10-Q 1 medleyllc-3312017x10q.htm 10-Q Document



 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017
or 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from            to            

 Commission File Number: 333-212514

Medley LLC
(Exact name of registrant as specified in its charter)

Delaware
27-2437343
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
280 Park Avenue, 6th Floor East
New York, New York 10017
(Address of principal executive offices)(Zip Code)
 
(212) 759-0777
(Registrant’s telephone number, including area code
 

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   ☒     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 (§232.405 of this chapter) 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a smaller reporting company)
Smaller reporting company
 
 
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.  

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

As of May 11, 2017, 29,492,224 units of membership interest of Medley LLC were outstanding. There is no trading market for Medley LLC's units of membership interests.





TABLE OF CONTENTS 
 
 
 
 Page
Part I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II.
 
 
 
Item 1.
 
 
 
Item 1A.  
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 







FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q (“Form 10-Q”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that reflect our current views with respect to, among other things, our operations and financial performance. Forward-looking statements include all statements that are not historical facts. In some cases, you can identify these forward-looking statements by the use of words such as “outlook,” “believes,” “expects,” “potential,” “may,” “should,” “could,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other comparable words. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause actual outcomes or results to differ materially from those indicated in these statements. We believe these factors include, but are not limited to, those described under Part I, Item 1A. “Risk Factors,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (the "Annual Report on Form 10-K") available on the SEC's website at www.sec.gov, which include, but are not limited to, the following:
 
difficult market and political conditions may adversely affect our business in many ways, including by reducing the value or hampering the performance of the investments made by our funds, each of which could materially and adversely affect our business, results of operations and financial condition;
we derive a substantial portion of our revenues from funds managed pursuant to advisory agreements that may be terminated or fund partnership agreements that permit fund investors to remove us as the general partner;
we may not be able to maintain our current fee structure as a result of industry pressure from fund investors to reduce fees, which could have an adverse effect on our profit margins and results of operations;
a change of control of us could result in termination of our investment advisory agreements;
the historical returns attributable to our funds should not be considered as indicative of the future results of our funds or of our future results;
if we are unable to consummate or successfully integrate development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully;
we depend on third-party distribution sources to market our investment strategies;
an investment strategy focused primarily on privately held companies presents certain challenges, including the lack of available information about these companies;
our funds’ investments in investee companies may be risky, and our funds could lose all or part of their investments;
prepayments of debt investments by our investee companies could adversely impact our results of operations;
our funds’ investee companies may incur debt that ranks equally with, or senior to, our funds’ investments in such companies;
subordinated liens on collateral securing loans that our funds make to their investee companies may be subject to control by senior creditors with first priority liens and, if there is a default, the value of the collateral may not be sufficient to repay in full both the first priority creditors and our funds;
there may be circumstances where our funds’ debt investments could be subordinated to claims of other creditors or our funds could be subject to lender liability claims;
our funds may not have the resources or ability to make additional investments in our investee companies;
economic recessions or downturns could impair our investee companies and harm our operating results;
a covenant breach by our investee companies may harm our operating results;
the investment management business is competitive;
our funds operate in a competitive market for lending that has recently intensified, and competition may limit our funds’ ability to originate or acquire desirable loans and investments and could also affect the yields of these assets and have a material adverse effect on our business, results of operations and financial condition;

i




dependence on leverage by certain of our funds and by our funds’ investee companies subjects us to volatility and contractions in the debt financing markets and could adversely affect our ability to achieve attractive rates of return on those investments;
some of our funds may invest in companies that are highly leveraged, which may increase the risk of loss associated with those investments;
we generally do not control the business operations of our investee companies and, due to the illiquid nature of our investments, may not be able to dispose of such investments;
a substantial portion of our investments may be recorded at fair value as determined in good faith by or under the direction of our respective funds’ boards of directors or similar bodies and, as a result, there may be uncertainty regarding the value of our funds’ investments;
we may need to pay “clawback” obligations if and when they are triggered under the governing agreements with respect to certain of our funds and SMAs;
our funds may face risks relating to undiversified investments;
third-party investors in our private funds may not satisfy their contractual obligation to fund capital calls when requested, which could adversely affect a fund’s operations and performance;
our funds may be forced to dispose of investments at a disadvantageous time;
hedging strategies may adversely affect the returns on our funds’ investments;
our business depends in large part on our ability to raise capital from investors. If we were unable to raise such capital, we would be unable to collect management fees or deploy such capital into investments, which would materially and adversely affect our business, results of operations and financial condition;
we depend on our senior management team, senior investment professionals and other key personnel, and our ability to retain them and attract additional qualified personnel is critical to our success and our growth prospects;
our failure to appropriately address conflicts of interest could damage our reputation and adversely affect our business;
rapid growth of our business may be difficult to sustain and may place significant demands on our administrative, operational and financial resources;
we may enter into new lines of business and expand into new investment strategies, geographic markets and business, each of which may result in additional risks and uncertainties in our business;
extensive regulation affects our activities, increases the cost of doing business and creates the potential for significant liabilities and penalties that could adversely affect our business and results of operations;
failure to comply with “pay to play” regulations implemented by the SEC and certain states, and changes to the “pay to play” regulatory regimes, could adversely affect our business;
new or changed laws or regulations governing our funds’ operations and changes in the interpretation thereof could adversely affect our business;
present and future business development companies for which we serve as investment adviser are subject to regulatory complexities that limit the way in which they do business and may subject them to a higher level of regulatory scrutiny;
we are subject to risks in using custodians, counterparties, administrators and other agents;
a portion of our revenue and cash flow is variable, which may impact our ability to achieve steady earnings growth on a quarterly basis;
we may be subject to litigation risks and may face liabilities and damage to our professional reputation as a result;
employee misconduct could harm us by impairing our ability to attract and retain investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm, and fraud and other deceptive practices or other misconduct at our investee companies could similarly subject us to liability and reputational damage and also harm our business;
our substantial indebtedness could adversely affect our financial condition, our ability to pay our debts or raise additional capital to fund our operations, our ability to operate our business and our ability to react to changes in the economy or our industry and could divert our cash flow from operations for debt payments;

ii




our Revolving Credit Facility imposes significant operating and financial restrictions on us and our subsidiaries, which may prevent us from capitalizing on business opportunities;
servicing our indebtedness will require a significant amount of cash. Our ability to generate sufficient cash depends on many factors, some of which are not within our control;
despite our current level of indebtedness, we may be able to incur substantially more debt and enter into other transactions, which could further exacerbate the risks to our financial condition;
operational risks may disrupt our business, result in losses or limit our growth;
our tax treatment depends on our status as a partnership for U.S. federal and state income tax purposes. If the Internal Revenue Service (“IRS”) were to treat us as a corporation for U.S. federal income tax purposes, which would subject us to entity-level taxation, or if we were subjected to a material amount of additional entity-level taxation by individual states, then our cash available for payments on the notes and our other debt obligations could be substantially reduced;

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q. Forward-looking statements speak as of the date on which they are made, and we undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law. 
 
Medley LLC was formed on October 27, 2010 and is the operating company of Medley Management Inc., a public company traded under the symbol “MDLY.” Medley Management Inc. is the sole managing member of Medley LLC. Medley Management Inc. was incorporated on June 13, 2014, and commenced operations on September 29, 2014 upon completion of its initial public offering (“IPO”) of its Class A common stock. Medley Management Inc.'s sole material operating asset is its investment in Medley LLC. Medley Management Inc. is controlled by the pre-IPO owners.
.
Unless the context suggests otherwise, references herein to the “Company,” “Medley,” “we,” “us” and “our” refer to Medley LLC, and its consolidated subsidiaries.
 
The “pre-IPO owners” refers to the senior professionals who were the owners of Medley LLC immediately prior to the Offering Transactions. The “Offering Transactions” refer to Medley Management Inc.’s purchase upon the consummation of its IPO of 6,000,000 newly issued limited liability company units (the “LLC Units”) from Medley LLC, which correspondingly diluted the ownership interests of the pre-IPO owners in Medley LLC and resulted in Medley Management Inc.’s holding a number of LLC Units in Medley LLC equal to the number of shares of Class A common stock it issued in its IPO.
 
Unless the context suggests otherwise, references herein to:
 
“Aspect” refers to Aspect-Medley Investment Platform A LP;
“AUM” refers to the assets of our funds, which represents the sum of the NAV of such funds, the drawn and undrawn debt (at the fund level, including amounts subject to restrictions) and uncalled committed capital (including commitments to funds that have yet to commence their investment periods);
“base management fees” refers to fees we earn for advisory services provided to our funds, which are generally based on a defined percentage of fee earning AUM or, in certain cases, a percentage of originated assets in the case of certain of our SMAs;
“BDC” refers to business development company;
“fee earning AUM” refers to the assets under management on which we directly earn base management fees;
“hurdle rates” refers to the rates above which we earn performance fees, as defined in the long-dated private funds’ and SMAs’ applicable investment management or partnership agreements;
“investee company” refers to a company to which one of our funds lends money or in which one of our funds otherwise makes an investment;
“long-dated private funds” refers to MOF II, MOF III, MCOF, Aspect and any other private funds we may manage in the future;
“management fees” refers to base management fees and Part I incentive fees;

iii




“MCOF” refers to Medley Credit Opportunity Fund LP;
“Medley LLC” refers to Medley LLC and its consolidated subsidiaries;
“MOF II” refers to Medley Opportunity Fund II LP;
“MOF III” refers to Medley Opportunity Fund III LP;
“our funds” refers to the funds, alternative asset companies and other entities and accounts that are managed or co-managed by us and our affiliates;
“our investors” refers to the investors in our permanent capital vehicles, our private funds and our SMAs;
“Part I incentive fees” refers to fees that we receive from our permanent capital vehicles, which are paid in cash quarterly and are driven primarily by net interest income on senior secured loans subject to hurdle rates. As it relates to Medley Capital Corporation (NYSE: MCC) (“MCC”), these fees are subject to netting against realized and unrealized losses;
“Part II incentive fees” refers to fees related to realized capital gains in our permanent capital vehicles;
“performance fees” refers to incentive allocations in our long-dated private funds and incentive fees from our SMAs, which are typically 15% to 20% of the total return after a hurdle rate, accrued quarterly, but paid after the return of all invested capital and in an amount sufficient to achieve the hurdle rate;
“permanent capital” refers to capital of funds that do not have redemption provisions or a requirement to return capital to investors upon exiting the investments made with such capital, except as required by applicable law, which funds currently consist of MCC and Sierra Income Corporation (“SIC”). Such funds may be required, or elect, to return all or a portion of capital gains and investment income. In certain circumstances, the investment adviser of such a fund may be removed;
“SMA” refers to a separately managed account; and
“STRF” refers to Sierra Total Return Fund.



iv




PART I.

Item 1.    Financial Statements



Condensed Consolidated Balance Sheets
(Amounts in thousands, except share and per share amounts)

As of
March 31, 2017
(unaudited)

As of December 31, 2016
Assets
 


 

Cash and cash equivalents
$
62,947


$
49,566

Restricted cash equivalents
7,554

 
4,897

Investments, at fair value
36,311


31,904

Management fees receivable
11,226


12,630

Performance fees receivable
2,744


4,961

Other assets
16,345


17,004

Total assets
$
137,127


$
120,962







Liabilities and Equity
 


 

Senior unsecured debt
$
116,480

 
$
49,793

Loans payable
8,736


52,178

Accounts payable, accrued expenses and other liabilities
27,508


37,178

Total liabilities
152,724


139,149







Commitments and contingencies (Note 9)











Redeemable Non-controlling Interests
36,041


30,805







Equity
 


 

Accumulated other comprehensive income
327


166

Non-controlling interests in consolidated subsidiaries
(1,714
)

(1,717
)
Members' deficit
(50,251
)

(47,441
)
Total deficit
(51,638
)

(48,992
)
Total liabilities, redeemable non-controlling interests and equity
$
137,127


$
120,962

  



See accompanying notes to unaudited condensed consolidated financial statements
F- 1

Medley LLC


Condensed Consolidated Statements of Operations (unaudited)
(Amounts in thousands, except share and per share amounts)


For the Three Months Ended March 31,
 

2017

2016
Revenues

 


 

Management fees (includes Part I incentive fees of $544 and $3,369, respectively)
 
$
13,895


$
16,263

Performance fees

(2,219
)

(591
)
Other revenues and fees

2,320


1,899

Total revenues

13,996


17,571

 
 
 
 
 
Expenses

 

 
 

Compensation and benefits

5,794


5,868

Performance fee compensation

(881
)

(71
)
General, administrative and other expenses

2,668


7,979

Total expenses

7,581


13,776

 
 
 
 
 
Other income (expense)

 

 
 

Dividend income

735


222

Interest expense

(3,647
)

(2,118
)
Other income (expense), net

1,560


(751
)
Total other expense, net

(1,352
)

(2,647
)
Income before income taxes

5,063


1,148

Provision for income taxes

127


35

Net income

4,936


1,113

Net income attributable to redeemable non-controlling interests
and non-controlling interests in consolidated subsidiaries
1,488


263

Net income attributable to Medley LLC
$
3,448


$
850



See accompanying notes to unaudited condensed consolidated financial statements
F- 2

Medley LLC


Condensed Consolidated Statements of Comprehensive Income (unaudited)
(Amounts in thousands)
 


For the Three Months Ended March 31,
 

2017

2016
Net income

$
4,936


$
1,113

Other comprehensive income:

 


 

Change in fair value of available-for-sale securities

485



Total comprehensive income

5,421


1,113

Comprehensive income attributable to redeemable non-controlling interests and non-controlling interests in consolidated subsidiaries
324


263

Comprehensive income attributable to Medley LLC
$
5,097


$
850

 

 


See accompanying notes to unaudited condensed consolidated financial statements
F- 3

Medley LLC


Condensed Consolidated Statement of Changes in Equity and Redeemable Non-controlling Interests (unaudited)
(Amounts in thousands, except share and per share amounts) 
 
 
Accumulated
Other
Comprehensive
Income
 
Non-
controlling
Interests in
Consolidated
Subsidiaries
 
Members' Deficit
 
Total
Deficit
 
 
Redeemable
Non-
controlling
Interests
 
 
 
 
 
 
 
Balance at December 31, 2016
 
$
166

 
$
(1,717
)
 
$
(47,441
)
 
$
(48,992
)
 
 
$
30,805

Cumulative effect of accounting change due to the adoption of ASU 2016-09
 

 

 
32

 
32

 
 

Net income
 

 
3

 
3,448

 
3,451

 
 
1,485

Change in fair value of available-for-sale securities
 
161

 

 

 
161

 
 
324

Stock-based compensation
 

 

 
(37
)
 
(37
)
 
 

Reclass of cumulative dividends on forfeited RSUs
 

 

 
416

 
416

 
 

Repurchases of LLC Units
 

 

 
(402
)
 
(402
)
 
 

Contributions
 

 

 

 

 
 
5,000

Distributions
 

 

 
(6,267
)
 
(6,267
)
 
 
(1,573
)
Balance at March 31, 2017
 
$
327

 
$
(1,714
)
 
$
(50,251
)
 
$
(51,638
)
 
 
$
36,041

 

See accompanying notes to unaudited condensed consolidated financial statements
F- 4

Medley LLC


Condensed Consolidated Statements of Cash Flows (unaudited)
(Amounts in thousands) 

 
For the Three Months Ended March 31,
 
2017
 
2016
Cash flows from operating activities
 

 
 

Net income
$
4,936

 
$
1,113

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

 
 

Stock-based compensation
(37
)
 
835

Amortization of debt issuance costs
979

 
135

Accretion of debt discount
552

 
198

Provision for (benefit from) deferred taxes
108

 
(18
)
Depreciation and amortization
235

 
188

Net change in unrealized depreciation on investments
72

 
110

Income from equity method investments
(69
)
 
(12
)
Reclassification of cumulative dividends paid on forfeited restricted stock units
416

 

Other non-cash amounts

 
27

Changes in operating assets and liabilities:
 

 
 

Management fees receivable
1,404

 
3,144

Performance fees receivable
2,217

 
574

Other assets
345

 
780

Accounts payable, accrued expenses and other liabilities
(9,658
)
 
(2,994
)
Net cash provided by operating activities
1,500


4,080

Cash flows from investing activities
 

 
 

Purchases of fixed assets
(18
)
 
(1,867
)
Distributions received from equity method investments
17

 
810

Purchases of available-for-sale securities
(3,728
)
 

Net cash used in investing activities
(3,729
)

(1,057
)
Cash flows from financing activities
 

 
 

Repayment of loans payable
(44,800
)
 
(312
)
Proceeds from issuance of senior unsecured debt
69,108

 

Capital contributions from redeemable non-controlling interests
5,000

 

Distributions to members and redeemable non-controlling interests
(7,840
)
 
(7,529
)
Debt issuance costs
(2,585
)
 

Repurchases of LLC Units
(402
)
 
(1,198
)
Capital contributions to equity method investments
(214
)
 
(53
)
Net cash provided by (used in) financing activities
18,267


(9,092
)
Net increase (decrease) in cash, cash equivalents and restricted cash equivalents
16,038

 
(6,069
)
Cash, cash equivalents and restricted cash equivalents, beginning of period
54,463

 
71,300

Cash, cash equivalents and restricted cash equivalents, end of period
$
70,501


$
65,231

 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements
F- 5

Medley LLC


Condensed Consolidated Statements of Cash Flows (unaudited)
(Amounts in thousands) 

 
For the Three Months Ended March 31,
 
2017
 
2016
Reconciliation of cash, cash equivalents, and restricted cash equivalents reported on the condensed consolidated balance sheets to the total of such amounts reported on the condensed consolidated statements of cash flows
 
 
 
Cash and cash equivalents
$
62,947

 
$
65,231

Restricted cash equivalents
7,554

 

Total cash, cash equivalents and restricted cash equivalents
$
70,501

 
$
65,231

Supplemental disclosure of non-cash investing and financing activities
 
 
 
Deferred tax asset impact on cumulative effect of accounting change
 due to the adoption of ASU 2016-09
$
32

 
$

Fixed assets

 
2,293

Reclassification of redeemable non-controlling interest

 
12,155

 

See accompanying notes to unaudited condensed consolidated financial statements
F- 6

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


1.          ORGANIZATION AND BASIS OF PRESENTATION
 
Medley LLC is an asset management firm offering yield solutions to retail and institutional investors. Medley LLC's national direct origination franchise provides capital to the middle market in the U.S. Medley LLC provides investment management services to permanent capital vehicles, long-dated private funds and separately managed accounts and serves as the general partner to the private funds, which are generally organized as pass-through entities. Medley LLC is headquartered in New York City and has an office in San Francisco.
 
The Company’s business is currently comprised of only one reportable segment, the investment management segment, and substantially all of the Company operations are conducted through this segment. The investment management segment provides investment management services to permanent capital vehicles, long-dated private funds and separately managed accounts. The Company conducts its investment management business in the U.S., where substantially all its revenues are generated.

Medley LLC was formed on October 27, 2010 and is the operating company of Medley Management Inc., a public company traded under the symbol “MDLY.” Medley Management Inc. is the sole managing member of Medley LLC. Medley Management Inc. was incorporated on June 13, 2014 and commenced operations on September 29, 2014 upon completion of its initial public offering (“IPO”) of its Class A common stock. Medley Management Inc.'s sole material operating asset is its investment in Medley LLC.
  
Registered Public Offering of Medley LLC Notes

On August 9, 2016, Medley LLC completed a registered public offering of $25.0 million of an aggregate principal amount of 6.875% senior notes due 2026 (the "2026 Notes") at a public offering price of 100% of the principal amount. On October 18, 2016, Medley LLC completed a public offering of an additional $28.6 million in aggregate principal amount of the 2026 Notes at a public offering price of $24.45 for each $25.00 principal amount of notes. The notes mature on August 15, 2026 and interest is payable quarterly. The notes will be redeemable in whole or in part at Medley's option on or after August 15, 2019 at a redemption price of 100% of the aggregate principal amount plus accrued and unpaid interest payments. The Company used the net proceeds from the offering to repay a portion of the outstanding indebtedness under the Company's Term Loan Facility. The 2026 Notes are listed on the New York Stock Exchange and trades thereon under the trading symbol “MDLX.”

On January 18, 2017, Medley LLC completed a registered public offering of $34.5 million of an aggregate principal amount of 7.25% senior notes due 2024 (the “2024 Notes”) at a public offering price of 100% of the principal amount. On February 22, 2017, Medley LLC completed a public offering of an additional $34.5 million in aggregate principal amount of the 2024 Notes at a public offering price of $25.25 for each $25.00 principal amount of notes. The 2024 Notes mature on January 30, 2024 and interest is payable quarterly commencing on April 30, 2017. The notes will be redeemable in whole or in part at Medley's option on or after January 30, 2020 at a redemption price of 100% of the aggregate principal amount plus accrued and unpaid interest payment. The Company used the net proceeds from the offering to repay the remaining outstanding indebtedness under the Term Loan Facility and for general corporate purposes. The 2024 Notes are listed on the New York Stock Exchange and trade thereon under the trading symbol “MDLQ.”


Medley LLC Reorganization
 
In connection with the IPO of Medley Management Inc. on September 29, 2014, Medley LLC amended and restated its limited liability agreement to modify its capital structure by reclassifying the 23,333,333 interests held by the pre-IPO members into a single new class of units (“LLC Units”). The pre-IPO members also entered into an exchange agreement under which they (or certain permitted transferees thereof) have the right, subject to the terms of an exchange agreement, to exchange their LLC Units for shares of Medley Management Inc.’s Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. In addition, pursuant to the amended and restated limited liability agreement, Medley Management Inc. became the sole managing member of Medley LLC. 
 
The pre-IPO owners are, subject to limited exceptions, prohibited from transferring any LLC Units held by them or any shares of Class A common stock received upon exchange of such LLC Units, until the third anniversary of the date of the closing of the IPO of Medley Management Inc. without the consent of the managing member. Thereafter and prior to the fourth and fifth anniversaries of the closing of the IPO of Medley Management Inc., such holders may not transfer more than 33 1/3% and 66 2/3%, respectively, of the number of LLC Units held by them, together with the number of any shares of Class A common stock received by them upon exchange therefor, without the consent of the managing member.

F- 7

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)



Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of Medley LLC and its consolidated subsidiaries (collectively, “Medley” or the “Company”). Additionally, the accompanying condensed consolidated financial statements of the Company and related financial information have been prepared pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with U.S. GAAP may be omitted. In the opinion of management, the unaudited condensed consolidated financial results included herein contain all adjustments, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods included herein. Therefore, this Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016. The current period's results of operations will not necessarily be indicative of results that ultimately may be achieved for the full year ending December 31, 2017.

2.          SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Principles of Consolidation
 
In accordance with Accounting Standards Codification (“ASC”) 810, Consolidation, the Company consolidates those entities where it has a direct and indirect controlling financial interest based on either a variable interest model or voting interest model. As such, the Company consolidates entities that the Company concludes are variable interest entities (“VIEs”), for which the Company is deemed to be the primary beneficiary and entities in which it holds a majority voting interest or has majority ownership and control over the operational, financial and investing decisions of that entity.
 
For legal entities evaluated for consolidation, the Company must determine whether the interests that it holds and fees paid to it qualify as a variable interest in an entity. This includes an evaluation of the management fees and performance fees paid to the Company when acting as a decision maker or service provider to the entity being evaluated. If fees received by the Company are customary and commensurate with the level of services provided, and the Company does not hold other economic interests in the entity that would absorb more than an insignificant amount of the expected losses or returns of the entity, the interest that the Company holds would not be considered a variable interest. The Company factors in all economic interests including proportionate interests through related parties, to determine if fees are considered a variable interest.
 
An entity in which the Company holds a variable interest is a VIE if any one of the following conditions exist: (a) the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support, (b) the holders of equity investment at risk have the right to direct the activities of the entity that most significantly impact the legal entity’s economic performance, (c) the voting rights of some investors are disproportionate to their obligation to absorb losses or rights to receive returns from a legal entity. For limited partnerships and other similar entities, non-controlling investors must have substantive rights to either dissolve the fund or remove the general partner (“kick-out rights”) in order to not qualify as a VIE.
 
For those entities that qualify as a VIE, the primary beneficiary is generally defined as the party who has a controlling financial interest in the VIE. The Company is generally deemed to have a controlling financial interest if it has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, and the obligation to absorb losses or receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of a VIE at the time it becomes initially involved with the VIE and reconsiders that conclusion continuously. The primary beneficiary evaluation is generally performed qualitatively on the basis of all facts and circumstances. However, quantitative information may also be considered in the analysis, as appropriate. These assessments require judgments. Each entity is assessed for consolidation on a case-by-case basis. 
 
For those entities evaluated under the voting interest model, the Company consolidates the entity if it has a controlling financial interest. The Company has a controlling financial interest in a voting interest entity (“VOE”) if it owns a majority voting interest in the entity.
 

F- 8

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


Consolidated Variable Interest Entities
 
As of March 31, 2017 and December 31, 2016, Medley LLC has three majority owned subsidiaries, SIC Advisors LLC, Medley Seed Funding I LLC and STRF Advisors LLC, which are consolidated VIEs. Each of these entities were organized as a limited liability company and was legally formed to either manage a designated fund or strategically invest capital as well as isolate business risk. As of March 31, 2017, total assets and total liabilities, after eliminating entries, of these VIEs reflected in the condensed consolidated balance sheets were $54.7 million and $20.1 million, respectively. As of December 31, 2016, total assets and total liabilities, after eliminating entries, of these VIEs reflected in the condensed consolidated balance sheets were $51.7 million and $22.8 million, respectively. Except to the extent of the assets of these VIEs that are consolidated, the holders of the consolidated VIEs’ liabilities generally do not have recourse to the Company.
 
Seed Investments
 
The Company accounts for seed investments through the application of the voting interest model under ASC 810-10-25-1 through 25-14 and consolidates a seed investment when the investment advisor holds a controlling interest, which is, in general, 50% or more of the equity in such investment. For seed investments in which the Company does not hold a controlling interest, the Company accounts for such seed investment under the equity method of accounting, at its ownership percentage of such seed investment’s net asset value.
 
Non-Consolidated Variable Interest Entities
 
The Company holds interests in certain VIEs that are not consolidated because the Company is not deemed the primary beneficiary. The Company's interest in these entities is in the form of insignificant equity interests and fee arrangements. The maximum exposure to loss represents the potential loss of assets by the Company relating to these non-consolidated entities.
 
As of March 31, 2017, the Company recorded investments, at fair value, attributed to these non-consolidated VIEs of $5.4 million, receivables of $2.0 million included as a component of other assets and a clawback obligation of $7.1 million included as a component of accounts payable, accrued expenses and other liabilities on the Company’s condensed consolidated balance sheets. The clawback obligation assumes a hypothetical liquidation of a fund’s investments, at their then current fair values and a portion of tax distributions relating to performance fees which would need to be returned. As of December 31, 2016, the Company recorded investments, at fair value of $5.1 million, receivables of $1.9 million included as a component of other assets and a clawback obligation of $7.1 million included as a component of accounts payable, accrued expenses and other liabilities on the Company’s condensed consolidated balance sheets. As of March 31, 2017, the Company’s maximum exposure to losses from these entities is $7.4 million.

Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Management’s estimates are based on historical experience and other factors, including expectations of future events that management believes to be reasonable under the circumstances. These assumptions and estimates also require management to exercise judgment in the process of applying the Company’s accounting policies. Significant estimates and assumptions by management affect the carrying value of investments, performance compensation payable and certain accrued liabilities. Actual results could differ from these estimates, and such differences could be material.  
 
Indemnification
 
In the normal course of business, the Company enters into contractual agreements that provide general indemnifications against losses, costs, claims and liabilities arising from the performance of individual obligations under such agreements. The Company has not experienced any prior claims or payments pursuant to such agreements. The Company’s individual maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not yet occurred. However, based on management’s experience, the Company expects the risk of loss to be remote.
 

F- 9

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


Non-Controlling Interests in Consolidated Subsidiaries

Non-controlling interests in consolidated subsidiaries represent the component of equity in such consolidated entities held by third-parties. These interests are adjusted for contributions to and distributions from Medley entities and are allocated income from Medley entities based on their ownership percentages.
 
Redeemable Non-Controlling Interests

Redeemable non-controlling interests represents interests of certain third parties that are not mandatorily redeemable but redeemable for cash or other assets at a fixed or determinable price or a fixed or determinable date, at the option of the holder or upon the occurrence of an event that is not solely within the control of the issuer. These interests are classified in temporary equity.

Investments
 
Investments include equity method investments that are not consolidated but over which the Company exerts significant influence. The Company measures the carrying value of its public non-traded equity method investment at NAV per share. The Company measures the carrying value of its privately-held equity method investments by recording its share of the underlying income or loss of these entities.
 
Unrealized appreciation (depreciation) resulting from changes in fair value of the equity method investments is reflected as a component of other income (expense), net in the condensed consolidated statements of operations. The Company evaluates its equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable.
 
The carrying amounts of equity method investments are reflected in investments in the consolidated statements of financial condition. As the underlying entities that the Company manages and invests in are, for U.S. GAAP purposes, primarily investment companies which reflect their investments at estimated fair value, the carrying value of the Company’s equity method investments in such entities approximates fair value. The Company evaluates its equity-method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable.
 
Investments also include available-for-sale securities which consist of an investment in publicly traded common stock. The Company measures the carrying value of its publicly traded investment in available-for-sale securities at the quoted market price on the primary market or exchange on which they trade. Unrealized appreciation (depreciation) resulting from changes in fair value of available-for-sale securities is recorded in accumulated other comprehensive income and redeemable non-controlling interests. Realized gains (losses) and declines in value determined to be other than temporary, if any, are reported in other income (expenses), net. The Company evaluates its investment in available-for-sale securities for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investment may not be recoverable.

Debt Issuance Costs
 
Debt issuance costs represent direct costs incurred in obtaining financing and are amortized over the term of the underlying debt using the effective interest method. Debt issuance costs, and the related amortization expense, are adjusted when any prepayments of principal are made to the related outstanding debt. Amortization of debt issuance costs is included as a component of interest expense in the Company's consolidated statement of operations.
 
Revenues
 
Management Fees
 
Medley provides investment management services to both public and private investment vehicles. Management fees include base management fees, other management fees, and Part I incentive fees, as described below.
 
Base management fees are calculated based on either (i) the average or ending gross assets balance for the relevant period, (ii) limited partners’ capital commitments to the funds, (iii) invested capital, (iv) NAV or (v) lower of cost or market value of a fund’s portfolio investments. Depending upon the contracted terms of the investment management agreement, management fees are paid either quarterly in advance or quarterly in arrears, and are recognized as earned over the period the services are provided. 
 

F- 10

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


Certain management agreements provide for Medley to receive other management fee revenue derived from up front origination fees paid by the funds' and/or separately managed accounts' underlying portfolio companies. These fees are recognized when Medley becomes entitled to such fees.
 
Certain management agreements also provide for Medley to receive Part I incentive fee revenue derived from net interest income (excluding gains and losses) above a hurdle rate. As it relates to Medley Capital Corporation (“MCC”), these fees are subject to netting against realized and unrealized losses. Part I incentive fees are paid quarterly and are recognized as earned over the period the services are provided.
  
Performance Fees
 
Performance fees consist principally of the allocation of profits from certain funds and separately managed accounts, to which Medley provides management services. Medley is generally entitled to an allocation of income as a performance fee after returning the invested capital plus a specified preferred return as set forth in each respective agreement. Medley recognizes revenues attributable to performance fees based upon the amount that would be due pursuant to the respective agreement at each period end as if the funds were terminated at that date. Accordingly, the amount recognized in the Company's condensed consolidated financial statements reflects Medley’s share of the gains and losses of the associated funds’ underlying investments measured at their current fair values. Performance fee revenue may include reversals of previously recognized performance fees due to a decrease in the net income of a particular fund that results in a decrease of cumulative performance fees earned to date. Since fund return hurdles are cumulative, previously recognized performance fees also may be reversed in a period of appreciation that is lower than the particular fund’s hurdle rate. During the three months ended March 31, 2017 and 2016, the Company reversed $2.6 million and $0.7 million, respectively, of previously recognized performance fees. As of March 31, 2017, the Company recognized cumulative performance fees of $4.8 million.
 
Performance fees received in prior periods may be required to be returned by Medley in future periods if the funds’ investment performance declines below certain levels. Each fund is considered separately in this regard and, for a given fund, performance fees can never be negative over the life of a fund. If upon a hypothetical liquidation of a fund’s investments, at their then current fair values, previously recognized and distributed performance fees would be required to be returned, a liability is established for the potential clawback obligation. As of March 31, 2017, the Company had not received any performance fee distributions, except for tax distributions related to the Company’s allocation of net income, which included an allocation of performance fees. Pursuant to the organizational documents of each respective fund, a portion of these tax distributions may be subject to clawback. As of March 31, 2017, the Company had accrued $7.1 million for clawback obligations that would need to be paid if the funds were liquidated at fair value as of the end of the reporting period. The Company’s actual obligation, however, would not become payable or realized until the end of a fund’s life.
 
Other Revenues and Fees
 
Medley provides administrative services to certain affiliated funds and is reimbursed for direct and allocated expenses incurred in providing such administrative services, as set forth in the respective underlying agreements. These fees are recognized as revenue in the period administrative services are rendered.
 
Performance Fee Compensation
 
Medley has issued profit interests in certain subsidiaries to select employees. These profit-sharing arrangements are accounted for under ASC 710, Compensation — General, which requires compensation expense to be measured at fair value at the grant date and expensed over the vesting period, which is usually the period over which the service is provided. The fair value of the profit interests are re-measured at each balance sheet date and adjusted for changes in estimates of cash flows and vesting percentages. The impact of such changes is recorded in the condensed consolidated statements of operations as an increase or decrease to performance fee compensation. 
       
Income Taxes

The Company is treated as a partnership for income tax purposes and is therefore not subject to U.S. federal, state and local income taxes. The Company is subject to New York City's unincorporated business tax attributable to the Company's taxable income apportioned to New York City.

F- 11

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


 
The Company accounts for income taxes using the asset and liability approach, which requires the recognition of tax benefits or expenses for temporary differences between the financial reporting and tax basis of assets and liabilities. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company also recognizes a tax benefit from uncertain tax positions only if it is “more likely than not” that the position is sustainable based on its technical merits. The Company’s policy is to recognize interest and penalties on uncertain tax positions and other tax matters as a component of income tax expense. For interim periods, the Company accounts for income taxes based on its estimate of the effective tax rate for the year. Discrete items and changes in its estimate of the annual effective tax rate are recorded in the period they occur.

Recently Issued Accounting Pronouncements Adopted as of January 1, 2017

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies and improves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The Company adopted ASU 2016-09 effective January 1, 2017.

Under the new guidance, all excess tax benefits and tax deficiencies related to employee stock compensation will be recognized within income tax expense. Under prior guidance, excess tax benefits were recognized to additional paid-in capital and tax deficiencies were only recognized to the extent they exceeded the pool of excess tax benefits. In addition, excess tax benefits will be classified as cash flows from operating activities, and cash withheld by the Company for employees' withholding taxes will be classified as cash flows from financing activities on the Company's consolidated statements of cash flows. In connection with the adoption of ASU 2016-09, the Company elected to account for forfeitures as they occur, instead of utilizing an estimated forfeiture rate assumption. The change in accounting for forfeitures was applied on a modified retrospective basis by means of a cumulative-effect adjustment to equity. As of January 1, 2017, a deferred tax asset was recorded in the amount of less than $0.1 million to reflect this change in accounting principle.
 
Recently Issued Accounting Pronouncements Not Yet Adopted
 
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which provides that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for such goods or services. To achieve this core principle, an entity should apply the following steps: (1) identify the contracts with a customer, (2) identify the performance obligations in the contracts, (3) determine the transaction prices, (4) allocate the transaction prices to the performance obligations in the contracts, and (5) recognize revenue when, or as, the entity satisfies a performance obligation. The guidance also requires advanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarified the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarified the implementation guidance regarding performance obligations and licensing arrangements. This new guidance will become effective for the Company on January 1, 2018. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. However, the adoption of this guidance is expected to impact the timing of performance fee revenue recognition. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which requires that all equity investments (except those accounted for under the equity method of accounting) be measured at fair value with changes in fair value recognized in net income. This guidance eliminates the available-for-sale classification for equity securities with readily determinable fair values. However, companies may elect to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. This new guidance will become effective for the Company on January 1, 2018. Under this new guidance, changes in the fair value of available-for-sale securities will no longer be classified in the Company's condensed consolidated statements of comprehensive income but rather as a component of other income in its condensed consolidated statements of operations.
 


F- 12

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This guidance requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. This new guidance will become effective for the Company on January 1, 2019, with early adoption permitted. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements. However, the adoption of this guidance is expected to result in a significant increase in total assets and total liabilities, but is not expected to have a significant impact on the consolidated statement of operations.
 
The Company does not believe any other recently issued, but not yet effective, revisions to authoritative guidance will have a material effect on its consolidated balance sheets, results of operations or cash flows.
 

3.          INVESTMENTS
  
The components of investments are as follows:
 
 
As of
March 31, 2017
(unaudited)
 
As of December 31, 2016
 
(Amounts in thousands)
Equity method investments, at fair value
$
15,088

 
$
14,895

Available-for-sale securities
21,223

 
17,009

Total investments, at fair value
$
36,311


$
31,904

 
Equity Method Investments
 
Medley measures the carrying value of its public non-traded equity method investments at NAV per share. Unrealized appreciation (depreciation) resulting from changes in NAV per share is reflected as a component of other income (expense) in the condensed consolidated statements of operations. The carrying value of the Company’s privately-held equity method investments is determined based on the amounts invested by the Company plus the equity in earnings or losses of the investee allocated based on the respective underlying agreements, less distributions received.
 
The Company evaluates its equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amounts of such investments may not be recoverable. There were no impairment losses recorded during the three months ended March 31, 2017 and 2016.
 
As of March 31, 2017 and December 31, 2016, the Company’s carrying value of its equity method investments was $15.1 million and $14.9 million, respectively. Included in this balance was $9.0 million as of March 31, 2017 and December 31, 2016 from the Company’s investment in publicly-held Sierra Income Corporation (“SIC”). The remaining balance as of March 31, 2017 and December 31, 2016 relates primarily to the Company’s investments in Medley Opportunity Fund II, LP ("MOF II"), Medley Opportunity Fund III LP (“MOF III”) and CK Pearl Fund, LP.
 
Available-For-Sale Securities
 
As of March 31, 2017 and December 31, 2016, the Company’s carrying value of its available-for-sale securities was $21.2 million and $17.0 million, respectively, and consisted of 2,759,748 and 2,264,892 shares of MCC, respectively. The Company measures the carrying value of its investment in MCC at fair value based on the quoted market price on the exchange on which its shares trade. As of March 31, 2017, cumulative unrealized gains in redeemable non-controlling interests and accumulated other comprehensive income on the Company's consolidated balance sheets was $0.4 million and $0.3 million, respectively. There were no impairment charges recorded related to the Company’s investments in available-for-sale securities during the three months ended March 31, 2017 and 2016.
 

F- 13

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


4.           FAIR VALUE MEASUREMENTS
 
The Company follows the guidance set forth in ASC 820 for measuring the fair value of investments in available-for-sale securities. Fair value is the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters, or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation models involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity. Financial instruments recorded at fair value in the consolidated financial statements are categorized for disclosure purposes based upon the level of judgment associated with the inputs to the valuation of the investment as of the measurement date. The three levels are defined as follows:
 
Level I – Valuations based on quoted prices in active markets for identical assets or liabilities at the measurement date.

Level II – Valuations based on inputs other than quoted prices in active markets included in Level I, which are either directly or indirectly observable at the measurement date. This category includes quoted prices for similar assets or liabilities in non-active markets including bids from third parties for privately held assets or liabilities, and observable inputs other than quoted prices such as yield curves and forward currency rates that are entered directly into valuation models to determine the value of derivatives or other assets or liabilities.

Level III – Valuations based on inputs that are unobservable and where there is little, if any, market activity at the measurement date. The inputs for the determination of fair value may require significant management judgment or estimation and is based upon management’s assessment of the assumptions that market participants would use in pricing the assets and liabilities. These investments include debt and equity investments in private companies or assets valued using the market or income approach and may involve pricing models whose inputs require significant judgment or estimation because of the absence of any meaningful current market data for identical or similar investments. The inputs in these valuations may include, but are not limited to, capitalization and discount rates, beta and EBITDA multiples. The information may also include pricing information or broker quotes that include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimer would result in classification as Level III information, assuming no additional corroborating evidence.

When determining the fair value of publicly traded equity securities, the Company uses the quoted market price as of the valuation date on the primary market or exchange on which they trade. The Company’s investments in available-for-sale securities are categorized as Level I. As of March 31, 2017 and December 31, 2016, there were no financial instruments classified as Level II or Level III.
 
Our equity method investments for which fair value is measured at NAV per share, or its equivalent, using the practical expedient, are not categorized in the fair value hierarchy.

A review of the fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting all levels of the fair value hierarchy are reported as transfers in or out of Level I, II or III category as of the beginning of the quarter during which the reclassifications occur. There were no transfers between levels in the fair value hierarchy during the three months ended March 31, 2017 and 2016.
  

F- 14

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


5.           OTHER ASSETS
 
The components of other assets are as follows:
 
As of
March 31, 2017
(unaudited)
 
As of December 31, 2016
 
(Amounts in thousands)
Fixed assets, net of accumulated depreciation of $2,053 and $1,816, respectively
$
4,781

 
$
4,998

Security deposits
1,975

 
1,975

Administrative fees receivable (Note 10)
2,113

 
2,068

Deferred tax assets (Note 11)
1,496

 
1,584

Due from affiliates (Note 10)
1,893

 
2,133

Prepaid expenses and taxes
1,825

 
2,188

Other
2,262

 
2,058

Total other assets
$
16,345


$
17,004

 
6.          LOANS PAYABLE
 
The Company's loans payable consist of the following:
 
As of
March 31, 2017
(unaudited)
 
As of December 31, 2016
 
(Amounts in thousands)
Term loans under the Credit Suisse Term Loan Facility, net of unamortized discount and debt issuance costs of $1,207 as of December 31, 2016
$

 
$
43,593

Non-recourse promissory notes, net of unamortized discount of $1,264 and $1,415, respectively
8,736

 
8,585

Total loans payable
$
8,736


$
52,178


Credit Suisse Term Loan Facility
 
On August 14, 2014, the Company entered into a $110.0 million senior secured term loan credit facility (as amended, “Term Loan Facility”) with Credit Suisse AG, Cayman Islands Branch, as administrative agent and collateral agent thereunder, Credit Suisse Securities (USA) LLC, as bookrunner and lead arranger, and the lenders from time-to-time party thereto, which had an original maturity date of June 15, 2019. In February 2017, borrowings under this facility were paid off using the proceeds from the issuance of senior unsecured debt and the Term Loan Facility was terminated.
 
Borrowings under the Term Loan Facility, bore interest, at the borrower’s option, at a rate equal to either a Eurodollar margin over an adjusted LIBOR (with a “floor” of 1.0%) or a base rate margin over an adjusted base rate determined by reference to the highest of (i) the term loan administrative agent’s prime rate; (ii) the federal funds effective rate in effect on such day plus 0.5%; and (iii) an adjusted LIBOR plus 1.0%. The applicable margins for the Term Loan Facility was 5.5%, in the case of Eurodollar loans and 4.5%, in the case of adjusted base rate loans. Outstanding borrowings under the Term Loan Facility bore interest at a rate of 6.5% as of December 31, 2016. Borrowings were collateralized by substantially all of the equity interests in Medley LLC’s wholly owned subsidiaries. Total interest expense under the Term Loan Facility, including accretion of the note discount and amortization of debt issuance costs, was $1.5 million and $1.8 million for the three months ended March 31, 2017 and 2016, respectively.
 
CNB Credit Agreement
 
On August 19, 2014, the Company entered into a $15.0 million senior secured revolving credit facility with City National Bank (as amended, the “Revolving Credit Facility”). The Company intends to use any proceeds from borrowings under the Revolving Credit Facility for general corporate purposes, including funding of its working capital needs. Borrowings under the Revolving Credit Facility bear interest at the option of the Company, either (i) at an Alternate Base Rate, as defined, plus an

F- 15

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


applicable margin not to exceed 3.25% or (ii) at an Adjusted LIBOR plus an applicable margin not to exceed 4.0%. As of and during the three months ended March 31, 2017 and 2016, there were no amounts drawn under the Revolving Credit Facility.
 
The Revolving Credit Facility also contains a financial covenant that requires the Company to maintain a Maximum Net Leverage Ratio of not greater than 3.5 to 1.0, with which the Company is compliant. This ratio is calculated on a trailing twelve months basis and is the ratio of Total Net Debt, as defined, to Core EBITDA, as defined, and is calculated using the Company’s financial results and includes adjustments made to calculate Core EBITDA. Non-compliance with any of the financial or non-financial covenants without cure or waiver would constitute an event of default under the Revolving Credit Facility. The Revolving Credit Facility also contains other customary events of default, including defaults based on events of bankruptcy and insolvency, dissolution, nonpayment of principal, interest or fees when due, breach of specified covenants, change in control and material inaccuracy of representations and warranties. There were no events of default under the Revolving Credit Facility as of March 31, 2017
 
Non-Recourse Promissory Notes 
 
In April 2012, the Company borrowed $10.0 million under two non-recourse promissory notes. Proceeds from the borrowings were used to purchase 1,108,033 shares of common stock of SIC, which were pledged as collateral for the obligations. Interest on the notes is paid monthly and is equal to the dividends received by the Company related to the pledged shares. The Company may prepay the notes in whole or in part at any time without penalty and the lenders may call the notes if certain conditions are met. The notes are scheduled to mature in March 2019. The proceeds from the notes were recorded net of issuance costs of $3.8 million and are being accreted, using the effective interest method, over the term of the non-recourse promissory notes. Total interest expense under these non-recourse promissory notes, including accretion of the note discount, was $0.3 million and $0.4 million for the three months ended March 31, 2017 and 2016, respectively. The fair value of the outstanding balance of the notes was $10.2 million as of March 31, 2017 and December 31, 2016.
  
Contractual Maturities of Loans Payable
 
As of March 31, 2017, $10.0 million of future principal payments will be due, relating to loans payable, during the year ended December 31, 2019.
 
7.          SENIOR UNSECURED DEBT

The Company’s senior unsecured debt consist of the following:

 
As of March 31,
2017
(unaudited)
 
As of
December 31, 2016
 
(Amounts in thousands)
6.875% Notes due 2026, net of unamortized discount and debt issuance costs of $3,549 at March 31, 2017 and $3,802 at December 31, 2016
$
50,046

 
$
49,793

7.25% Notes due 2024, net of unamortized premium and debt issuance costs of $2,565 at March 31, 2017
66,434

 

Total senior unsecured debt
$
116,480

 
$
49,793


2026 Notes 

On August 9, 2016 and October 18, 2016, the Company issued debt consisting of $53.6 million in aggregate principal amount of senior unsecured notes due 2026 at a stated coupon rate of 6.875% (the "2026 Notes"). The net proceeds from these offerings were used to pay down a portion of the Company's outstanding indebtedness under its Term Loan Facility. Interest is payable quarterly commencing on November 15, 2016. The 2026 Notes are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after August 15, 2019 at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments. The 2026 notes were recorded net of discount and direct issuance costs of $3.8 million which are being amortized over the term of notes using the effective interest rate method. The 2026 Notes are listed on the New York Stock Exchange and trades thereon under the trading symbol “MDLX.” The fair value of the 2026 Notes based on there underlying quoted market price was $53.0 million as of March 31, 2017.

F- 16

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)



Interest expense on the 2026 Notes, including amortization of discount and debt issuance costs, was $1.0 million for the three months ended March 31, 2017.

2024 Notes

On January 18, 2017 and February 22, 2017, the Company issued $69.0 million in aggregate principal amount of senior unsecured notes due 2024 at a stated coupon rate of 7.25% (the "2024 Notes"). The net proceeds from these offerings were used to pay down the remaining portion of the Company's outstanding indebtedness under its Term Loan Facility with the remaining to be used for general corporate purposes. Interest is payable quarterly commencing on April 30, 2017. The 2024 Notes are subject to redemption in whole or in part at any time or from time to time, at the option of the Company, on or after January 30, 2020 at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments. The 2024 notes were recorded net of discount and direct issuance costs of $2.6 million which are being amortized over the term of notes using the effective interest rate method. The 2024 Notes are listed on the New York Stock Exchange and trades thereon under the trading symbol “MDLQ.” The fair value of the 2024 Notes based on there underlying quoted market price was $70.4 million as of March 31, 2017.

Interest expense on the 2024 Notes, including amortization of debt premium and debt issuance costs, was $0.8 million for the three months ended March 31, 2017.

 
8.          ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER LIABILITIES
 
The components of accounts payable, accrued expenses and other liabilities are as follows:
 
As of
March 31, 2017
(unaudited)
 
As of December 31, 2016
 
(Amounts in thousands)
Accrued compensation and benefits
$
1,755

 
$
7,978

Due to affiliates (Note 10)
14,257

 
15,533

Revenue share payable (Note 9)
4,903

 
6,472

Accrued interest
1,472

 
558

Professional fees
331

 
425

Deferred rent
2,755

 
2,833

Deferred tax liabilities (Note 11)
190

 
202

Performance fee compensation payable
105

 
985

Accounts payable and other accrued expenses
1,740

 
2,192

Total accounts payable, accrued expenses and other liabilities
$
27,508


$
37,178

 

9.          COMMITMENTS AND CONTINGENCIES 
 
Operating Leases
 
Medley leases office space in New York City and San Francisco under non-cancelable lease agreements that expire at various times through September 2023. Rent expense was $0.6 million and $0.7 million for the three months ended March 31, 2017 and 2016.
 

F- 17

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


Future minimum rental payments under non-cancelable leases are as follows as of March 31, 2017 (in thousands):
Remaining in 2017
$
2,017

2018
2,704

2019
2,710

2020
2,833

2021
2,430

Thereafter
4,254

Total future minimum lease payments
$
16,948

 
Capital Commitments to Funds
 
As of March 31, 2017 and December 31, 2016, the Company had aggregate unfunded commitments of $0.3 million and $0.5 million, respectively, to certain long-dated private funds.
 
Other Commitments
 
In April 2012, the Company entered into an obligation to pay a fixed percentage of management and incentive fees received by the Company from SIC. The agreement was entered into contemporaneously with the $10 million non-recourse promissory notes that were issued to the same parties (Note 6). The two transactions were deemed to be related freestanding contracts and the $10 million of loan proceeds were allocated to the contracts using their relative fair values. At inception, the Company recognized an obligation of $4.4 million representing the present value of the future cash flows expected to be paid under this agreement. As of March 31, 2017 and December 31, 2016, this obligation amounted to $4.9 million and $6.5 million, respectively, and is recorded as revenue share payable, a component of accounts payable, accrued expenses and other liabilities on the consolidated balance sheets. The change in the estimated cash flows for this obligation is recorded in other income (expense) on the consolidated statements of operations.
 
Legal Proceedings

From time to time, the Company is involved in various legal proceedings, lawsuits and claims incidental to the conduct of its business. Its business is also subject to extensive regulation, which may result in regulatory proceedings against it. Except as described below, the Company is not currently party to any material legal proceedings.

One of the Company's subsidiaries, MCC Advisors LLC, was named as a defendant in a lawsuit on May 29, 2015, by Moshe Barkat and Modern VideoFilm Holdings, LLC (“MVF Holdings”) against MCC, MOF II, MCC Advisors LLC, Deloitte Transactions and Business Analytics LLP A/K/A Deloitte ERG (“Deloitte”), Scott Avila (“Avila”), Charles Sweet, and Modern VideoFilm, Inc. (“MVF”). The lawsuit is pending in the California Superior Court, Los Angeles County, Central District, as Case No. BC 583437. The lawsuit was filed after MCC, as agent for the lender group, exercised remedies following a series of defaults by MVF and MVF Holdings on a secured loan with an outstanding balance at the time in excess of $65 million. The lawsuit sought damages in excess of $100 million. Deloitte and Avila have settled the claims against them in exchange for payment of $1.5 million. Following a separate lawsuit by Mr. Barkat against MVF’s D&O insurance carrier, the carrier, Charles Sweet and MVF have settled the claims against them. On June 6, 2016, the court granted the defendants’ demurrers on several counts and dismissed Mr. Barkat’s claims with prejudice except with respect to his claim for intentional interference with contract. MCC and the other defendants continue to dispute the remaining allegations and are vigorously defending the lawsuit while pursuing affirmative counterclaims against Mr. Barkat and MVF Holdings. On August 29, 2016, MVF Holdings filed another lawsuit in the California Superior Court, Los Angeles County, Central District, as Case No. BC 631888 (the “Derivative Action”), naming MCC Advisors LLC and certain of Medley’s employees as defendants, among others. The plaintiff in the Derivative Action, asserts claims against the defendants for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, unfair competition, breach of the implied covenant of good faith and fair dealing, interference with prospective economic advantage, fraud, and declaratory relief. MCC Advisors LLC and the other defendants believe the outstanding claims for alleged interference with Mr. Barkat’s employment contract, and the other causes of action asserted in the Derivative Action are without merit and all defendants intend to continue to assert a vigorous defense.

F- 18

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


On May 4, 2017, Medley Capital LLC entered into a Settlement Agreement with CK Pearl Fund, Ltd. and CK Pearl Fund, LP (the “CK Pearl Funds”), pursuant to which the CK Pearl Funds granted Medley Capital LLC and its affiliates, managers, officers, directors, employees (the “Medley Parties”) a full release of claims and further agreed to indemnify the Medley Parties from any liabilities and to reimburse Medley Capital LLC for its reasonable legal fees and expenses in connection with the following lawsuit: CK Pearl Fund, Ltd. and CK Pearl Fund, LP v. Rothstein Kass & Company, P.C., Rothstein-Kass P.A., Rothstein Kass & Co. LLC and Rothstein, Kass & Company (Cayman); Rothstein Kass & Company, P.C., Rothstein-Kass P.A., Rothstein Kass & Co. LLC and Rothstein, Kass & Company (Cayman) v. Medley Capital LLC, filed on September 19, 2016, in the Superior Court of New Jersey Law Division: Essex County, as Docket No. L-5196-15 (the “Rothstein Lawsuit”). Pursuant to the settlement, Medley Capital LLC will be filing a motion seeking dismissal as a defendant in the Rothstein Litigation. While Medley Capital LLC will remain as a named defendant until it is dismissed or the action is resolved, in light of the CK Pearl Funds’ agreement to indemnify the Medley Parties and to advance expenses on their behalf, we believe the Rothstein litigation no longer constitutes a material pending legal proceeding. The settlement also resolves our affirmative lawsuit against the CK Pearl Funds, Medley Capital LLC v. CK Pearl Fund, Ltd., filed on November 28, 2016, in the Grand Court of the Cayman Islands in the Financial Services Division, as Cause No. FSD 196 of 2016. 

10.         RELATED PARTY TRANSACTIONS
 
Substantially all of Medley’s revenue is earned through agreements with its non-consolidated funds for which it collects management and performance fees for providing investment and management services.

From June 2012 through December 2016, Medley was party to an Expense Support and Reimbursement Agreement (“ESA”) with SIC. During the term of the ESA, which expired on December 31, 2016, Medley agreed to pay up to 100% of SIC's operating expenses in order for SIC to achieve a reasonable level of expenses relative to its investment income. Pursuant to the ESA, SIC had a conditional obligation to reimburse Medley for any amounts they funded under the ESA if, within three years of the date on which Medley funded such amounts, SIC met certain financial levels. ESA expenses are recorded within general, administrative, and other expense in the consolidated statements of operations. The remaining amounts due to SIC as of March 31, 2017 and December 31, 2016 under the ESA agreement were $6.6 million and $7.9 million, respectively. These amounts are included in accounts payable, accrued expenses and other liabilities as due to affiliates on the consolidated balance sheets. For the three months ended March 31, 2016, Medley recorded $5.2 million of ESA expenses under this agreement.
  
In January 2011, Medley entered into an administration agreement with MCC (the “MCC Admin Agreement”), whereby Medley agreed to provide administrative services necessary for the operations of MCC. MCC agreed to pay Medley for the costs and expenses incurred in providing such administrative services, including an allocable portion of Medley’s overhead expenses and an allocable portion of the cost of MCC’s officers and their respective staffs. Medley records these administrative fees as revenue in the period when the services are provided and are included in other revenues and fees on the consolidated statements of operations. During the three months ended March 31, 2017 and 2016, the Company recorded $1.0 million and $1.1 million, respectively, of revenue related to the MCC Admin Agreement. Amounts due from MCC under the MCC Admin Agreement were $1.0 million and $0.9 million as of March 31, 2017 and December 31, 2016, respectively, and are included as a component of other assets on the consolidated balance sheets.

In April 2012, Medley entered into an administration agreement with SIC (the “SIC Admin Agreement”), whereby Medley agreed to provide administrative services necessary for the operations of SIC. SIC agreed to pay Medley for the costs and expenses incurred in providing such administrative services including an allocable portion of Medley’s overhead expenses and an allocable portion of the cost of SIC’s officers and their respective staffs. Medley records these administrative fees as revenue in the period when the services are provided and are included in other revenues and fees on the condensed consolidated statement of operations. During the three months ended March 31, 2017 and 2016, the Company recorded $0.8 million and $0.6 million, respectively, of revenue related to the SIC Admin Agreement. Amounts due from SIC under the SIC Admin Agreement were $0.8 million and $0.9 million as of March 31, 2017 and December 31, 2016, respectively, and are included as a component of other assets on the consolidated balance sheets. 
 
Additionally, Medley entered into administration agreements with other entities that it manages (the “Funds Admin Agreements”), whereby Medley agreed to provide administrative services necessary for the operations of these other vehicles. These other entities agreed to pay Medley for the costs and expenses incurred in providing such administrative services, including an allocable portion of Medley’s overhead expenses and an allocable portion of the cost of these other vehicles' officers and their respective staffs. Medley records these administrative fees as revenue in the period when the services are provided and are included in other revenues and fees on the consolidated statement of operations. During the three months ended March 31, 2017 and 2016, the Company recorded $0.3 million and $0.2 million, respectively, of revenue related to the Funds Admin Agreements. Amounts

F- 19

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


due from these entities under the Funds Admin Agreements were $0.3 million as of March 31, 2017 and December 31, 2016, and are included as a component of other assets on the consolidated balance sheets.

In connection with the amended and restated limited liability agreement of Medley LLC, Medley LLC agreed to, at the sole discretion of the managing member, reimburse Medley Management Inc. for all expenses incurred other than expenses incurred in connection with its income tax obligations. From time to time, the Company may also advance funds to Medley Management Inc. to cover its operating needs. For the three months ended March 31, 2017 and 2016, the Company recorded expense reimbursements of $0.5 million and $1.1 million , respectively, which were recorded as a component of Other income (expense), net on the consolidated statements of operations. As of March 31, 2017 and December 31, 2016, amounts due from Medley Management Inc. was $0.3 million and $0.5 million and was recorded as a component of other assets on the consolidated balance sheets.

Pursuant to the organization agreement between Medley Management Inc. and Medley LLC, Medley Management Inc. may from time to time make grants of restricted stock units or other awards providing the holder with the contractual right to receive cash payments pursuant to an equity plan to employees, advisors or other persons, as defined, in respect of Medley LLC and its subsidiaries. These awards may entitle the holder thereof to receive dividends paid with respect to the shares of Class A common stock underlying such awards as if such holder were a holder of record of the underlying shares of Class A common stock. Medley LLC has agreed that it assumes any obligation to pay such dividend equivalent amounts to the holders of the respective awards. Additionally, pursuant to this agreement, the number of LLC Units held by Medley Management Inc., shall, at all times, equal the number of shares of Class A common stock outstanding and Medley LLC has agreed to issue additional LLC units equal to the number of shares of Medley Management Inc. issued pursuant to its equity plan.
 
Equity Method Investments
 
The Company holds equity method investments in SIC, MOF II, MOF III, CK Pearl Fund, L.P. and other vehicles. As of March 31, 2017 and December 31, 2016, the Company’s carrying value of its equity method investments was $15.1 million and $14.9 million, respectively. Included in this balance was $9.0 million as of March 31, 2017 and December 31, 2016, from the Company’s investment in SIC.
 
Available-For-Sale Securities
 
As of March 31, 2017 and December 31, 2016, the Company’s carrying value of its available-for-sale securities was $21.2 million and $17.0 million, respectively, and consisted of 2,759,748 and 2,264,892 shares of MCC, respectively. As of March 31, 2017, the Company recorded $0.7 million of cumulative unrealized gains in redeemable non-controlling interests and accumulated other comprehensive income on the Company's condensed consolidated balance sheets.

Exchange Agreement

Prior to the completion of the IPO of Medley Management Inc., the Medley LLC Agreement was restated among other things, to modify its capital structure by reclassifying the interests held by its existing owners (i.e. the members of Medley prior to the IPO of Medley Management Inc.) into the LLC Units. Medley’s existing owners also entered into an exchange agreement under which they (or certain permitted transferees thereof) have the right (subject to the terms of the exchange agreement as described therein) to exchange their LLC Units for shares of Medley Management Inc.’s Class A common stock on a one-for-one basis at fair value, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications.

 
 
11.         INCOME TAXES
 
Deferred income taxes reflect the net effect of temporary differences between the tax basis of an asset or liability and its reported amount in the Company’s consolidated balance sheets. These temporary differences result in taxable or deductible amounts in future years. As of March 31, 2017 and December 31, 2016, the Company had total deferred tax assets of $1.5 million and $1.6 million, respectively, which consists primarily of temporary differences relating to certain accrued expenses, stock compensation and a tax benefit relating to tax goodwill. Total deferred tax liabilities were $0.2 million as of March 31, 2017 and December 31, 2016 and consists primarily of temporary differences relating to accrued fee income and accumulated net unrealized losses. The tax provision for deferred income taxes results from temporary differences arising principally from certain accrued expenses, deferred rent, fee income accruals and depreciation.

F- 20

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


 
The Company’s effective tax rate was 2.5% and 3.0% for the three months ended March 31, 2017 and 2016, respectively. The quarterly provision for income taxes is determined based on the Company’s estimated full year effective tax rate adjusted by the amount of tax attributable to infrequent or unusual items that are separately recognized on a discrete basis in the income tax provision in the quarter in which they occur. The Company is subject to New York City unincorporated business tax attributable to its taxable income apportioned to New York City.
 
Interest expense and penalties related to income tax matters are recognized as a component of the provision for income taxes. There were no such amounts incurred during the three months ended March 31, 2017 and 2016. As of March 31, 2017 and December 31, 2016 and during the three months ended March 31, 2017 and 2016, there were no uncertain tax positions taken that were not more likely than not to be sustained. Certain subsidiaries of the Company are no longer subject to tax examinations by taxing authorities for tax years prior to 2012.

12.         COMPENSATION EXPENSE
 
Compensation generally includes salaries, bonuses, and profit sharing awards. Bonuses and profit sharing awards are accrued over the service period to which they relate. Guaranteed payments made to our senior professionals who are members of Medley LLC are recognized as compensation expense. The guaranteed payments to the Company’s Co-Chief Executive Officers are performance based and are periodically set subject to maximums based on the Company’s total assets under management. Such maximums aggregated to $0.6 million for each of the Co-Chief Executive Officers during each of the three months ended March 31, 2017 and 2016. During the three months ended March 31, 2017 and 2016, neither of the Company’s Co-Chief Executive Officers received any guaranteed payments.
 
Performance Fee Compensation
 
In October 2010 and January 2014, the Company granted shares of vested profit interests in certain subsidiaries to select employees. These awards are viewed as a profit-sharing arrangement and are accounted for under ASC 710, which requires compensation expense to be recognized over the vesting period, which is usually the period over which service is provided. The shares were vested at grant date, subject to a divestiture percentage based on percentage of service completed from the award grant date to the employee’s termination date. The Company adjusts the related liability quarterly based on changes in estimated cash flows for the profit interests.

In February 2015 and March 2016, the Company granted incentive cash bonus awards to select employees.  These awards entitle employees to receive cash compensation based on distributed performance fees received by the Company from certain institutional funds. Eligibility to receive payments pursuant to these incentive awards is based on continued employment and ceases automatically upon termination of employment.  Performance compensation expense is recorded based on the fair value of the incentive awards at the date of grant and is recognized on a straight-line basis over the expected requisite service period.  The performance compensation liability is subject to re-measurement at the end of each reporting period and any changes in the liability are recognized in such reporting period.
 
For the three months ended March 31, 2017 and 2016, the Company recorded a reversal of performance fee compensation expense of $0.9 million and $0.1 million, respectively. As of March 31, 2017 and December 31, 2016, the total performance fee compensation payable for these awards was $0.1 million and $1.0 million, respectively, and is included as a component of accounts payable, accrued expenses and other liabilities on the Company's condensed consolidated balance sheets.
 
Retirement Plan
 
The Company sponsors a defined-contribution 401(k) retirement plan that covers all employees. Employees are eligible to participate in the plan immediately, and participants are 100% vested from the date of eligibility. The Company makes contributions to the plan of 3% of an employee’s eligible wages, up to a maximum limit as determined by the Internal Revenue Service. The Company also pays all administrative fees related to the plan. The Company's accrued contributions to the plan were $0.1 million for each of the three months ended March 31, 2017 and 2016. As of March 31, 2017 and December 31, 2016 the Company's outstanding liability to the Plan was $0.6 million and $0.5 million, respectively.
 

F- 21

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)


Stock-Based Compensation
 
In connection with the IPO of Medley Management Inc., Medley Management Inc. and Medley LLC adopted the Medley Management Inc. 2014 Omnibus Incentive Plan (the “Plan”). The purpose of the Plan is to provide a means through which the Company may attract and retain key personnel and to provide a means whereby directors, officers, employees, consultants and advisors (and prospective directors, officers, employees, consultants and advisors) of the Company can acquire and maintain an equity interest in the managing member of the Company, Medley Management Inc., or be paid incentive compensation, including incentive compensation measured by reference to the value of Medley Management Inc.’s Class A common stock or Medley LLC’s unit interests, thereby strengthening their commitment to the welfare of the Company and aligning their interests with those of Medley Management Inc.’s stockholders. The Plan provides for the issuance of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), restricted Class A LLC Units, stock bonuses, other stock-based awards and cash awards. As the grant of these awards are primarily for the benefit of the employees of Medley LLC, stock compensation is recognized in Medley LLC’s separate consolidated financial statements through a corresponding credit to members’ equity (deficit), representing a capital contribution by Medley Management Inc.

For the three months ended March 31, 2017 stock-based compensation was less than $0.1 million. Stock-based compensation was $0.8 million for the three months ended March 31, 2016. Stock-based compensation was recorded as compensation and benefits on the consolidated statements of operations and contributions on the consolidated statements of changes in equity and redeemable non-controlling interests.

 
13.         REDEEMABLE NON-CONTROLLING INTERESTS
 
In January 2016, the Company executed an amendment to SIC Advisors' operating agreement which provided the Company with the right to redeem membership units owned by the minority interest holder.  The Company’s redemption right is triggered by the termination of the dealer manager agreement between SIC and SC Distributors LLC, an affiliate of the minority interest holder. As a result of this redemption feature, the Company reclassified the non-controlling interest in SIC Advisors from the equity section to redeemable non-controlling interests in the mezzanine section of the balance sheet based on its fair value as of the amendment date.  The fair value of the non-controlling interest was determined to be $12.2 million on the date of the amendment and was adjusted through a charge to Members' Capital. During the three months ended March 31, 2017, net income allocated to this non-controlling interest was $1.0 million and distributions paid were $1.1 million. As of March 31, 2017, the balance of the redeemable non-controlling interest in SIC Advisors LLC was $13.2 million.
 
On June 3, 2016, the Company entered into a Master Investment Agreement with DB MED Investor I LLC and DB MED Investor II LLC (the ‘‘Investors’’) to invest up to $50 million in new and existing Medley managed funds (the ‘‘Joint Venture’’). The Company will contribute up to $10 million and an interest in STRF Advisors LLC, the investment advisor to Sierra Total Return Fund, in exchange for common equity interests in the Joint Venture. The Investors will invest up to $40 million in exchange for preferred equity interests in the Joint Venture. On account of the preferred equity interests, the Investors will receive an 8% preferred distribution, 15% of the Joint Venture’s profits, and all of the profits from the contributed interest in STRF Advisors LLC. Medley has the option, subject to certain conditions, to cause the Joint Venture to redeem the Investors’ interest in exchange for repayment of the outstanding investment amount at the time of redemption, plus certain other considerations. The Investors have the right, after seven years, to redeem their interests in the Joint Venture. As such, the Investors’ interest in the Joint Venture is included as a component of redeemable non-controlling interests on the Company’s consolidated balance sheets and amounted to $22.8 million as of March 31, 2017. Total contributions to the Joint Venture amounted to $27.5 million through March 31, 2017 and were used to purchase $20.5 million of MCC shares on the open market. During the three months ended March 31, 2017, net income and other comprehensive income allocated to this non-controlling interest was $0.5 million and $0.3 million, respectively. Distributions paid during the three months ended March 31, 2017 were $0.4 million. The Company intends to use the remaining contributions of $7.0 million, which is included in restricted cash equivalents on our consolidated balance sheets, to fund future investments.


F- 22

Medley LLC

Notes to Condensed Consolidated Financial Statements (unaudited)



14.         MARKET AND OTHER RISK FACTORS
 
Due to the nature of the Medley funds’ investment strategy, their portfolio of investments has significant market and credit risk. As a result, the Company is subject to market and other risk factors, including, but not limited to the following:
 
Market Risk
 
The market price of investments may significantly fluctuate during the period of investment. Investments may decline in value due to factors affecting securities markets generally or particular industries represented in the securities markets. The value of an investment may decline due to general market conditions that are not specifically related to such investment, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors that affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry. 
 
Credit Risk
 
There are no restrictions on the credit quality of the investments the Company intends to make. Investments may be deemed by nationally recognized rating agencies to have substantial vulnerability to default in payment of interest and/or principal. Some investments may have low-quality ratings or be unrated. Lower rated and unrated investments have major risk exposure to adverse conditions and are considered to be predominantly speculative. Generally, such investments offer a higher return potential than higher rated investments, but involve greater volatility of price and greater risk of loss of income and principal.
 
In general, the ratings of nationally recognized rating organizations represent the opinions of agencies as to the quality of the securities they rate. Such ratings, however, are relative and subjective; they are not absolute standards of quality and do not evaluate the market value risk of the relevant securities. It is also possible that a rating agency might not change its rating of a particular issue on a timely basis to reflect subsequent events. The Company may use these ratings as initial criteria for the selection of portfolio assets for the Company but is not required to utilize them.
 
Limited Liquidity of Investments
 
The funds managed by the Company invest and intend to continue to invest in investments that may not be readily marketable. Illiquid investments may trade at a discount from comparable, more liquid investments and, at times there may be no market at all for such investments. Subordinate investments may be less marketable, or in some instances illiquid, because of the absence of registration under federal securities laws, contractual restrictions on transfer, the small size of the market or the small size of the issue (relative to issues of comparable interests). As a result, the funds managed by the Company may encounter difficulty in selling its investments or may, if required to liquidate investments to satisfy redemption requests of its investors or debt service obligations, be compelled to sell such investments at less than fair value.
 
Counterparty Risk
 
Some of the markets in which the Company, on behalf of its underlying funds, may affect its transactions are “over-the-counter” or “interdealer” markets. The participants in such markets are typically not subject to credit evaluation and regulatory oversight, unlike members of exchange-based markets. This exposes the Company to the risk that a counterparty will not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the applicable contract (whether or not such dispute is bona fide) or because of a credit or liquidity problem, causing the Company to suffer loss. Such “counterparty risk” is accentuated for contracts with longer maturities where events may intervene to prevent settlement, or where the Company has concentrated its transactions with a single or small group of counterparties.
 

F- 23




Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q and our financial statements included in our Annual Report on Form 10-K.

Overview
 
We are an alternative asset management firm offering yield solutions to retail and institutional investors. We focus on credit-related investment strategies, primarily originating senior secured loans to private middle market companies in the U.S. that have revenues between $50 million and $1 billion. We generally hold these loans to maturity. Our national direct origination franchise, with over 85 people, provides capital to the middle market in the U.S. Over the past 15 years, we have provided capital to over 350 companies across 35 industries in North America.
                                                 
We manage two permanent capital vehicles, both of which are BDCs, as well as long-dated private funds and SMAs, focusing on senior secured credit.
 
As of March 31, 2017, we had $5.5 billion of AUM, $2.5 billion in permanent capital vehicles and $3.0 billion in long-dated private funds and SMAs. Our year over year AUM growth as of March 31, 2017 was 9% and was driven in large part by the growth of our long-dated private funds and SMAs. Our compounded annual AUM growth rate from December 31, 2010 through March 31, 2017 was 31% and our compounded annual Fee Earning AUM growth rate was 22%, both of which have been driven in large part by the growth in our permanent capital vehicles. As of March 31, 2017, we had $3.2 billion of Fee Earning AUM, $2.2 billion in permanent capital vehicles and $1.0 billion in long-dated private funds and SMAs. Typically the investment periods of our institutional commitments range from 18 to 24 months and we expect our Fee Earning AUM to increase as capital commitments included in AUM are invested.

In general, our institutional investors do not have the right to withdraw capital commitments and, to date, we have not experienced any withdrawals of capital commitments. For a description of the risk factor associated with capital commitments, see “Risk Factors – Third-party investors in our private funds may not satisfy their contractual obligation to fund capital calls when requested, which could adversely affect a fund’s operations and performance” included in our Annual Report on Form 10-K.
 
Direct origination, careful structuring and active monitoring of the loan portfolios we manage are important success factors in our business, which can be adversely affected by difficult market and political conditions, such as the turmoil in the global capital markets from 2007 to 2009. Since our inception in 2006, we have adhered to a disciplined investment process that employs these principles with the goal of delivering strong risk-adjusted investment returns while protecting investor capital. We believe that our ability to directly originate, structure and lead deals enables us to consistently lend at higher yields with better terms. In addition, the loans we manage generally have a contractual maturity of between three and seven years and are typically floating rate, which we believe positions our business well for rising interest rates.
 
Our senior management team has, on average, over 20 years of experience in credit, including originating, underwriting, principal investing and loan structuring. We have made significant investments in our corporate infrastructure and have over 85 employees, including over 45 investment, origination and credit management professionals, and over 40 operations, accounting, legal, compliance and marketing professionals, each with extensive experience in their respective disciplines.

The significant majority of our revenue is derived from management fees, which include base management fees earned on all of our investment products as well as Part I incentive fees earned from our permanent capital vehicles and from certain of our long-dated private funds. Our base management fees are generally calculated based upon fee earning assets and paid quarterly in cash. Our Part I incentive fees are typically calculated based upon net investment income, subject to a hurdle rate, and are also paid quarterly in cash.
 
We also may earn performance fees from our long-dated private funds and SMAs. Typically, these performance fees are 15.0% to 20.0% of the total return above a hurdle rate. These performance fees are accrued quarterly and paid after the return of all invested capital and an amount sufficient to achieve the hurdle rate of return.

We also may receive incentive fees related to realized capital gains in our permanent capital vehicles and certain of our long-dated private funds that we refer to as Part II incentive fees. Part II incentive fees are payable annually and are calculated at the end of each applicable year by subtracting (i) the sum of cumulative realized capital losses and unrealized capital depreciation

1




from (ii) cumulative aggregate realized capital gains. If the amount calculated is positive, then the Part II incentive fee for such year is equal to 20% of such amount, less the aggregate amount of Part II incentive fees paid in all prior years. If such amount is negative, then no Part II incentive fee will be payable for such year. As our investment strategy is focused on generating yield from senior secured credit, historically we have not generated Part II incentive fees.
 
For the three months ended March 31, 2017 and March 31, 2016, 83%, and 89%, respectively, of our revenues were generated from management fees and performance fees derived primarily from net interest income on senior secured loans.

Our primary expenses are compensation to our employees and general, administrative and other expenses. Compensation includes salaries, discretionary bonuses, stock-based compensation and benefits paid and payable to our employees. Performance fee compensation is related to performance fees, generally consisting of incentive allocations in our long-dated private funds that we grant to certain of our professionals. General and administrative expenses include costs primarily related to professional services, office rent and related expenses, depreciation and amortization, travel and related expenses, information technology, communication and information services, placement fees and third-party marketing expenses, other general operating items, and, in 2016, expense support agreement expenses related to SIC.

Registered Public Offering of Medley LLC Notes

On August 9, 2016, Medley LLC completed a registered public offering of $25.0 million of an aggregate principal amount of 6.875% senior notes due 2026 (the "2026 Notes") at a public offering price of 100% of the principal amount. On October 18, 2016, Medley LLC completed a public offering of an additional $28.6 million in aggregate principal amount of 2026 Notes at a public offering price of $24.45 for each $25.00 principal amount of notes. The notes mature on August 15, 2026 and interest is payable quarterly. The notes will be redeemable in whole or in part at our option on or after August 15, 2019 at a redemption price of 100% of the aggregate principal amount plus accrued and unpaid interest payments. We used the net proceeds from the offering to repay a portion of the outstanding indebtedness under the Company's Term Loan Facility. The 2026 Notes are listed on the New York Stock Exchange and trades thereon under the trading symbol “MDLX.”

On January 18, 2017, Medley LLC completed a registered public offering of $34.5 million of an aggregate principal amount of 7.25% senior notes due 2024 (the “2024 Notes”) at a public offering price of 100% of the principal amount. On February 22, 2017, Medley LLC completed a public offering of an additional $34.5 million in aggregate principal amount of 2024 Notes at a public offering price of $25.25 for each $25.00 principal amount of notes. The 2024 Notes mature on January 30, 2024 and interest is payable quarterly commencing on April 30, 2017. The notes will be redeemable in whole or in part at our option on or after January 30, 2020 at a redemption price of 100% of the aggregate principal amount plus accrued and unpaid interest payment. We used the net proceeds from the offering to repay the remaining outstanding indebtedness under the Term Loan Facility and for general corporate purposes. The 2024 Notes are listed on the New York Stock Exchange and trade thereon under the trading symbol “MDLQ.”
 
Medley LLC Reorganization

In connection with the initial public offering (“IPO”) of Medley Management Inc., Medley LLC amended and restated its limited liability agreement to modify its capital structure by reclassifying the 23,333,333 interests held by the pre-IPO members into a single new class of units. The pre-IPO members also entered into an exchange agreement under which they (or certain permitted transferees thereof) have the right, subject to the terms of the exchange agreement, to exchange their LLC Units for shares of Medley Management Inc.’s Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. In addition, pursuant to the amended and restated limited liability agreement, Medley Management Inc. became the sole managing member of Medley LLC. Medley Management Inc. is controlled by the pre-IPO owners.

The pre-IPO owners, are, subject to limited exceptions, prohibited from transferring any LLC Units held by them or any shares of Class A common stock received upon exchange of such LLC Units, until the third anniversary of the date of the closing of the IPO of Medley Management Inc. without the consent of the managing member. Thereafter and prior to the fourth and fifth anniversaries of the closing of the IPO of Medley Management Inc., such holders may not transfer more than 33 1/3% and 66 2/3%, respectively, of the number of LLC Units held by them, together with the number of any shares of Class A common stock received by them upon exchange therefor, without the consent of the managing member.


2




Our Structure
 
Medley LLC is a partially owned subsidiary of Medley Management Inc., a holding company whose sole material asset is its controlling equity interest in Medley LLC. Medley Management Inc. operates and controls all of the business and affairs and consolidates the financial results of Medley LLC and its subsidiaries. Medley Management Inc. owns 100% of the voting interests in Medley LLC and 19.12% of the issued and outstanding LLC Units of Medley LLC. The remaining LLC Units (80.88%) are held by Brook Taube, Seth Taube and other members of senior management ("Senior Management Owners"). The LLC Units do not have voting rights. Medley Management Inc. and the Senior Management Owners have also entered into an exchange agreement under which the Senior Management Owners (or certain permitted transferees) have the right (subject to the terms of the exchange agreement), to exchange their equity interest in Medley LLC for shares of Medley Management Inc.'s Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications.

Medley Group LLC, an entity wholly-owned by the pre-IPO owners, holds all 100 issued and outstanding shares of Medley Management Inc.'s Class B common stock. For so long as the pre-IPO owners and then-current Medley personnel hold at least 10% of the aggregate number of shares of Class A common stock and LLC Units (excluding those LLC Units held by Medley Management Inc.), which we refer to as the “Substantial Ownership Requirement,” the Class B common stock entitles Medley Group LLC, without regard to the number of shares of Class B common stock held by it, to a number of votes that is equal to 10 times the aggregate number of LLC Units held by all non-managing members of Medley LLC that do not themselves hold shares of Class B common stock and entitle each other holder of Class B common stock, without regard to the number of shares of Class B common stock held by such other holder, to a number of votes that is equal to 10 times the number of LLC Units held by such holder. For purposes of calculating the Substantial Ownership Requirement, (1) shares of Class A common stock deliverable to our pre-IPO owners and then-current Medley personnel pursuant to outstanding equity awards will be deemed then outstanding and (2) shares of Class A common stock and LLC Units held by any estate, trust, partnership or limited liability company or other similar entity of which any pre-IPO owner or then-current Medley personnel, or any immediate family member thereof, is a trustee, partner, member or similar party will be considered held by such pre-IPO owner or other then-current Medley personnel. From and after the time that the Substantial Ownership Requirement is no longer satisfied, the Class B common stock will entitle Medley Group LLC, without regard to the number of shares of Class B common stock held by it, to a number of votes that is equal to the aggregate number of LLC Units held by all non-managing members of Medley LLC that do not themselves hold shares of Class B common stock and entitle each other holder of Class B common stock, without regard to the number of shares of Class B common stock held by such other holder, to a number of votes that is equal to the number of LLC Units held by such holder. At the completion of our IPO, our pre-IPO owners were comprised of all of the non-managing members of Medley LLC. However, Medley LLC may in the future admit additional non-managing members that would not constitute pre-IPO owners. If at any time the ratio at which LLC Units are exchangeable for shares of our Class A common stock changes from one-for-one as set forth in the Exchange Agreement, the number of votes to which Class B common stockholders are entitled will be adjusted accordingly. Holders of shares of our Class B common stock will vote together with holders of our Class A common stock as a single class on all matters on which stockholders are entitled to vote generally, except as otherwise required by law.
 
Holders of equity interests in Medley LLC (other than Medley Management Inc.), are, subject to limited exceptions, prohibited from transferring any LLC Units held by them as of September 23, 2014 (the date of consummation of the IPO of Medley Management Inc.), or any shares of Medley Management Inc.'s Class A common stock received upon exchange of such LLC Units, until September 23, 2017 without Medley Management Inc.'s consent. Thereafter and prior to September 23, 2018 and September 23, 2019, such holders may not transfer more than 33 1/3% and 66 2/3%, respectively, of the number of any shares of Medley LLC's equity interests held by them as of September 23, 2014 (the date of consummation of the IPO of Medley Management Inc.), together with the number of any shares of Medley management Inc.'s Class A common stock received by them upon exchange therefor, without our consent. While this agreement could be amended or waived by Medley Management Inc., the holders of the equity interests in Medley LLC (other than Medley Management Inc.) have advised us that they do not intend to seek any waivers of these restrictions.
 

3




The diagram below depicts our organizational structure (excluding those operating subsidiaries with no material operations or assets) as of May 11, 2017:

orgchart.jpg
 
____________
(1)
The Class B common stock provides Medley Group LLC with a number of votes that is equal to 10 times the aggregate number of LLC Units held by all non-managing members of Medley LLC. From and after the time that the Substantial Ownership Requirement is no longer satisfied, the Class B common stock will provide Medley Group LLC with a number of votes that is equal to the aggregate number of LLC Units held by all non-managing members of Medley LLC that do not themselves hold shares of Class B common stock.
(2)
If the pre-IPO owners exchanged all of their LLC Units for shares of Class A common stock, they would hold 80.88% of the outstanding shares of Class A common stock, entitling them to an equivalent percentage of economic interests and voting power in Medley Management Inc., Medley Group LLC would hold no voting power or economic interests in Medley

4




Management Inc. and Medley Management Inc. would hold 100% of outstanding LLC Units and 100% of the voting power in Medley LLC.
(3)
Strategic Capital Advisory Services, LLC owns 20% of SIC Advisors LLC and is entitled to receive distributions of up to 20% of the gross cash proceeds received by SIC Advisors LLC from the management and incentive fees payable by Sierra Income Corporation to SIC Advisors LLC, net of certain expenses, as well as 20% of the returns of the investments held at SIC Advisors LLC.
(4)
Medley LLC holds 96.5% of the Class B economic interests in each of MCOF Management LLC, and Medley (Aspect) Management LLC.
(5)
Pursuant to the Master Investment Agreement among Medley LLC, Medley Seed Funding I LLC, Medley Seed Funding II LLC, Medley Seed Funding III LLC, DB MED Investor I LLC and DB MED Investor II LLC, dated June 3, 2016, Medley LLC holds 100% of the outstanding Common Interest and DB MED Investor I LLC holds 100% of the outstanding Preferred Interest in this entity.
(6)
Certain employees, former employees and former members of Medley LLC hold approximately 40% of the limited liability company interests in MOF II GP LLC, the entity that serves as general partner of MOF II, entitling the holders to share the performance fees earned from MOF II.
(7)
Medley GP Holdings LLC holds 96.5% of the Class B economic interests in each of MCOF GP LLC, and Medley (Aspect) GP LLC.

Trends Affecting Our Business
 
Our results of operations, including the fair value of our AUM, are affected by a variety of factors, including conditions in the global financial markets as well as economic and political environments, particularly in the U.S.
 
During the first half of fiscal year 2016, economic conditions continued to be unpredictable and volatile as it was during fiscal year 2015. However, during the second half of fiscal year 2016, broad economic markets showed stability and loan volumes across the lending spectrum improved. Loan funds received significant inflows while CLO issuances continued to increase in the second half of 2016. Both these factors drove significant volume in the loan market and drove pricing lower in 2016 and into the first quarter of 2017. As a result, the opportunity set for appropriate risk-adjusted investments reduced. Our platform provides us the ability to lend across the capital structure and at varying interest rates providing our firm access to a larger borrower subset over time; however, we believe the deployment of capital during fiscal year 2016 and into the first quarter of 2017, was prudent and cautious in-light of the prevailing market conditions.
 
In addition to these macroeconomic trends and market factors, our future performance is dependent on our ability to attract new capital. We believe the following factors will influence our future performance:
 
The extent to which investors favor directly originated private credit investments. Our ability to attract additional capital is dependent on investors’ views of directly originated private credit investments relative to traditional assets. We believe fundraising efforts will continue to be impacted by certain fundamental asset management trends that include: (i) the increasing importance of directly originated private credit investment strategies for institutional investors; (ii) increasing demand for directly originated private credit investments from retail investors; (iii) recognition by the consultant channel, which serves endowment and pension fund investors, that directly originated private credit is an important component of asset allocation; (iv) increasing demand from insurance companies seeking alternatives to investing in the liquid credit markets; and (v) de-leveraging of the global banking system, bank consolidation and increased bank regulatory requirements. 
Our ability to generate strong, stable returns and retain investor capital throughout market cycles. The capital we are able to attract and retain drives the growth of our AUM, fee earning AUM and management fees. We believe we are well positioned to invest through market cycles given our AUM is in either permanent capital vehicles or long-dated private funds and SMAs.
Our ability to source investments with attractive risk-adjusted returns. Our ability to grow our revenue is dependent on our continued ability to source attractive investments and deploy the capital that we have raised. We believe that the current economic environment provides attractive investment opportunities. Our ability to identify attractive investments and execute on those investments is dependent on a number of factors, including the general macroeconomic environment, valuation, size and the liquidity of these investment opportunities. A significant decrease in the quality or quantity of investment opportunities in the directly originated private credit market, a substantial increase in corporate default rates, an increase in competition from new entrants providing capital to the private debt market and a decrease in recovery rates of directly originated private credit could adversely affect our ability to source investments with attractive risk-adjusted returns.

5




The attractiveness of our product offering to investors. We believe defined contribution plans, retail investors, public institutional investors, pension funds, endowments, sovereign wealth funds and insurance companies are increasing exposure to directly originated private credit investment products to seek differentiated returns and current yield. Our permanent capital vehicles and long-dated private funds and SMAs benefit from this demand by offering institutional and retail investors the ability to invest in our private credit investment strategy. We believe that the breadth, diversity and number of investment vehicles we offer allow us to maximize our reach with investors.
The strength of our investment process, operating platform and client servicing capabilities. Following the most recent financial crisis, investors in alternative investments, including those managed by us, have heightened their focus on matters such as manager due diligence, reporting transparency and compliance infrastructure. Since inception, we have invested heavily in our investment monitoring systems, compliance and enterprise risk management systems to proactively address investor expectations and the evolving regulatory landscape. We believe these investments in operating infrastructure will continue to support our growth in AUM. 
 
Components of Our Results of Operations
 
Management Fees. Management fees include both base management fees as well as Part I incentive fees.
 
Base Management Fees. Base management fees are generally based on a defined percentage of (i) average or total gross assets, including assets acquired with leverage, (ii) total commitments, (iii) net invested capital, (iv) NAV or (v) lower of cost or market value of a fund’s portfolio investments. These fees are calculated quarterly and are paid in cash in advance or in arrears. Base management fees are recognized as revenue in the period advisory services are rendered, subject to our assessment of collectability.

In addition, we also receive non asset-based management fees that may include special fees such as origination fees, transaction fees and similar fees paid to us in connection with portfolio investments of our funds. These fees are specific to particular transactions and the contractual terms of the portfolio investments, and are recognized when earned.
 
Part I Incentive Fees. We also include Part I incentive fees that we receive from our permanent capital vehicles and certain of our long-dated private funds in management fees. Part I incentive fees are paid quarterly, in cash, and are driven primarily by net interest income on senior secured loans. As it relates to MCC, these fees are subject to netting against realized and unrealized losses. We are primarily an asset manager of yield-oriented products and our incentive fees are primarily derived from spread income rather than trading or capital gains. In addition, we also carefully manage interest rate risk. We are generally positioned to benefit from a raising rate environment, which should benefit fees paid to us from our vehicles and funds.
 
Performance Fees. Our long-dated private funds and SMAs may have industry standard carried interest performance fee structures and are typically 15% to 20% of the total return over a 6.0% to 8.0% annualized preferred return. We record these fees on an accrual basis, to the extent such amounts are contractually due but not paid, and we present this revenue as a separate line item on our consolidated statements of operations. These fees are subject to repayment (clawback).

The timing and amount of performance fees generated by our funds is uncertain. If we were to have a realization event in a particular quarter or year, it may have a significant impact on our results for that particular quarter or year that may not be replicated in subsequent periods. Refer to “Risk Factors — Risks Related to Our Business and Industry” included in our Annual Report on Form 10-K.
 
Generally, if at the termination of a fund (and sometimes at interim points in the life of a fund), the fund has not achieved investment returns that (in most cases) exceed the preferred return threshold or (in all cases) the general partner receives net profits over the life of the fund in excess of its allocable share under the applicable partnership agreement, we will be obligated to repay an amount equal to the extent to which carried interest that was previously distributed to us exceeds the amounts to which we are ultimately entitled. Medley has not received any distributions of performance fees through March 31, 2017, other than tax distributions, a portion of which is subject to clawback. As of March 31, 2017, we accrued $7.1 million for clawback obligations that would need to be paid if the funds were liquidated at fair value at the end of the reporting period. Our actual obligation, however, would not become payable or realized until the end of a fund’s life.


6




For any given period, performance fee revenue on our consolidated statements of operations may include reversals of previously recognized performance fees due to a decrease in the value of a particular fund that results in a decrease of cumulative performance fees earned to date. Since fund return hurdles are cumulative, previously recognized fees also may be reversed in a period of appreciation that is lower than the particular fund's hurdle rate. During the three months ended March 31, 2017 and 2016, we reversed $2.6 million and $0.7 million, respectively, of previously recognized performance fees. As of March 31, 2017, we recognized cumulative performance fees of $4.8 million.
 
Part II Incentive Fees. For our permanent capital vehicles and certain of our long-dated private funds, Part II incentive fees generally represent 20.0% of each fund’s cumulative realized capital gains (net of realized capital losses and unrealized capital depreciation). We have not received these fees historically, and do not expect such fees to be material in the future given our focus on senior secured lending.

Other Revenues and Fees. We provide administrative services to certain of our vehicles that are reported as other revenues and fees. Such fees are recognized as revenue in the period that administrative services are rendered. These fees are generally based on expense reimbursements for the portion of overhead and other expenses incurred by certain professionals directly attributable to each respective fund. These fees are reported within total revenues in our unaudited condensed consolidated financial statements included in this Form 10-Q.
 
In certain cases, the entities that receive management and incentive fees from our funds are owned by Medley LLC together with other persons. See “Critical Accounting Policies” and Note 2, “Summary of Significant Accounting Policies,” to our unaudited condensed consolidated financial statements included in this Form 10-Q for additional information regarding the manner in which management fees, performance fees and other fees are generated.
 
Expenses
 
Compensation and Benefits. Compensation and benefits generally includes salaries, discretionary bonuses and benefits paid and payable to our employees. Compensation also includes stock-based compensation associated with the grants of equity-based awards to our employees. Compensation expense relating to equity based awards are measured at fair value as of the grant date, reduced for actual forfeitures, and expensed over the vesting period on a straight-line basis. Bonuses are accrued over the service period to which they relate.
 
Guaranteed payments made to our senior professionals who are members of Medley LLC are recognized as compensation expense. The guaranteed payments to our Co-Chief Executive Officers are performance based and periodically set subject to maximums based on our total assets under management. Such maximums aggregated to $0.6 million for each of the three months ended March 31, 2017 and 2016. During the three months ended March 31, 2017 and 2016, neither of our Co-Chief Executive Officers received any guaranteed payments.
 
Performance Fee Compensation. Performance fee compensation includes compensation related to performance fees, which generally consists of profit interests that we grant to our employees. Depending on the nature of each fund, the performance fee participation is generally structured as a fixed percentage or as an annual award. The liability is recorded subject to the vesting of the profit interests granted and is calculated based upon the net present value of the projected performance fees. Payments to profit interest holders are payable when the performance fees are paid to Medley LLC by the respective fund. It is possible that we may record performance fee compensation during a period in which we do not record any performance fee revenue or we have a reversal of previously recognized performance fee revenue.

General, Administrative and Other Expenses. General and administrative expenses include costs primarily related to professional services, office rent, depreciation and amortization, general insurance, recruiting, travel and related expenses, information technology, communication and information services, other general operating items and, in 2016, SIC expenses under an expense support and reimbursement agreement.
 
Other Income (Expense)
 
Dividend Income. Dividend income consists of dividends associated with our equity method investment in SIC and our available-for-sale securities. Dividends are recognized on an accrual basis to the extent that such amounts are declared and expected to be collected.
 
Interest Expense. Interest expense consists primarily of interest expense relating to debt incurred by us.
 

7




Other Income (Expenses), Net. Other income (expenses), net consists primarily of expenses associated with our revenue share payable, equity income (loss) and unrealized gains (losses) associated with our equity method investments.

Provision for Income Taxes. We are treated as a partnership for income tax purposes and are therefore not subject to U.S. federal, state and local corporate income taxes. We are subject to New York City unincorporated business tax attributable to taxable income allocable to New York City.
 
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. To the extent it is more likely than not that the deferred tax assets will not be recognized, a valuation allowance is provided to offset their benefit.
 
We recognize the benefit of an income tax position only if it is more likely than not that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit is recognized. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% percent likelihood of being realized upon ultimate settlement. Interest expense and penalties related to income tax matters are recognized as a component of the provision for income taxes.

Net Income Attributable to Redeemable Non-Controlling Interests and Non-Controlling Interests in Consolidated Subsidiaries. Net income attributable to redeemable non-controlling interests and non-controlling interests in consolidated subsidiaries represents the ownership interests that third parties hold in certain consolidated subsidiaries.
 
Our private funds are closed-end funds, and accordingly do not permit investors to redeem their interests other than in limited circumstances that are beyond our control, such as instances in which retaining the limited partnership interest could cause the limited partner to violate a law, regulation or rule. In addition, SMAs for a single investor may allow such investor to terminate the investment management agreement at the discretion of the investor pursuant to the terms of the applicable documents. We manage assets for MCC and SIC, both of which are BDCs. The capital managed by MCC and SIC is permanently committed to these funds and cannot be redeemed by investors.

Managing Business Performance
 
Non-GAAP Financial Information 
 
In addition to analyzing our results on a GAAP basis, management also makes operating decisions and assesses business performance based on the financial and operating metrics and data that are presented in the table below. Core Net Income and Core EBITDA are non-GAAP financial measures that are used by management to assess the performance of our business. There are limitations associated with the use of non-GAAP financial measures as compared to the use of the most directly comparable U.S. GAAP financial measure and these measures supplement and should be considered in addition to and not in lieu of the results of operations discussed further under "Results of Operations,’’ which are prepared in accordance with U.S. GAAP. Furthermore, such measures may be inconsistent with measures presented by other companies. For a reconciliation of these measures to the most comparable measure in accordance with U.S. GAAP, see "Reconciliation of Certain Non-GAAP Performance Measures to Consolidated U.S. GAAP Financial Measures.’’
 
Core Net Income. Core Net Income is an income measure that is used by management to assess the performance of our business through the removal of non-core items, as well as non-recurring expenses associated with the IPO of Medley Management Inc. It is calculated by adjusting net income attributable to Medley LLC to exclude reimbursable expenses associated with the launch of funds, amortization of stock-based compensation expense associated with grants of restricted stock units at the time of the IPO of Medley Management Inc., other non-core items and the income tax impact of these adjustments.
 
Core Earnings Before Interest, Income Taxes, Depreciation and Amortization (Core EBITDA). Core EBITDA is an income measure also used by management to assess the performance of our business. Core EBITDA is calculated as Core Net Income before interest expense, income taxes, depreciation and amortization.




8




Key Performance Indicators
 
When we review our performance we focus on the indicators described below: 
 
 
 
For the Three Months Ended March 31,
 
 
2017
 
2016
 
 
(Amounts in thousands, except AUM, share and per share amounts)
Consolidated Financial Data:
 
 
 
 

Net income attributable to Medley LLC
 
$
3,448

 
$
850

 
 
 
 
 
Non-GAAP Data:
 
 
 
 

Core Net Income
 
$
5,012

 
$
6,547

Core EBITDA
 
7,920

 
9,067

 
 
 
 
 
Other Data (at period end, in millions):
 
 
 
 

AUM
 
$
5,452

 
$
5,012

Fee Earning AUM
 
3,214

 
3,169


AUM
 
AUM refers to the assets of our funds. We view AUM as a metric to measure our investment and fundraising performance as it reflects assets generally at fair value plus available uncalled capital. For our funds, our AUM equals the sum of the following:
 
Gross asset values or NAV of such funds;
the drawn and undrawn debt (at the fund-level, including amounts subject to restrictions); and
uncalled committed capital (including commitments to funds that have yet to commence their investment periods).

The table below provides the roll forward of AUM.
 
 
 
 
 
 
 
 
% of AUM
 
Permanent
Capital
Vehicles
 
Long-dated
Private Funds
and SMAs
 
Total
 
Permanent
Capital
Vehicles
 
Long-dated
Private Funds
and SMAs
 
(Dollars in millions)
 
 
 
 
Beginning balance, December 31, 2016
$
2,527

 
$
2,808

 
$
5,335

 
47
%
 
53
%
Commitments (1)
13

 
208

 
221

 
 

 
 

Capital reduction (2)
(45
)
 

 
(45
)
 
 

 
 

Distributions (3)
(27
)
 
(31
)
 
(58
)
 
 

 
 

Change in fund value (4)
(4
)
 
3

 
(1
)
 
 

 
 

Ending balance, March 31, 2017
$
2,464

 
$
2,988

 
$
5,452

 
45
%
 
55
%
____________ 
(1)
With respect to permanent capital vehicles, represents increases during the period through equity and debt offerings, subject to restrictions, as well as any changes in available undrawn borrowings or capital commitments. With respect to long-dated private funds and SMAs, represents new commitments or gross inflows, respectively, as well as any increases in available undrawn borrowings.
(2)
Represents the permanent reduction in equity or leverage during the period.
(3)
With respect to permanent capital vehicles, represents distributions of income. With respect to long-dated private funds and SMAs, represents return of capital, given our funds’ stage in their respective life cycle and the prioritization of capital distributions.

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(4)
Includes interest income, realized and unrealized gains (losses), fees and/or expenses.

AUM increased to $5.5 billion as of March 31, 2017 compared to $5.3 billion of AUM as of December 31, 2016. Our permanent capital vehicles decreased $62.5 million as of March 31, 2017, primarily due to a reduction of debt and distributions, partly offset by increased equity raise. Our long-dated private funds and SMAs increased AUM by $180.4 million, or 6%, primarily associated with new debt commitments, partly offset by distributions as some of our vehicles are no longer in the investment period.

Fee Earning AUM
 
Fee earning AUM refers to assets under management on which we directly earn base management fees. We view fee earning AUM as a metric to measure changes in the assets from which we earn management fees. Our fee earning AUM is the sum of all the individual fee earning assets of our funds that contribute directly to our management fees and generally equals the sum of:
 
for our permanent capital vehicles, the average or total gross asset value, including assets acquired with the proceeds of leverage (see “Fee earning AUM based on gross asset value” in the “Components of Fee Earning AUM” table below for the amount of this component of fee earning AUM as of each period);

for certain funds within the investment period in the long-dated private funds, the amount of limited partner capital commitments (see “Fee earning AUM based on capital commitments” in the “Components of Fee Earning AUM” table below for the amount of this component of fee earning AUM as of each period); and

for the aforementioned funds beyond the investment period and certain managed accounts within their investment period, the amount of limited partner invested capital or the NAV of the fund (see “Fee earning AUM based on invested capital or NAV” in the “Components of Fee Earning AUM” table below for the amount of this component of fee earning AUM as of each period).

Our calculations of fee earning AUM and AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by others. In addition, our calculations of fee earning AUM and AUM may not be based on any definition of fee earning AUM or AUM that is set forth in the agreements governing the investment funds that we advise.
 
Components of Fee Earning AUM
 
 
As of
March 31,
2017
 
As of December 31, 2016
 
(Amounts in millions)
Fee earning AUM based on gross asset value
$
2,214

 
$
2,207

Fee earning AUM based on capital commitments
113

 
113

Fee earning AUM based on invested capital or NAV
887

 
870

Total fee earning AUM
$
3,214

 
$
3,190

 
As of March 31, 2017, fee earning AUM based on gross asset value increased by $6.9 million, compared to December 31, 2016. The increase in fee earning AUM based on gross asset value was due primarily to an increase in equity commitments, partly offset by distributions.
 
As of March 31, 2017, fee earning AUM based on capital commitments remained consistent compared to December 31, 2016.
 
As of March 31, 2017, fee earning AUM based on invested capital or NAV increased by $16.7 million, or 2%, compared to December 31, 2016. The increase in fee earning AUM based on invested capital or NAV was due primarily to capital deployment from our long-dated private funds and SMAs, partially offset by distributions of income and return of capital by our long-dated private funds and SMAs as some of our vehicles are no longer in the investment period.

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The table below presents the roll forward of Fee Earning AUM.
 
 
 
 
 
 
 
 
 
% of Fee Earning AUM
 
 
Permanent
Capital
Vehicles
 
Long-dated
Private Funds
and SMAs
 
Total
 
Permanent
Capital
Vehicles
 
Long-dated
Private Funds
and SMAs
 
 
(Dollars in millions)
 
 
 
 
Ending balance, December 31, 2016
 
$
2,207

 
$
983

 
$
3,190

 
69
%
 
31
%
Commitments (1)
 
38

 
89

 
127

 
 

 
 

Capital reduction (2)
 

 

 

 
 

 
 

Distributions (3)
 
(27
)
 
(58
)
 
(85
)
 
 

 
 

Change in fund value (4)
 
(4
)
 
(14
)
 
(18
)
 
 

 
 

Ending balance, March 31, 2017
 
$
2,214

 
$
1,000

 
$
3,214

 
69
%
 
31
%
____________ 
(1)
With respect to permanent capital vehicles, represents increases or temporary reductions during the period through equity and debt offerings, as well as any increases in capital commitments. With respect to long-dated private funds and SMAs, represents new commitments or gross inflows, respectively.
(2)
Represents the permanent reduction in equity or leverage during the period.
(3)
Represents distributions of income, return of capital and return of portfolio investment capital to the fund.
(4)
Includes interest income, realized and unrealized gains (losses), fees and/or expenses.

Total fee earning AUM increased by $23.7 million, or 1%, to $3.2 billion as of March 31, 2017 compared to total fee earning AUM as of December 31, 2016, due primarily to capital commitments by our private funds and SMAs, partly offset by distributions from all permanent capital vehicles and private funds and SMAs.

Returns
 
The following section sets forth historical performance for our active funds.
 
Sierra Income Corporation (SIC)
 
We launched SIC, our first public non-traded permanent capital vehicle, in April 2012. SIC primarily focuses on direct lending to middle market borrowers in the U.S. Since inception, we have provided capital for a total of 275 investments and have invested a total of $1.7 billion. As of March 31, 2017, the fee earning AUM was $1.2 billion. The performance for SIC as of March 31, 2017 is summarized below:
 
Annualized Net Total Return(1):
6.7
%
Annualized Realized Losses on Invested Capital:
0.6
%
Average Recovery:
75.6
%
 
Medley Capital Corporation (MCC)
 
We launched MCC, our first permanent capital vehicle in January 2011. MCC primarily focuses on direct lending to private middle market borrowers in the U.S. Since inception, we have provided capital for a total of 182 investments and have invested a total of $2.0 billion. As of March 31, 2017, excluding Medley SBIC LP, the fee earning AUM was $791 million. The performance for MCC as of March 31, 2017 is summarized below:
 
Annualized Net Total Return(2):
4.8
%
Annualized Realized Losses on Invested Capital:
1.3
%
Average Recovery:
52.0
%

11




 
Medley SBIC LP (Medley SBIC)
 
We launched Medley SBIC in March 2013 as a wholly owned subsidiary of MCC. Medley SBIC lends to smaller middle market private borrowers that we otherwise would not target in our other funds, due primarily to size. Since inception, we have provided capital for a total of 33 investments and have invested a total of $353 million. As of March 31, 2017, the fee earning AUM was $232 million. The performance for Medley SBIC fund as of March 31, 2017 is summarized below:
 
Gross Portfolio Internal Rate of Return(4):
13.1
%
Net Investor Internal Rate of Return(5):
15.3
%
Annualized Realized Losses on Invested Capital:
0.0%

Average Recovery:
N/A

 
Medley Opportunity Fund II LP (MOF II)
 
MOF II is a long-dated private investment fund that we launched in December 2010. MOF II lends to middle market private borrowers, with a focus on providing senior secured loans. Since inception, we have provided capital for a total of 69 investments and have invested a total of $906 million. As of March 31, 2017, the fee earning AUM was $380 million. MOF II is currently fully invested and actively managing its assets. The performance for MOF II as of March 31, 2017, is summarized below:
 
Gross Portfolio Internal Rate of Return(4):
11.3
%
Net Investor Internal Rate of Return(6):
6.7
%
Annualized Realized Losses on Invested Capital:
1.7
%
Average Recovery(3):
NM


Medley Opportunity Fund III LP (MOF III)
 
MOF III is a long-dated private investment fund that we launched in December 2014. MOF III lends to middle market private borrowers in the U.S., with a focus on providing senior secured loans. Since inception, we have provided capital for a total of 30 investments and have invested a total of $143 million. As of March 31, 2017, the fee earning AUM was $113 million. The performance for MOF III as of March 31, 2017 is summarized below:        

Gross Portfolio Internal Rate of Return(4):
11.6
%
Net Investor Internal Rate of Return(6):
5.9
%
Annualized Realized Losses on Invested Capital:
%
Average Recovery(3):
N/A


Other Long-Dated Private Funds
 
We launched Medley Credit Opportunity Fund (“MCOF”) in July 2016 to meet the current demand for equity capital solutions in the traditional corporate debt-backed collateralized loan obligation (“CLO”) market. Its investment objective is to generate current income, and also to generate capital appreciation through investing in CLO equity, as well as, equity and junior debt tranches trading in the secondary market.

We launched Aspect-Medley Investment Platform A LP (“Aspect”) in November 2016 to meet the current demand for equity capital solutions in the traditional corporate debt-backed collateralized loan obligation (“CLO”) market. Its investment objective is to generate current income, and also to generate capital appreciation through investing in CLO equity, as well as, equity and junior debt tranches trading in the secondary market.

The performance of MCOF and Aspect as of March 31, 2017 is not meaningful given the funds' limited operations and capital invested to date.


12




Separately Managed Accounts (SMAs)
 
In the case of our SMAs, the investor, rather than us, may control the assets or investment vehicle that holds or has custody of the related investments. Certain subsidiaries of Medley LLC serve as the investment adviser for our SMAs. Since inception, we have provided capital for a total of 133 investments and have invested a total of $779 million. As of March 31, 2017, the fee earning AUM in our SMAs was $455 million. The aggregate performance of our SMAs as of March 31, 2017, is summarized below:
 
Gross Portfolio Internal Rate of Return(4):
10.4
%
Net Investor Internal Rate of Return(7):
8.2
%
Annualized Realized Losses on Invested Capital:
0.2%

Average Recovery(3):
NM

____________
(1)
Annualized Net Total Return for SIC represents the annualized return assuming an investment at the initial public offering price, reinvestments of all dividends and distributions at prices obtained under SIC’s dividend reinvestment plan and selling at the NAV as of the measurement date.
(2)
Annualized Net Total Return for MCC, including Medley SBIC, represents the annualized return assuming an investment at the initial public offering price, reinvestments of all dividends and distributions at prices obtained under MCC's dividend reinvestment plan and selling at NAV as of the measurement date.
(3)
Average Recovery includes only those realized investments in which we experience a loss of principal on a cumulative cash flow basis and is calculated by dividing the total actual cash inflows for each respective investment, including all interest, principal and fee note repayments, dividends and transactions fees, if applicable, by the total actual cash outflows for each respective investment. For MOF II and the SMAs, we have presented the Average Recovery as “NM” or “Not Meaningful” because we believe the number of realized losses for each respective vehicle is not sufficient to provide an accurate representation of the expected Average Recovery for each vehicle.
(4)
For MOF II, MOF III, SMAs and Medley SBIC, the Gross Portfolio Internal Rate of Return represents the cumulative investment performance from inception of each respective fund through March 31, 2017. The Gross Portfolio Internal Rate of Return includes both realized and unrealized investments and excludes the impact of base management fees, incentive fees and other fund related expenses. For realized investments, the investment returns were calculated based on the actual cash outflows and inflows for each respective investment and include all interest, principal and fee note repayments, dividends and transactions fees, if applicable. For unrealized investments, the investment returns were calculated based on the actual cash outflows and inflows for each respective investment and include all interest, principal and fee note repayments, dividends and transactions fees, if applicable. The investment return assumes that the remaining unrealized portion of the investment is realized at the investment’s most recent fair value, as calculated in accordance with U.S. GAAP. There can be no assurance that the investments will be realized at these fair values and actual results may differ significantly.
(5)
Earnings from Medley SBIC are paid to MCC. The Net Internal Rate of Return for Medley SBIC was calculated based upon i) the actual cash contribution and distributions to/from MCC and Medley SBIC ii) an allocable portion of MCC’s management and incentive fees and general fund related expenses and iii) assumes the NAV as of the measurement date is distributed to MCC. As of March 31, 2017, Medley SBIC Net Internal Rate of Return as described above assuming only the inclusion of management fees was 20.0%.
(6)
Net Investor Internal Rate of Return for MOF II and MOF III was calculated net of all management fees and carried interest allocation since inception and was computed based on the actual dates of capital contributions and the ending aggregate partners’ capital at the end of the period.
(7)
Net Investor Internal Rate of Return for our SMAs was calculated using the Gross Portfolio Internal Rate of Return, as described in note 4, and includes the actual management fees, incentive fees and general fund related expenses.


13




Results of Operations
  
The following table and discussion sets forth information regarding our consolidated results of operations for the three months ended March 31, 2017 and 2016. The unaudited condensed consolidated financial statements of Medley have been prepared on substantially the same basis for all historical periods presented.
 
 
 
For the Three Months Ended March 31,
 
 
 
(unaudited)
 
 
 
2017
 
2016
 
 
 
(Amounts in thousands, except AUM data)
Revenues
 
 
 

 
 

Management fees
 
 
$
13,895

 
$
16,263

Performance fees
 
 
(2,219
)
 
(591
)
Other revenues and fees
 
 
2,320

 
1,899

Total revenues
 
 
13,996

 
17,571

 
 
 
 
 
 
Expenses
 
 
 

 
 

Compensation and benefits
 
 
5,794

 
5,868

Performance fee compensation
 
 
(881
)
 
(71
)
General, administrative and other expenses
 
 
2,668

 
7,979

Total expenses
 
 
7,581

 
13,776

 
 
 
 
 
 
Other income (expense)
 
 
 
 
 

Dividend income
 
 
735

 
222

Interest expense
 
 
(3,647
)
 
(2,118
)
Other income (expense), net
 
 
1,560

 
(751
)
Total other expense, net
 
 
(1,352
)
 
(2,647
)
Income before income taxes
 
 
5,063

 
1,148

Provision for income taxes
 
 
127

 
35

Net income
 
 
4,936

 
1,113

Net income attributable to redeemable non-controlling interests
and non-controlling interests in consolidated subsidiaries
1,488

 
263

Net income attributable to Medley LLC
$
3,448

 
$
850

 
 
 
 
 
 
Other data (at period end, in millions):
 
 
 
 
 
AUM
 
 
$
5,452

 
$
5,012

Fee earning AUM
 
 
$
3,214

 
$
3,169


14





Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016 

Revenues
 
Management Fees. Total management fees decreased by $2.4 million, or 15%, to $13.9 million for the three months ended March 31, 2017 compared to the three months ended March 31, 2016

Our management fees from permanent capital vehicles decreased by $2.7 million during the three months ended March 31, 2017 compared to the same period in 2016. Management fees from SIC decreased by $1.3 million due to a decrease in Part I incentive fees partially offset by a $0.4 million increase in base management fees for three months ended March 31, 2017 compared to the same period in 2016. Management fees from MCC decreased by $1.4 million due to a decrease in Part I incentive fees and an 8% decrease in average fee earning AUM for the three months ended March 31, 2017 compared to the same period in 2016.
Our management fees from long-dated private funds and SMAs increased by $0.4 million for the three months ended March 31, 2017, compared to the same period in 2016. The increase was primarily due to an increase in origination fees.

Performance Fees. There was a reversal of performance fees of $2.2 million during the three months ended March 31, 2017 compared to a reversal of performance fees of $0.6 million for the same period in 2016. The variance was attributed primarily to declines in the underlying fund values of our SMAs.
 
Other Revenues and Fees. Other revenues and fees increased by $0.4 million, or 22%, to $2.3 million for the three months ended March 31, 2017 compared to the same period in 2016. The increase was due primarily to an increase in administrative fees from our permanent capital vehicles.
 
Expenses
 
Compensation and Benefits. Compensation and benefits decreased by $0.1 million, or 1% to $5.8 million for the three months ended March 31, 2017 compared to the same period in 2016. The decrease was due primarily to the impact of forfeited RSUs on compensation expense, partly offset by severance charges during the three months ended March 31, 2017
 
Performance Fee Compensation. There was a reversal in performance fee compensation of $0.9 million during the three months ended March 31, 2017 as compared to a reversal of performance fee compensation of $0.1 million for the same period in 2016. The variance in performance fee compensation was due primarily to changes in projected future payments.
  
General, Administrative and Other Expenses. General, administrative and other expenses decreased by $5.3 million to $2.7 million for the three months ended March 31, 2017 compared to the same period in 2016. The decrease was due primarily to a $5.2 million decrease in expense support agreement expenses related to SIC. The expense support agreement with SIC expired on December 31, 2016, as such, we are no longer responsible for expenses under the expense support agreement relating to SIC.

Other Income (Expense)
 
Dividend Income. Dividend income increased by $0.5 million to $0.7 million for the three months ended March 31, 2017 compared to the same period in 2016. The increase was primarily due to dividend income from our investment in available-for-sale securities which were acquired after March 31, 2016.
 
Interest Expense. Interest expense increased by $1.5 million, or 72%, to $3.6 million for the three months ended March 31, 2017 compared to the same period in 2016. The increase was primarily due to an acceleration of amortization of debt issuance costs and discount relating to prepayments made on our Term Loan Facility as a result of the refinancing of our indebtedness from the issuance of senior unsecured debt. Average debt outstanding during the three months ended March 31, 2017 and 2016 was $120.5 million and $105.1 million, respectively.
 
Other Income (Expenses), net. Other income (expenses), net increased by $2.3 million to $1.6 million for the three months ended March 31, 2017 compared to the same period in 2016. The increase was due primarily to the revaluation of our revenue share payable.

15




  
Provision for Income Taxes
 
Our provision for income taxes in any given interim period is recorded based on an estimated full-year tax rate adjusted for discrete items in the period they occur. Our effective income tax rate was 2.5% and 3.0% for the three months ended March 31, 2017 and 2016, respectively. Our tax rate is affected by recurring items, such as permanent differences and income allocated to non-controlling interests which is not subject to U.S. federal, state and local corporate income taxes. The decrease in the effective tax rate during the three months ended March 31, 2017 as compared to the same period in 2016 was primarily attributed to an increase in taxable income allocable to non-controlling interests which is not subject to corporate income taxes partly offset by the impact of discrete items associated with the forfeiture of RSUs.
 
Redeemable Non-Controlling Interests and Non-Controlling Interests in Consolidated Subsidiaries
 
Net income attributable to redeemable non-controlling interests and non-controlling interests in consolidated subsidiaries increased by $1.2 million to $1.5 million for the three months ended March 31, 2017 compared to the same period in 2016. The increase was due primarily to income earned from a joint venture which was formed on June 3, 2016 with a redeemable non-controlling interest to acquire shares of MCC and seed new investments.

Reconciliation of Certain Non-GAAP Performance Measures to Consolidated U.S. GAAP Financial Measures
 
In addition to analyzing our results on a GAAP basis, management also makes operating decisions and assesses business performance based on the financial and operating metrics and data that are presented in the table below. Management believes that these measures provide analysts, investors and management with helpful information regarding our underlying operating performance and our business, as they remove the impact of items management believes are not reflective of underlying operating performance. These non-GAAP measures are also used by management for planning purposes, including the preparation of internal budgets; and for evaluating the effectiveness of operational strategies. Additionally, we believe these non-GAAP measures provide another tool for investors to use in comparing our results with other companies in our industry, many of whom use similar non-GAAP measures. There are limitations associated with the use of non-GAAP financial measures as compared to the use of the most directly comparable U.S. GAAP financial measure and these measures supplement and should be considered in addition to and not in lieu of the results of operations discussed below. Furthermore, such measures may be inconsistent with measures presented by other companies.

Net income attributable to Medley LLC is the U.S. GAAP financial measure most comparable to Core Net Income and Core EBITDA. The following table is a reconciliation of net income attributable to Medley LLC on a consolidated basis to Core Net Income and Core EBITDA. 
 
 
For the Three Months Ended March 31,
 
 
2017
 
2016
 
 
(Amounts in thousands, except share and per share amounts)
Net income attributable to Medley LLC
 
$
3,448

 
$
850

Reimbursable fund startup expenses
 

 
5,203

IPO date award stock-based compensation
 
(661
)
 
673

Other non-core items (1)
 
2,273

 

Income tax benefit (expense) on adjustments
 
(48
)
 
(179
)
Core Net Income
 
$
5,012

 
$
6,547

Interest expense
 
2,498

 
2,118

Income taxes
 
175

 
214

Depreciation and amortization
 
235

 
188

Core EBITDA
 
$
7,920

 
$
9,067



16




(1)
For the three months ended March 31, 2017, other non-core items consist of $1.2 million in additional interest expense associated with the acceleration of amortization of debt issuance costs and discount relating to prepayments made on our Term Loan Facility as a result of the refinancing of our indebtedness from the issuance of senior unsecured debt and $1.1 million in severance costs to former employees. There were no such charges during the three months ended March 31, 2016.

Liquidity and Capital Resources
  
Our primary cash flow activities involve: (i) generating cash flow from operations, which largely includes management fees; (ii) making distributions to our members and redeemable non-controlling interests; (iii) paying dividends and (iv) borrowings, interest payments and repayments under our debt facilities. As of March 31, 2017, our cash and cash equivalents were $62.9 million and our restricted cash equivalents balance was $7.6 million.
 
Our material source of cash from our operations is management fees, which are collected quarterly. We primarily use cash flows from operations to pay compensation and benefits, general, administrative and other expenses, federal, state and local corporate income taxes, debt service costs and distributions to our owners. Our cash flows, together with the proceeds from equity and debt issuances, are also used to fund investments in limited partnerships, purchase available-for-sale securities, purchase fixed assets and other capital items. If cash flows from operations were insufficient to fund distributions, we expect that we would suspend paying such distributions.
 
Debt Instruments 

Senior Unsecured Debt
 
2026 Notes

On August 9, 2016, Medley LLC completed a registered public offering of $25.0 million of an aggregate principal amount of 6.875% senior notes due 2026 (the “2026 Notes”) at an offering price of 100% of the principal amount. On October 18, 2016, Medley LLC completed a public offering of an additional $28.6 million in aggregate principal amount of the 2026 Notes at a public offering price of $24.45 for each $25.00 principal amount of notes. We used the net proceeds from these offerings to repay a portion of the outstanding indebtedness under the Term Loan Facility. Collectively, these offerings compose the senior unsecured debt balance as of December 31, 2016.

The 2026 Notes mature on August 15, 2026 and interest is payable quarterly commencing on November 15, 2016. The 2026 Notes are subject to redemption in whole or in part at any time or from time to time, at our option, on or after August 15, 2019 at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments. The 2026 Notes are listed on the New York Stock Exchange and trade thereon under the trading symbol “MDLX.”
    
2024 Notes

On January 18, 2017, Medley LLC completed a registered public offering of $34.5 million in aggregate principal amount of 7.25% senior notes due 2024 (the “2024 Notes”) at an offering price of 100% of the principal amount of notes. On February 22, 2017, Medley LLC completed a public offering of an additional $34.5 million in aggregate principal amount of 2024 Notes at a public offering price of $25.25 for each $25.00 principal amount of notes. We used the net proceeds from the offering to repay the remaining outstanding indebtedness under the Term Loan Facility and for general corporate purposes.
 
The 2024 Notes mature on January 30, 2024 and interest is payable quarterly commencing on April 30, 2017. The senior unsecured debt is subject to redemption in whole or in part at any time or from time to time, at our option, on or after January 30, 2020 at a redemption price per security equal to 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments. The 2024 Notes are listed on the New York Stock Exchange and trade thereon under the trading symbol “MDLQ.”

As of March 31, 2017, the outstanding senior unsecured debt balance was $116.5 million, and is reflected net of unamortized discount, unamortized premium and debt issuance costs of $6.1 million.


17




Revolving Credit Facility
 
On August 19, 2014, we entered into a $15.0 million senior secured revolving credit facility with City National Bank (as amended, the “Revolving Credit Facility”), as administrative agent and collateral agent thereunder, and the lenders from time to time party thereto, which will mature on August 19, 2017, with a one-year extension at the option of the borrower, provided certain conditions are met. On May 3, 2016, the Revolving Credit Facility was amended to permit us to issue additional indebtedness. The amendment also provided for the creation and funding of certain future funds, as well as for certain other technical changes to the Revolving Credit Facility. We intend to use any proceeds of borrowings under the Revolving Credit Facility for general corporate purposes, including funding our working capital needs. We have not incurred any borrowings under the Revolving Credit Facility through the date of this filing.
  
Interest Rate and Fees
 
Borrowings under the Revolving Credit Facility bear interest, at our option, at a rate equal to either (1) a Eurodollar margin over an adjusted LIBOR rate or (2) a base rate margin over an adjusted base rate determined by reference to the highest of (a) the term loan administrative agent’s prime rate; (b) the federal funds effective rate in effect on such day plus 0.5%; and (c) an adjusted LIBOR rate plus 1.0%. The applicable margins for the Revolving Credit Facility are (i) if the ratio of net debt to Core EBITDA is less than 1.0 to 1.0, 1.5% in the case of adjusted base rate loans, and, in the case of Eurodollar loans, (x) 3.0% until maturity; and (ii) if the ratio of net debt to Core EBITDA is greater than or equal to 1.0 to 1.0, 2.50% in the case of adjusted base rate loans, and, in the case of Eurodollar loans, (x) 3.25% until maturity. In addition to paying interest on any outstanding principal under the Revolving Credit Facility, we are required to pay an unused line fee of 0.25% per annum of the unused portion of the commitments.

 Guarantees and Collateral

Any obligations under the Revolving Credit Facility are unconditionally and irrevocably guaranteed by certain of Medley LLC’s subsidiaries, including Medley Capital LLC, MOF II Management LLC, MOF III Management LLC, Medley SMA Advisors LLC, Medley GP Holdings LLC, and Medley GP LLC (the “Credit Agreement Guarantors”). In addition, any outstanding borrowings are collateralized by first priority or equivalent security interests in (i) all the capital stock of, or other equity interests in, the borrower and each of the borrower’s and Credit Agreement Guarantors’ direct or indirect domestic subsidiaries and 65% of the capital stock of, or other equity interests in, each of the borrower’s or any subsidiary guarantors’ direct wholly owned first-tier restricted foreign subsidiaries, and (ii) certain tangible and intangible assets of the borrower and the credit agreement guarantors (subject to certain exceptions and qualifications).
 
None of our non-wholly owned domestic subsidiaries are obligated to guarantee the Revolving Credit Facility. Such subsidiaries include MCC Advisors LLC, SIC Advisors LLC, MOF II GP LLC, MCOF GP LLC, MCOF Management LLC, Medley (Aspect) GP LLC, Medley (Aspect) Management LLC and STRF Advisors LLC.

Certain Covenants and Events of Default
 
The Revolving Credit Facility contains a number of significant affirmative and negative covenants and customary events of default. Such covenants, among other things, will limit or restrict, subject to certain exceptions, the ability of the borrower and its restricted subsidiaries to:
 
incur additional indebtedness, make guarantees and enter into hedging arrangements;
create liens on assets;
enter into sale and leaseback transactions;
engage in mergers or consolidations;
make fundamental changes;
pay dividends and distributions or repurchase our capital stock;
make investments, loans and advances, including acquisitions;
engage in certain transactions with affiliates;
make changes in the nature of their business; and
make prepayments of junior debt.


18




In addition, the credit agreement governing our Revolving Credit Facility contains a financial covenant that requires us to maintain, with respect to each four quarter period, a ratio of net debt to Core EBITDA not greater than 3.5 to 1.0. The ratio of net debt to Core EBITDA in respect of the Revolving Credit Facility is calculated using our financial results and includes the adjustments made to calculate Core EBITDA. 
 
Our Revolving Credit Facility contains certain customary representations and warranties, affirmative covenants and events of default. If an event of default occurs, the lender under the Revolving Credit Facility will be entitled to take various actions, including the acceleration of any amounts due under the Revolving Credit Facility and all actions permitted to be taken by a secured creditor.
 
Non-Recourse Promissory Notes
 
In April 2012, we borrowed $5.0 million under a non-recourse promissory note with a foundation, and $5.0 million under a non-recourse promissory note with a trust. Proceeds from the borrowings were used to purchase 1,108,033 shares of common stock of SIC, which were pledged as collateral for the obligations. Interest on the notes is paid monthly and is equal to the dividends received by us related to the pledged shares. We may prepay the notes in whole or in part at any time without penalty. The notes are scheduled to mature in March 2019. The proceeds from the notes were recorded net of issuance costs of $3.8 million and are being accrued, using the effective interest method, over the term of the non-recourse promissory notes.
 
Cash Flows
 
The significant captions and amounts from our condensed consolidated statements of cash flows are summarized below. Negative amounts represent a net outflow, or use of cash.
 
 
For the Three Months Ended March 31,
 
2017
 
2016
 
(Amounts in thousands)
Statements of cash flows data
 

 
 

Net cash provided by operating activities
$
1,500

 
$
4,080

Net cash used in investing activities
(3,729
)
 
(1,057
)
Net cash provided by (used in) financing activities
18,267

 
(9,092
)
Net increase (decrease) in cash and cash equivalents
$
16,038

 
$
(6,069
)
 
Operating Activities

Our net cash flow provided by operating activities was $1.5 million and $4.1 million during the three months ended March 31, 2017 and 2016, respectively. During the three months ended March 31, 2017 and 2016, net cash flow provided by operating activities was due to net income of $4.9 million and $1.1 million, respectively, non-cash adjustments of $2.3 million and $1.5 million, respectively, and changes in operating assets and liabilities of $(5.7) million and $1.5 million, respectively.
 
Investing Activities
 
Our investing activities generally reflect cash used for acquisitions of fixed assets, distributions received from our equity method investments and, subsequent to June 30, 2016, purchases of available-for-sale securities. Purchases of fixed assets were less than $0.1 million for the three months ended March 31, 2017 and $1.9 million for the three months ended March 31, 2016. Distributions received from equity method investments during the three months ended March 31, 2017 were less than $0.1 million and during the three months ended March 31, 2016 were $0.8 million. Purchases of available-for-sale securities were $3.7 million during the three months ended March 31, 2017. There were no purchases of available-for-sale securities during the three months ended March 31, 2016.
 

19




Financing Activities
 
Distributions to members and redeemable non-controlling interests were $7.8 million and $7.5 million for the three months ended March 31, 2017 and 2016, respectively. Capital contributions from non-controlling interests and redeemable non-controlling interests resulted in an inflow of cash of $5.0 million for the three months ended March 31, 2017. There were no capital contributions from non-controlling interests and redeemable non-controlling interests during the three months ended March 31, 2016. Repurchases of LLC Units represented a use of cash from financing activities of $0.4 million and $1.2 million for the three months ended March 31, 2017 and 2016, respectively. Capital contributions to equity method investments represented a use of cash from financing activities of $0.2 million and $0.1 million for the three months ended March 31, 2017 and 2016, respectively.
 
On August 9, 2016, we completed our first registered public offering of senior unsecured debt and on October 18, 2016, January 18, 2017, and February 22, 2017 we completed additional public offerings of senior unsecured debt. The proceeds from these offerings, net of offering expenses payable by us, amounted to $116.2 million. The net proceeds from the offering were used to pay-down the outstanding indebtedness under the Term Loan Facility with the remaining amount to be used for working capital purposes. Repayments of debt obligations resulted in an outflow of cash of $44.8 million and $0.3 million for the three months ended March 31, 2017 and 2016, respectively. Proceeds from the issuance of debt obligations provided an inflow of cash of $69.1 million for the three months ended March 31, 2017. There were no proceeds from the issuance of debt obligations during the three months ended March 31, 2016.

Sources and Uses of Liquidity
 
Our sources of liquidity are (i) cash on hand, (ii) net working capital, (iii) cash flows from operations, (iv) realizations on our investments, (v) net proceeds from borrowings under the Revolving Credit Facility and issuances of publicly-registered debt and (vi) other potential financings. We believe that these sources of liquidity will be sufficient to fund our working capital requirements and to meet our commitments in the foreseeable future. We expect that our primary liquidity needs will be comprised of cash to (i) provide capital to facilitate the growth of our existing investment management business, (ii) fund our commitments to funds that we advise, (iii) provide capital to facilitate our expansion into business that are complementary to our existing investment management business, (iv) pay operating expenses, including cash compensation to our employees (v) fund capital expenditures, (vi) pay income taxes, and (vii) make distributions to our unitholders.
  
We intend to use a portion of our available liquidity to fund cash distributions to our unitholders on a quarterly basis. Our ability to fund cash distributions to our unitholders is dependent on a myriad of factors, including among others: general economic and business conditions; our strategic plans and prospects; our business and investment opportunities; timing of capital calls by our funds in support of our commitments; our financial condition and operating results; working capital requirements and other anticipated cash needs; contractual restrictions and obligations; legal, tax and regulatory restrictions; restrictions on the payment of distributions by our subsidiaries to us; and other relevant factors.
 
Critical Accounting Policies
 
We prepare our condensed consolidated financial statements in accordance with U.S. GAAP. In applying many of these accounting principles, we need to make assumptions, estimates or judgments that affect the reported amounts of assets, liabilities, revenues and expenses in our consolidated financial statements. We base our estimates and judgments on historical experience and other assumptions that we believe are reasonable under the circumstances. These assumptions, estimates or judgments, however, are both subjective and subject to change, and actual results may differ from our assumptions and estimates. If actual amounts are ultimately different from our estimates, the revisions are included in our results of operations for the period in which the actual amounts become known. We believe the following critical accounting policies could potentially produce materially different results if we were to change underlying assumptions, estimates or judgments. See Note 2, “Summary of Significant Accounting Policies,” to our unaudited condensed consolidated financial statements included in this Form 10-Q for a summary of our significant accounting policies.

 Principles of Consolidation
 
In accordance with ASC 810, Consolidation, we consolidate those entities where we have a direct and indirect controlling financial interest based on either a variable interest model or voting interest model. As such, we consolidate entities that we conclude are VIEs, for which we are deemed to be the primary beneficiary and entities in which we hold a majority voting interest or have majority ownership and control over the operational, financial and investing decisions of that entity.
 

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For legal entities evaluated for consolidation, we must determine whether the interests that it holds and fees paid to it qualify as a variable interest in an entity. This includes an evaluation of the management fees and performance fees paid to us when acting as a decision maker or service provider to the entity being evaluated. Fees received by us that are customary and commensurate with the level of services provided, and we don’t hold other economic interests in the entity that would absorb more than an insignificant amount of the expected losses or returns of the entity, would not be considered a variable interest. We factor in all economic interests including proportionate interests through related parties, to determine if fees are considered a variable interest.
 
An entity in which we hold a variable interest is a VIE if any one of the following conditions exist: (a) the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support, (b) the holders of equity investment at risk have the right to direct the activities of the entity that most significantly impact the legal entity’s economic performance, (c) the voting rights of some investors are disproportionate to their obligation to absorb losses or rights to receive returns from a legal entity. For limited partnerships and other similar entities, non-controlling investors must have substantive rights to either dissolve the fund or remove the general partner (“kick-out rights”) in order to qualify as a VIE.

For those entities that qualify as a VIE, the primary beneficiary is generally defined as the party who has a controlling financial interest in the VIE. We are generally deemed to have a controlling financial interest if we have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, and the obligation to absorb losses or receive benefits from the VIE that could potentially be significant to the VIE. We determine whether we are the primary beneficiary of a VIE at the time we become initially involved with the VIE and we reconsider that conclusion continuously. The primary beneficiary evaluation is generally performed qualitatively on the basis of all facts and circumstances. However, quantitative information may also be considered in the analysis, as appropriate. These assessments require judgments. Each entity is assessed for consolidation on a case-by-case basis. 
 
For those entities evaluated under the voting interest model, we consolidate the entity if we have a controlling financial interest. We have a controlling financial interest in a voting interest entity (“VOE”) if we own a majority voting interest in the entity.

Performance Fees
 
Performance fees are based on certain specific hurdle rates as defined in the funds’ applicable investment management or partnership agreements. Performance fees are recorded on an accrual basis to the extent such amounts are contractually due.
 
We have elected to adopt Method 2 of ASC 605, Revenue Recognition, for revenue based on a formula. Under this method, we are entitled to performance-based fees that can amount to as much as 20.0% of a fund's profits, subject to certain hurdles. Performance-based fees are assessed as a percentage of the investment performance of the funds. The performance fee for any period is based upon an assumed liquidation of the fund's net assets on the reporting date, and distribution of the net proceeds in accordance with the fund 's income allocation provisions. The performance fees may be subject to reversal to the extent that the performance fees recorded exceeds the amount due to the general partner or investment manager based on a fund's cumulative investment returns.
 
Performance fees receivable is presented separately in our unaudited condensed consolidated balance sheets included in this Form 10-Q and represents performance fees recognized but not yet collected. The timing of the payment of performance fees due to the general partner or investment manager varies depending on the terms of the applicable fund agreements.
 
If applicable, we record an accrual for the potential repayment of previously received performance fees which represents amounts that would need to be repaid to the underlying funds if these funds were to be liquidated based on the current fair value of the underlying funds’ investments as of the reporting date. Our actual obligation, however, would not become payable or realized until the end of a fund’s life.

 Performance Fee Compensation Payable
 
We have an obligation to pay our professionals a portion of the performance fees earned from certain funds. These amounts are accounted for as compensation expense in conjunction with the recognition of the related performance fee revenue and, until paid, are recognized as performance fee compensation payable. Performance fee compensation is recognized in the same period

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that the related performance fees are recognized. Performance fee compensation can be reversed during periods when there is a decline in performance fees that were previously recognized.
 
Income Taxes

We are treated as a partnership for income tax purposes and are therefore not subject to U.S. federal, state and local corporate income taxes. We are subject to New York City unincorporated business tax attributable to taxable income allocable to New York City.
 
We account for income taxes using the asset and liability approach, which requires the recognition of tax benefits or expenses for temporary differences between the financial reporting and tax basis of assets and liabilities. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized. We also recognize a tax benefit from uncertain tax positions only if it is “more likely than not” that the position is sustainable based on its technical merits. Our policy is to recognize interest and penalties on uncertain tax positions and other tax matters as a component of income tax expense. For interim periods, we account for income taxes based on its estimate of the effective tax rate for the year. Discrete items and changes in its estimate of the annual effective tax rate are recorded in the period they occur.

We analyze our tax filing positions in all of the U.S. federal, state and local tax jurisdictions where we are required to file income tax returns, as well as for all open tax years in these jurisdictions. If, based on this analysis, we determine that uncertainties in tax positions exist, a liability is established.
 
Recent Accounting Pronouncements
 
Information regarding recent accounting pronouncements and their impact on us can be found in Note 2, “Summary of Significant Accounting Policies,” to our audited consolidated financial statements included in this Form 10-Q.
 
Off-Balance Sheet Arrangements
 
In the normal course of business, we may engage in off-balance sheet arrangements, including transactions in guarantees, commitments, indemnifications and potential contingent repayment obligations.
 
See Note 9, “Commitments and Contingencies,” to our unaudited condensed consolidated financial statements included in this Form 10-Q for a discussion of our commitments and contingencies.
 
Contractual Obligations
 
The following table sets forth information relating to our contractual obligations as of March 31, 2017.
 
 
Less than
1 year
 
1 - 3
years
 
4 - 5
years
 
More than
5 years
 
Total
 
(Amounts in thousands)
Medley Obligations
 

 
 

 
 

 
 

 
 

Operating lease obligations (1)  
$
2,017

 
$
5,414

 
$
5,263

 
$
4,254

 
$
16,948

Loans payable (2)

 
10,000

 

 

 
10,000

Senior unsecured debt (3)

 

 

 
122,595

 
122,595

Revenue share payable
787

 
1,789

 
1,384

 
297

 
4,257

Capital commitments to funds (4)
275

 

 

 

 
275

Total
$
3,079

 
$
17,203

 
$
6,647

 
$
127,146

 
$
154,075

____________ 
(1)
We lease office space in New York and San Francisco under non-cancelable lease agreements. The amounts in this table represent the minimum lease payments required over the term of the lease, and include operating leases for office equipment.
(2)
We have included all loans described in Note 6, “Loans Payable,” to our condensed consolidated financial statements included in this Form 10-Q.
(3)
We have included all our obligations described in Note 7, “Senior Unsecured Debt,” to our condensed consolidated financial statements included in this Form 10-Q.

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(4)
Represents equity commitments by us to certain long-dated private funds managed by us. These amounts are generally due on demand and are therefore presented in the less than one year category.

Indemnifications
 
In the normal course of business, we enter into contracts that contain indemnities for our affiliates, persons acting on our behalf or such affiliates and third parties. The terms of the indemnities vary from contract to contract and the maximum exposure under these arrangements, if any, cannot be determined and has neither been recorded in our consolidated financial statements. As of March 31, 2017, we have not had prior claims or losses pursuant to these contracts and expect the risk of loss to be remote.
 
Contingent Obligations
 
The partnership documents governing our funds generally include a clawback provision that, if triggered, may give rise to a contingent obligation that may require the general partner to return amounts to the fund for distribution to investors. Therefore, performance fee revenue, generally, is subject to reversal in the event that the funds incur future losses. These losses are limited to the extent of the cumulative performance fee revenue recognized in income to date, net of a portion of taxes paid. Due in part to our investment performance and the fact that our performance fee revenue is generally determined on a liquidation basis, as of March 31, 2017, we accrued $7.1 million for clawback obligations that would need to be paid had the funds been liquidated as of that date. There can be no assurance that we will not incur additional clawback obligations in the future. If all of the existing investments were valued at $0, the amount of cumulative performance fee revenue that have been recognized would be reversed. We believe that the possibility of all of the existing investments becoming worthless is remote. At March 31, 2017, had we assumed all existing investments were valued at $0, the net amount of performance fee revenue subject to additional reversal would have been approximately $4.8 million.
 
Performance fee revenue is also affected by changes in the fair values of the underlying investments in the funds that we advise. Valuations, on an unrealized basis, can be significantly affected by a variety of external factors including, but not limited to, bond yields and industry trading multiples. Under the governing agreements of certain of our funds, we may have to fund additional amounts on account of clawback obligations beyond what we received in performance fee compensation on account of distributions of performance fee payments made to current or former professionals from such funds if they do not fund their respective shares of such clawback obligations. We will generally retain the right to pursue any remedies that we have under such governing agreements against those carried interest recipients who fail to fund their obligations.
 
Additionally, at the end of the life of the funds, there could be a payment due to a fund by us if we have recognized more performance fee revenue than was ultimately earned. The general partner obligation amount, if any, will depend on final realized values of investments at the end of the life of the fund.
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Our primary exposure to market risk is related to our role as general partner or investment adviser to our investment funds and the sensitivity to movements in the fair value of their investments, including the effect on management fees, performance fees and investment income.
 
The market price of investments may significantly fluctuate during the period of investment. Investments may decline in value due to factors affecting securities markets generally or particular industries represented in the securities markets. The value of an investment may decline due to general market conditions which are not specifically related to such investment, such as real or perceived adverse economic conditions, changes in the general outlook for corporate earnings, changes in interest or currency rates or adverse investor sentiment generally. They may also decline due to factors that affect a particular industry or industries, such as labor shortages or increased production costs and competitive conditions within an industry.
 
Effect on Management Fees
 
Management fees are generally based on a defined percentage of gross asset values, total committed capital, net invested capital and NAV of the investment funds managed by us as well as a percentage of net interest income over a performance hurdle. Management fees calculated based on fair value of assets or net investment income are affected by short-term changes in market values.


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The overall impact of a short-term change in market value may be mitigated by fee definitions that are not based on market value including invested capital and committed capital, market value definitions that exclude the impact of realized and/or unrealized gains and losses, market value definitions based on beginning of the period values or a form of average market value including daily, monthly or quarterly averages, as well as monthly or quarterly payment terms.
 
As such, based on an incremental 10% short-term increase in fair value of the investments in our permanent capital vehicles, long-dated private funds and SMAs’ as of March 31, 2017, we calculated a $0.8 million increase in management fees for the three months ended March 31, 2017. In the case of a 10% short-term decline in fair value of the investments in our permanent capital, long-dated funds and SMAs’ as of March 31, 2017, we calculated a $1.0 million decrease in management fees for the three months ended March 31, 2017.
    
Effect on Performance Fees
 
Performance fees are based on certain specific hurdle rates as defined in the funds' applicable investment management or partnership agreements. The performance fees for any period are based upon an assumed liquidation of the fund's net assets on the reporting date, and distribution of the net proceeds in accordance with the fund's income allocation provisions, which can result in a performance-based fee to us, subject to certain hurdles and benchmarks. The performance fees may be subject to reversal to the extent that the performance fees recorded exceed the amount due to the general partner or investment manager based on a fund's cumulative investment returns.
 
Short-term changes in the fair values of funds' investments may materially impact accrued performance fees depending on the respective funds' performance relative to applicable hurdles. The overall impact of a short-term change in market value may be mitigated by a number of factors including, but not limited to, the way in which carried interest performance fees are calculated, which is not ultimately dependent on short-term moves in fair market value, but rather realize cumulative performance of the investments through the end of the long-dated private funds and SMAs’ lives. However, short-term moves can meaningfully impact our ability to accrue performance fees and receive cash payments in any given period.
 
As such, based on an incremental 10% short-term increase in fair value of the investments in our long-dated private funds and SMAs’ as of March 31, 2017, we calculated a $26.3 million increase in performance fees for the three months ended March 31, 2017. In the case of a 10% short-term decline in fair value of investments in our long-dated private funds and SMAs’ as of March 31, 2017, we calculated a $0.8 million decrease in performance fees for the three months ended March 31, 2017.
 
Effect on Part I and Part II Incentive Fees
 
Incentive fees are based on certain specific hurdle rates as defined in our permanent capital vehicles' applicable investment management agreements. The Part II incentive fees are based upon realized gains netted against cumulative realized and unrealized losses. The Part I incentive fees are not subject to clawbacks as our carried interest performance fees are.
 
Short-term changes in the fair values of the investments of our permanent capital vehicles may materially impact Part II incentive fees depending on the respective vehicle's performance relative to applicable hurdles to the extent there were realized gains that we would otherwise earn Part II incentive fees on.
 
As such, based on an incremental 10% short-term increase in fair value of the investments in our permanent capital vehicles as of March 31, 2017, we calculated a $9.2 million increase in Part I and II incentive fees for the three months ended March 31, 2017. In the case of a 10% short-term decline in fair value of the investments in our permanent capital vehicles as of March 31, 2017, we calculated a $0.4 million increase in Part I incentive fees for the three months ended March 31, 2017.
 
Interest Rate Risk
 
As of March 31, 2017, we had $125.2 million of debt outstanding, presented as loans payable and senior unsecured debt in our unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q. Our debt bears interest at fixed rates, and therefore is not subject to interest rate fluctuation risk.
 
As credit-oriented investors, we are also subject to interest rate risk through the securities we hold in our funds. A 100 basis point increase in interest rates would be expected to negatively affect prices of securities that accrue interest income at fixed rates and therefore negatively impact net change in unrealized appreciation on the funds' investments. The actual impact is dependent on the average duration of such holdings. Conversely, securities that accrue interest at variable rates would be expected to benefit

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from a 100 basis points increase in interest rates because these securities would generate higher levels of current income and therefore positively impact interest and dividend income, subject to LIBOR. In the cases where our funds pay management fees based on NAV, we would expect management fees to experience a change in direction and magnitude corresponding to that experienced by the underlying portfolios.
 
Credit Risk
 
We are party to agreements providing for various financial services and transactions that contain an element of risk in the event that the counterparties are unable to meet the terms of such agreements. In such agreements, we depend on the respective counterparty to make payment or otherwise perform. We generally endeavor to minimize our risk of exposure by limiting to reputable financial institutions the counterparties with which we enter into financial transactions. In other circumstances, availability of financing from financial institutions may be uncertain due to market events, and we may not be able to access these financing markets.  
  
Item 4.     Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our co-principal executive officers and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. The design of any disclosure controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives. Our management, with the participation of our Co-Chief Executive Officers and our Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, and subject to the foregoing, our Co-Chief Executive Officers and our Chief Financial Officer have concluded that, as of the end of the period covered by this report, the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.
 
Changes in Internal Control over Financial Reporting
 
There have been no changes in our internal control over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II.
 
Item 1.     Legal Proceedings
 
From time to time, we are involved in various legal proceedings, lawsuits and claims incidental to the conduct of our business. Our business is also subject to extensive regulation, which may result in regulatory proceedings against us. Except as described below, we are not currently party to any material legal proceedings.
 
MCC Advisors LLC was named as a defendant in a lawsuit on May 29, 2015, by Moshe Barkat and Modern VideoFilm Holdings, LLC (“MVF Holdings”) against MCC, MOF II, MCC Advisors LLC, Deloitte Transactions and Business Analytics LLP A/K/A Deloitte ERG (“Deloitte”), Scott Avila (“Avila”), Charles Sweet, and Modern VideoFilm, Inc. (“MVF”). The lawsuit is pending in the California Superior Court, Los Angeles County, Central District, as Case No. BC 583437. The lawsuit was filed after MCC, as agent for the lender group, exercised remedies following a series of defaults by MVF and MVF Holdings on a secured loan with an outstanding balance at the time in excess of $65 million. The lawsuit sought damages in excess of $100 million. Deloitte and Avila have settled the claims against them in exchange for payment of $1.5 million. Following a separate lawsuit by Mr. Barkat against MVF’s D&O insurance carrier, the carrier, Charles Sweet and MVF have settled the claims against them. On June 6, 2016, the court granted the defendants’ demurrers on several counts and dismissed Mr. Barkat’s claims with prejudice except with respect to his claim for intentional interference with contract. MCC and the other defendants continue to dispute the remaining allegations and are vigorously defending the lawsuit while pursuing affirmative counterclaims against Mr. Barkat and MVF Holdings. On August 29, 2016, MVF Holdings filed another lawsuit in the California Superior Court, Los Angeles County, Central District, as Case No. BC 631888 (the “Derivative Action”), naming MCC Advisors LLC and certain of Medley’s employees as defendants, among others. The plaintiff in the Derivative Action, asserts claims against the defendants for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, unfair competition, breach of the implied covenant of good faith and fair dealing, interference with prospective economic advantage, fraud, and declaratory relief. MCC Advisors LLC and the other defendants believe the outstanding claims for alleged interference with Mr. Barkat’s employment contract, and the other causes of action asserted in the Derivative Action are without merit and all defendants intend to continue to assert a vigorous defense.
On May 4, 2017, Medley Capital LLC entered into a Settlement Agreement with CK Pearl Fund, Ltd. and CK Pearl Fund, LP (the “CK Pearl Funds”), pursuant to which the CK Pearl Funds granted Medley Capital LLC and its affiliates, managers, officers, directors, employees (the “Medley Parties”) a full release of claims and further agreed to indemnify the Medley Parties from any liabilities and to reimburse Medley Capital LLC for its reasonable legal fees and expenses in connection with the following lawsuit: CK Pearl Fund, Ltd. and CK Pearl Fund, LP v. Rothstein Kass & Company, P.C., Rothstein-Kass P.A., Rothstein Kass & Co. LLC and Rothstein, Kass & Company (Cayman); Rothstein Kass & Company, P.C., Rothstein-Kass P.A., Rothstein Kass & Co. LLC and Rothstein, Kass & Company (Cayman) v. Medley Capital LLC, filed on September 19, 2016, in the Superior Court of New Jersey Law Division: Essex County, as Docket No. L-5196-15 (the “Rothstein Lawsuit”). Pursuant to the settlement, Medley Capital LLC will be filing a motion seeking dismissal as a defendant in the Rothstein Litigation. While Medley Capital LLC will remain as a named defendant until it is dismissed or the action is resolved, in light of the CK Pearl Funds’ agreement to indemnify the Medley Parties and to advance expenses on their behalf, we believe the Rothstein litigation no longer constitutes a material pending legal proceeding. The settlement also resolves our affirmative lawsuit against the CK Pearl Funds, Medley Capital LLC v. CK Pearl Fund, Ltd., filed on November 28, 2016, in the Grand Court of the Cayman Islands in the Financial Services Division, as Cause No. FSD 196 of 2016. 

 
Item 1A.     Risk Factors

For a discussion of our potential risks and uncertainties, see the information under the heading “Risk Factors” in Part I., Item 1A. of our Annual Report on Form 10-K, which is accessible on the SEC's website at www.sec.gov. There were no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.     Defaults Upon Senior Securities

None.

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Item 4.     Mine Safety Disclosures
 
Not Applicable.
 
Item 5.     Other Information
 
Not Applicable.

Item 6.     Exhibits

The required exhibits are listed in the Exhibit Index and are incorporated herein by reference.






SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Medley LLC
 
(Registrant)
 
 
Date: May 12, 2017
By:
/s/ Richard T. Allorto, Jr.
 
 
Richard T. Allorto, Jr.
 
 
Chief Financial Officer of Medley LLC
 
 
 

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EXHIBIT INDEX
Exhibit No.
 
Description
 
 
 
3.1
 
Amended and Restated Certificate of Incorporation of Medley Management Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K (File No. 001-36638) filed on September 29, 2014).
 
 
 
3.2
 
Amended and Restated By-Laws of Medley Management Inc. (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K (File No. 001-36638) filed on September 29, 2014).
 
 
 
4.1
 
Indenture, dated August 9, 2016, between Medley LLC and U.S. Bank National Association, as trustee (incorporated by reference to Exhibit 4.1 of Medley LLC’s Current Report on Form 8-K filed on August 9, 2016).
 
 
 
4.2
 
First Supplemental Indenture, dated August 9, 2016, between Medley LLC and U.S. Bank National Association, as trustee, including the form of note attached as an exhibit thereto (incorporated by reference to Exhibit 4.2 of Medley LLC’s Current Report on Form 8-K filed on August 9, 2016).
 
 
 
4.3
 
Second Supplemental Indenture dated as of October 18, 2016, between Medley LLC and U.S. Bank National Association, as Trustee, with the form of note included therein (incorporated by reference to Exhibit 4.1 of Medley LLC’s Current Report on Form 8-K filed on October 19, 2016).
 
 
 
4.4
 
Third Supplemental Indenture, dated January 18, 2017, between Medley LLC and U.S. Bank National Association, as trustee, including the form of note attached as an exhibit thereto (incorporated by reference to Exhibit 4.1 of Medley LLC's Current Report on Form 8-K filed on January 20, 2017).
 
 
 
4.5
 
Fourth Supplemental Indenture, dated February 22, 2017, between Medley LLC and U.S. Bank National Association, as trustee, including the form of note attached as an exhibit thereto (incorporated by reference to Exhibit 4.1 of Medley LLC's Current Report on Form 8-K filed on February 22, 2017).
 
 
 
10.1
 
Form of Class A Medley LL Unit Award Agreement, as amended *+
 
 
 
31.1*
 
Certification by Co-Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
 
Certification by Co-Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.3*
 
Certification by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1**
 
Certification of Co-Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.2**
 
Certification of Co-Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
32.3**
 
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101.INS*
 
XBRL Instance Document
 
 
 
101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 

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101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
* Filed herewith
** Furnished herewith
+ Management contract or compensatory plan in which directors and/or executive officers are eligible to participate

 
The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

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