be required to either refinance the obligations by entering into new facilities, which could result in higher borrowing costs, or raise cash by issuing equity or other securities, which would dilute existing shareholders. No assurance can be given that we will be able to enter into new facilities or issue equity or other securities in the future on attractive terms or at all. Any new facilities that we may be able to enter into may have covenants that impose additional limitations on us, including with respect to making distributions, entering into business transactions or other matters, and may result in increased interest expense. If we are unable to meet our debt obligations on terms that are favorable to us, our business may be adversely impacted.

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

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

 

   

support the future growth in our business;

 

   

create new or enhance existing products and investment platforms;

 

   

repay borrowings;

 

   

pursue new investment opportunities; and

 

   

develop new distribution channels.

Market and other factors may make it mo