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EX-31.2 - RULE 13A-14(A) CERTIFICATION OF MICHAEL J. CASTELLANO - Lazard Group LLCdex312.htm
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EX-12.1 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - Lazard Group LLCdex121.htm
EX-31.1 - RULE 13A-14(A) CERTIFICATION OF STEVEN J. GOLUB - Lazard Group LLCdex311.htm
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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2009

 

OR

 

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

 

For the transition period from                          to                         

 

333-126751

(Commission File Number)

 


 

LAZARD GROUP LLC

(Exact name of registrant as specified in its charter)

 

Delaware

  

51-0278097

(State or Other Jurisdiction of Incorporation    (I.R.S. Employer Identification No.)
or Organization)     

 


 

30 Rockefeller Plaza

New York, NY 10020

(Address of principal executive offices)

 

Registrant’s telephone number: (212) 632-6000

 


 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

   

    Large Accelerated Filer  ¨

  

Accelerated Filer  ¨

    
   

    Non-Accelerated Filer  x

  

Smaller Reporting Company  ¨

    

 

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

 

As of October 29, 2009, in addition to profit participation interests, there were 123,686,338 common membership interests and two managing member interests outstanding.

 



Table of Contents

TABLE OF CONTENTS

 

When we use the terms “Lazard Group”, “Lazard”, “we”, “us”, “our”, and “the Company”, we mean Lazard Group LLC (formerly named Lazard LLC), a Delaware limited liability company, that is the current holding company for the subsidiaries that conduct our businesses. Lazard Ltd is a Bermuda exempt company whose shares of Class A common stock are publicly traded on the New York Stock Exchange under the Symbol “LAZ”. Lazard Ltd’s subsidiaries include Lazard Group and their respective subsidiaries. Lazard Ltd has no material assets other than indirect ownership as of September 30, 2009 of approximately 74.5% of the common membership interests in Lazard Group. Lazard Ltd controls Lazard Group through two of its indirect wholly-owned subsidiaries who are co-managing members of Lazard Group.

 

Lazard Group has two primary holders of its common membership interests: Lazard Ltd and LAZ-MD Holdings LLC (“LAZ-MD Holdings”), a holding company that is owned by current and former managing directors of Lazard Group. The Lazard Group common membership interests held by LAZ-MD Holdings are effectively exchangeable over time on a one-for-one basis with Lazard Ltd for shares of Lazard Ltd’s Class A common stock. In addition, Lazard Group has granted profit participation interests in Lazard Group to certain of its managing directors in connection with the recapitalization of Lazard Group at the time of Lazard Ltd’s equity public offering. The profit participation interests are discretionary profits interests that are intended to enable Lazard Group to compensate its managing directors in a manner consistent with historical practices.

 

     Page

Part I. Financial Information

  

Item 1. Financial Statements (Unaudited)

   1

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

   39

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   74

Item 4. Controls and Procedures

   74

Part II. Other Information

  

Item 1. Legal Proceedings

   75

Item 1A. Risk Factors

   75

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

   75

Item 3. Defaults Upon Senior Securities

   75

Item 4. Submission of Matters to a Vote of Security Holders

   75

Item 5. Other Information

   75

Item 6. Exhibits

   75

Signatures

   81

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

    Page

Condensed Consolidated Statements of Financial Condition as of September 30, 2009 and December 31,  2008

  2

Condensed Consolidated Statements of Operations for the three month and nine month periods ended  September 30, 2009 and 2008

  4

Condensed Consolidated Statements of Cash Flows for the nine month periods ended
September 30, 2009 and 2008

  5

Condensed Consolidated Statements of Changes in Members’ Equity for the nine month periods  ended September 30, 2009 and 2008

  6

Notes to Condensed Consolidated Financial Statements

  8

 

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LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

(UNAUDITED)

(dollars in thousands)

 

     September 30,
2009
   December 31,
2008

ASSETS

     
Cash and cash equivalents    $ 679,272    $ 907,278
Cash deposited with clearing organizations and other segregated cash      19,678      14,583
Receivables—net:      

Banks

     7,104      229,092

Fees

     400,570      391,251

Customers and other

     109,807      81,806

Related parties

     148,279      66,491
             
     665,760      768,640
Investments:      

Debt:

     

U.S. Government and agencies (includes $126,369 of securities at amortized cost at September 30, 2009)

     147,591      –  

Other (includes $10,096 of securities at amortized cost at September 30, 2009)

     336,837      333,070

Equities

     80,269      71,105

Other

     272,549      215,792
             
     837,246      619,967

Property (net of accumulated amortization and depreciation of $236,621 and $213,249 at September 30, 2009 and December 31, 2008, respectively)

     170,917      171,443

Goodwill and other intangible assets (net of accumulated amortization of $4,870 and $2,150 at September 30, 2009 and December 31, 2008, respectively)

     311,705      175,144
Other assets      208,320      228,527
             

Total assets

   $ 2,892,898    $ 2,885,582
             

 

See notes to condensed consolidated financial statements.

 

2


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LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION—(Continued)

SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

(UNAUDITED)

(dollars in thousands)

 

    September 30,
2009
    December 31,
2008
 

LIABILITIES AND MEMBERS’ EQUITY

   

Liabilities:

   

Deposits and other customer payables

  $ 286,580      $ 541,784   

Accrued compensation and benefits

    191,947        203,750   

Senior debt

    1,086,850        1,087,750   

Capital lease obligations

    25,905        26,825   

Related party payables

    246,349        263,975   

Other liabilities

    498,201        484,988   

Subordinated debt

    150,000        150,000   
               

Total liabilities

    2,485,832        2,759,072   

Commitments and contingencies

   

MEMBERS’ EQUITY

   

Members’ equity (net of 10,330,199 and 9,376,162 shares of Lazard Ltd Class A common stock, at cost of $337,480 and $321,852 at September 30, 2009 and December 31, 2008, respectively)

    313,564        227,036   

Accumulated other comprehensive loss, net of tax

    (30,661     (121,407
               

Total Lazard Group members’ equity

    282,903        105,629   

Noncontrolling interests

    124,163        20,881   
               

Total members’ equity

    407,066        126,510   
               

Total liabilities and members’ equity

  $ 2,892,898      $ 2,885,582   
               

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(UNAUDITED)

(dollars in thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2009   2008     2009   2008  

REVENUE

       

Investment banking and other advisory fees

  $
252,538
  $ 260,708      $ 650,327   $ 736,863   

Money management fees

    149,102    
155,920
  
   
368,346
    479,701   

Interest income

    9,661     23,743        25,770     66,833   

Other

    27,997     (755     76,229     7,868   
                           

Total revenue

    439,298     439,616        1,120,672     1,291,265   

Interest expense

    27,892     34,080        85,364     111,366   
                           

Net revenue

    411,406     405,536        1,035,308     1,179,899   
                           

OPERATING EXPENSES

       

Compensation and benefits

    250,912     432,771        693,718     906,351   

Occupancy and equipment

    23,690     22,864        63,766     74,635   

Marketing and business development

    14,070     18,368        43,309     64,040   

Technology and information services

    17,592     17,683        49,670     51,013   

Professional services

    11,550     15,727        30,555     44,035   

Fund administration and outsourced services

    10,272    
8,569
  
    26,075     21,712   

Amortization of intangible assets related to acquisitions

    2,032     507        2,720     4,252   

Restructuring

    –       –          62,550     –     

Other

    8,118     23,712        22,568     42,579   
                           

Total operating expenses

    338,236     540,201        994,931     1,208,617   
                           

OPERATING INCOME (LOSS)

    73,170     (134,665     40,377     (28,718

Provision for income taxes

    21,286     4,884        29,951     23,276   
                           

NET INCOME (LOSS)

    51,884     (139,549     10,426     (51,994

LESS - NET INCOME (LOSS) ATTRIBUTABLE TO NONCONTROLLING INTERESTS

    2,030     (8,161     1,218     (9,770
                           

NET INCOME (LOSS) ATTRIBUTABLE TO LAZARD GROUP

  $ 49,854   $ (131,388   $ 9,208   $ (42,224
                           

 

See notes to condensed consolidated financial statements.

 

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LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND 2008

(UNAUDITED)

(dollars in thousands)

 

     Nine Months Ended
September 30,
 
        2009             2008      

CASH FLOWS FROM OPERATING ACTIVITIES:

   

Net income (loss)

  $ 10,426      $ (51,994)   

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

   

Noncash items included in net income (loss):

   

Depreciation and amortization of property

    16,781        15,338   

Amortization of deferred expenses, stock units and interest rate hedge

    223,763        185,740   

Amortization of intangible assets related to acquisitions

    2,720        4,252   

Gain on extinguishment of debt

    (258     –     

(Increase) decrease in operating assets:

   

Cash deposited with clearing organizations and other segregated cash

    (4,267     13,989   

Receivables-net

    112,249        (148,407

Investments

    (40,830     453,143   

Other assets

    13,385        (43,204

Increase (decrease) in operating liabilities:

   

Deposits and other payables

    (270,016     170,735   

Accrued compensation and benefits and other liabilities

    (7,414     (381,431
               

Net cash provided by operating activities

    56,539        218,161   
               

CASH FLOWS FROM INVESTING ACTIVITIES:

   

Acquisition of businesses in 2009, net of cash acquired of $23,280, and equity method investments

    (22,500     (74,855

Additions to property

    (8,579     (12,444

Disposals of property

    896        470   

Purchases of held-to-maturity securities

    (135,950     –     

Purchases of available-for-sale securities

    (3,399     (146,959

Proceeds from sales and maturities of available-for-sale securities

    54,467        91,430   
               

Net cash used in investing activities

    (115,065     (142,358
               

CASH FLOWS FROM FINANCING ACTIVITIES:

   

Proceeds from:

   

Issuance of common membership interests

    –          437,500   

Other financing activities

    56        7,592   

Payments for:

   

Senior borrowings

    (635     (437,488

Capital lease obligations

    (2,084     (2,317

Distributions to noncontrolling interests

    (7,165     (7,017

Repurchase of common membership interests from members of LAZ-MD Holdings

    (13,285     (2,559

Purchase of Lazard Ltd Class A common stock

    (50,479     (209,353

Distribution to members

    (104,038     (115,642

Settlement of vested RSUs and DSUs

    (12,291     (3,881

Other financing activities

    (90     (60
               

Net cash used in financing activities

    (190,011     (333,225
               

EFFECT OF EXCHANGE RATE CHANGES ON CASH

    20,531        (8,508
               

NET DECREASE IN CASH AND CASH EQUIVALENTS

    (228,006     (265,930

CASH AND CASH EQUIVALENTS—January 1

    907,278        1,000,573   
               

CASH AND CASH EQUIVALENTS—September 30

  $ 679,272      $ 734,643   
               

 

See notes to condensed consolidated financial statements.

 

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LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS’ EQUITY

FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2009

(UNAUDITED)

(dollars in thousands)

 

      Members’
Equity
    Accumulated
Other
Comprehensive
Loss, Net of Tax
    Total
Lazard Group
Members’ Equity
    Noncontrolling
Interests
   Total
Members’
Equity
 

Balance - January 1, 2009(*)

   $227,036      $(121,407   $105,629      $20,881    $126,510   
                     

Comprehensive income (loss):

           

Net income

   9,208        9,208      1,218    10,426   

Other comprehensive income (loss) - net of tax:

           

Currency translation adjustments

     64,522      64,522      1    64,523   

Amortization of interest rate hedge

     808      808         808   

Available-for-sale securities:

           

Net unrealized gain

     23,460
  
  23,460      2    23,462   

Adjustments for items reclassified to earnings

     1,200      1,200         1,200   

Employee benefit plans:

           

Net actuarial gain

     1,129      1,129         1,129   

Adjustments for items reclassified to earnings

     (373   (373      (373
                     

Comprehensive income (loss)

       99,954      1,221    101,175   
                     

Amortization of stock units

   216,190        216,190         216,190   

Acquisitions of and distributions to members and noncontrolling interests

   (104,038     (104,038   102,061    (1,977

Purchase of Lazard Ltd Class A common stock

   (50,479     (50,479      (50,479

Delivery of Lazard Ltd Class A common stock for settlement of vested RSUs

   (12,291     (12,291      (12,291

Repurchase of common membership interests from LAZ-MD Holdings

   (13,285     (13,285      (13,285

Common membership interests issued in connection with business acquisitions

   32,384        32,384         32,384   

Adjustments related to business acquisitions and related amortization

   8,929        8,929         8,929   

Other

   (90     (90      (90
                             

Balance - September 30, 2009(*)

   $313,564      $(30,661   $282,903      $124,163    $407,066   
                             

 

 

(*)

Includes 122,233,664 and 123,686,338 common membership interests at January 1, 2009 and September 30, 2009, respectively. Also includes profit participation interests and two managing member interests at each such date.

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

LAZARD GROUP LLC

 

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS’ EQUITY

FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2008

(UNAUDITED)

(dollars in thousands)

 

    Members’
Equity
    Accumulated Other
Comprehensive Loss,
Net of Tax
    Total Lazard Group
Members’ Equity
(Deficiency)
    Noncontrolling
Interests
    Total
Members’

Equity
 

Balance - January 1, 2008(*)

  $ (81,980   $ 55,673      $ (26,307   $ 51,755      $ 25,448   
                           

Comprehensive income (loss):

         

Net loss

    (42,224       (42,224     (9,770     (51,994

Other comprehensive income (loss) - net of tax:

         

Currency translation adjustments

      (54,017     (54,017     (1     (54,018

Amortization of interest rate hedge

      825        825          825   

Available-for-sale securities:

         

Net unrealized loss

      (15,619     (15,619     (1     (15,620

Adjustments for items reclassified to earnings

      5        5          5   

Employee benefit plans:

         

Net actuarial loss

      93        93          93   

Adjustments for items reclassified to earnings

      (681     (681       (681
                           

Comprehensive income (loss)

        (111,618     (9,772     (121,390
                           

Amortization of stock units

    177,844          177,844          177,844   

Distributions to members and noncontrolling interests

    (115,642       (115,642     (7,017     (122,659

Purchase of Lazard Ltd Class A common stock

    (209,353       (209,353       (209,353

Delivery of Lazard Ltd Class A common stock for settlement of vested RSUs and DSUs

    (3,881       (3,881       (3,881

14,582,750 common membership interests issued in the settlement of the purchase contracts forming part of the ESUs

    437,500          437,500          437,500   

Repurchase of common membership interests from LAZ-MD Holdings

    (2,559       (2,559       (2,559

Common membership interests issued in connection with business acquisitions

    18,622          18,622          18,622   

Adjustments related to business acquisitions and related amortization

    2,850          2,850          2,850   

Other

    299          299          299   
                                       

Balance - September 30, 2008(*)

  $ 181,476      $ (13,721   $ 167,755      $ 34,966      $ 202,721   
                                       

 

(*)

Includes 107,068,617 and 122,213,574 common membership interests at January 1, 2008 and September 30, 2008, respectively. Also includes profit participation interests and two managing member interests at each such date.

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

1. ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

 

The accompanying condensed consolidated financial statements are those of Lazard Group LLC and its subsidiaries (formerly known as Lazard LLC and collectively referred to with its subsidiaries as “Lazard Group” or the “Company”). Lazard Group is a Delaware limited liability company and is governed by an Operating Agreement dated as of May 10, 2005, as amended (the “Operating Agreement”).

 

Lazard Ltd, a Bermuda holding company, through its subsidiaries held approximately 74.5% and 62.4% of all outstanding Lazard Group common membership interests as of September 30, 2009 and December 31, 2008, respectively. Lazard Ltd, through its control of the managing members of Lazard Group, controls Lazard Group.

 

Lazard Ltd, including its indirect investment in Lazard Group, is a preeminent international financial advisory and asset management firm that has long specialized in crafting solutions to the complex financial and strategic challenges of our clients. We serve a diverse set of clients around the world, including corporations, partnerships, institutions, governments and high net worth individuals.

 

LAZ-MD Holdings LLC (“LAZ-MD Holdings”), an entity owned by Lazard Group’s current and former managing directors, held approximately 25.5% and 37.6% of the outstanding Lazard Group common membership interests as of September 30, 2009 and December 31, 2008, respectively. Subject to certain limitations, LAZ-MD Holdings’ interests in Lazard Group are exchangeable for Lazard Ltd Class A common stock, par value $0.01 per share (“Class A common stock”).

 

Lazard Group’s principal operating activities are included in two business segments:

 

   

Financial Advisory, which includes providing advice on mergers and acquisitions (“M&A”) and strategic advisory matters, restructurings and capital structure advisory services, capital raising and other transactions, and

 

   

Asset Management, which includes the management of equity and fixed income securities, alternative investments and private equity funds.

 

In addition, the Company records selected other activities in its Corporate segment, including management of cash, certain investments and the commercial banking activities of Lazard Group’s Paris-based Lazard Frères Banque SA (“LFB”). LFB is a registered bank regulated by the Banque de France and its primary operations include asset and liability management for Lazard Group’s businesses in France through its money market desk and commercial banking operations, deposit taking and, to a lesser extent, financing activities and custodial oversight over assets of various clients. LFB also engages in underwritten offerings of securities in France. The Company also allocates outstanding indebtedness to its Corporate segment.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements of Lazard Group have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in Lazard Group’s annual

 

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Table of Contents

LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

report on Form 10-K for the year ended December 31, 2008 (the “Form 10-K”). The accompanying December 31, 2008 unaudited condensed consolidated statement of financial condition data was derived from audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP for annual financial statement purposes. The accompanying condensed consolidated financial statements reflect all adjustments, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. Preparing financial statements requires management to make estimates and assumptions that affect the amounts that are reported in the financial statements and the accompanying disclosures. Although these estimates are based on management’s knowledge of current events and actions that Lazard may undertake in the future, actual results may differ materially from the estimates. The consolidated results of operations for the three month and nine month periods ended September 30, 2009 are not necessarily indicative of the results to be expected for any future period or the full fiscal year. Any material events or transactions that occurred subsequent to September 30, 2009 through the date of filing of this Quarterly Report on Form 10-Q were reviewed for purposes of determining whether any adjustments or additional disclosures were required to be made to the accompanying condensed consolidated financial statements.

 

The condensed consolidated financial statements include Lazard Group and Lazard Group’s principal operating subsidiaries: Lazard Frères & Co. LLC (“LFNY”), a New York limited liability company, along with its subsidiaries, including Lazard Asset Management LLC and its subsidiaries (collectively referred to as “LAM”); its French limited liability companies Compagnie Financière Lazard Frères SAS (“CFLF”) along with its subsidiaries, LFB and Lazard Frères Gestion SAS (“LFG”) and Maison Lazard SAS and its subsidiaries; and Lazard & Co., Limited (“LCL”), through Lazard & Co., Holdings Limited, an English private limited company (“LCH”), together with their jointly owned affiliates and subsidiaries.

 

The Company’s policy is to consolidate (i) entities in which it has a controlling financial interest, (ii) variable interest entities (“VIEs”) where the Company has a variable interest and is deemed to be the primary beneficiary and (iii) limited partnerships where the Company is the general partner, unless the presumption of control is overcome. When the Company does not have a controlling interest in an entity, but exerts significant influence over the entity’s operating and financial decisions, the Company applies the equity method of accounting in which it records in earnings its share of earnings or losses of the entity. All material intercompany transactions and balances have been eliminated.

 

Certain prior period amounts have been reclassified to conform to the manner of presentation in the current period, including those amounts pertaining to noncontrolling (minority) interests in subsidiaries as required by new accounting guidance issued by the Financial Accounting Standards Board (the “FASB”) (see Note 2 of Notes to Condensed Consolidated Financial Statements).

 

2. RECENT ACCOUNTING DEVELOPMENTS

 

Fair Value Measurements - On January 1, 2008, the Company adopted, on a prospective basis, the required provisions of new accounting guidance issued by the FASB on fair value measurements, which, among other things, defined fair value, established a framework for measuring fair value and enhanced disclosure requirements about fair value measurements with respect to its financial assets and financial liabilities. On January 1, 2009, the Company adopted the remaining provisions of the new guidance issued, as permitted by an amendment which delayed the effective date of the new accounting guidance for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). These nonfinancial items included, for example, reporting units required to be measured at fair value for annual goodwill impairment testing purposes and nonfinancial assets acquired and

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

liabilities assumed in a business combination. Neither the adoption of the required provisions of the new guidance, nor the subsequent adoption of the remaining provisions of the new guidance as permitted by the amendment, had a material impact on the Company’s consolidated financial statements.

 

On April 1, 2009, the Company adopted, on a prospective basis, additional accounting guidance issued by the FASB on fair value measurements. The additional accounting guidance assists in the determination of fair value for securities or other financial assets when the volume and level of activity for such items have significantly decreased when compared with normal market activity and there is no longer sufficient frequency or volume to provide pricing information on an ongoing basis. The additional accounting guidance also assists in determining whether or not a transaction is orderly and whether or not a transaction or quoted price can be considered in the determination of fair value. Accordingly, the additional accounting guidance does not apply to quoted prices for identical assets or liabilities in active markets categorized as Level 1 in the fair value measurement hierarchy, and also requires that additional fair value disclosures be included on an interim basis. See Note 5 of Notes to Condensed Consolidated Financial Statements for the additional disclosures provided pursuant to the additional accounting guidance. The adoption of additional guidance regarding fair value measurements did not materially impact the Company’s consolidated financial statements.

 

Business Combinations - On January 1, 2009, the Company adopted, on a prospective basis, new accounting guidance issued by the FASB on business combinations. The new accounting guidance supersedes or amends other related authoritative literature although it retains the fundamental requirements that the acquisition method of accounting (previously referred to as the “purchase method”) be used for all business combinations and that an acquirer be identified for each business combination. The new guidance also establishes principles and requirements for how the acquirer (a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in an acquiree; (b) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase; and (c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of a business combination. The new guidance also requires the acquirer to expense, as incurred, costs relating to any acquisitions. The adoption of the new accounting guidance did not have an impact on the Company’s consolidated financial statements. Prospectively, all acquisitions will conform to the new accounting guidance.

 

On April 1, 2009, the Company adopted amended accounting guidance issued by the FASB for business combinations. The amended guidance clarifies the initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. The adoption of the amended guidance did not materially impact the Company’s consolidated financial statements.

 

Noncontrolling Interests - On January 1, 2009, the Company adopted, on a retrospective basis, new presentation and disclosure requirements issued by the FASB with respect to noncontrolling interests in consolidated financial statements. Additional guidance was also issued to establish accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. The new accounting guidance clarified that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. In addition, the new guidance also changes the way the consolidated income statement is presented by requiring consolidated net income to include amounts attributable to both the parent and the noncontrolling interests with separate disclosure of each component on the face of the consolidated income statement.

 

Derivative Instruments and Hedging Activities - On January 1, 2009, the Company adopted, on a prospective basis, new disclosure guidance issued by the FASB regarding derivative instruments and hedging activities. The new guidance enhances the current disclosure framework for derivative instruments and hedging

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

activities, including how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. See Note 6 of Notes to Condensed Consolidated Financial Statements for the additional disclosures provided pursuant to the new guidance. The adoption of the new disclosure guidance did not materially impact the Company’s consolidated financial statements.

 

Fair Value Estimates for Certain Financial Instruments - On April 1, 2009, the Company adopted, on a prospective basis, additional disclosure requirements issued by the FASB regarding the fair value of certain financial instruments. The additional disclosure requirements increase the frequency of qualitative and quantitative information about fair value estimates for all financial instruments not remeasured on the balance sheet at fair value by requiring this information on an interim basis. The adoption of the additional disclosure requirements did not have a material impact on the Company’s consolidated financial statements. See Note 10 of Notes to Condensed Consolidated Financial Statements.

 

Other-Than-Temporary Impairments of Debt Securities - On April 1, 2009, the Company adopted, on a prospective basis, new accounting guidance issued by the FASB with respect to the recognition and presentation of other-than-temporary impairments pertaining to debt securities. The new accounting guidance requires greater clarity about the credit and non-credit components of debt securities that are not expected to be sold and whose fair value is below amortized cost, and also requires increased disclosures regarding expected cash flows, credit losses and an aging of securities with unrealized losses. The adoption of the new accounting guidance did not have a material impact on the Company’s consolidated financial statements. See Note 4 of Notes to Condensed Consolidated Financial Statements.

 

Employers’ Postretirement Benefit Plans - In December 2008, the FASB amended its disclosure requirements with respect to employers’ postretirement benefit plan assets by requiring more detailed disclosures about an employer’s plan assets, including an employer’s investment strategies, major categories of plan assets, concentrations of risk within plan assets and valuation techniques used to measure the fair value of plan assets. The disclosures about plan assets required by this amendment are required to be provided for fiscal years ending after December 15, 2009. Upon initial application, the provisions of this amendment are not required for earlier periods that are presented for comparative purposes. Earlier application of the provisions of this amendment is permitted. We do not anticipate that the adoption of this amendment in 2009 will have a material impact on the Company’s consolidated financial statements.

 

VIEs - In June 2009, the FASB amended its guidance on VIEs. The amended guidance changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. It also requires a company to provide additional disclosures about its involvement with VIEs and any significant changes in risk exposure due to that involvement. The requirements of the amended accounting guidance are effective for interim and annual periods beginning after November 15, 2009 and early adoption is prohibited. The Company is currently assessing the impact the amended accounting guidance will have on its consolidated financial statements.

 

3. RECEIVABLES—NET

 

Receivables—net is comprised of receivables from banks, fees, customers and other and related parties.

 

Receivables from banks represent those related to LFB’s short-term inter-bank deposits. The level of these inter-bank deposits is primarily driven by the level of LFB customer and bank-related interest-bearing time and

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

demand deposits, which can fluctuate significantly on a daily basis. As the amount of such deposits held at LFB changes, there is generally a corresponding, but indirect, impact on the level of short-term inter-bank deposits.

 

Customers and other receivables at September 30, 2009 and December 31, 2008 include $4,517 and $13,109, respectively, of loans by LFB to managing directors and employees in France that are made in the ordinary course of business at market terms and $7,797 and $16,444, respectively, pertaining to a receivable from the Reserve Primary Fund (the “Primary Fund”), a money market fund based in New York that is engaged in the liquidation of its assets for distribution to investors under the supervision of the SEC. In September 2008, the Primary Fund, which held certain securities issued by Lehman Brothers Holdings, Inc. (“LBI”), temporarily suspended the payment of redemption proceeds to investors. At September 15, 2008, the Company had $77,713 of investments in the Primary Fund. Through September 30, 2009, the Company had recovered partial distributions from the Primary Fund aggregating $69,916, and, on October 2, 2009, the Company received an additional distribution of $1,517. Following the events of September 2008, various investors in the Primary Fund commenced litigations against the Primary Fund, certain officers and trustees of the Primary Fund and certain related entities. On February 26, 2009, the Primary Fund announced that it would set aside a “special reserve” of $3.5 billion of its assets to cover damages and expenses claimed in actual and potential litigations against it by Primary Fund investors. On May 5, 2009, the SEC asked the Court overseeing the Reserve Fund-related litigation to enjoin the Primary Fund’s plan to set aside a special reserve and to compel the Primary Fund to make a pro rata distribution of its assets to the Fund’s remaining investors. On September 23, 2009, the Court held a hearing to consider the SEC’s proposal and the objections thereto. The Company expects to receive an amount approximating the carrying value of its receivable relating to its investment in the Primary Fund, but it is possible that the process of liquidating the Primary Fund may ultimately result in some diminution in value of the Company’s investment position. The Company is closely monitoring the situation and reserving all of its rights.

 

Receivables are stated net of an estimated allowance for doubtful accounts of $14,115 and $15,883 at September 30, 2009 and December 31, 2008, respectively, for past due amounts and for specific accounts deemed uncollectible. The Company recorded bad debt expense of $1,148 and $4,770 for the three month and nine month periods ended September 30, 2009, respectively, and $2,451 and $8,179 for the three month and nine month periods ended September 30, 2008, respectively. In addition, the Company recorded charge-offs, foreign currency translation and other adjustments, which resulted in a net decrease to the allowance for doubtful accounts of $2,043 and $6,538 for the three month and nine month periods ended September 30, 2009, respectively, and $1,341 and $1,728 for the three month and nine month periods ended September 30, 2008, respectively. At September 30, 2009 and December 31, 2008, the Company had $15,803 and $17,916, respectively, of receivables past due in excess of 180 days or deemed uncollectible.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

4. INVESTMENTS

 

The Company’s investments and securities sold, not yet purchased consist of the following at September 30, 2009 and December 31, 2008:

 

     September 30,
2009
   December 31,
2008

Debt:

     

U.S. Government and agencies

   $ 147,591    $ –  

Non-U.S. Governments and agencies

     43,723      36,396

Corporate

     293,114      296,674
             
     484,428      333,070
             

Equities

     80,269      71,105
             

Other:

     

Interest in LAM alternative asset management funds:

     

General Partner (“GP”) interests owned by Lazard

     48,065      35,300

GP interests consolidated but not owned by Lazard

     13,908      20,866

Private equity:

     

Private equity investments owned by Lazard

     100,156      83,931

Private equity investments consolidated but not owned by Lazard

     35,392      –  

Equity method

     75,028      75,695
             
     272,549      215,792
             

Total investments

     837,246      619,967

Less:

     

Debt at amortized cost

     136,465      –  

Equity method investments

     75,028      75,695
             

Investments, at fair value

   $ 625,753    $ 544,272
             

Securities sold, not yet purchased (included in “other liabilities”)

   $ 5,078    $ 6,975
             

 

Debt investments include U.S. Government and agency securities, as well as corporate and non-U.S. Government securities that are primarily held by LFB, which typically holds them long-term, as part of its asset-liability management program. Debt investments held by LFB primarily consists of fixed and floating rate European corporate and French government debt securities. Debt investments at September 30, 2009 and December 31, 2008 were as follows:

 

      September 30,
2009
   December 31,
2008
        

Trading securities:

     

U.S. Government and agencies

   $ 21,222    $ –  

Non-U.S. Governments and agencies

     33,627      36,396

Corporate

     1,565      7,573
             
     56,414      43,969
             

Available-for-sale securities:

     

Corporate

     291,549      289,101
             

Held-to-maturity securities:

     

U.S. Government and agencies

     126,369      –  

Non-U.S. Government and agencies

     10,096      –  
             
     136,465      –  
             

Total debt securities

   $ 484,428    $ 333,070
             

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Effective July 1, 2008, certain debt securities held by LFB with a carrying value of $236,999 on that date, which were previously designated as “trading” securities, were re-designated as “available-for-sale” securities. Such re-designation represented a non-cash transaction between “trading” and “available-for-sale” securities.

 

The fair value and amortized cost basis pertaining to debt securities classified as “available-for-sale” at September 30, 2009, by maturity date/first call date, are as follows:

 

Maturity Date/First Call Date

   Fair Value    Amortized
Cost
Basis

Within one year

   $ 75,888    $ 78,083

After 1 year through 5 years

     138,623      146,890

After 5 years through 10 years

     62,753      77,401

After 10 years

     14,285      14,934
             
   $ 291,549    $ 317,308
             

 

Debt investments include corporate perpetual securities that are callable. Such securities are listed in the table above based on their respective call dates. All other “available-for-sale” securities are listed in the table based on their contractual maturities.

 

Debt securities classified as “available-for-sale” at September 30, 2009 that are in an unrealized loss position are as follows:

 

Securities in a

Continuous Loss

Position for

Less than 12 Months

 

Securities in a

Continuous Loss

Position for

12 Months or Longer

Fair Value

 

Unrealized

Loss

 

Fair Value

 

Unrealized

Loss

$13,258

  $83   $196,104   $26,988
             

 

The unrealized loss for securities in a continuous loss position for 12 months or longer has been reduced by an other-than-temporary impairment charge of $528 and $1,444 recognized in “other-revenue” on the condensed consolidated statements of operations during the three month and nine month periods ended September 30, 2009, respectively. Such amounts represent management’s estimate of the credit loss component of debt securities whose fair value is below amortized cost.

 

LFB does not intend to sell its debt securities classified as “available-for-sale”, nor is it more likely than not that LFB will be required to sell such debt securities before their anticipated recovery. Based on the qualitative and quantitative analysis performed, debt securities in unrealized loss positions were not considered to be other-than-temporarily impaired at September 30, 2009, except for the amounts recognized above.

 

The fair value and amortized cost basis pertaining to debt securities classified as “held-to-maturity” at September 30, 2009, by maturity date, are as follows:

 

Maturity Date

   Fair Value    Amortized
Cost
Basis

After 1 year through 5 years

   $ 138,731    $ 136,465
             

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

There were no debt securities classified as “held-to-maturity” at September 30, 2009 that were in an unrecognized loss position.

 

Equities principally represent the Company’s investments in marketable equity securities of large-, mid- and small-cap domestic, international and global companies to seed new Asset Management products and includes investments in public and private asset management funds managed both by LAM and third-party asset managers.

 

In 2008, LFNY was a party to a Prime Brokerage Agreement with LBI for certain accounts involving investment strategies managed by LAM. On September 9, 2008, LAM requested a transfer of such accounts, of which $11,368 was not received. On September 15, 2008, LBI, the ultimate parent company in the Lehman group, filed for protection under Chapter 11 of the United States Bankruptcy Code and a number of Lehman group entities in the UK entered into administration proceedings under the Insolvency Act 1986. In addition, the Securities Investor Protection Corporation (“SIPC”) commenced liquidation proceedings on September 19, 2008 pursuant to the Securities Investor Protection Act of 1970, as amended, with respect to LBI. The Chapter 11 filing, Insolvency Act Administration and SIPC proceedings exposed Lazard to possible loss due to counterparty credit and other risk. During the three month period ended September 30, 2008, the Company reserved the entire amount of such possible loss and through September 30, 2009, no funds have been received by the Company. We continue to actively seek recovery of all amounts.

 

Interests in LAM alternative asset management funds represent (i) GP interests owned by Lazard in LAM-managed alternative asset management funds and (ii) GP interests consolidated by the Company pertaining to noncontrolling interests in LAM alternative asset management funds. Such noncontrolling interests in LAM alternative asset management funds, which represent GP interests held directly by certain of our LAM managing directors or employees of the Company, are deemed to be controlled by, and therefore consolidated by, the Company in accordance with U.S. GAAP. Noncontrolling interests are required to be presented within “members’ equity” on the condensed consolidated statements of financial condition (see Note 12 of Notes to Condensed Consolidated Financial Statements).

 

Private equity investments owned by Lazard are primarily comprised of investments in private equity funds and direct private equity interests. Such investments primarily include (i) a mezzanine fund, which invests in mezzanine debt of a diversified selection of small- to mid-cap European companies; (ii) Corporate Partners II Limited (“CP II”), a private equity fund targeting significant noncontrolling-stake investments in established public and private companies; and (iii) Lazard Senior Housing Partners LP (“Senior Housing”), which acquires companies and assets in the senior housing, extended-stay hotel and shopping center sectors.

 

Private equity investments consolidated but not owned by Lazard are related solely to Lazard’s July 2009 acquisition of the Edgewater Funds’ (“Edgewater”) management vehicles. The Edgewater Funds are focused on buyout and growth equity investments in middle market companies.

 

Equity method investments include investments made in the first quarter of 2008 in Sapphire Industrials Corp. (“Sapphire”) (see Note 11 of Notes to Condensed Consolidated Financial Statements) and Merchant Bankers Asociados (“MBA”).

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

5. FAIR VALUE MEASUREMENTS

 

Lazard categorizes its investments and certain other assets and liabilities recorded at fair value into a three-level fair value hierarchy as follows:

 

Level 1. Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that Lazard has the ability to access.

 

Level 2. Assets and liabilities whose values are based on quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in non-active markets or inputs other than quoted prices that are directly observable or derived principally from or corroborated by market data.

 

Level 3. Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability. Items included in Level 3 include securities or other financial assets whose volume and level of activity have significantly decreased when compared with normal market activity and there is no longer sufficient frequency or volume to provide pricing information on an ongoing basis.

 

Principally all of the Company’s investments in corporate debt securities are considered Level 2 investments with such fair value based on observable data, principally broker quotes as provided by external pricing services. The Company’s other debt securities at fair value are considered Level 1 investments with such fair value based on unadjusted quoted prices in active markets.

 

The fair value of equities is principally classified as Level 1 or Level 2 as follows: marketable equity securities are classified as Level 1 and are valued based on the last trade price on the primary exchange for that security; public asset management funds are classified as Level 1 and are valued based on the reported closing price for the fund; and investments in private asset management funds are classified as Level 2 and are primarily valued based on information provided by fund managers and, secondarily, from external pricing services to the extent managed by LAM.

 

The fair value of interests in LAM alternative asset management funds is classified as Level 2 and is based on information provided by external pricing services.

 

The fair value of private equity investments is classified as Level 3 and is based on financial statements provided by fund managers, appraisals and internal valuations.

 

Where information reported is based on broker quotes, the Company generally obtains one quote/price per instrument. In some cases, quotes related to corporate bonds obtained through external pricing services represent the average of several broker quotes.

 

Where information reported is based on data received from fund managers or from external pricing services, the Company reviews such information to ascertain at which level within the fair value hierarchy to classify the investment.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

The following tables present the categorization of investments and certain other assets and liabilities measured at fair value on a recurring basis as of September 30, 2009 and December 31, 2008 into a three-level fair value hierarchy in accordance with fair value measurement disclosure requirements:

 

    Fair Value Measurements on a Recurring Basis
As of September 30, 2009
    Level 1   Level 2   Level 3   Total

Assets:

       

Investments:

       

Debt (excluding debt at amortized cost)

  $ 54,973   $ 292,990   $ –     $ 347,963

Equities

    62,467     17,498     304     80,269

Other (excluding equity method investments):

       

Interest in LAM alternative asset management funds:

       

GP interests owned by Lazard

    –       48,065     –       48,065

GP interests consolidated by Lazard

    –       13,908     –       13,908

Private equity:

       

Private equity investments owned by Lazard

    –       –       100,156     100,156

Private equity investments consolidated but not owned by Lazard

    –       –       35,392     35,392

Derivatives

    63     2,141     –       2,204
                       

Total Assets

  $ 117,503   $ 374,602   $ 135,852   $ 627,957
                       

Liabilities:

       

Securities sold, not yet purchased

  $ 5,078   $ –     $ –     $ 5,078

Derivatives

    –       21,142     –       21,142
                       

Total Liabilities

  $ 5,078   $ 21,142   $ –     $ 26,220
                       

 

    Fair Value Measurements on a Recurring Basis
As of December 31, 2008
    Level 1   Level 2   Level 3   Total

Assets:

       

Investments:

       

Debt

  $ 43,969   $ 289,101   $ –     $ 333,070

Equities

    54,108     14,544     2,453     71,105

Other (excluding equity method investments):

       

Interest in LAM alternative asset management funds:

       

GP interests owned by Lazard

    –       35,300     –       35,300

GP interests consolidated by Lazard

    –       20,866     –       20,866

Private equity investments owned by Lazard

    –       –       83,931     83,931

Derivatives

    –       4,661     –       4,661
                       

Total Assets

  $ 98,077   $ 364,472   $ 86,384   $ 548,933
                       

Liabilities:

       

Securities sold, not yet purchased

  $ 6,975   $ –     $ –     $ 6,975

Derivatives

    –       43,990     –       43,990
                       

Total Liabilities

  $ 6,975   $ 43,990   $ –     $ 50,965
                       

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

The following tables provide a summary of changes in fair value of the Company’s Level 3 assets and liabilities for the three month and nine month periods ended September 30, 2009 and 2008.

 

    Level 3 Assets and Liabilities
For the Three Month Period Ended September 30, 2009
    Beginning
Balance
  Net Unrealized/
Realized
Gains (Losses)
Included In
Revenue – Other
  Net
Purchases,

Issuances
and
Settlements/
Acquisitions
  Foreign
Currency
Translation
Adjustments
  Ending
Balance
         

Level 3 Assets:

         

Investments:

         

Equities

  $ 297   $ –     $ 3   $ 4   $ 304

Private equity:

         

Private equity investments owned by Lazard

    93,530     1,773     3,344     1,509     100,156

Private equity investments consolidated but not owned by Lazard

    –       1,976     33,416     –       35,392
                             

Total Level 3 Assets

  $ 93,827   $ 3,749   $ 36,763   $ 1,513   $ 135,852
                             

 

    Level 3 Assets and Liabilities
For the Three Month Period Ended September 30, 2008
    Beginning
Balance
  Net Unrealized/
Realized
Gains (Losses)
Included In
Revenue – Other
  Net
Purchases,

Issuances
and
Settlements/
Acquisitions
    Foreign
Currency
Translation
Adjustments
    Ending
Balance
         

Level 3 Assets:

         

Investments:

         

Equities

  $ 4,465   $ (372)     $(226   $ (391   $ 3,476

Private equity investments owned by Lazard

    96,055     (920)     3,020        (4,377     93,778
                                 

Total Level 3 Assets

  $ 100,520   $ (1,292)     $2,794      $ (4,768   $ 97,254
                                 

 

    Level 3 Assets and Liabilities
For the Nine Month Period Ended September 30, 2009
    Beginning
Balance
  Net Unrealized/
Realized
Gains (Losses)
Included In
Revenue – Other
    Net
Purchases,

Issuances
and
Settlements/
Acquisitions
    Foreign
Currency
Translation
Adjustments
    Ending
Balance
         

Level 3 Assets:

         

Investments:

         

Equities

  $ 2,453   $ (5   $ (2,053   $ (91   $ 304

Private equity:

         

Private equity investments owned by Lazard

    83,931     1,665        11,957        2,603        100,156

Private equity investments consolidated but not owned by Lazard

    –       1,976        33,416        –          35,392
                                   

Total Level 3 Assets

  $ 86,384   $ 3,636      $ 43,320      $ 2,512      $ 135,852
                                   

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

    Level 3 Assets and Liabilities
For the Nine Month Period Ended September 30, 2008
    Beginning
Balance
  Net Unrealized/
Realized
Gains (Losses)
Included In
Revenue – Other
    Net
Purchases,

Issuances
and
Settlements/
Acquisitions
    Foreign
Currency
Translation
Adjustments
    Ending
Balance
         

Level 3 Assets:

         

Investments:

         

Equities

  $ 4,469   $ (411   $ (492   $ (90   $ 3,476

Private equity investments owned by Lazard

    74,051     1,001        21,054        (2,328     93,778
                                   

Total Level 3 Assets

  $ 78,520   $ 590      $ 20,562      $ (2,418   $ 97,254
                                   

 

There were net realized gains of $595 and $616 included in income for the three month and nine month periods ended September 30, 2009, respectively, and $801 of realized gains included in income for both the three month and nine month periods ended September 30, 2008 with respect to Level 3 assets and liabilities.

 

The Company recognized gross investment gains and losses on investments measured at fair value for the three month and nine month periods ended September 30, 2009 in “revenue - other” on the respective condensed consolidated statements of operations as follows:

 

     Three Month Period Ended
September 30, 2009
   Nine Month Period Ended
September 30, 2009

Gross investment gains

   $ 20,489    $ 41,419

Gross investment losses

   $ –      $ 5,371

 

The table above includes gross unrealized investment gains and losses pertaining to “trading” securities as follows:

 

     Three Month Period Ended
September 30, 2009
   Nine Month Period Ended
September 30, 2009

Gross unrealized investment gains

   $ 2,297    $ 3,021

Gross unrealized investment losses

   $ –      $ 17

 

In addition, the Company recorded gross pre-tax unrealized investment gains and gross pre-tax unrealized investment losses of $41,281 and $364, respectively, in “accumulated other comprehensive income (loss)” (“AOCI”) during the nine month period ended September 30, 2009 pertaining to debt securities that are designated as “available-for-sale” securities. There were no significant reclassifications from AOCI to earnings during the nine month period ended September 30, 2009.

 

6. DERIVATIVES

 

The Company enters into forward foreign currency exchange rate contracts, interest rate swaps, interest rate futures, equity swaps and other derivative contracts to hedge exposures to fluctuations in interest rates, currency exchange rates and equity markets. The Company reports its derivative instruments separately as assets and liabilities unless a legal right of set-off exists under a master netting agreement enforceable by law. The Company’s derivative instruments are recorded at their fair value, and are included in “other assets” and “other liabilities” on the condensed consolidated statements of financial condition. Except for derivatives hedging “available-for-sale” securities, the Company elected to not apply hedge accounting to its other derivative

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

instruments held. Gains and losses on the Company’s derivatives not designated as hedging instruments, as well as gains and losses on derivatives accounted for as fair value hedges, are included in “interest income” and “interest expense”, respectively, or “revenue – other”, depending on the nature of the underlying item, on the condensed consolidated statements of operations.

 

The table below represents the fair values of the Company’s derivative assets and liabilities reported within “other assets” and “other liabilities” on the accompanying condensed consolidated statements of financial condition as of September 30, 2009 and December 31, 2008:

 

    Derivatives Designated
as Hedging Instruments
  Derivatives Not Designated
as Hedging Instruments
  Total
    September 30,
2009
  December 31,
2008
  September 30,
2009
  December 31,
2008
  September 30,
2009
  December 31,
2008

Derivative Assets:

           

Forward foreign currency exchange rate contracts

  $ –     $ –     $ 2,055   $ 4,377   $ 2,055   $ 4,377

Interest rate swaps

    –       75     86     209     86     284

Other derivatives

    –       –      
63
    –       63     –  
                                   
  $     $ 75   $ 2,204   $ 4,586   $ 2,204   $ 4,661
                                   

Derivative Liabilities:

           

Forward foreign currency exchange rate contracts

  $ –     $ –     $ 3,680   $ 26,593   $ 3,680   $ 26,593

Interest rate swaps

    14,922     12,980     138     1,051     15,060     14,031

Equity swaps

    –       –       2,402     3,366     2,402     3,366
                                   
  $ 14,922   $ 12,980   $ 6,220   $ 31,010   $ 21,142   $ 43,990
                                   

 

The effect of gains (losses) with respect to derivatives not designated as hedging instruments on the accompanying condensed consolidated statements of operations for the three month and nine month periods ended September 30, 2009 (predominantly reflected in “revenue – other”), by type of derivative, is as follows:

 

     Three Month Period Ended
September 30, 2009
    Nine Month Period Ended
September 30, 2009
 

Forward foreign currency exchange rate contracts

   $ (699   $ 2,951   

Interest rate swaps

     82        564   

Equity swaps and other derivatives

     (7,847     (11,110
                
   $ (8,464   $ (7,595
                

 

With respect to derivatives designated as hedging instruments, such derivatives relate to interest rate swaps that hedge “available-for-sale” securities and are being accounted for as fair value hedges. For the three month and nine month periods ended September 30, 2009, net pre-tax losses of $1,597 and $1,787, respectively, pertaining to such interest rate swaps were recognized, which were substantially offset by equivalent amounts on the hedged risk portion of such “available-for-sale” securities.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

7. LAM MERGER TRANSACTION

 

On September 25, 2008, Lazard Ltd, LAM and LAZ Sub I, LLC, a then newly-formed subsidiary of LFNY, completed the merger of LAZ Sub I, LLC with and into LAM (the “LAM Merger”). Prior to the LAM Merger, the common equity interests of LAM were held by LFNY and certain other equity interests of LAM, representing contingent payments should a fundamental transaction occur, as described below, were held by present and former employees of LAM. Following the LAM Merger, all equity interests of LAM are owned directly or indirectly by LFNY. The equity interests of LAM that were held, prior to the LAM Merger, by the then present and former employees of LAM and its subsidiaries (and certain related phantom rights issued as incentive compensation) entitled the holders to payments totaling approximately 23% of the net proceeds or imputed valuation of LAM (after deductions for payments to creditors of LAM and the return of capital in LAM) in connection with certain specified fundamental transactions concerning LAM or Lazard, including a sale of LAM or Lazard, certain non-ordinary course asset sales and major acquisitions. As a consequence of the LAM Merger, during the three month period ended September 30, 2008, the Company recorded a reduction to its after-tax income of $192,123, consisting of compensation and benefits expense of $197,550 related to the equity interests of LAM held by present and former employees of LAM and $2,000 of non-compensation related transaction costs (together aggregating to a reduction of operating income of $199,550), with these charges partially offset by an associated income tax credit of $7,427.

 

The aggregate non-contingent consideration relating to the equity interests of LAM (and the phantom rights referred to above) held by present and former employees of LAM and its subsidiaries (the “Transaction Consideration”) consists of (i) cash payments made from the closing of the LAM Merger through January 2, 2009 of approximately $60,100, (ii) a cash payment on October 31, 2011 of approximately $90,300 and (iii) an issuance on October 31, 2011 of 2,201,457 shares of Lazard Ltd’s Class A common stock (plus additional shares of Class A common stock in an amount determined by reference to the cash dividends paid on Class A common stock since the closing of the LAM Merger), subject, in the case of clause (ii) and (iii) and with respect to certain present employees of LAM and its subsidiaries, to delayed payment/issuance until the eighth anniversary of the closing of the LAM Merger if the applicable employee is no longer employed by Lazard or its affiliates on October 31, 2011, subject to certain exceptions. The merger agreement also generally provides that if there is a change in control of Lazard Ltd or a sale of LAM, any and all of the Transaction Consideration will be payable as of the date of such change in control. The related liabilities for the present value of the unpaid cash consideration have been recorded in “accrued compensation and benefits” and “other liabilities”, and amounted to $14,065 and $64,129, respectively, as of September 30, 2009, and $16,013 and $60,324, respectively, as of December 31, 2008.

 

In connection with the LAM Merger, Lazard Group recorded a related party payable to subsidiaries of Lazard Ltd of $64,305 and $64,512 at September 30, 2009 and December 31, 2008, respectively, which corresponds to the increase in stockholders’ equity recorded by Lazard Ltd for such merger (see Note 17 of Notes to Condensed Consolidated Financial Statements).

 

8. BUSINESS ACQUISITIONS

 

On July 15, 2009, the Company established a private equity business with Edgewater, a private equity firm based in Chicago, Illinois, through the acquisition of Edgewater’s management vehicles. Following such acquisition, Edgewater’s current leadership team retained a substantial economic interest in such entities. Edgewater primarily manages two middle market funds, Edgewater Growth Capital Partners, L.P. and Edgewater Growth Capital Partners II, L.P. (the “underlying funds”), with an aggregate of approximately $700,000 of capital raised.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

The acquisition was structured as a purchase by Lazard Group of interests in a holding company that in turn owns interests in the general partner and management company entities of the current Edgewater private equity funds.

 

The aggregate fair value of the consideration recognized by the Company at the acquisition date was $61,624. Such consideration consisted of (i) a one-time cash payment, (ii) 1,142,857 shares of Class A common stock (the “Initial Shares”) and (iii) up to 1,142,857 additional shares of Class A common stock subject to earnout criteria and payable over time (the “Earnout Shares”). The Initial Shares are subject to transfer restrictions and forfeiture provisions that lapse only upon the achievement of certain performance thresholds for the next Edgewater fund that must be met by July 15, 2011. The Earnout Shares will be issued only if certain performance thresholds for the next two Edgewater funds are met.

 

The acquisition of Edgewater’s management vehicles was accounted for under the acquisition method of accounting, whereby the results of the acquired business are included in our consolidated financial results from July 15, 2009, the effective date of the acquisition. As a result of the acquisition, we recorded net tangible assets, identifiable intangible assets and goodwill of approximately $53,635 (consisting primarily of Edgewater’s investments in their underlying funds and cash), $57,300 and $59,914, respectively, which include amounts for Edgewater’s noncontrolling interests held (whose economic interests approximate 50%) aggregating approximately $109,226. Goodwill pertaining to this acquisition is deductible for income tax purposes. See Note 9 of Notes to Condensed Consolidated Financial Statements for additional information relating to goodwill and other intangible assets. The operating results relating to Edgewater, which have not been material, are included in the Company’s Asset Management segment.

 

On August 13, 2007, Lazard Group acquired all of the outstanding ownership interests of Goldsmith, Agio, Helms & Lynner, LLC (“GAHL”), a Minneapolis-based investment bank specializing in financial advisory services to mid-sized private companies. On July 31, 2007, Lazard Ltd acquired all of the outstanding shares of Carnegie, Wylie & Company (Holdings) PTY LTD (“CWC”), an Australia-based financial advisory firm, and concurrently sold such investment to Lazard Group. These purchases were effected though an exchange of a combination of cash, Class A common stock, and by Lazard Ltd issuing shares of non-participating convertible Series A and Series B preferred stock (the “Series A preferred stock” and “Series B preferred stock”, respectively, which are or were each convertible into Class A common stock). The total number of Class A common shares to be issued in connection with the acquisitions will depend, in part, upon the future performance of each of GAHL and CWC.

 

The aggregate non-contingent consideration relating to the GAHL and the CWC acquisitions (before transaction costs) consisted of cash and Lazard Ltd stock and aggregated to approximately $220,500 and $216,200 through September 30, 2009 and December 31, 2008, respectively. At September 30, 2009 and December 31, 2008, 662,015 and 993,024 shares of Class A common stock, respectively, were issuable on a non-contingent basis. Additionally, at September 30, 2009 and December 31, 2008, 4,862 and 7,293 shares of Series A preferred stock, respectively, were convertible into Class A common shares on a non-contingent basis, with the number of Class A common shares dependent, in part, upon future prices of the Class A common stock. At September 30, 2009 and December 31, 2008, 948,631 shares of Class A common stock were contingently issuable and, at September 30, 2009 and December 31, 2008, 22,021 and 24,452 shares of Series A preferred stock, respectively, were contingently convertible into shares of Class A common stock as of each respective date, dependent upon the future performance of GAHL and CWC. The Class A common stock described above related to the GAHL and CWC acquisitions is issuable over multi-year periods.

 

In connection with Lazard Group’s acquisitions of GAHL and Edgewater’s management vehicles, as well as Lazard Ltd’s acquisition of CWC and subsequent contribution of CWC to Lazard Group, Lazard Group recorded

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

related party payables of $33,264 and $43,634 at September 30, 2009 and December 31, 2008, respectively, to subsidiaries of Lazard Ltd. When combined with the additional members’ equity recorded by Lazard Group of $50,800 and $18,416 at September 30, 2009 and December 31, 2008, respectively, these increases correspond to the increases in stockholders’ equity recorded by Lazard Ltd for such acquisitions (see Note 17 of Notes to the Condensed Consolidated Financial Statements).

 

9. GOODWILL AND OTHER INTANGIBLE ASSETS

 

The components of goodwill and other intangible assets at September 30, 2009 and December 31, 2008 are presented below.

 

    September 30,
2009
  December 31,
2008
     

Goodwill

  $ 252,258   $ 170,277

Other intangible assets (net of accumulated amortization)

    59,447     4,867
           
  $ 311,705   $ 175,144
           

 

At September 30, 2009, $192,344 of goodwill was attributable to the Company’s Financial Advisory segment and $59,914 of goodwill was attributable to the Company’s Asset Management segment. At December 31, 2008, goodwill was attributable to the Company’s Financial Advisory segment.

 

Changes in the carrying amount of goodwill for the nine month periods ended September 30, 2009 and 2008, are as follows:

 

    Nine Month Period Ended
September 30,
 
    2009   2008  

Balance, January 1

  $ 170,277   $ 178,446   

Current year business acquisition

    59,914     –     

Prior year business acquisitions, including additional contingent consideration earned

    2,779     9,282   

Foreign currency translation adjustments

    19,288     (6,704
             

Balance, September 30

  $ 252,258   $ 181,024   
             

 

The gross cost and accumulated amortization of other intangible assets as of September 30, 2009 and December 31, 2008, by major intangible asset category, are as follows:

 

    September 30, 2009   December 31, 2008
    Gross
Cost
  Accumulated
Amortization
  Net
Carrying
Amount
  Gross
Cost
  Accumulated
Amortization
  Net
Carrying
Amount

Success/performance fees

  $ 30,740   $ –     $ 30,740   $ –     $ –     $ –  

Management fees, customer relationships and non-compete agreements

    33,577     4,870     28,707     7,017     2,150     4,867
                                   
  $ 64,317   $ 4,870   $ 59,447   $ 7,017   $ 2,150   $ 4,867
                                   

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Amortization expense of intangible assets for the three month and nine month periods ended September 30, 2009 was $2,032 and $2,720, respectively, and for the three month and nine month periods ended September 30, 2008 was $507 and $4,252, respectively. Estimated future amortization expense is as follows:

 

Year Ending December 31,

   Amortization
Expense (a)

2009 (October 1 through December 31)

   $ 6,165

2010

     15,805

2011

     14,394

2012

     11,831

2013

     6,594

Thereafter

     4,658
      

Total amortization expense

   $ 59,447
      
 
  (a) Approximately 46% of intangible asset amortization is attributable to a noncontrolling interest.  

 

10. SENIOR AND SUBORDINATED DEBT

 

Senior Debt—Senior debt is comprised of the following as of September 30, 2009 and December 31, 2008:

 

      Initial
Principal

Amount
  Maturity
Date
   Annual
Interest
Rate
     Outstanding As Of
             September 30,
2009
   December 31,
2008

Lazard Group 7.125% Senior Notes

   $ 550,000   2015    7.125    $ 538,500    $ 538,500

Lazard Group 6.85% Senior Notes(a)

     600,000   2017    6.85      548,350      549,250

Lazard Group Credit Facility

     150,000   2010    1.75      –        –  
                     

Total

           $ 1,086,850    $ 1,087,750
                     

 

(a) During the nine month period ended September 30, 2009, the Company repurchased $900 principal amount of the 6.85% Senior Notes at a cost, excluding accrued interest, of $635 and, after the write-off of unamortized debt issuance costs of $7, recognized a pre-tax gain of $258.

 

Subordinated Debt—Subordinated debt at September 30, 2009 and December 31, 2008 amounted to $150,000 at each date and represents a note which is convertible into a maximum of 2,631,570 shares of Class A common stock at an effective conversion price of $57 per share. The note matures on September 30, 2016 and has a fixed interest rate of 3.25% per annum. One-third in principal amount became convertible on and after July 1, 2008, an additional one-third became convertible on and after July 1, 2009 and a final one-third in principal amount will become convertible on and after July 1, 2010, and no principal amount will be convertible after June 30, 2011. As of September 30, 2009 there have been no conversions of the note.

 

Lazard Group maintains a $150,000 senior revolving credit facility with a group of lenders (the “Lazard Group Credit Facility”) which contains certain financial condition covenants. In addition, the Lazard Group Credit Facility, the indenture and supplemental indentures relating to Lazard Group’s senior notes as well as its subordinated convertible note contain certain covenants (none of which relate to financial condition), events of default and other customary provisions, including a customary make-whole provision in the event of early redemption where applicable. As of September 30, 2009, the Company was in compliance with all of these provisions. All of the Company’s senior and subordinated debt obligations are unsecured.

 

As of September 30, 2009, the Company had approximately $263,000 in unused lines of credit available to it, including approximately $45,000 of unused lines of credit available to each of LFB and Edgewater. In addition, LFB has access to the Eurosystem covered bond purchase program of the Banque de France.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

The Company’s senior and subordinated debt are recorded at historical amounts. At September 30, 2009 and December 31, 2008, the aggregate carrying value of the Company’s senior and subordinated debt ($1,236,850 and $1,237,750, respectively) exceeded fair value by $22,656 and $354,382, respectively. The fair value of the Company’s senior and subordinated debt was estimated using a discounted cash flow analysis based on the Company’s current borrowing rates for similar types of borrowing arrangements or based on market quotations where available.

 

11. COMMITMENTS AND CONTINGENCIES

 

Leases—Lazard has various leases and other contractual commitments arising in the ordinary course of business. In the opinion of management, the fulfillment of such commitments in accordance with their terms will not have a material adverse effect on Lazard’s consolidated financial position, results of operations or cash flows.

 

Guarantees—On March 12, 2007, Lazard entered into an agreement to guarantee to a foreign tax jurisdiction the deferred payment of certain income tax obligations and potential tax penalties of certain managing directors of Lazard Group, which, as of September 30, 2009, aggregated $8,324. These managing directors have pledged their interests in LAZ-MD Holdings and unsold shares of Class A common stock received in exchange for such interests to collateralize such guarantee, with the value of such collateral in each case exceeding the guarantee provided by Lazard.

 

In the normal course of business, LFB provides indemnifications to third parties to protect them in the event of non-performance by its clients. At September 30, 2009, LFB had $7,025 of such indemnifications and held $4,488 of collateral/counter-guarantees to secure these commitments. The Company believes the likelihood of loss with respect to these indemnities is remote. Accordingly, no liability is recorded in the condensed consolidated statements of financial condition.

 

Private Equity Funding Commitments—At September 30, 2009, the principal commitments by the Company for capital contributions to private equity investment funds were as set forth below. Senior Housing is managed by Lazard Alternative Investments Holdings LLC (“LAI”), a subsidiary of LFCM Holdings LLC (“LFCM Holdings”). LAI owns and operates the alternative investments of LFCM Holdings (an entity that includes Lazard’s former Capital Markets and Other business segment as well as other specified non-operating assets and liabilities transferred pursuant to the separation from the Company on May 10, 2005). CP II was managed by a subsidiary of LAI until February 16, 2009. Effective February 17, 2009, ownership and control of CP II was transferred to the investment professionals who manage CP II.

 

           Total Lazard Commitments (b)

Name of Fund

   Total
Institutional
Commitments
    Maximum 
Commitment
    Funding
Expiration
Date
    Unfunded
As of
September 30, 2009

CP II

   $ 500,000      $ 50,000      2010      $ 9,322

Senior Housing

     201,000        10,000      2009 (a)      544
                        
   $ 701,000      $ 60,000        $ 9,866
                        

 

(a) Funding expired on July 6, 2009. However, under certain circumstances, $544 may be called at any time prior to the fund’s liquidation.

 

(b) The table above excludes other unfunded commitments by Lazard at September 30, 2009 of $3,347 to Company-sponsored private equity investment funds (including $2,531 in connection with the Company’s compensation plans), which are contingent upon certain events and have no definitive final payment dates.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Other Commitments—In the normal course of business, LFB enters into commitments to extend credit, predominately at variable interest rates. The commitments have an expiration date and, once drawn upon, may require the counterparty to post collateral depending on the counterparty’s creditworthiness. Outstanding commitments at September 30, 2009 were $20,903. This amount may not represent future cash requirements as commitments may expire without being drawn upon.

 

On January 24, 2008, Sapphire, a newly-organized special purpose acquisition company formed by Lazard Funding Limited LLC (“Lazard Funding”), a wholly-owned subsidiary of Lazard Group, completed an initial public offering which, prior to offering costs, raised $800,000 through the sale of 80,000,000 units at an offering price of $10.00 per unit (the “Sapphire IPO”). Each unit consists of one share of Sapphire common stock and one warrant, with such warrant entitling the holder to purchase one share of Sapphire common stock for $7.00. Sapphire was formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more operating businesses primarily with general industrial companies in North America (collectively referred to as the “Initial Business Combination”).

 

In connection with the formation of Sapphire, Lazard Funding purchased from Sapphire 15,144,000 units (“Founders’ Units”) at a total cost of approximately $95. Each Founders’ Unit consists of one share of Sapphire common stock and one warrant, with such warrant entitling the holder to purchase one share of Sapphire common stock for $7.50. On January 24, 2008, in connection with the Sapphire IPO, Lazard Funding purchased (i) 5,000,000 units in the Sapphire IPO at a purchase price equal to the public offering price of $10.00 per unit (for an aggregate purchase price of $50,000), and (ii) an aggregate of 12,500,000 warrants from Sapphire at a price of $1.00 per warrant (for a total purchase price of $12,500). Furthermore, Lazard Funding entered into an agreement with the underwriter to purchase up to an additional $37,500 worth of Sapphire common shares in open market purchases, commencing two business days after Sapphire files a proxy statement relating to an Initial Business Combination and ending on the business day immediately preceding the record date for the meeting of Sapphire stockholders at which such Initial Business Combination is to be approved, or earlier in certain circumstances.

 

In connection with the Sapphire IPO, and pursuant to certain rights afforded LFCM Holdings under the business alliance agreement, dated as of May 10, 2005, between Lazard Group and LFCM Holdings (the “business alliance agreement”), Lazard Funding offered CP II the right, through the date of a public announcement of the Initial Business Combination, to purchase from Lazard Funding, at a cost of $10.00 per unit, up to 2,000,000 Sapphire units (for an aggregate purchase price of up to $20,000).

 

See Notes 7 and 8 of Notes to Condensed Consolidated Financial Statements for information regarding commitments relating to the LAM Merger and business acquisitions, respectively. See Note 14 of Notes to Condensed Consolidated Financial Statements for information regarding obligations to fund our pension plans in the U.K.

 

The Company has various other contractual commitments arising in the ordinary course of business. In the opinion of management, the consummation of such commitments will not have a material adverse effect on the Company’s consolidated financial position or results of operations. In addition, from time to time, LFB enters into underwriting commitments in which it participates as a joint underwriter. The settlement of such transactions are not expected to have a material adverse effect on the Company’s consolidated financial position or results of operations.

 

Legal—The Company’s businesses, as well as the financial services industry generally, are subject to extensive regulation throughout the world. The Company is involved from time to time in a number of judicial,

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

regulatory and arbitration proceedings and inquiries concerning matters arising in connection with the conduct of our businesses, including proceedings initiated by former employees alleging wrongful termination. The Company reviews such matters on a case-by-case basis and establishes any required reserves if a loss is probable and the amount can be reasonably estimated. Management believes, based on currently available information, that the results of such matters, in the aggregate, will not have a material adverse effect on its financial condition but might be material to its operating results or cash flows for any particular period, depending upon the operating results for such period.

 

12. MEMBERS’ EQUITY

 

Pursuant to Lazard Group’s Operating Agreement, Lazard Group allocates and distributes to its members a substantial portion of its distributable profits in three monthly installments, as soon as practicable after the end of each fiscal year. Such installment distributions usually begin in February. In addition, Lazard Group makes periodic distributions to its members to fund, among other things, capital withdrawals and income tax advances made on behalf of its members.

 

At September 30, 2009 and 2008, Lazard Group common membership interests held by subsidiaries of Lazard Ltd amounted to 74.5% and 62.2%, respectively, and by LAZ-MD Holdings amounted to 25.5% and 37.8%, respectively. Pursuant to provisions of its Operating Agreement, Lazard Group distributions in respect of its common membership interests are allocated to the holders of such interests on a pro rata basis. Such distributions represent amounts necessary to fund (i) any dividends Lazard Ltd may declare on its Class A common stock and (ii) tax distributions in respect of income taxes that Lazard Ltd’s subsidiaries and the members of LAZ-MD Holdings incur as a result of holding Lazard Group common membership interests. During the nine month periods ended September 30, 2009 and 2008, Lazard Group distributed $13,462 and $16,100, respectively, to LAZ-MD Holdings and $23,216 and $16,184, respectively, to the subsidiaries of Lazard Ltd, which latter amounts were used by Lazard Ltd to pay dividends to third-party holders of its Class A common stock. In addition, during the nine month periods ended September 30, 2009 and 2008, Lazard Group made tax distributions of $67,360 and $83,358, respectively, including $25,316 and $39,205, respectively, paid to LAZ-MD Holdings and $42,044 and $44,153, respectively, paid to subsidiaries of Lazard Ltd.

 

Secondary Offerings—In September 2009, pursuant to a Prospectus Supplement dated September 8, 2009, certain current and former managing directors of Lazard (including certain of our executive officers) and their permitted transferees (the “September 2009 Selling Shareholders”) sold 5,215,921 shares of Class A common stock (including 2,411,001 shares of Class A common stock previously received upon the exchange of a like number of LAZ-MD Holdings exchangeable interests and 2,804,920 shares of Class A common stock received upon a simultaneous exchange of a like number of LAZ-MD Holdings exchangeable interests) at a price of $37.00 per share (the “September 2009 Secondary Offering”).

 

In June 2009, pursuant to a Prospectus Supplement dated June 2, 2009, certain current and former managing directors of Lazard (including certain of our executive officers) and their permitted transferees (the “June 2009 Selling Shareholders”) sold 4,000,000 shares of Class A common stock at a price of $26.00 per share (the “June 2009 Secondary Offering”). Separately, in connection with the June 2009 Secondary Offering, Lazard Group agreed to purchase from the June 2009 Selling Shareholders 1,700,000 shares of Class A common stock for an aggregate cost of $44,200 ($26.00 per share), with such purchase being part of the share repurchase program described below. In the aggregate, the June 2009 Selling Shareholders sold a total of 5,700,000 shares of Class A common stock (including 2,110,754 shares of Class A common stock previously received upon the exchange of a like number of LAZ-MD Holdings exchangeable interests and 3,589,246 shares of Class A common stock received upon a simultaneous exchange of a like number of LAZ-MD Holdings exchangeable interests).

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Lazard Ltd did not receive any net proceeds from the sales of Class A common stock in the September and June 2009 Secondary Offerings (collectively, the “2009 Secondary Offerings”).

 

Exchange of Lazard Group Common Membership Interests—In addition to the exchanges that occurred in connection with the 2009 Secondary Offerings, on March 6, 2009, May 11, 2009 and August 4, 2009, Lazard Ltd issued 244,968, 6,832,773 and 435,233 shares of Class A common stock, respectively, in connection with the exchange of a like number of common membership interests of Lazard Group (received from members of LAZ-MD Holdings in exchange for a like number of LAZ-MD Holdings exchangeable interests).

 

Share Repurchase Program

 

The Board of Directors of Lazard Ltd has authorized, on a cumulative basis, the repurchase of up to $500,000 in aggregate cost of its Class A common stock and Lazard Group common membership interests through December 31, 2009. The Company expects that the share repurchase program, with respect to the Class A common stock, will be used primarily to offset a portion of the shares that have been or will be issued under the Lazard Ltd 2005 Equity Incentive Plan (the “2005 Plan”) and the Lazard Ltd 2008 Incentive Compensation Plan (the “2008 Plan”). Purchases may be made in the open market or through privately negotiated transactions. Pursuant to this authorization, since inception of the program in February 2006 through September 30, 2009, Lazard Group purchased an aggregate of 12,086,767 shares of Class A common stock at an average price of $33.08 per share (including, during the nine month period ended September 30, 2009, 1,984,997 shares at an average price of $25.43 per share, inclusive of the 1,700,000 shares purchased in connection with the June 2009 Secondary Offering described above), and an aggregate of 1,156,675 Lazard Group common membership interests at an average price of $32.58 per common membership interest (including, during the nine month period ended September 30, 2009, 500,924 common membership interests at an average price of $26.52 per common membership interest). As a result of Lazard Group’s delivery of an aggregate of 1,756,568 shares for the settlement of vested restricted stock unit grants (“RSUs”) and deferred stock unit grants (“DSUs”) during the two year period ended December 31, 2008 and the nine month period ended September 30, 2009, there were 10,330,199 and 9,376,162 shares of Class A common stock held by Lazard Group at September 30, 2009 and December 31, 2008, respectively. Such Class A common shares are reported, at cost, as a reduction of members’ equity within the condensed consolidated statements of financial condition.

 

As of September 30, 2009, $62,542 of the initial $500,000 repurchase authorization remained available under the share repurchase program.

 

Accumulated Other Comprehensive Loss, Net of Tax

 

The components of AOCI at September 30, 2009 and December 31, 2008 are as follows:

 

     September 30,
        2009        
    December 31,
2008
 

Currency translation adjustments

   $ 37,224      $ (27,299

Interest rate hedge

     (6,043     (6,851

Available-for-sale securities

     (16,850     (41,512

Employee benefit plans

     (44,989     (45,745
                

Total AOCI

     (30,658     (121,407

Less amount attributable to noncontrolling interests

     3          
                

Total Lazard Group AOCI

   $ (30,661   $ (121,407
                

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Noncontrolling Interests

 

Noncontrolling interests principally represent interests in various LAM-related GP interests and Edgewater’s management vehicles (see Note 8 of Notes to Condensed Consolidated Financial Statements) that the Company is deemed to control but does not own.

 

13. INCENTIVE PLANS

 

Share-Based Incentive Plan Awards

 

A description of Lazard Ltd’s 2005 Plan and 2008 Plan, and activity with respect thereto during the nine month periods ended September 30, 2009 and 2008, is presented below.

 

Shares Available Under the 2005 Plan and 2008 Plan

 

The 2005 Plan authorizes the issuance of up to 25,000,000 shares of Class A common stock pursuant to the grant or exercise of stock options, stock appreciation rights, restricted stock, stock units and other equity-based awards. Each stock unit granted under the 2005 Plan represents a contingent right to receive one share of Class A common stock, at no cost to the recipient. The fair value of such stock unit awards is determined based on the closing market price of Lazard Ltd’s Class A common stock at the date of grant.

 

In addition to the shares available under the 2005 Plan, additional shares of Class A common stock are available under the 2008 Plan, which was approved by the stockholders of Lazard Ltd on May 6, 2008. The maximum number of shares available under the 2008 Plan is based on a formula that limits the aggregate number of shares that may, at any time, be subject to awards that are considered “outstanding” under the 2008 Plan to 30% of the then-outstanding shares of Class A common stock (treating, for this purpose, the then-outstanding exchangeable interests of LAZ-MD Holdings on a “fully-exchanged” basis as described in the 2008 Plan).

 

Restricted Stock Unit Grants

 

RSUs require future service as a condition for the delivery of the underlying shares of Class A common stock and convert into Class A common stock on a one-for-one basis after the stipulated vesting periods. The grant date fair value of the RSUs, net of an estimated forfeiture rate, is amortized over the vesting periods or requisite service periods. Expense relating to RSUs is charged to “compensation and benefits” expense (and, as applicable in 2009, “restructuring” expense, with respect to the expense associated with the acceleration of unrecognized expense pertaining to RSUs granted previously to individuals who were terminated in the restructuring) within the condensed consolidated statements of operations, and amounted to $63,392 and $216,190 for the three month and nine month periods ended September 30, 2009, respectively (including $24,239 in the restructuring expense recognized in the first quarter of 2009), and $65,514 and $177,844 during the three month and nine month periods ended September 30, 2008, respectively. RSUs issued subsequent to December 31, 2005 generally include a dividend participation right that provides that during vesting periods each RSU is attributed additional RSUs (or fractions thereof) equivalent to any ordinary quarterly dividends paid on Class A common stock during such period. During the nine month periods ended September 30, 2009 and 2008, dividend participation rights required the issuance of 249,048 and 145,966 RSUs, respectively.

 

During the nine month periods ended September 30, 2009 and 2008, 1,446,827 and 729,328 RSUs vested, respectively. In connection therewith, and after considering the withholding tax obligations pertaining thereto, 1,030,960 and 618,977 shares of Class A common stock held by Lazard Group were delivered, respectively.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Deferred Stock Unit Grants

 

Non-executive members of the Board of Directors of Lazard Group (who are also the same Non-Executive Director of Lazard Ltd) receive approximately 55% of their annual compensation for service on the Board of Directors and its committees in the form of DSUs which amounted to 36,627 and 28,090 DSUs granted during the nine month periods ended September 30, 2009 and 2008, respectively. Their remaining compensation is payable in cash, which they may elect to receive in the form of additional DSUs under the Directors’ Fee Deferral Unit Plan described below. DSUs are convertible into Class A common stock at the time of cessation of service to the Board. The DSUs include a cash dividend participation right equivalent to any ordinary quarterly dividends paid on Class A common stock resulting in nominal cash payments for the nine months ended September 30, 2009 and 2008. DSU awards are expensed at their fair value on their date of grant, which, inclusive of amounts related to the Directors’ Fee Deferral Unit Plan, totaled $79 and $620 during the three month and nine month periods ended September 30, 2009, respectively, and $93 and $627 during the three month and nine month periods ended September 30, 2008, respectively.

 

On May 9, 2006, the Board of Directors adopted the Directors’ Fee Deferral Unit Plan, which allows the Company’s Non-Executive Directors to elect to receive additional DSUs pursuant to the 2005 Plan or the 2008 Plan in lieu of some or all of their cash fees. The number of DSUs that shall be granted to a Non-Executive Director pursuant to this election will equal the value of cash fees that the applicable Non-Executive Director has elected to forego pursuant to such election, divided by the closing market value of a share of Class A common stock on the date on which the foregone cash fees would otherwise have been paid. DSUs granted pursuant to such Plan amounted to 6,963 and 4,735 DSUs during the nine month periods ended September 30, 2009 and 2008, respectively.

 

The following is a summary of activity relating to RSUs and DSUs during the nine month periods ended September 30, 2009 and 2008:

 

    RSUs   DSUs
    Units     Weighted
Average
Grant Date
Fair Value
  Units   Weighted
Average
Grant Date
Fair Value

Balance, January 1, 2009

  22,141,468      $ 39.17   65,256   $ 40.32

Granted (including 249,048 RSUs relating to dividend participation)

  7,504,232      $ 31.00   43,590   $ 28.45

Forfeited

  (805,721   $ 36.92   –       –  

Vested/Converted

  (1,446,827   $ 38.81   –       –  
             

Balance, September 30, 2009

  27,393,152      $ 37.02   108,846   $ 35.57
             

 

    RSUs   DSUs
    Units     Weighted
Average
Grant Date
Fair Value
  Units     Weighted
Average
Grant Date
Fair Value

Balance, January 1, 2008

  9,507,935      $ 42.35   35,310      $ 43.16

Granted (including 145,966 RSUs relating to dividend participation)

  13,653,186      $ 37.31   32,825      $ 38.22

Forfeited

  (434,970   $ 40.10    

Vested/Converted

  (729,328   $ 38.10   (5,839   $ 38.28
               

Balance, September 30, 2008

  21,996,823      $ 39.40   62,296      $ 41.01
               

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

As of September 30, 2009, unrecognized RSU compensation expense, adjusted for estimated forfeitures, was approximately $429,000, with such unrecognized compensation expense expected to be recognized over a weighted average period of approximately 2.0 years subsequent to September 30, 2009. The ultimate amount of such expense is dependent upon the actual number of RSUs that vest. The Company periodically assesses the forfeiture rates used for such estimates. A change in estimated forfeiture rates would cause the aggregate amount of compensation expense recognized in future periods to differ from the estimated unrecognized compensation expense described herein. See Note 20 of Notes to Condensed Consolidated Financial Statements for information regarding certain RSUs that vested subsequent to September 30, 2009.

 

Other Incentive Awards

 

A portion of the incentive awards granted in February 2009 included a deferred cash component currently aggregating $141,625, which vests over a maximum period of four years. Such deferred cash awards vest and are payable as follows: $46,757 on November 30, 2009, $33,787 on November 30, 2010, $33,637 on February 28, 2012 and $27,444 on February 28, 2013. Payments are subject to the employee meeting the vesting requirements, and, except for the November 30, 2009 payment, earn interest at an annual rate of 5%. The compensation expense with respect to the deferred cash component award, net of estimated forfeitures, is being recognized over a weighted average period of 2.2 years from the date of grant. Compensation and benefits expense relating to such awards amounted to $22,684 and $64,456 for the three month and nine month periods ended September 30, 2009, respectively.

 

14. EMPLOYEE BENEFIT PLANS

 

The Company, through its subsidiaries, provides retirement and other post-employment benefits to certain of its employees through defined contribution and defined benefit pension plans and other post-retirement benefit plans. The Company has the right to amend or terminate its benefit plans at any time subject to the terms of such plans. Expenses (benefits) related to the Company’s employee benefit plans are included in “compensation and benefits” expense on the condensed consolidated statements of operations. The Company uses December 31 as the measurement date for its employee benefit plans.

 

Employer Contributions to Pension Plans—In accordance with agreements reached with the Trustees of the two U.K. pension plans in 2005, the Company contributed a final committed payment of approximately $16,000 (8.2 million British pounds) during the nine month period ended September 30, 2008. Under the same agreements, the Company is contingently obligated to make further contributions to its U.K. pension plans depending on the cumulative performance of the plans’ assets against specific benchmarks as measured on June 1, 2009 (the “measurement date”) and subsequently on June 1, 2010 (the “remeasurement date”). The obligation related to the cumulative underperformance of the plans’ assets (the “underperformance obligation”) at the measurement date was 11.5 million British pounds ($18,519 at September 30, 2009 exchange rates) which is payable over four years commencing June 1, 2009 in equal monthly installments, and will be subject to further adjustment on the remeasurement date. At September 30, 2009, the Company contributed 962 thousand British pounds ($1,549 at September 30, 2009 exchange rates) with respect to the underperformance obligation.

 

In addition, on June 30, 2009 the Company and Trustees concluded the December 31, 2007 triennial valuation of the two U.K. pension plans, pursuant to which: (i) the Company agreed to contribute 2.3 million British pounds ($3,703 at September 30, 2009 exchange rates), during each year from 2011 to 2018 inclusive, subject to adjustment resulting from the December 31, 2010 triennial valuation, which the Company expects to

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

have concluded prior to the contribution payment scheduled for 2011, and (ii) to secure the Company’s obligations thereunder, on July 15, 2009 the Company placed in escrow 12.5 million British pounds ($20,130 at September 30, 2009 exchange rates), with a final redemption date of December 31, 2018. Income on the escrow balance accretes to the Company. This amount is subject to adjustment based on the results of the December 31, 2010 triennial valuation and subsequent triennial valuations. The escrow balance as of September 30, 2009 has been recorded in “cash deposited with clearing organizations and other segregated cash” and “investments: debt-other” in the amounts of 6.25 million British pounds and 6.25 million British pounds ($10,065 and $10,065 at September 30, 2009 exchange rates), respectively, on the accompanying condensed consolidated statement of financial condition as of September 30, 2009.

 

The following tables summarize the components of total benefit cost (credit) for the three month and nine month periods ended September 30, 2009 and 2008:

 

    Pension Plans     Pension Plan
Supplement
  Post-Retirement
Medical Plans
 
    For The Three Month Period Ended September 30,  
      2009         2008         2009       2008         2009             2008      

Components of Net Periodic Benefit Cost (Credit):

           

Service cost

  $ –        $ –        $     –     $     –     $ 25      $ 30   

Interest cost

    6,217        7,430        15     17     78        103   

Expected return on plan assets

    (6,922     (8,580     –       –       –          –     

Amortization of:

           

Prior service credit

    –          –          –       –       (345     (345

Net actuarial loss

    227        94        –       –       –          22   
                                           

Net periodic benefit cost (credit)

  $ (478   $ (1,056   $ 15   $ 17   $ (242   $ (190
                                           

 

    Pension Plans     Pension Plan
Supplement
  Post-Retirement
Medical Plans
 
    For The Nine Month Period Ended September 30,  
      2009         2008         2009       2008         2009             2008      

Components of Net Periodic Benefit Cost (Credit):

           

Service cost

  $ –        $ –        $     –     $     –     $ 74      $ 88   

Interest cost

    17,607        22,935        45     50     233        309   

Expected return on plan assets

    (19,622     (26,495     –       –       –          –     

Amortization of:

           

Prior service credit

    –          –          –       –       (1,036     (1,036

Net actuarial loss

    663        289        –       –       –          66   

LCH post-retirement medical plan termination

    –          –          –       –       –          (198
                                           

Net periodic benefit cost (credit)

  $ (1,352   $ (3,271   $ 45   $ 50   $ (729   $ (771
                                           

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

15. RESTRUCTURING PLAN

 

In February 2009, the Company announced a restructuring plan to optimize its mix of personnel, which included certain staff reductions and realignments of personnel. In connection with such plan, the Company recorded an increase to the after-tax loss attributable to Lazard Ltd in the three month period ended March 31, 2009 of $56,149, as a result of a charge of $62,550 (principally consisting of compensation-related expenses, including the acceleration of unrecognized expense pertaining to RSUs previously granted to individuals who were terminated pursuant to the restructuring), with this charge partially offset by an associated income tax credit of $6,401.

 

As of September 30, 2009, the remaining liability associated with the restructuring plan was approximately $16,400 and primarily relates to severance and benefit payments and other costs associated with the restructuring. Such aggregate amount is reported within “accrued compensation and benefits” and “other liabilities” on the accompanying condensed consolidated statement of financial condition as of September 30, 2009.

 

16. INCOME TAXES

 

Lazard Group primarily operates in the U.S. as a limited liability company that is treated as a partnership for U.S. federal income tax purposes. As a result, Lazard Group’s income from its U.S. operations is generally not subject to U.S. federal income taxes because such income is attributable to the partners. Lazard Group is subject to the Unincorporated Business Tax (“UBT”) which is attributable to Lazard Group’s operations apportioned to New York City. UBT is incremental to the U.S. federal statutory tax rate. Outside the U.S., Lazard Group operates principally through subsidiary corporations that are subject to local income taxes.

 

The Company recorded income tax provisions of $21,286 and $29,951 for the three month and nine month periods ended September 30, 2009, respectively, and $4,884 and $23,276 for the three month and nine month periods ended September 30, 2008, respectively, representing effective tax rates on operating income of 29.1%, 74.2%, (3.6)% and (81.1)%, respectively. Excluding the income tax benefit of $6,401 related to the $62,550 restructuring charge in the first quarter of 2009 and the income tax benefit of $7,427 related to the LAM Merger in the third quarter of 2008, which served to reduce operating income by $199,550, the Company had income tax provisions of $21,286 and $36,352 for the three month and nine month periods ended September 30, 2009, respectively, and $12,311 and $30,703 for the three month and nine month periods ended September 30, 2008, respectively, representing effective tax rates of 29.1%, 35.3%, 19.0% and 18.0%, respectively.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

17. RELATED PARTIES

 

Amounts receivable from, and payable to, related parties as of September 30, 2009 and December 31, 2008 are set forth below:

 

      September 30,
2009
   December 31,
2008
     

Receivables

     

LFCM Holdings

   $ 8,244    $ 10,377

Lazard Ltd Subsidiaries

     140,023      56,114

Other

     12      –  
             

Total

   $ 148,279    $ 66,491
             

Payables

     

LFCM Holdings

   $ 2,428    $ 704

Lazard Ltd Subsidiaries

     243,902      262,875

Other

     19      396
             

Total

   $ 246,349    $ 263,975
             

 

LFCM Holdings

 

LFCM Holdings owns and operates the capital markets business and fund management activities, as well as other specified non-operating assets and liabilities that were transferred by Lazard Group (referred to as the “separated businesses”) in May 2005, and is owned by the current and former working members, including certain of Lazard’s current and former managing directors (which also include our executive officers) who are also members of LAZ-MD Holdings. In addition to the master separation agreement, which effected the separation and recapitalization that occurred in May 2005, LFCM Holdings entered into an insurance matters agreement and a license agreement that addressed various business matters associated with the separation, as well as employee benefits, administrative services, business alliance and lease indemnity agreements, all of which are described in the Company’s Form 10-K.

 

For the three month and nine month periods ended September 30, 2009, amounts recorded by Lazard Group relating to administrative and support services under the administrative services agreement (the “administrative services agreement”) amounted to $1,287 and $3,779, respectively, and net referral fees for underwriting, private placement, M&A and restructuring transactions under the business alliance agreement amounted to $3,077 and $9,665, respectively. For the three month and nine month periods ended September 30, 2008, amounts recorded by Lazard Group relating to administrative and support services under the administrative services agreement amounted to $1,014 and $2,953, respectively, and net referral fees for underwriting and private placement transactions under the business alliance agreement amounted to $3,148 and $22,837, respectively. Amounts relating to administrative and support services under the administrative services agreement are reported as reductions to operating expenses. Net referral fees for underwriting transactions under the business alliance agreement are reported as reductions to “revenue – other”. Net referral fees for private placement, M&A and restructuring transactions under the business alliance agreement are reported as reductions to advisory fee revenue.

 

With respect to the lease indemnity agreement, the net present value of the receivable due from LFCM Holdings with respect to its indemnification for obligations relating to abandoned lease space in the U.K. at September 30, 2009 and December 31, 2008 was $2,685 and $4,085, respectively. The balance is due based on a schedule of periodic payments through May 10, 2010.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

The remaining receivables from LFCM Holdings and its subsidiaries as of September 30, 2009 and December 31, 2008 primarily include $1,600 and $4,949, respectively, related to administrative and support services and reimbursement of expenses incurred on behalf of LFCM Holdings and $3,350 and $1,087, respectively, related to referral fees for underwriting and private placement transactions.

 

Payables to LFCM Holdings and its subsidiaries at September 30, 2009 and December 31, 2008 principally relate to referral fees for Financial Advisory transactions.

 

Lazard Ltd Subsidiaries

 

Lazard Group’s receivables from subsidiaries of Lazard Ltd at September 30, 2009 and December 31, 2008 include interest-bearing loans of $138,724 and $55,715, respectively, including accrued interest thereon, with related interest income amounting to $1,023 and $3,880 for the three month and nine month periods ended September 30, 2009, respectively.

 

As of September 30, 2009 and December 31, 2008, Lazard Group’s payables to subsidiaries of Lazard Ltd included $64,305 and $64,512, respectively, related to the LAM Merger (see Note 7 of Notes to Condensed Consolidated Financial Statements), as well as payables at September 30, 2009 and December 31, 2008 in connection with Lazard Group’s acquisition of GAHL and Edgewater’s management vehicles, as well as Lazard Ltd’s acquisition of CWC and subsequent contribution of CWC to Lazard Group, of $33,264 and $43,634, respectively (see Note 8 of Notes to Condensed Consolidated Financial Statements). In addition, as of September 30, 2009 and December 31, 2008, Lazard Group’s payables to subsidiaries of Lazard Ltd include interest-bearing loans, plus accrued interest thereon, of $146,288 and $154,706, respectively, with related interest expense amounting to $1,428 and $4,915 for the three month and nine month periods ended September 30, 2009, respectively, and $518 and $935 for the three month and nine month periods ended September 30, 2008, respectively.

 

LAZ-MD Holdings

 

Lazard Group provides selected administrative and support services to LAZ-MD Holdings through the administrative services agreement, with such services generally to be provided until December 31, 2014 unless terminated earlier because of a change in control of either party. Lazard Group charges LAZ-MD Holdings for these services based on Lazard Group’s cost allocation methodology and, for the three month and nine month periods ended September 30, 2009, such charges amounted to $188 and $563, respectively. For the three month and nine month periods ended September 30, 2008, such charges amounted to $188 and $563, respectively.

 

Other

 

In addition, see Note 11 of Notes to Condensed Consolidated Financial Statements for information regarding CP II and the Sapphire IPO.

 

18. REGULATORY AUTHORITIES

 

LFNY is a U.S. registered broker-dealer and is subject to the net capital requirements of Rule 15c3-1 under the Exchange Act. Under the basic method permitted by this rule, the minimum required net capital, as defined, is a specified fixed percentage of total aggregate indebtedness recorded in LFNY’s Financial and Operational

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Combined Uniform Single (“FOCUS”) report filed with the Financial Industry Regulatory Authority (“FINRA”), or $100, whichever is greater. At September 30, 2009, LFNY’s regulatory net capital was $40,214, which exceeded the minimum requirement by $32,475.

 

Certain U.K. subsidiaries of the Company, including LCL, Lazard Fund Managers Limited and Lazard Asset Management Limited (the “U.K. Subsidiaries”), are regulated by the Financial Services Authority. At September 30, 2009, the aggregate regulatory net capital of the U.K. Subsidiaries was $148,851, which exceeded the minimum requirement by $111,206.

 

CFLF, through which non-corporate finance advisory activities are carried out in France, is subject to regulation by the Commission Bancaire and the Comité des Etablissements de Crédit et des Entreprises d’Investissement for its banking activities conducted through its subsidiary, LFB. In addition, the investment services activities of the Paris group, exercised through LFB and other subsidiaries of CFLF, primarily LFG (asset management), are subject to regulation and supervision by the Autorité des Marchés Financiers. At September 30, 2009, the consolidated regulatory net capital of CFLF was $194,789, which exceeded the minimum requirement set for regulatory capital levels by $87,638.

 

Certain other U.S. and non-U.S. subsidiaries are subject to various capital adequacy requirements promulgated by various regulatory and exchange authorities in the countries in which they operate. At September 30, 2009, for those subsidiaries with regulatory capital requirements, their aggregate net capital was $73,627, which exceeded the minimum required capital by $52,033.

 

At September 30, 2009, each of these subsidiaries individually was in compliance with its regulatory capital requirements.

 

Lazard Ltd is currently subject to supervision by the SEC as a Supervised Investment Bank Holding Company (“SIBHC”). As a SIBHC, Lazard Ltd is subject to group-wide supervision, which requires it to compute allowable capital and risk allowances on a consolidated basis. We believe that Lazard Ltd is the only institution currently subject to supervision by the SEC as a SIBHC. We are in discussions with the SEC regarding the scope and nature of Lazard Ltd’s reporting and other obligations under the SIBHC program.

 

On June 17, 2009, the U.S. Department of the Treasury (the “Treasury”), in coordination with the White House, released a white paper entitled “Financial Regulatory Reform: A New Foundation: Rebuilding Financial Supervision and Regulation”. The paper sets forth a plan for comprehensive regulatory reform of the financial services industry. The plan includes, among other things, a significant expansion of the oversight powers of the Federal Reserve and the creation of a new Financial Services Oversight Council. The plan also includes a recommendation to eliminate the SIBHC program. On October 27, 2009, the Treasury and the House Financial Services Subcommittee jointly released draft legislation, titled the “Financial Stability Improvement Act of 2009”. Section 1315 of the draft legislation would expressly eliminate the SIBHC program. We are monitoring these regulatory reform developments and their possible effects on our business and operations.

 

19. SEGMENT INFORMATION

 

The Company’s reportable segments offer different products and services and are managed separately as different levels and types of expertise are required to effectively manage the segments’ transactions. Each segment is reviewed to determine the allocation of resources and to assess its performance. The Company’s principal operating activities are included in two business segments: Financial Advisory (which includes providing general strategic and transaction-specific advice on M&A and strategic advisory matters, restructuring and capital structure advisory services, capital raising and other transactions), and Asset Management (which includes the management of equity and fixed income

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

securities and alternative investment and private equity funds). In addition, the Company records selected other activities in its Corporate segment, including management of cash, certain investments and the commercial banking activities of LFB. The Company also allocates outstanding indebtedness to its Corporate segment.

 

The Company’s segment information for the three month and nine month periods ended September 30, 2009 and 2008 is prepared using the following methodology:

 

   

Revenue and expenses directly associated with each segment are included in determining operating income (loss).

 

   

Expenses not directly associated with specific segments are allocated based on the most relevant measures applicable, including headcount, square footage and other factors.

 

   

Segment assets are based on those directly associated with each segment, and include an allocation of certain assets relating to various segments, based on the most relevant measures applicable, including headcount, square footage and other factors.

 

The Company allocates investment gains and losses, interest income and interest expense among the various segments based on the segment in which the underlying asset or liability is reported.

 

Each segment’s operating expenses include (i) compensation and benefits expense incurred directly in support of the businesses and (ii) other operating expenses, which include directly incurred expenses for occupancy and equipment, marketing and business development, technology and information services, professional services, fund administration and outsourced services and indirect support costs (including compensation and other operating expenses related thereto) for administrative services. Such administrative services include, but are not limited to, accounting, tax, legal, facilities management and senior management activities.

 

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LAZARD GROUP LLC

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

(dollars in thousands, unless otherwise noted)

 

Management evaluates segment results based on net revenue and operating income (loss) and believes that the following information provides a reasonable representation of each segment’s contribution to operations with respect to net revenue, operating income (loss) and total assets:

 

          Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
          2009     2008     2009     2008  

Financial Advisory

   Net Revenue    $ 259,221      $ 269,740      $ 674,222      $ 770,699   
   Operating Expenses      212,543        197,494        595,649        601,927   
                                   
   Operating Income    $ 46,678      $ 72,246      $ 78,573      $ 168,772   
                                   

Asset Management

   Net Revenue    $ 160,744      $ 147,780      $ 393,810      $ 493,183   
   Operating Expenses      117,728        317,915  (a)      312,141        574,850  (a) 
                                   
   Operating Income (Loss)    $ 43,016      $ (170,135 )(a)    $ 81,669      $ (81,667 )(a) 
                                   

Corporate

   Net Revenue    $ (8,559   $ (11,984   $ (32,724   $ (83,983
   Operating Expenses      7,965        24,792  (a)      87,141  (b)      31,840  (a) 
                                   
   Operating Loss    $ (16,524   $ (36,776 )(a)    $ (119,865 )(b)    $ (115,823 )(a) 
                                   

Total

   Net Revenue    $    411,406      $    405,536      $ 1,035,308      $ 1,179,899   
   Operating Expenses      338,236        540,201        994,931        1,208,617   
                                   
   Operating Income (Loss)    $ 73,170      $ (134,665   $ 40,377      $ (28,718
                                   

 

(a) Includes, in the three month and nine month periods ended September 30, 2008, compensation and benefits expense in the Asset Management segment of $197,550 related to the LAM Merger and non-compensation-related transaction costs in the Corporate segment of $2,000 (see Note 7 of Notes to Condensed Consolidated Financial Statements).
(b) Includes, in the nine month period ended September 30, 2009, restructuring expense of $62,550 (see Note 15 of Notes to Condensed Consolidated Financial Statements).

 

           As of
           September 30,
2009
     December 31,
2008

Total Assets:

       

Financial Advisory

   $ 685,288      $ 739,444

Asset Management

     627,953        419,858

Corporate

     1,579,657        1,726,280
                        

Total

   $ 2,892,898      $ 2,885,582
                        

 

20.    SUBSEQUENT EVENT

 

On October 14, 2009, Lazard Ltd announced that its Chairman and CEO, Bruce Wasserstein, had passed away. In accordance with the provisions of the Company’s 2005 Plan, RSU awards previously granted to Mr. Wasserstein will vest on the 30th day following his death. As a result, the Company will record a pre-tax charge to compensation and benefits expense in the fourth quarter of 2009 of approximately $86,500, representing the unamortized expense relating to those awards.

 

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

 

The following discussion should be read in conjunction with Lazard Group’s condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q (the “Form 10-Q”).

 

Forward-Looking Statements and Certain Factors that May Affect Our Business

 

Management has included in Parts I and II of this Form 10-Q, including in its Management’s Discussion and Analysis of Financial Condition and Results of Operations (the “MD&A”), statements that are forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” and the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to known and unknown risks, uncertainties and assumptions about us, may include projections of our future financial performance based on our growth strategies and anticipated trends in our business. These statements are only predictions based on our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. These factors include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2008 (the “Form 10-K”) under the caption “Risk Factors,” including the following:

 

   

a decline in general economic conditions or the global financial markets,

 

   

losses caused by financial or other problems experienced by third parties,

 

   

losses due to unidentified or unanticipated risks,

 

   

a lack of liquidity, i.e., ready access to funds, for use in our businesses, and

 

   

competitive pressure on our businesses and on our ability to retain our employees.

 

These risks and uncertainties are not exhaustive. Other sections of the Form 10-K may include additional factors, which could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for our management to predict all risks and uncertainties, nor can management assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy or completeness of any of these forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We are under no duty to update any of these forward-looking statements after the date of this Form 10-Q to conform our prior statements to actual results or revised expectations and we do not intend to do so.

 

Forward-looking statements include, but are not limited to, statements about:

 

   

the business’ possible or assumed future results of operations and operating cash flows,

 

   

the business’ strategies and investment policies,

 

   

the business’ financing plans and the availability of short-term borrowing,

 

   

the business’ competitive position,

 

   

future acquisitions, including the consideration to be paid and the timing of consummation,

 

   

potential growth opportunities available to our businesses,

 

   

recruitment and retention of managing directors and employees,

 

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target levels of compensation expense,

 

   

the business’ potential operating performance, achievements, productivity improvements, efficiency and cost reduction efforts,

 

   

the likelihood of success and impact of litigation,

 

   

expected tax rates,

 

   

changes in interest and tax rates,

 

   

expectations with respect to the economy, securities markets, the market for mergers, acquisitions and strategic advisory activity, the market for asset management activity and other industry trends,

 

   

the effects of competition on our business, and

 

   

the impact of future legislation and regulation on our business.

 

The Company is committed to providing timely and accurate information to the investing public, consistent with our legal and regulatory obligations. To that end, the Company uses its websites to convey information about its businesses, including the anticipated release of quarterly financial results, quarterly financial, statistical and business-related information and the posting of updates of assets under management (“AUM”) in various mutual funds, hedge funds and other investment products managed by Lazard Asset Management LLC and its subsidiaries (“LAM”). Monthly updates of these funds are posted to the LAM website (www.lazardnet.com) on the third business day following the end of each month. Investors can link to Lazard Ltd, Lazard Group and their operating company websites through www.lazard.com. Our websites and the information contained therein or connected thereto are not incorporated into this Form 10-Q.

 

Business Summary

 

The Company’s principal sources of revenue are derived from activities in the following business segments:

 

   

Financial Advisory, which includes providing general strategic and transaction-specific advice on mergers and acquisitions (“M&A”) and strategic advisory matters, restructuring and capital structure advisory services, capital raising and other transactions, and

 

   

Asset Management, which includes strategies for the management of equity and fixed income securities, alternative investments and private equity funds.

 

In addition, the Company records selected other activities in its Corporate segment, including management of cash, certain investments and the commercial banking activities of Lazard Group’s Paris-based Lazard Frères Banque SA (“LFB”, or “our bank”). The Company also allocates outstanding indebtedness to its Corporate segment.

 

LFB is a registered bank regulated by the Banque de France and its primary operations include asset and liability management for Lazard Group’s Paris House through its money market desk and commercial banking operations, deposit taking and, to a lesser extent, financing activities and custodial oversight over assets of various clients. LFB engages in underwritten offerings of securities in France, and we expect that it may expand its scope to include placements elsewhere in Europe.

 

On September 25, 2008, pursuant to a definitive merger agreement dated August 14, 2008, Lazard Ltd, LAM, and LAZ Sub I, LLC, a then newly-formed subsidiary of Lazard Frères & Co. LLC (“LFNY”), completed the merger of LAZ Sub I, LLC with and into LAM (the “LAM Merger”). See Note 7 of Notes to Condensed Consolidated Financial Statements for additional information relating to the LAM Merger.

 

In June, 2009, the Company formed a new wealth management subsidiary, Lazard Wealth Management LLC (“Lazard Wealth Management”). Lazard Wealth Management will provide customized, investment

 

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management and financial planning services to high net worth investors in the U.S. Lazard Wealth Management expects to work with investors to construct, implement and monitor an asset allocation strategy designed to meet the individual client’s investment objectives, integrating tax planning, estate planning, philanthropic interests and legacy planning with investment and risk management services. Prior to the launch of this business, we intend to register Lazard Wealth Management as a registered investment adviser with the SEC.

 

Lazard also has a long history of making alternative investments with its own capital, usually alongside capital of qualified institutional and individual investors. At the time of Lazard Ltd’s equity public offering and as a part of the separation, we transferred to LFCM Holdings LLC (“LFCM Holdings”) all of our alternative investment activities, except for Fonds Partenaires Gestion (“FPG”), our private equity business in France. Such activities transferred to LFCM Holdings represented the alternative investment activities of Lazard Alternative Investments Holdings LLC (“LAI”) and included private equity investments of Corporate Partners II Limited (“CP II”) and Lazard Senior Housing Partners LP. CP II was managed by a subsidiary of LAI until February 16, 2009. Effective February 17, 2009, ownership and control of CP II was transferred to the investment professionals who manage CP II. We also transferred to LFCM Holdings certain principal investments by Lazard Group in the funds managed by the separated businesses, subject to certain options by us to reacquire such investments, while we retained our investment in our French private equity funds. Since 2005, consistent with our obligations to LFCM Holdings, we have engaged in a number of alternative investments and private equity activities. See Note 11 of Notes to Condensed Consolidated Financial Statements for additional information regarding alternative investments. Effective September 30, 2009, the Company sold FPG to a fund management company forming part of a group managing investment companies and funds, in some of which Lazard could earn carried interests, and the managing directors and staff conducting this activity were accordingly transferred to the buyer. The sale of FPG had no material impact on our financial condition or results of operations. Operating results of FPG have been included in our consolidated financial statements through the effective date of sale.

 

We continue to explore and discuss opportunities to expand the scope of our alternative investment and private equity activities in Europe, the U.S. and elsewhere. These opportunities could include internal growth of new funds and direct investments by us, partnerships or strategic relationships, investments with third parties or acquisitions of existing funds or management companies. In that regard, on July 15, 2009, the Company established a private equity business with The Edgewater Funds (“Edgewater”), a Chicago-based private equity firm, through the acquisition of Edgewater’s management vehicles (see Note 8 of Notes to Condensed Consolidated Financial Statements). Also, consistent with our obligations to LFCM Holdings, we may explore discrete capital markets opportunities.

 

For the three month and nine month periods ended September 30, 2009 and 2008, the Company’s consolidated net revenue was derived from the following segments:

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
         2009             2008             2009             2008      

Financial Advisory

   63   67   65   65

Asset Management

   39      36      38      42   

Corporate

   (2   (3   (3   (7
                        

Total

   100   100   100   100
                        

 

Business Environment

 

Economic and market conditions since early 2008 in the U.S. and global economies have been adversely impacted by factors including the contraction in worldwide credit markets and the related tightening of lending, volatility in currency and commodity markets and oil prices and write-downs within the financial sector. Overall, these economic and market conditions negatively affected our financial performance in both our Financial Advisory and Asset Management businesses through the first nine months of 2009, with improvement in the three month period ended September 30, 2009.

 

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Lazard operates in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for Lazard’s management to predict all risks and uncertainties, nor can Lazard assess the impact of all potentially applicable factors on its business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. See the section entitled “Risk Factors” in the Form 10-K. Furthermore, net income (loss) and revenue in any period may not be indicative of full-year results or the results of any other period and may vary significantly from year to year and quarter to quarter.

 

Financial Advisory

 

M&A activity for the three month and nine month periods ended September 30, 2009 decreased substantially versus the corresponding periods in 2008 for global completed transactions as well as global and transatlantic announced transactions, while activity in restructuring accelerated during the 2009 periods driven by a significant increase in the number of corporate debt defaults. According to Moody’s Investors Service, Inc., in the nine month period ended September 30, 2009, a total of 222 issuers defaulted as compared to 62 in the corresponding period in 2008. The following table sets forth industry statistics regarding the volume of M&A transactions in the 2008 and 2009 periods:

 

      Three Months Ended September 30,     Nine Months Ended September 30,  
          2009            2008        %
    Incr /(Decr)    
        2009            2008        %
    Incr /(Decr)    
 
     ($ in billions)  

Completed M&A Transactions:

                

Global

   $ 358    $ 675    (47 )%    $ 1,136    $ 2,081    (45 )% 

Transatlantic

     29      70    (59 )%      91      183    (50 )% 

Announced M&A Transactions:

                

Global

     381      768    (50 )%      1,375      2,113    (35 )% 

Transatlantic

     59      82    (28 )%      97      266    (64 )% 

 

Source: Thomson Financial as of October 14, 2009

 

While overall M&A industry statistics regarding the number and size of announced transactions declined in the first nine months of 2009 as compared to 2008, we believe that in the current environment we are relatively well positioned for the upturn in the economy as our clients refinance, restructure and position their asset portfolios for growth. Nevertheless, we remain cautious with respect to the environment. Generally, during such periods of unfavorable market or economic conditions, the volume and value of M&A transactions may decrease, thereby reducing the demand for our advisory services and increasing competition among financial services companies seeking such engagements.

 

We believe that corporate defaults will remain at a high level, and will be on a more global scale than during the last cycle. We expect that our Restructuring business should continue to be very active over the next several years from such significant level of corporate defaults, as well as from advising companies during this period of volatility on matters relating to debt and financing restructuring and other on- and off-balance sheet assignments. Our Restructuring assignments normally are executed over a six- to eighteen-month period.

 

In April 2009, governmental officials in New York announced a new policy banning the use of placement agents by funds seeking investment contributions from the New York State and New York City public pension funds. The use of placement agents has also been prohibited or otherwise restricted with respect to investments by public pension funds in Illinois, Ohio and New Mexico, and similar measures are being considered in other jurisdictions and by the SEC. Our Private Fund Advisory Group, which is part of our Financial Advisory segment, acts as placement agent for investment funds, including investment funds that have historically received capital from certain of these affected public pension funds. We are continuing to evaluate the potential impact of these restrictions on our Private Fund Advisory Group.

 

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Asset Management

 

As shown in the table below, major global market indices at September 30, 2009 have improved compared to such indices at June 30, 2009 and December 31, 2008, but were lower across most regions as compared to September 30, 2008.

 

     Percentage Change
September 30, 2009 vs.
 
     June 30,
2009
    December 31,
2008
    September 30,
2008
 

MSCI World Index

   17   23   (5 )% 

CAC 40

   21   18   (6 )% 

DAX

   18   18   (3 )% 

FTSE 100

   21   16   5

TOPIX 100

   (3 )%    5   (21 )% 

MSCI Emerging Market

   20   61   16

Dow Jones Industrial Average

   15   11   (11 )% 

NASDAQ

   16   35   2

S&P 500

   15   17   (9 )% 

 

The fees that we receive for providing investment management and advisory services are primarily driven by the level of AUM. Accordingly, since market appreciation (depreciation) and foreign currency volatility impact the level of our AUM, such items will impact the level of revenues we receive from our Asset Management business. Since a substantial portion of our AUM is invested in equities, market appreciation reflected in the changes in Lazard’s AUM during the three and nine month periods ended September 30, 2009 generally corresponded to the changes in global market indices. While AUM in the third quarter of 2009 improved versus the first half of 2009 and the second half of 2008, our management fee revenues, when compared to the corresponding periods in 2008, continued to be adversely impacted by the continuing effects on AUM of significant market depreciation experienced in the second half of 2008 through March 31, 2009.

 

Financial Statement Overview

 

Net Revenue

 

The majority of Lazard’s Financial Advisory net revenue is earned from the successful completion of M&A transactions, strategic advisory matters, restructuring and capital structure advisory services, capital raising and similar transactions. The main driver of Financial Advisory net revenue is overall M&A activity, the level of corporate debt defaults and the environment for capital raising activities, particularly in the industries and geographic markets in which Lazard focuses. In some client engagements, often those involving financially distressed companies, revenue is earned in the form of retainers and similar fees that are contractually agreed upon with each client for each assignment and are not necessarily linked to the completion of a transaction. In addition, Lazard also earns fees from providing strategic advice to clients, with such fees not being dependent on a specific transaction. Lazard’s Financial Advisory segment also earns revenue from public and private securities offerings in the form of referral fees for referring opportunities to LFCM Holdings for underwriting and distribution of securities. The referral fees received from LFCM Holdings are generally one-half of the revenue recorded by LFCM Holdings in respect of such activities. Significant fluctuations in Financial Advisory net revenue can occur over the course of any given year. These fluctuations arise because a significant portion of Financial Advisory net revenue is earned upon the successful completion of a transaction, restructuring or capital raising activity, the timing of which is uncertain and is not subject to Lazard’s control.

 

Lazard’s Asset Management segment principally includes LAM, Lazard Frères Gestion SAS (“LFG”), FPG and, effective July 15, 2009, Edgewater. Effective October 1, 2009, the Asset Management segment will no longer include the operating results of FPG due to the sale of FPG effective September 30, 2009. Asset Management net revenue is derived from fees for investment management and advisory services provided to

 

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institutional and private clients. The main driver of Asset Management net revenue is the level of AUM, which is influenced by Lazard’s investment performance, its ability to successfully attract and retain assets, the broader performance of the global equity markets and, to a lesser extent, fixed income markets. As a result, fluctuations in financial markets and client asset inflows and outflows have a direct effect on Asset Management net revenue and operating income. Asset Management fees are generally based on the level of AUM measured as of the end of a quarter or month, and an increase or reduction in AUM at such dates, due to market price fluctuations, currency fluctuations, net client asset flows or otherwise, will result in a corresponding increase or decrease in management fees. The majority of our investment advisory contracts are generally terminable at any time or on notice of 30 days or less. Institutional and individual clients, and firms with which we have strategic alliances, can terminate their relationship with us, reduce the aggregate amount of AUM or shift their funds to other types of accounts with different rate structures for a number of reasons, including investment performance, changes in prevailing interest rates and financial market performance. In addition, as Lazard’s AUM includes significant assets that are denominated in currencies other than U.S. dollars, changes in the value of the U.S. dollar relative to foreign currencies will impact the value of Lazard’s AUM. Fees vary with the type of assets managed, with higher fees earned on equity assets, alternative investments (such as hedge funds) and private equity investments, and lower fees earned on fixed income and cash management products.

 

The Company earns performance-based incentive fees on various investment products, including traditional products and alternative investment funds such as hedge funds and private equity funds.

 

For hedge funds, incentive fees are calculated based on a specified percentage of a fund’s net appreciation, in some cases in excess of established benchmarks. The Company records incentive fees on traditional products and hedge funds at the end of the relevant performance measurement period, when potential uncertainties regarding the ultimate realizable amounts have been determined. The performance fee measurement period is generally an annual period (unless an account terminates during the year), and therefore such incentive fees are usually recorded in the fourth quarter of Lazard’s fiscal year. These incentive fees received at the end of the measurement period are not subject to reversal or payback. Incentive fees on hedge funds generally are subject to loss carryforward provisions in which losses incurred by the funds in any year are applied against certain future period net appreciation before any incentive fees can be earned.

 

For private equity funds, incentive fees may be earned in the form of a “carried interest” if profits arising from realized investments exceed a specified threshold. Typically, such carried interest is ultimately calculated on a whole-fund basis and therefore clawback of carried interests during the life of the fund can occur. As a result, incentive fees earned on our private equity funds are not recorded until potential uncertainties regarding the ultimate realizable amounts have been determined, including any potential for clawback.

 

Corporate segment net revenue consists primarily of net interest income, including amounts earned at LFB, and investment gains and losses on the Company’s investment portfolio of LAM-managed equity funds and principal investments in equities, debt securities at our bank and alternative investment funds managed by LAI and FPG. Interest expense is also included in Corporate net revenue. Corporate net revenue can fluctuate due to changes in the fair value of investments classified as “trading”, and with respect to “available-for-sale”, when realized, or when a decline is determined to be other than temporary, with respect to “available-for-sale” and “held-to-maturity” investments, as well as due to changes in interest and currency exchange rates and in the levels of cash, investments and indebtedness.

 

Effective July 1, 2008, as permitted by accounting principles generally accepted in the United States of America (“U.S. GAAP”), the portion of our bank’s corporate debt portfolio that had been previously designated as “trading” was re-designated to “available-for-sale”. During the three month and nine month periods ended September 30, 2009 and the three month period ended September 30, 2008, the Company recorded mark-ups and mark-downs of $22, $38 and $(18) million, respectively, in “accumulated other comprehensive income (loss), net of tax” (“AOCI”).

 

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Although Corporate segment net revenue during the nine month period ended September 30, 2009 represented (3)% of Lazard’s net revenue, total assets in Corporate represented 55% of Lazard’s consolidated total assets as of September 30, 2009, principally attributable to the level of assets associated with LFB, and, to a lesser extent, investments in LAM-managed funds, other securities and cash.

 

Operating Expenses

 

The majority of Lazard’s operating expenses relate to compensation and benefits for employees and managing directors. We have a policy that targets our ongoing compensation and benefits expense in our traditional businesses, excluding special items, to usually not exceed 57.5% of operating revenue each year, including compensation and benefits payable to our managing directors and amortization of the relevant portion of the restricted stock unit awards (“RSUs”) under the Lazard Ltd 2005 Equity Incentive Plan, the Lazard Ltd 2008 Incentive Compensation Plan and the related deferred cash component of such incentive awards, with such amortization determined on a straight-line basis over the vesting periods and not on the basis of revenue recognition (see Note 13 of Notes to Condensed Consolidated Financial Statements). As discussed in our Form 10-K, there can be no guarantee that this target ratio will continue to be achieved in future periods or that our policy may not change in the future, including to adapt to changes in the economic environment, or that a change may not be necessitated by lower operating revenues or to fund a major expansion. Increased competition for senior professionals, continued turmoil and volatility in the financial markets generally or other factors could prevent us from continuing to maintain this target ratio.

 

Our compensation expense-to-operating revenue ratio for the nine month periods ended September 30, 2009 and 2008 was 62.7% and 55.7%, respectively, and for the three month periods ended September 30, 2009 and 2008 was 58.0% and 53.8%, respectively (with such ratios for the 2008 periods excluding the compensation charge relating to the LAM Merger). As a result of the challenging market conditions in the 2009 periods described above, and the resulting declines in operating revenue, the ratios in the 2009 periods exceeded our target ratio. Our compensation ratio for the nine month period of 2009 is not necessarily representative of the ratio for the full year. The timing of our actual operating revenue during the year will impact the compensation ratio for each period. The ratio may also be impacted in the short term by our accelerated global senior-level hiring initiative and competitive considerations to meet our employee retention objectives. Our plan is for compensation expense, excluding special items, to usually be below 57.5% of operating revenue in any year and to average below 57.5% over time in our existing businesses. As in the nine month period of 2009, this ratio may rise above 57.5% during periods of significant revenue decline. See also Note 20 of Notes to Condensed Consolidated Financial Statements.

 

Lazard’s operating expenses also include “non-compensation expense”, amortization of intangible assets related to acquisitions and, in the nine month period ended September 30, 2009, restructuring expense. Non-compensation expense includes costs for occupancy and equipment, marketing and business development, technology and information services, professional services, fund administration and outsourced services, and other expenses. Amortization of intangibles related to acquisitions are associated with the acquisitions of Edgewater, Goldsmith, Agio, Helms & Lynner, LLC (“GAHL”) and Carnegie, Wylie & Company (Holdings) PTY LTD (“CWC”). Restructuring expense relates to the reduction of headcount in the first quarter of 2009, and includes severance and related benefits expense, the acceleration of unrecognized expense pertaining to RSUs previously granted to individuals who were terminated and certain other costs related to this initiative.

 

Income Taxes

 

Lazard Group primarily operates in the U.S. as a limited liability company that is treated as a partnership for U.S. federal income tax purposes. As a result, Lazard Group’s income from its U.S. operations is generally not subject to U.S. federal income taxes because such income is attributable to the individual partners. Outside the U.S., Lazard Group operates principally through corporations and is subject to local income taxes. Income taxes shown on Lazard’s consolidated statements of operations are attributable to taxes in non-U.S. entities and to New York City Unincorporated Business Tax (“UBT”) attributable to Lazard’s operations apportioned to New York City.

 

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Noncontrolling Interests

 

The Company records a charge (credit) principally attributable to the noncontrolling interests in Edgewater (in the three month and nine month periods ended September 30, 2009) and various LAM-related general partnerships (“GPs”) held directly by certain of our LAM managing directors.

 

See Note 12 of Notes to Condensed Consolidated Financial Statements for information regarding noncontrolling interests.

 

Consolidated Results of Operations

 

Lazard’s consolidated financial statements are presented in U.S. dollars. Many of our non-U.S. subsidiaries have a functional currency (i.e., the currency in which operational activities are primarily conducted) that is other than the U.S. dollar, generally the currency of the country in which the subsidiaries are domiciled. Such subsidiaries’ assets and liabilities are translated into U.S. dollars using exchange rates as of the respective balance sheet date, while revenue and expenses are translated at average exchange rates during the respective periods based on the daily closing exchange rates. Adjustments that result from translating amounts from a subsidiary’s functional currency are reported as a component of members’ equity. Foreign currency remeasurement gains and losses on transactions in non-functional currencies are included in the consolidated statements of operations.

 

As a result of the restructuring plan implemented during the first quarter of 2009 (see Note 15 of Notes to Condensed Consolidated Financial Statements), net income attributable to Lazard Group in the nine month period ended September 30, 2009 was reduced by $56 million due to a charge to operating income of $62 million, with this charge being partially offset by an income tax credit of $6 million. In addition, as more fully described in Note 7 of Notes to Condensed Consolidated Financial Statements, on September 25, 2008, Lazard Ltd completed the LAM Merger. Net income attributable to Lazard Group was reduced by $192 million as a result of the LAM Merger, consisting of compensation and benefits expense of $197 million related to the equity interests of LAM held by present and former employees of LAM, and $2 million of non-compensation-related transaction costs (together aggregating a reduction of operating income of $199 million), with these charges partially offset by an income tax credit of $7 million. For comparability purposes in the discussion that follows, the 2009 and 2008 results are shown in the tables below, as applicable, on an “as reported”, “excluding the restructuring” and “excluding LAM Merger” basis.

 

A discussion of the Company’s consolidated results of operations for the three month and nine month periods ended September 30, 2009 and 2008 is set forth below, followed by a more detailed discussion of business segment results.

 

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The following tables summarize the Company’s consolidated operating results:

 

      Three Months
Ended
September 30,
2009
    Three Months Ended September 30, 2008  
       As Reported     Impact of
LAM Merger (a)
    Excluding
LAM Merger (b)
 
    

($ in thousands)

 

Revenue:

        

Investment banking and other advisory fees

   $ 252,538      $ 260,708        $ 260,708   

Money management fees

     149,102        155,920          155,920   

Interest income

     9,661        23,743          23,743   

Other

     27,997        (755       (755
                          

Total revenue

     439,298        439,616          439,616   

Interest expense

     27,892        34,080          34,080   
                          

Net revenue

     411,406        405,536          405,536   
                          

Operating Expenses:

        

Compensation and benefits

     250,912        432,771      $ 197,550        235,221   

Non-compensation expense

     85,292        106,923        2,000        104,923   

Amortization of intangible assets related to acquisitions

     2,032        507          507   
                                

Total operating expenses

     338,236        540,201        199,550        340,651   
                                

Operating Income (Loss)

     73,170        (134,665     (199,550     64,885   

Provision (benefit) for income taxes

     21,286        4,884        (7,427     12,311   
                                

Net Income (Loss)

     51,884        (139,549     (192,123     52,574   

Less—Net Income (Loss) Attributable to Noncontrolling Interests

     2,030        (8,161       (8,161
                                

Net Income (Loss) Attributable to Lazard Group

   $ 49,854      $ (131,388   $ (192,123   $ 60,735   
                                

As a % of Net Revenue:

        

Operating Income (Loss)

     18     (33 )%        16
                          

 

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     Nine Months Ended September 30, 2009     Nine Months Ended September 30, 2008  
    As Reported     Impact of
Restructuring (c)
    Excluding
Restructuring (b)
    As Reported     Impact of
LAM Merger (a)
    Excluding
LAM Merger (b)
 
   

($ in thousands)

 

Revenue:

           

Investment banking and other advisory fees

  $ 650,327        $ 650,327      $ 736,863        $ 736,863   

Money management fees

    368,346          368,346        479,701          479,701   

Interest income

    25,770          25,770        66,833          66,833   

Other

    76,229          76,229        7,868          7,868   
                                   

Total revenue

    1,120,672          1,120,672        1,291,265          1,291,265   

Interest expense

    85,364          85,364        111,366          111,366   
                                   

Net revenue

    1,035,308          1,035,308        1,179,899          1,179,899   
                                   

Operating Expenses:

           

Compensation and benefits

    693,718          693,718        906,351      $ 197,550        708,801   

Non-compensation expense

    235,943          235,943        298,014        2,000        296,014   

Amortization of intangible assets related to acquisitions

    2,720          2,720        4,252          4,252   

Restructuring

    62,550      $ 62,550        –           
                                               

Total operating expenses

    994,931        62,550        932,381        1,208,617        199,550        1,009,067   
                                               

Operating Income (Loss)

    40,377        (62,550     102,927        (28,718     (199,550     170,832   

Provision (benefit) for income taxes

    29,951        (6,401     36,352        23,276        (7,427     30,703   
                                               

Net Income (Loss)

    10,426        (56,149     66,575        (51,994     (192,123     140,129   

Less—Net Income (Loss) Attributable to Noncontrolling Interests

    1,218          1,218        (9,770       (9,770
                                               

Net Income (Loss) Attributable to Lazard Group

  $ 9,208      $ (56,149   $ 65,357      $ (42,224   $ (192,123   $ 149,899   
                                               

As a % of Net Revenue:

           

Operating Income (Loss)

    4       10     (2 )%        14
                                   

 

(a) See Note 7 of Notes to Condensed Consolidated Financial Statement for information regarding the LAM Merger.
(b) A non-GAAP measure that management believes provides the most meaningful comparison between historical, present and future periods.
(c) Relates to costs recorded in the first quarter of 2009 associated with staff reductions and realignments. See Note 15 of Notes to Condensed Consolidated Financial Statements.

 

The table below describes the components of operating revenue, a non-GAAP measure used by the Company to manage total compensation and benefits expense to managing directors and employees. Management believes operating revenue provides the most meaningful basis for comparison between present, historical and future periods.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  
    

($ in thousands)

 

Operating revenue

        

Total revenue

   $ 439,298      $ 439,616      $
1,120,672
  
  $ 1,291,265   

Add (deduct):

        

LFB interest expense (a)

     (3,075     (10,319     (10,721     (29,183

Revenue related to noncontrolling interests (b)

     (3,716     8,161        (2,903     9,771   
                                

Operating revenue

   $ 432,507      $ 437,458      $ 1,107,048      $ 1,271,853   
                                

 

(a) The interest expense incurred by LFB is excluded from total revenue because LFB is a commercial bank and we consider its interest expense to be a cost directly related to the conduct of its business.
(b) Revenue related to the consolidation of noncontrolling interests is excluded because we do not deem such amount as operating in nature and the Company has no economic interest in such amount. Further, such results are offset by a charge or credit to noncontrolling interests.

 

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Certain key ratios, statistics and headcount information for the three month and nine month periods ended September 30, 2009 and 2008 are set forth below:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  

As a % of Net Revenue, By Revenue Category:

        

Investment banking and other advisory fees

   61   64   63   62

Money management fees

   36      38      36      41   

Interest income

   2      6      2      5   

Other

   7      0      7      1   

Interest expense

   (6   (8   (8   (9
                        

Net Revenue

   100   100   100   100
                        

 

     As of September 30,
     2009    2008

Headcount:

     

Managing Directors:

     

Financial Advisory

   146    152

Asset Management

   53    55

Corporate

   7    8

Limited Managing Directors

   3    6

Other Employees:

     

Business segment professionals

   990    1,041

All other professionals and support staff

   1,085    1,212
         

Total

   2,284
   2,474
         

 

During the first nine months of 2009, we continued to hire key professionals on a selective basis, and to redeploy employees into areas where we saw potential for growth. As described above, to further optimize our mix of personnel we have reduced staff in other areas, including the back office.

 

Operating Results

 

The Company’s quarterly revenue and profits can fluctuate materially depending on the number, size and timing of completed transactions on which it advised, as well as seasonality and other factors. Accordingly, the revenue and profits in any particular quarter may not be indicative of future results. As reflected in the tables of consolidated results of operations above, the restructuring charge in the first quarter of 2009 and the LAM Merger in the third quarter of 2008 had a significant impact on the Company’s reported operating results in the 2009 and 2008 periods, respectively. Lazard management believes that comparisons between years are most meaningful after excluding the impact of such items. Further, Lazard management believes that annual results are the most meaningful basis for comparison among present, historical and future periods.

 

Three Months Ended September 30, 2009 versus September 30, 2008

 

The Company reported net income attributable to Lazard Group of $50 million for the three month period ended September 30, 2009, an increase of $181 million as compared to a net loss of $131 million in the corresponding period in 2008. Such increase was principally the result of the impact of the LAM Merger in the third quarter of 2008, which reduced net income in that period by $192 million. Net income in the 2009 period reflected (i) a 4% decline in Financial Advisory net revenue which has been impacted by a slowdown in global M&A activity, but was substantially offset by an increase in restructuring activity, and (ii) a 9% increase in Asset

 

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Management net revenue as a result of increases in incentive fees and other revenue. In addition, net income was favorably impacted by lower amounts relating to compensation (the 2008 period included the impact of the LAM Merger) and non-compensation expense. When excluding the impact of the LAM Merger in the 2008 period, net income attributable to Lazard Group in the 2009 period of $50 million was $11 million, or 18%, lower than net income of the corresponding period in 2008.

 

Net revenue increased $6 million, or 1%, while operating revenue decreased $5 million, or a 1%, for the three month period ended September 30, 2009, as compared to the corresponding period in 2008. Fees from investment banking and other advisory activities decreased $8 million, or 3%, as compared to the 2008 period, principally reflecting a change in the mix of advisory activities as a $106 million, or 46%, decline in M&A and Strategic Advisory revenue was significantly offset by a $95 million, or 397%, increase in Restructuring revenue. Our investment banking fees reflect fees from M&A and Strategic Advisory, Restructuring and Capital Markets and Other Advisory assignments encompassing general strategic and transaction-specific advice to public and private companies, governments and other parties, and includes various capital markets advisory services. Restructuring revenue also includes fees for advising on distressed asset sales. Some of our assignments and, therefore, related revenue, are not reflected in or correlated to publicly available statistical information and, therefore, may not correlate to global industry statistics. Money management fees, including incentive fees, in the 2009 period decreased $7 million, or 4%, as compared to the corresponding period in 2008 due to a $15 billion, or 12%, decline in average AUM for the three month period ended September 30, 2009 versus the corresponding period in 2008, primarily the result of market and foreign exchange depreciation, partially offset by increased incentive fees earned in 2009. Interest income in the 2009 period decreased $14 million, or 59%, due to a lower interest rate environment as well as lower average cash balances and receivables from banks. Other revenue increased by $29 million in the three month period ended September 30, 2009 as compared to the 2008 period, principally due to higher investment income from the Company’s investment portfolio and revenue from noncontrolling interests. Interest expense for the three month period ended September 30, 2009 decreased by $6 million, or 18%, which resulted principally from the Company’s partial repurchases of senior notes, as well as lower interest paid on LFB’s customer deposits.

 

Compensation and benefits expense for the three month period ended September 30, 2009 decreased by $182 million. Compensation and benefits expense in the 2008 period included a $197 million charge relating to the LAM Merger. When excluding such charge, compensation and benefits expense in the 2009 period increased by $16 million due to $22 million of additional amortization of deferred cash incentive awards, partially offset by lower salaries due to the staff reductions associated with the restructuring plan implemented during the first quarter of 2009. Compensation and benefits expense was 58.0% of operating revenue in the three month period ended September 30, 2009, as compared to 53.8% in the 2008 period (excluding the impact of the LAM Merger in the 2008 period).

 

Non-compensation expense for the three month period ended September 30, 2009 decreased by $22 million, or 20%, including the $2 million charge relating to the LAM Merger in the 2008 period. Factors contributing to the decrease are (i) the $12 million provision in the 2008 period for losses from counterparty defaults related primarily to the bankruptcy filing of one of our prime brokers, (ii) lower spending on travel and other business development activities, lower consulting and recruiting fees and (iii) the strengthening of the U.S. dollar versus foreign currencies. The ratio of non-compensation expense to operating revenue was 19.7% for the three month period ended September 30, 2009, as compared to 24.4% of operating revenue for the 2008 period. The ratio, when excluding, in the 2008 period, the $2 million non-compensation charge relating to the LAM merger, was 24.0% of operating revenues in the 2008 period compared to 19.7% in the 2009 period.

 

Amortization of intangible assets for the three month period ended September 30, 2009 increased by $2 million due to the acquisition of Edgewater’s management vehicles.

 

Operating income for the three month period ended September 30, 2009 was $73 million, an increase of $208 million as compared to an operating loss of $135 million in the 2008 period (including the impact of the LAM Merger in the 2008 period). When excluding the impact of the LAM Merger charge in the 2008 period, operating income in the 2009 period increased by $8 million. As a percentage of net revenue, operating income

 

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in the 2009 period was 18% as compared to (33)% (including the impact of the LAM Merger in the 2008 period), or 16% when excluding the LAM Merger charge in the 2008 period.

 

The provision for income taxes for the three month period ended September 30, 2009 was $21 million, an increase of $16 million compared to a tax provision of $5 million in the 2008 period. When excluding the tax benefit of $7 million related to the LAM Merger in the 2008 period, the income tax provision in the 2009 period increased by $9 million, with such increase principally due to higher operating income in the 2009 period as compared to the 2008 period, and the geographic mix of operating income.

 

Net income attributable to noncontrolling interests for the three month period ended September 30, 2009 increased by $10 million as compared to the 2008 period.

 

Nine Months Ended September 30, 2009 versus September 30, 2008

 

The Company reported net income attributable to Lazard Group of $9 million for the nine month period ended September 30, 2009, an increase of $51 million, as compared to a net loss of $42 million in the corresponding period in 2008. Such increase was principally the result of the impact of the LAM Merger in the third quarter of 2008, which reduced net income in the nine month period ended September 30, 2008 by $192 million, partially offset by the restructuring charge in the first quarter of 2009, which reduced net income attributable to Lazard Group in the nine month period ended September 30, 2009 by $56 million. Excluding the after-tax impact of the restructuring expense in the 2009 period and the LAM Merger charge in the 2008 period, net income attributable to Lazard Group in the nine month period ended September 30, 2009 was $65 million, a decrease of $85 million, or 56%, as compared to the corresponding period in 2008. Such reduction of $85 million in net income was affected by a 13% decline in Financial Advisory net revenue, which reflected a slowdown in global M&A activity (which was partially offset by an increase in restructuring activity) and a 20% decline in Asset Management net revenue as a result of the decline in average AUM. In aggregate, the impact on net income of the decline in revenue was partially offset by lower amounts relating to compensation and non-compensation expense.

 

Net revenue decreased $145 million, or 12%, for the nine month period ended September 30, 2009, as compared to the corresponding period in 2008, with operating revenue decreasing $165 million, or 13%, compared to the prior year period. Fees from investment banking and other advisory activities decreased $87 million, or 12%, as compared to the 2008 period principally reflecting a change in the mix of advisory activities as a $266 million, or 43%, decline in M&A and Strategic Advisory revenue, was partially offset by a $201 million, or 279%, increase in Restructuring revenue, which includes fees for advising on distressed asset sales. Money management fees, including incentive fees, in the 2009 period decreased $111 million, or 23%, as compared to the corresponding period in 2008 due to a $33 billion, or 25%, decline in average AUM for the nine month period ended September 30, 2009 versus the corresponding period in 2008, primarily as the result of market and foreign exchange depreciation, partially offset by higher incentive fees earned in 2009. Interest income decreased $41 million, or 61%, due to a lower interest rate environment as well as lower average cash balances and receivables from banks. Other revenue increased by $68 million in the nine month period ended September 30, 2009 as compared to the 2008 period principally due to increased investment income and revenue from noncontrolling interests. Other revenue in the 2008 period was negatively impacted by investment-related losses of $43 million in aggregate in our bank’s corporate debt portfolio (redesignated as “available-for-sale” effective July 1, 2008) and the Company’s investment portfolio. With respect to the latter, during the 2009 period, the Company had in place a hedging strategy to minimize its risks associated with volatility in the equity markets. Interest expense for the nine month period ended September 30, 2009 decreased $26 million, or 23%, primarily related to the Company’s May 2008 repurchase of $437 million aggregate principal amount of its 6.12% senior notes in connection with the remarketing of such notes, the partial repurchases of other senior notes and lower interest paid on LFB’s customer deposits.

 

Compensation and benefits expense for the nine month period ended September 30, 2009 decreased by $213 million. Compensation and benefits expense in the 2008 period included a $197 million charge relating to the

 

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LAM Merger in the third quarter of 2008. When excluding such charge, compensation and benefits expense in the 2009 period decreased by $16 million, reflecting lower salary and benefit costs due to the impact of the staff reductions associated with the restructuring program implemented during the first quarter of 2009 discussed below, the strengthening of the U.S. dollar versus foreign currencies and lower discretionary bonuses as a result of lower operating revenue, partially offset by $78 million of additional amortization of an increased amount of RSUs and deferred cash awards granted. Compensation and benefits expense was 62.7% of operating revenue in the nine month period ended September 30, 2009, as compared to 55.7% in the 2008 period excluding the impact of the LAM Merger. As described above, our compensation ratio for the first nine months of 2009 is not necessarily representative of the ratio for the full year.

 

Non-compensation expense for the nine month period ended September 30, 2009 decreased by $62 million, or 21%, including the $2 million charge relating to the LAM Merger in the 2008 period. Factors contributing to the decrease include (i) the $12 million provision in the 2008 period for losses from counterparty defaults related primarily to the bankruptcy filing of one of our prime brokers, (ii) lower spending on travel and other business development activities, lower consulting and recruiting fees and (iii) the strengthening of the U.S. dollar versus foreign currencies. The ratio of non-compensation expense to operating revenue was 21.3% for the nine month period ended September 30, 2009, as compared to 23.4% of operating revenue for the 2008 period. The ratio, when excluding, in the 2008 period, the $2 million non-compensation charge relating to the LAM merger, was 23.3% of operating revenues in the 2008 period compared to 21.3% in the 2008 period.

 

Amortization of intangible assets for the nine month period ended September 30, 2009 decreased by $2 million principally due to lower amortization of intangibles related to GAHL and CWC, partially offset by an increase related to Edgewater.

 

During the first nine months of 2009, we continued to redeploy our banking professionals into growth areas and reduced staffing in other areas to further optimize our mix of personnel. As a result, a pre-tax charge of $62 million was recorded in the first quarter of 2009 in connection with severance and benefit payments, the acceleration of unrecognized expense pertaining to RSUs previously granted to individuals who were terminated and certain other costs related to the restructuring initiative.

 

Operating income for the nine month period ended September 30, 2009 was $40 million, an increase of $69 million as compared to an operating loss of $29 million in the 2008 period (including the impact of the restructuring charge in the first quarter of 2009 and the LAM Merger charge in the third quarter of 2008). Excluding the impact of such charges, operating income in the 2009 period was $103 million, a decline of $68 million, or 40%, from operating income in the 2008 period of $171 million. As a percentage of net revenue, operating income in the 2009 period was 4% as compared to an operating loss of (2)% in the corresponding period in 2008. When excluding the impact of such of the restructuring charge in the 2009 period and charge related to the LAM Merger in the 2008 period, operating income as a percentage of net revenue in the 2009 period was 10% compared to 14% in the 2008 period.

 

The provision for income taxes for the nine month period ended September 30, 2009 was $30 million, an increase of $7 million compared to a tax provision of $23 million in the 2008 period. When excluding the tax benefits of $6 million relating to the restructuring charge in the first quarter of 2009 and $7 million related to the LAM Merger in the 2008 period, the income tax provision in the 2009 period increased by $6 million.

 

Net income attributable to noncontrolling interests for the nine month period ended September 30, 2009 increased by $11 million as compared to the 2008 period due to a higher charge related to revenue from noncontrolling interests (included in “revenue – other”).

 

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Business Segments

 

The following is a discussion of net revenue and operating income (loss) for the Company’s business segments - Financial Advisory, Asset Management and Corporate. Each segment’s operating expenses include (i) compensation and benefits expense incurred directly in support of the segment and (ii) other operating expenses, which include directly incurred expenses for occupancy and equipment, marketing and business development, technology and information services, professional services, fund administration and outsourcing, and indirect support costs (including compensation and benefits expense and other operating expenses related thereto) for administrative services. Such administrative services include, but are not limited to, accounting, tax, legal, facilities management and senior management activities. Such support costs are allocated to the relevant segments based on various statistical drivers such as, among other items, headcount, square footage and transactional volume. For the nine month period ended September 30, 2009, restructuring expense was recorded in the Corporate segment.

 

Financial Advisory

 

The following table summarizes the operating results of the Financial Advisory segment:

 

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

M&A and Strategic Advisory

   $ 124,691      $ 230,890      $ 356,020      $ 621,982   

Restructuring

     119,101        23,944        273,261        72,148   

Capital Markets and Other Advisory

     15,429        14,906        44,941        76,569   
                                

Net Revenue

     259,221        269,740        674,222        770,699   

Operating Expenses (a)

     212,543        197,494        595,649        601,927   
                                

Operating Income

   $ 46,678      $ 72,246      $ 78,573      $ 168,772   
                                

Operating Income, as a Percentage of Net Revenue

     18     27     12     22
                                

 

     As of September 30,
         2009            2008    

Headcount (b):

     

Managing Directors

   146    152

Limited Managing Directors

   3    5

Other Employees:

     

Business segment professionals

   683    698

All other professionals and support staff

   215    249
         

Total

   1,047
   1,104
         

 

(a) Includes indirect support costs (including compensation and benefits expense and other operating expenses related thereto).
(b) Excludes headcount related to indirect support functions, with such headcount being included in the Corporate segment.

 

Net revenue trends in Financial Advisory for M&A and Strategic Advisory and Restructuring are generally correlated to the volume of completed industry-wide M&A transactions and restructurings occurring subsequent to corporate debt defaults, respectively. However, deviations from this relationship can occur in any given year for a number of reasons. For instance, our results can diverge from industry-wide activity where there are material variances from the level of industry-wide M&A activity in a particular market where Lazard has significant market share, or regarding the relative number of our advisory engagements with respect

 

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to larger-sized transactions, and where we are involved in significant non-public assignments. Certain Lazard client statistics and global industry statistics are set forth below:

 

     Nine Months Ended
September 30,
 
         2009             2008      

Lazard Statistics:

    

Number of Clients:

    

Total

   478      548   

With Fees Greater Than $1 Million

   188      167   

Percentage of Total Financial Advisory Revenue From Top 10 Clients

   19   24

Number of M&A Transactions Completed With Values Greater Than $1 Billion (a)

   23      34   

 

(a) Source: Thomson Financial as of October 14, 2009

 

The geographical distribution of Financial Advisory net revenue is set forth below in percentage terms. The offices that generate Financial Advisory net revenue are located in the U.S., Europe (principally in the U.K., France, Italy, Spain and Germany) and the rest of the world (principally in Australia).

 

     Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
         2009             2008             2009             2008      

United States

   47   46   51   51

Europe

   45      50      43      43   

Rest of World

   8      4      6      6   
                        

Total

   100   100   100   100
                        

 

The Company’s managing directors and many of its professionals have significant experience, and many of them are able to use this experience to advise on M&A, strategic advisory matters and restructuring transactions, depending on clients’ needs. This flexibility allows Lazard to better match its professionals with the counter-cyclical business cycles of mergers and acquisitions and restructurings. While Lazard measures revenue by practice area, Lazard does not separately measure the costs or profitability of M&A and strategic advisory services as compared to restructuring services. Accordingly, Lazard measures performance in its Financial Advisory segment based on overall segment net revenue and operating income margins.

 

Financial Advisory Results of Operations

 

Financial Advisory’s quarterly revenue and profits can fluctuate materially depending on the number, size and timing of completed transactions on which it advised, as well as seasonality and other factors. Accordingly, the revenue and profits in any particular quarter or period may not be indicative of future results. Lazard management believes that annual results are the most meaningful basis for comparison among present, historical and future periods.

 

Three Months Ended September 30, 2009 versus September 30, 2008

 

For the three month period ended September 30, 2009, Financial Advisory net revenue decreased $11 million, or 4%, as compared to the corresponding period in 2008, reflecting a change in the mix of advisory activities as M&A and Strategic Advisory revenue decreased $106 million, or 46%, substantially offset by Restructuring revenue which increased $95 million, or 397%, and Capital Markets and Other Advisory net revenue which increased $0.5 million, or 4%.

 

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The decrease in M&A and Strategic Advisory revenue for the three month period ended September 30, 2009 was principally due to the continued weakness related to M&A activity described above, which resulted in a lower number of transactions and lower average fees per transaction. Our major clients, which in the aggregate represented a significant portion of our M&A and Strategic Advisory revenue for the 2009 period, included Anheuser-Busch InBev, Caisse d’Epargne, Eurotunnel, GlaxoSmithKline, IBM, KKR Private Equity Investors, Kraft Foods, and Theolia.

 

Restructuring revenue is derived from various activities including bankruptcy assignments, global debt and financing restructurings, distressed asset sales and advice on complex on- and off-balance sheet assignments, such as retiree health care obligations. Restructuring revenue during the 2009 period increased significantly as compared to the 2008 period due to the significant increases in defaults and in-court and out-of-court restructurings. Notable assignments completed in the third quarter of 2009 included Asciano, CapitalSource, Cemex, Ineos Group and Landsource. Recently announced Restructuring assignments that we are currently involved with include in-court Chapter 11 bankruptcies and restructuring and debt advisory assignments relating to major industry groups such as Automotive, Chemicals, Consumer Goods, Professional and Financial Services, Real Estate and Property Development, Technology and Media, Gaming, Entertainment and Hospitality, among others.

 

Capital Markets and Other Advisory net revenue in the 2009 period reflected increases in the value of fund closings by our Private Fund Advisory Group, which were principally offset by decreases in Equity Capital Markets transactions and private placements, which have been impacted by the deterioration of the financial markets in 2008 and 2009. Transactions in the third quarter of 2009 included Gores III and Triton III in our Private Fund Advisory Group, A123 Systems and CDC Corporation on their IPOs, Onyx Pharmaceuticals on its new convertible issue, and ARIAD Pharmaceuticals on its follow-on capital markets transaction. In addition, we advised on Private Investment in Public Equity transactions (“PIPEs”) and Registered Direct (“RD”) Offerings for Orexigen and Oxigene.

 

Operating expenses for the three month period ended September 30, 2009 increased $15 million, or 8%, as compared to the 2008 period, primarily due to additional amortization of RSUs and deferred cash awards granted, partially offset by lower salaries and benefits due to the impact of the staff reductions associated with the restructuring program implemented during the first quarter of 2009, the strengthening of the U.S. dollar versus foreign currencies, lower discretionary bonuses as a result of lower operating revenue, reductions in travel and other business development expenses and technology expenses.

 

Financial Advisory operating income for the third quarter of 2009 was $47 million, a decrease of $26 million as compared to the 2008 period, and represented 18% of segment net revenues for the 2009 period, as compared to 27% in the 2008 period.

 

Nine Months Ended September 30, 2009 versus September 30, 2008

 

For the nine month period ended September 30, 2009, Financial Advisory net revenue decreased $96 million, or 13%, as compared to the corresponding period in 2008, reflecting a change in the mix of advisory activities as M&A and Strategic Advisory revenue decreased $266 million, or 43%, and Capital Markets and Other Advisory net revenue decreased $32 million, or 41%, with such decreases partially offset by Restructuring revenue which increased $201 million, or 279%, which includes fees for advising on distressed asset sales.

 

The decrease in M&A and Strategic Advisory revenue for the nine month period ended September 30, 2009 was principally due to the adverse economic and market conditions described above, which resulted in lower average fees per transaction for clients generating fee revenues greater than $1 million.

 

The decrease in Capital Markets and Other Advisory net revenue reflected decreases in the value of fund closings by our Private Fund Advisory Group and private placements by our Capital Markets Group, as well as declines in Equity Capital Markets transactions, all of which have been impacted by the continued deterioration of the financial markets during 2009.

 

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Operating expenses for the nine month period ended September 30, 2009 decreased $6 million, or 1%, as compared to the 2008 period, primarily due to lower salaries and benefits due to the impact of the staff reductions associated with the restructuring program implemented during the first quarter of 2009, the strengthening of the U.S. dollar versus foreign currencies, lower discretionary bonuses as a result of lower operating revenue, partially offset by additional amortization of an increased amount of RSUs and deferred cash incentive awards granted. Other factors contributing to the decrease were lower costs related to travel and other business development expenses, technology expenses and support group charges.

 

Financial Advisory operating income for the first nine months of 2009 was $79 million, a decrease of $90 million as compared to the 2008 period, and represented 12% of segment net revenues for the 2009 period, as compared to 22% in the 2008 period.

 

Asset Management

 

The following table shows the composition of AUM for the Asset Management segment:

 

     As of
     September 30,
2009
   December 31,
2008
    

($ in millions)

AUM:

     

International Equities

   $ 30,826    $ 25,000

Global Equities

     51,414      31,553

U.S. Equities

     14,889      13,177
             

Total Equities

     97,129      69,730
             

European and International Fixed Income

     14,078      12,690

Global Fixed Income

     2,063      1,183

U.S. Fixed Income

     2,429      1,951
             

Total Fixed Income

     18,570      15,824
             

Alternative Investments

     3,582      3,196

Private Equity(a)

     783      1,579

Cash Management

     121      780
             

Total AUM

   $ 120,185    $ 91,109
             

 

(a) At September 30, 2009, includes $0.6 billion related to the July 15, 2009 acquisition of Edgewater’s management vehicles and no longer includes AUM of FPG and the investment company for which Lazard may earn carried interests (which amounted to $1.4 billion of AUM at December 31, 2008) due to the sale of FPG effective September 30, 2009.

 

Average AUM for the three month and nine month periods ended September 30, 2009 and 2008 is set forth below. Average AUM is based on an average of quarterly ending balances for the respective periods.

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
         2009            2008            2009            2008    
     ($ in millions)

Average AUM

   $ 109,102    $
123,713
   $ 97,599    $
130,758