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EX-31.2 - EXHIBIT 31.2 - ZAIS Group Holdings, Inc.tv492947_ex31-2.htm
EX-32.2 - EXHIBIT 32.2 - ZAIS Group Holdings, Inc.tv492947_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - ZAIS Group Holdings, Inc.tv492947_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - ZAIS Group Holdings, Inc.tv492947_ex31-1.htm
EX-10.3 - EXHIBIT 10.3 - ZAIS Group Holdings, Inc.tv492947_ex10-3.htm
EX-10.2 - EXHIBIT 10.2 - ZAIS Group Holdings, Inc.tv492947_ex10-2.htm
EX-10.1 - EXHIBIT 10.1 - ZAIS Group Holdings, Inc.tv492947_ex10-1.htm

 

 

 

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 March 31, 2018

 

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

 

For the transition period from                      to                     

 

Commission file number: 001-35848

 

ZAIS GROUP HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 46-1314400
(State or Other Jurisdiction of
Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

Two Bridge Avenue, Suite 322

Red Bank, NJ 07701-1106

(Address of Principal Executive Offices and Zip Code)

 

(732) 978-7518
(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨

 

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 May 10, 2018, 14,618,332 shares of Class A common stock, par value $0.0001 per share, and 20,000,000 shares of Class B Common Stock, par value $0.000001 per share, were issued and outstanding. 

 

 

 

 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION 3
   
Item 1. Financial Statements 3
   
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 50
   
Item 4. Controls and Procedures 75
   
PART II − OTHER INFORMATION 75
   
Item 1. Legal Proceedings 75
   
Item 1A. Risk Factors 76
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 76
   
Item 3. Defaults Upon Senior Securities 76
   
Item 4. Mine Safety Disclosures 76
   
Item 5. Other Information 76
   
Item 6. Exhibits 77
   
SIGNATURES 78

 

EXHIBIT 31.1  CERTIFICATIONS
 
EXHIBIT 31.2  CERTIFICATIONS
 
EXHIBIT 32.1  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350
 
EXHIBIT 32.2  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350

 

 2 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Financial Condition (Unaudited)
(Dollars in thousands, except share amounts)

 

  

March 31,

2018

  

December 31,

2017

 
         
Assets          
Cash and cash equivalents  $30,906   $41,619 
Income and fees receivable   2,947    8,863 
Investments in affiliates, at fair value   158    10,151 
Due from related parties   594    798 
Property and equipment, net   1,791    278 
Prepaid expenses   786    967 
Withdrawals receivable   9,380     
Other assets   1,570    359 
Assets of Consolidated Variable Interest Entities          
Cash   29,762    8,975 
Investments in affiliated securities, at fair value – $46,212 and $46,136 pledged as collateral for repurchase agreement, at March 31, 2018 and December 31, 2017, respectively.   117,195    114,911 
Other assets   619    968 
Total Assets  $195,708   $187,889 
           
Liabilities and Equity          
Liabilities          
Compensation payable  $2,427   $9,222 
Due to related parties       31 
Fees payable   2,235    2,171 
Other liabilities   1,686    1,285 
Liabilities of Consolidated Variable Interest Entities          
Repurchase agreement   45,500    45,943 
Other liabilities   451    415 
Total Liabilities   52,299    59,067 
           
Commitments and Contingencies (Note 12)          
           
Equity          
Preferred Stock, $0.0001 par value; 2,000,000 shares authorized; 0 shares issued and outstanding.        
Class A Common Stock, $0.0001 par value; 180,000,000 shares authorized; 14,555,113 and 14,555,113 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively.   1    1 
Class B Common Stock, $0.000001 par value; 20,000,000 shares authorized; 20,000,000 shares issued and outstanding at March 31, 2018 and December 31, 2017.        
Additional paid-in capital   64,436    64,365 
Retained earnings (Accumulated deficit)   (27,191)   (23,414)
Accumulated other comprehensive income (loss)   (55)   (61)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   37,191    40,891 
Non-controlling interests in ZAIS Group Parent, LLC   17,755    19,568 
Non-controlling interests in Consolidated Funds   88,463    68,363 
Total Equity   143,409    128,822 
Total Liabilities and Equity  $195,708   $187,889 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 3 

 

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(Dollars in thousands, except share and per share amounts)

 

  

Three Months Ended

March 31,

 
   2018   2017 
Revenues        
Management fee income  $5,063   $3,107 
Incentive income   146    297 
Reimbursement revenue   309    494 
Other revenues   77    93 
Income of Consolidated Funds   1,013     
Total Revenues   6,608    3,991 
Expenses          
Compensation and benefits   6,086    7,424 
General, administrative and other   4,496    3,669 
Depreciation and amortization   16    40 
Expenses of Consolidated Funds   480    43 
Total Expenses   11,078    11,176 
Other income (loss)          
Net gain (loss) on investments in affiliates   (586)   75 
Other income (expense)   104    (16)
Net gain (loss) of Consolidated Funds’ investments in affiliated securities   2,130    1,107 
Net gain (loss) on beneficial interest of consolidated collateralized financing entity       589 
Total Other Income (Loss)   1,648    1,755 
Income (loss) before income taxes   (2,822)   (5,430)
Income tax (benefit) expense   4    5 
Consolidated net income (loss)   (2,826)   (5,435)
Other comprehensive income (loss), net of tax:          
Foreign currency translation adjustment   9    30 
Total Comprehensive Income (Loss)  $(2,817)  $(5,405)
           
Allocation of Consolidated Net Income (Loss)          
Non-controlling interests in Consolidated Funds  $2,767   $810 
Stockholders’ equity, ZAIS Group Holdings, Inc.   (3,777)   (4,162)
Non-controlling interests in ZAIS Group Parent, LLC   (1,816)   (2,083)
Total Allocation of Consolidated Net Income (Loss)  $(2,826)  $(5,435)
           
Allocation of Total Comprehensive Income (Loss)          
Non-controlling interests in Consolidated Funds  $2,767   $810 
Stockholders’ equity, ZAIS Group Holdings, Inc.   (3,771)   (4,142)
Non-controlling interests in ZAIS Group Parent, LLC   (1,813)   (2,073)
Total Allocation of Total Comprehensive Income (Loss)  $(2,817)  $(5,405)
           
Consolidated Net Income (Loss), per Class A common share applicable to ZAIS Group Holdings, Inc. – Basic  $(0.26)  $(0.30)
Consolidated Net Income (Loss), per Class A common share applicable to ZAIS Group Holdings, Inc. – Diluted  $(0.26)  $(0.30)
           
Weighted average shares of Class A common stock outstanding:          
Basic   14,555,113    13,986,305 
Diluted   21,555,113    20,986,305 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 4 

 

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Equity and Non-controlling Interests (Unaudited)
(Dollars in thousands except share amounts)

 

   Class A Common Stock   Class B Common Stock   Additional
paid-in-capital
   Retained
earnings
(Accumulated
deficit)
   Accumulated
other
comprehensive
income
(loss)
   Non-controlling
interests in
ZAIS Group
Parent, LLC
   Non-controlling
interests in
Consolidated
Funds
   Total
Equity
 
   Shares   Amount   Shares   Amount                         
Three Months Ended March 31, 2018                                                  
December 31, 2017   14,555,113   $1    20,000,000   $-   $64,365   $(23,414)  $(61)  $19,568   $68,363   $128,822 
                                                   
Capital contributions   -    -    -    -    -    -    -    -    17,333    17,333 
Equity-based compensation charges   -    -    -    -    71    -    -    -    -    71 
Consolidated net income (loss)   -    -    -    -    -    (3,777)   -    (1,816)   2,767    (2,826)
Other comprehensive income (loss)   -    -    -    -    -    -    6    3    -    9 
March 31, 2018   14,555,113   $1    20,000,000   $-   $64,436   $(27,191)  $(55)  $17,755   $88,463   $143,409 
                                                   

Three Months Ended March 31, 2017 

                                                  
                                                   
December 31, 2016   13,900,917   $1    20,000,000   $-   $63,413   $(18,965)  $(70)  $22,258   $23,328   $89,965 
Settlement of Restricted Stock Units   548,923    -    -    -    527    -    -    (527)   -    - 
Payment of employee taxes in connection with net settlement of Restricted Stock Units   -    -    -    -    (534)   -    -    (267)   -    (801)
Modification of equity awards to liability awards   -    -    -    -    (17)   -    -    (9)   -    (26)
Capital contributions   -    -    -    -    -    -    -    -    5,880    5,880 
Equity-based compensation charges   -    -    -    -    741    -    -    371    -    1,112 
Consolidated net income
(loss)
   -    -    -    -    -    (4,162)   -    (2,083)   810    (5,435)
Other comprehensive income (loss)   -    -    -    -    -    -    20    10    -    30 
March 31, 2017   14,449,840   $1    20,000,000   $-   $64,130   $(23,127)  $(50)  $19,753   $30,018   $90,725 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 5 

 

  

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)

 

  

Three Months Ended

March 31,

 
   2018   2017 
         
Cash Flows from Operating Activities          
Consolidated net income (loss)  $(2,826)  $(5,435)
Adjustments to reconcile consolidated net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   16    40 
Net (gain) loss on investments in affiliates   612    (75)
Non-cash stock-based compensation   71    1,112 
Cash Flows Due to Changes in Operating Assets and Liabilities:          
Income and fees receivable   5,916    7,305 
Due from related parties   204    (628)
Prepaid expenses   181    (544)
Other assets   (1,211)   31 
Compensation payable   (6,795)   (5,655)
Due to related parties   (31)    
Fees payable   64    63 
Other liabilities   (145)   276 
Proceeds from investments in affiliates       62 
Items related to Consolidated Funds:          
Purchases of investments and investments in affiliated securities   (55,350)   (123,951)
Proceeds from sale of investments and investments in affiliated securities   52,500    78,691 
Proceeds from sale of beneficial interest of collateralized financing entities and distributions from CLO warehouses   2,567    5,390 
Net (gain) loss on investments in affiliated securities   (2,000)   422 
Net (gain) loss on beneficial interest of consolidated collateralized financing entity       589 
Change in due from broker       7,097 
Change in other assets   (95)   91 
Change in due to broker       (2,766)
Change in other liabilities   36    2,991 
Net Cash Provided by (Used in) Operating Activities   (6,286)   (34,894)
           
Cash Flows from Investing Activities          
Purchases of property and equipment   (983)    
Purchases of investments in affiliates   1     
Net Cash Provided by (Used in) Investing Activities   (982)    
           
Cash Flows from Financing Activities          
Payment of employee taxes in connection with net settlement of RSUs       (801)
Repayment of notes payable       (1,263)
Contributions from non-controlling interests in Consolidated Funds   17,333    5,880 
Net Cash Provided by (Used in) Financing Activities   17,333    3,816 
           
Net increase (decrease) in cash and cash equivalents denominated in foreign currency   9    30 
Net increase (decrease) in cash and cash equivalents   10,074    (31,048)
Cash and cash equivalents, beginning of period   50,594    75,792 
Cash and cash equivalents, end of period  $60,668   $44,744 
           
Supplemental Cash Flow Information:          
Income taxes paid  $   $ 
Interest expense paid on Notes Payable  $   $16 
Interest expense paid on Repurchase Agreement  $366   $ 
           
Non-Cash Investing Activities:          
Purchases of leasehold improvements  $546   $ 
Withdrawals receivable  $9,380   $ 
           
Reconciliation of Cash and cash equivalents reported in the Consolidated Statements of Financial Condition to the amounts shown in the Consolidated Statements of Cash Flows:          
Cash and cash equivalents  $30,906   $25,456 
Cash of Consolidated Variable Interest Entities   29,762    19,288 

Total cash and cash equivalents reported in the Consolidated Statements of

Cash Flows

  $60,668   $44,744 

 

Cash of Consolidated Variable Interest Entities is comprised of cash accounts held by Zephyr A-6. These accounts belong to the investors of Zephyr A-6 and are available for its use. This cash is not available for use by the Company.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 6 

 

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

1. Organization

 

ZAIS Group Holdings, Inc. (“ZAIS”, and collectively with its consolidated subsidiaries, as the context may require, the “Company”) is a holding company conducting substantially all of its operations through ZAIS Group, LLC (“ZAIS Group”), an investment advisory and asset management firm focused on specialized credit which commenced operations in July 1997 and is headquartered in Red Bank, New Jersey. ZAIS Group also maintains an office in London. ZAIS Group is a wholly-owned consolidated subsidiary of ZAIS Group Parent, LLC (“ZGP”), a majority-owned consolidated subsidiary of ZAIS. ZAIS is the managing member of ZGP.

 

ZAIS Group is registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940 and with the Commodity Futures Trading Commission as a Commodity Pool Operator and Commodity Trading Advisor. ZAIS Group provides investment advisory and asset management services to private funds, separately managed accounts and structured vehicles (collateralized debt obligation vehicles and collateralized loan obligation vehicles, together referred to as “CLOs”) (collectively, the “ZAIS Managed Entities”).

 

Commencing in 2015, the Company’s management and its board of directors (“Board of Directors”) have been conducting periodic strategic reviews of the Company’s business in order to enhance shareholder value. On February 15, 2017, the Board of Directors established a special committee of independent and disinterested directors (the “Special Committee”) to consider any proposals thereafter by management or third parties for strategic transactions, as well as to consider all other strategic options for the Company. On September 5, 2017, Z Acquisition LLC (“Z Acquisition”), an entity in which Christian Zugel (“Mr. Zugel”), the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group, is the managing member, entered into a share purchase agreement with Ramguard LLC (“Ramguard”), pursuant to which Z Acquisition LLC agreed to acquire 6,500,000 shares of Class A Common Stock (“Class A Common Stock”) of the Company at a purchase price of $4.00 per share for a combination of cash and a note, which was amended and restated on January 11, 2018 (as amended and restated, the “Share Purchase Agreement”) to, among other things, increase the purchase price to $4.10 per share. After giving effect to the Share Purchase Agreement, Mr. Zugel would hold, directly or indirectly, 6,800,000 shares of the Class A Common Stock and 3,325,000 Class A Units of ZGP (“Class A Units”). Also, on September 5, 2017, the Special Committee received a letter (the “Letter”) from Mr. Zugel seeking to pursue discussions with the Special Committee to take the Company private by acquiring through a merger the remaining issued and outstanding shares of Class A Common Stock of the Company, other than shares held by Mr. Zugel and his affiliates, at $4.00 per share in an all cash transaction. On January 11, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Z Acquisition, and ZGH Merger Sub, Inc., a wholly-owned subsidiary of the Company (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a subsidiary of Z Acquisition. Mr. Zugel is the sole managing member of Z Acquisition, and Daniel Curry, the Company’s Chief Executive Officer, President and a Director, is a member of Z Acquisition. At the effective time of the Merger, shares of Class A Common Stock, other than shares held by Mr. Zugel, affiliates of Mr. Zugel, and certain other shareholders, will be converted into the right to receive $4.10 per share in cash without interest, subject to any required withholding taxes. All outstanding restricted stock units (“RSUs”) are held by the Company’s independent directors and will also be converted in the Merger into the right to receive $4.10 per share in cash for the number of shares of Class A Common Stock underlying such RSUs. The proposed Merger is a “going private transaction” under SEC rules. There is no assurance that the Merger will be consummated.

 

The Company filed a Definitive Proxy Statement on March 30, 2018. The Company established April 2, 2018 as the record date for stockholders entitled to vote at its 2017 Annual Meeting of Stockholders (the “Annual Meeting”), which has been scheduled for May 17, 2018. Stockholders of record at the close of business on April 2, 2018 may vote at the Annual Meeting. At the Annual Meeting, stockholders will be asked to consider and vote upon a proposal to adopt the Merger Agreement. Stockholders will also be asked to elect the Company’s Board of Directors, approve the adjournment of the Annual Meeting, if necessary, to solicit additional proxies if there are insufficient votes at the time of the Annual Meeting to approve adoption of the Merger Agreement, and vote on any other matter properly brought before the Annual Meeting.

 

 7 

 

  

The ZAIS Managed Entities predominantly invest in a variety of specialized credit instruments including corporate credit instruments such as leveraged bank loans and CLOs, real estate, securities backed by residential and commercial mortgage loans and asset backed securities collateralized by a range of consumer loan products. ZAIS Group’s assets under management (“AUM”) is primarily comprised of (i) total assets for mark-to-market funds and separately managed accounts; (ii) uncalled capital commitments, if any, for funds that are not in liquidation; and (iii) for issued structured vehicles, all assets being managed calculated per the management fee basis methodology defined in the respective vehicles’ indenture, although in certain circumstances some or all of the referenced management fees may be waived.  AUM also includes assets in the warehouse phase for new structured credit vehicles and is based on actual assets managed without reductions for leverage and most other liabilities and includes all assets regardless of whether management fees are being earned.

 

ZAIS Group had the following AUM:

 

Reporting Period 

AUM

(in billions)

 
As of March 31, 2018(1)  $4.793 
As of December 31, 2017  $4.512 

 

(1) In order to finance a portion of the purchase of the Company’s Class A Common Stock pursuant to the Share Purchase Agreement, Sonia Zugel, Mr. Zugel’s spouse, has indicated an intention to withdraw approximately $1.7 million of interests from the ZAIS Opportunity Domestic Feeder Fund, LP (the “Domestic Feeder”), which serves as the feeder fund to ZAIS Opportunity Master Fund, Ltd, a ZAIS Managed Entity, effective September 30, 2018. The AUM presented has not been reduced for this withdrawal request.

 

ZAIS Group also serves as the general partner to certain ZAIS Managed Entities, which are generally organized as pass-through entities for U.S. federal income tax purposes.

 

The Company’s primary sources of revenues are (i) management fee income, which is based predominantly on the net asset values of the funds and accounts managed by ZAIS Group or par values of the collateral and cash held by CLOs managed by ZAIS Group (“ZAIS CLOs”) and (ii) incentive income, which is based on the investment performance of the ZAIS Managed Entities.

 

Additionally, a significant source of the Company’s revenues and other income is derived from the underlying investments of certain ZAIS Managed Entities (including CLOs) which are consolidated by the Company (the “Consolidated Funds”). This income is comprised of interest, dividends and net gains from the underlying investments in CLOs and net gains on beneficial interests of consolidated collateralized financing entities which invest in first lien, senior secured loans. A portion of income of Consolidated Funds and net gains of Consolidated Funds’ investments are allocated to non-controlling interests in Consolidated Funds.

 

2. Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited, interim, condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") as contained within the Financial Accounting Standards Board’s ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the SEC for interim reporting. In the opinion of management, all adjustments considered necessary for a fair statement of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for the interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP as contained in the ASC have been condensed or omitted from the unaudited interim condensed consolidated financial statements according to the SEC rules and regulations. The information and disclosures contained in these unaudited interim condensed consolidated financial statements and notes should be read in conjunction with the condensed consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K. Certain comparative amounts in the condensed consolidated financial statements have been reclassified to conform to the current period presentation.

 

 8 

 

 

Fair Value Option

 

U.S. GAAP permits entities to choose to measure certain eligible financial assets, financial liabilities and firm commitments at fair value (the “Fair Value Option”), on an instrument-by-instrument basis. The election to use the Fair Value Option is available when an entity first recognizes a financial asset or financial liability or upon entering into a firm commitment. The Fair Value Option is irrevocable and requires changes in fair value to be recognized in earnings. The Company has elected the Fair Value Option for Investments in affiliates and Investments in affiliated securities, at fair value.

 

Specifically, the Company has applied the Fair Value Option to consolidated CLOs as described more fully below. See Note 4 for further disclosure on the assets and liabilities of consolidated CLOs for which the Fair Value Option has been elected.

 

The Company has also applied the Fair Value Option to its investments in the ZAIS Managed Entities that are not consolidated. The Company believes that reporting the fair value of these investments is more indicative of the Company’s financial position than the equity method of accounting. See Note 3 for further disclosure on investments in affiliates for which the Fair Value Option has been elected.

 

Segment Reporting

 

The Company currently is comprised of one reportable segment, the investment management segment, and all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities.

 

Use of Estimates

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the estimates used in preparing the condensed consolidated financial statements are reasonable and prudent, actual results may ultimately materially differ from those estimates.

 

Principles of Consolidation

 

The condensed consolidated financial statements included herein are the financial statements of ZAIS, its subsidiaries and the Consolidated Funds. All intercompany balances and transactions are eliminated in consolidation, including ZAIS’s investment in ZGP and ZGP’s investment in ZAIS Group. The Company's fiscal year ends on December 31.

 

The condensed consolidated financial statements include (i) non-controlling interests in ZGP which is comprised of Class A Units held by Mr. Zugel and certain related parties (collectively, the “ZGP Founder Members”) and (ii) the non-controlling interests in the Consolidated Funds. The Company’s condensed consolidated financial statements also include (i) ZGP, a voting interest entity in which the Company has a controlling financial interest; (ii) ZAIS Group, a voting interest entity in which ZGP has a controlling financial interest and (iii) the following Consolidated Funds which are VIEs for which ZAIS Group is considered the primary beneficiary during the reporting periods presented:

 

    As of  

Three Months Ended

March 31,

 
Entity  

March 31,

2018

 

December 31,

2017

 

 

2018

 

 

2017

 
                       
ZAIS Zephyr A-6, LP (“Zephyr A-6”)   ü     ü   ü     ü  
                           
ZAIS CLO 5, Limited (“ZAIS CLO 5”)(1)             ü  

 

 (1) ZAIS CLO 5 was consolidated from October 26, 2016 through August 10, 2017 (see Note 5 – “Variable Interest Entities”).

 

 9 

 

 

The Consolidated Funds, except for the consolidated CLO, are deemed to be investment companies under U.S. GAAP, and therefore, the Company has retained the specialized investment company accounting of these consolidated entities in its condensed consolidated financial statements.

 

For the consolidated CLO, the Company used the measurement alternative included in the collateralized financing entity guidance (the “Measurement Alternative”). The Company measured both the financial assets and financial liabilities of the consolidated CLO in its condensed consolidated financial statements using the fair value of the financial assets of the consolidated CLO, which were more observable than the fair value of the financial liabilities of the consolidated CLO. As a result, the financial assets of the consolidated CLO were measured at fair value and the financial liabilities were measured in consolidation as: the sum of the fair value of the financial assets and the carrying value of any non-financial assets that were incidental to the operations of the CLO less (ii) the sum of the fair value of any beneficial interests retained by the reporting entity (other than those that represent compensation for services) and the Company’s carrying value of any beneficial interests that represented compensation for services. The resulting amount was allocated to the individual financial liabilities (other than the beneficial interest retained by the Company) using a reasonable and consistent methodology. Under the Measurement Alternative, the Company’s consolidated net income reflects the Company’s own economic interests in the consolidated CLO including changes in the (i) fair value of the beneficial interests retained by the Company and (ii) beneficial interests that represent compensation for collateral management services. Such changes are presented in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

Non-Controlling Interests

 

The non-controlling interests within the Consolidated Statements of Financial Condition are comprised of (i) equity attributable to non-controlling interests in Consolidated Funds (excluding CLOs) reported inside the permanent capital section when the investors do not have the right to redeem their interests and (ii) equity attributable to non-controlling interests in ZGP inside the permanent capital section.

 

Changes in the Company’s ownership interest while the Company retains its controlling financial interest in its subsidiary are accounted for as equity transactions. Therefore, no gain or loss is recognized in the Company’s consolidated statements of comprehensive income (loss). The carrying amount of the non-controlling interest is adjusted to reflect the change in its ownership interest in the subsidiary. Any difference between the fair value of the consideration received or paid and the amount by which the non-controlling interest is adjusted is recognized in equity attributable to ZAIS Group.

 

Allocations of income and loss to non-controlling interests follow the contractual provisions of the pertinent agreements. Accordingly, amounts of incentive compensation due to ZAIS from Consolidated Funds are not deducted from non-controlling interest holders’ capital accounts until the applicable legal conditions for incentive income have been fulfilled.

 

Revenue Recognition

 

ZAIS Group’s primary sources of revenue are (i) management fee income, (ii) incentive income and (iii) income of Consolidated Funds. The management fee income and incentive income are derived from ZAIS Group’s advisory agreements with the ZAIS Managed Entities, which ZAIS considers to be its clients. Certain investments held by employees, executives and other related parties in the ZAIS Managed Entities are not subject to management fees or incentive fees/allocations and therefore do not generate revenue for ZAIS Group. All of the management fee income and incentive income earned by ZAIS Group from the Consolidated Funds are eliminated in consolidation.

 

Management Fee Income

 

ZAIS Group earns management fee income for investment advisory and asset management services provided to the ZAIS Managed Entities. ZAIS Group earns management fees from the funds and accounts it manages. Such management fees are generally based on a fixed percentage of (i) the net asset value of these funds and accounts prior to the accrual of incentive fees/allocations or (ii) drawn capital during the investment period. Management fees are calculated and collected on a monthly or quarterly basis, depending on the applicable agreement.

 

 10 

 

 

Management fee income earned for ZAIS CLOs is generally based on a fixed percentage of the par value of the collateral and cash held in the CLOs. Additionally, subordinated management fee income may be earned from the ZAIS CLOs for which ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager. Subordinated management fees are additional payments, but have a lower priority in the CLOs’ cash flows than non-subordinated management fees and are contingent upon the economic performance of the respective CLOs. If the CLOs experience a certain level of asset defaults, these fees may not be paid. There is no recovery by the CLOs of previously paid subordinated fees.

 

A fixed percentage asset-based management fee is considered a type of variable consideration. The amount of revenue recognized is limited to the amount for which it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur in future periods. The Company updates its estimate of the variable consideration each reporting period. Any uncertainty related to the variable consideration will be resolved as of the end of each reporting period. The Company attributes the management fee income to the services provided during the period because the fee relates specifically to the entity’s efforts to transfer the services for that period.

 

In the event management fee income is received before it is earned, deferred revenue is recorded and is included in Other liabilities in the Consolidated Statements of Financial Condition.

 

Incentive Income

 

ZAIS Group earns incentive income for investment advisory and asset management services provided to the ZAIS Managed Entities. Incentive income typically arises from investment management activities that were initially undertaken in prior reporting periods and is recognized when it is (i) contractually receivable and (ii) the Company concludes that it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur when any uncertainty, which existed at the time the revenue was recognized, is resolved, which generally occurs in the quarter of, or the quarter immediately prior to, payment of the incentive income to ZAIS Group by the ZAIS Managed Entities.

 

The criteria for revenue recognition related to incentive income is typically met only after all contributed capital and the preferred return, if any, on that capital have been distributed to the ZAIS Managed Entities’ investors for vehicles with private equity style fee arrangements, and is typically met only after (i) any profits exceed a high-water mark for vehicles with hedge fund style fee arrangements, (ii) all contributed capital and the preferred return, if any, have been distributed to the investors in vehicles with private equity-style fee arrangements and (iii) all contributed capital and the preferred return, if any, have been distributed to the investors and subordinate management fees (if any) have been paid to the collateral manager for CLOs.

 

The Company primarily considers the type of assets held by each ZAIS Managed Entity, cash held by the entity, estimated future expenses and potential fluctuations in the expected realizable value of investments held by the ZAIS Managed Entity when determining whether or not it is probable that a significant reversal in the cumulative amount of revenue recognized from the entity will not occur when the uncertainty is resolved.

 

Reimbursement Revenue

 

Research and data services expenses (the “Research Costs”) and other costs (the “Other Direct Costs”) relating to the management of the ZAIS Managed Entities are paid by ZAIS Group directly to vendors for which ZAIS Group is the principal. Certain of these amounts may be reimbursable by the respective ZAIS Managed Entities per the terms of the applicable agreement. Reimbursed amounts are recorded as Reimbursement revenue in the Consolidated Statements of Comprehensive Income (Loss). Research Costs and Other Direct Costs which have not yet been collected are included in Due from related parties in the Consolidated Statements of Financial Condition.

 

Other Revenue

 

Other revenue primarily consists of consulting fees. Such consulting services are transferred over time.

 

 11 

 

 

Income of Consolidated Funds

 

Income of Consolidated Funds reflects the interest and dividend income recognized by Zephyr A-6 related to its investments in unconsolidated CLOs. Any discounts and premiums on fixed income securities purchased are accreted or amortized into income or expense using the effective interest rate method over the lives of such securities. The effective interest rates are calculated using projected cash flows including the impact of paydowns on each of the aforementioned securities.

 

Income and Fees Receivable

 

Income and fees receivable primarily includes management fee income and incentive income due from ZAIS Managed Entities, excluding the Consolidated Funds. The Company evaluates the collectability of the amounts receivable to determine whether any allowance for doubtful accounts is necessary.

 

Recently Issued Accounting Pronouncements Adopted by the Company

 

Revenue Recognition

 

Since May 2014, the FASB has issued ASU Nos. 2014-09, 2015-14, 2016-08, 2016-10 and 2016-12, Revenue from Contracts with Customers, which superseded previous revenue recognition guidance, including industry specific guidance. The objective of the new standard and related guidance is to clarify the principles for recognizing revenue. The Company has elected to apply the modified retrospective transition approach on January 1, 2018, the effective date of the new standard. Following this approach, the Company has applied the new standard to contracts which were open at the adoption date and will not adjust prior reporting periods. The adoption of the new standard did not result in a change in the amount and timing of revenue recognition for management fee income, incentive income, reimbursement revenue or other revenue for open contracts at the adoption date. No cumulative adjustment to revenue was required under the modified retrospective transition approach for applicable contracts at the adoption date.

 

Financial Instruments

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The amendments, among other things, (i) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) and (iv) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-01 as of January 1, 2018. The adoption of ASU-2016-01 did not have any impact on the Company’s condensed consolidated financial statements.

 

Share-Based Payments

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payments Accounting ("ASU 2016-09"). ASU 2016-09 simplifies accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the consolidated statement of cash flows. The Company adopted ASU 2016-09 as of January 1, 2017. The adoption of ASU 2016-09 did not have any impact on the Company’s condensed consolidated financial statements.

 

 12 

 

 

Statement of Cash Flows

 

Classification of Certain Receipts and Cash Payments

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early application is permitted, including adoption in an interim period. The Company adopted ASU 2016-15 as of January 1, 2018. The adoption of ASU 2016-15 did not have any impact on the Company’s Consolidated Statements of Cash Flows.

 

Presentation of Change in Cash and Cash Equivalents of Consolidated Funds

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. The amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. ASU 2016-18 is effective for fiscal years and interim periods within those years beginning after December 15, 2017 and requires a retrospective approach to adoption.

 

The Company adopted ASU 2016-18 as of January 1, 2018. After the adoption of ASU 2016-18, changes in cash and cash equivalents of the Consolidated Funds will no longer be presented as a component of the Company's Net Cash Provided by (Used in) Operating Activities. Instead, the changes in cash and cash equivalents of the Consolidated Funds will form part of the reconciliation of the cash and cash equivalents of both the Company and the Consolidated Funds for the reporting period. The adoption of this standard does not impact the Company’s cash and cash equivalents (excluding Consolidated Funds) but is a change in presentation within the Consolidated Statements of Cash Flows. The presentation of the Consolidated Statement of Cash Flows for the three months ended March 31, 2017 has been revised to conform to the presentation for the three months ended March 31, 2018.

 

The impact on the presentation of the Company’s Consolidated Statements of Cash Flows for the three months ended March 31, 2017 was as follows:

 

Line Item  As
Previously
Reported
  

Subsequent to

the Adoption
of
ASU2016-18

 
   (Dollars in thousands) 
         
Items related to Consolidated Funds: Change in cash and cash equivalents  $17,793   $ 
           
Net Cash Used in Operating Activities  $(17,102)  $(34,894)
           
Net decrease in cash and cash equivalents  $(13,256)  $(31,048)
           
Cash and cash equivalents, beginning of period  $38,712   $75,792 
           
Cash and cash equivalents, end of period  $25,456   $44,744 

 

 13 

 

 

Recently Issued Accounting Pronouncements Pending Adoption by the Company

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases. The amendments in ASU No. 2016-02 are effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period with early adoption permitted. The Company is currently evaluating the impact of adopting this new standard.

 

3. Investments in Affiliates, at fair value

 

In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity, which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of May 10, 2018.

 

The Company had investments at December 31, 2017 in two ZAIS Managed Entities that carried first loss risk in the aggregate amount of approximately $10.0 million and such amount is included in Investment in affiliates, at fair value in the Consolidated Statements of Financial Condition at December 31, 2017.

 

On March 12, 2018, ZAIS Group sent notice to terminate its management contracts for these two ZAIS Managed Entities effective March 16, 2018. In connection with the termination of these management contracts, ZAIS Group also requested a complete withdrawal of its investment amounts as of March 30, 2018. The withdrawals were recorded using trade date accounting. The withdrawal receivable of approximately $9.4 million is included in Withdrawals receivable in the Consolidated Statements of Financial Condition at March 31, 2018. ZAIS Group received the majority of the proceeds from the withdrawals in the second quarter of 2018 (see Note 17 – “Subsequent Events”).

 

At March 31, 2018 and December 31, 2017, the Company held investments in one and four unconsolidated ZAIS Managed Entities (excluding an investment in a ZAIS Managed Entity for which no capital has been called as of May 10, 2018), respectively.

  

The Company recorded a change in unrealized gain (loss) associated with the investments still held at the end of each period as follows:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$3   $75 

 

Such amounts are included in Net gain (loss) on investments in affiliates in the Consolidated Statements of Comprehensive Income (Loss).

 

At March 31, 2018 and December 31, 2017, neither the Company’s equity investment, nor the Company’s proportionate share of the total assets of unconsolidated ZAIS Managed Entities in which the Company invested, individually or in the aggregate, exceeded 20% of the Company’s total consolidated assets. Additionally, the Company did not have any income related to these investments, individually or in the aggregate, which exceeded 20% of its total Consolidated net income, for the three months ended March 31, 2018 and March 31, 2017. As such, the Company did not present separate or summarized financial statements for any of these investees in the notes to its condensed consolidated financial statements.

 

4. Fair Value Measurements

 

ASC 820 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values.

 

 14 

 

  

The Company follows the fair value measurement and disclosure guidance under U.S. GAAP, which establishes a hierarchical disclosure framework. This framework prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace including the existence and transparency of transactions between market participants. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in an orderly market generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. In all cases, an instrument’s level within the hierarchy is based upon the market pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk or liquidity of the instrument.

 

The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment.

  

Assets and liabilities that are measured and reported at fair value are classified and disclosed in one of the following categories:

 

Level 1 — Fair value is determined based on quoted prices for identical assets or liabilities in an active market at measurement date. Assets and liabilities included in Level 1 include listed securities. As required in the fair value measurement and disclosure guidance under U.S. GAAP, the Company does not adjust the quoted price for these investments. The hierarchy gives highest priority to Level 1.

 

Level 2 — Fair value is determined based on inputs other than quoted prices that are observable for the asset or liability either directly or indirectly as of the reporting date. Assets and liabilities which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives, including foreign exchange forward contracts whose values are based on the following:

 

  Quoted prices for similar assets or liabilities in active markets.

 

  Quoted prices for identical or similar assets or liabilities in non-active markets.

 

  Pricing models whose inputs are observable for substantially the full term of the asset or liability.

 

  Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.

 

Level 3 — Fair value is determined based on inputs that are unobservable for the investment and includes situations where there is little, if any, market activity for the asset or liability. The inputs into the determination of fair value require significant management judgment or estimation and the Company may use models or other valuation methodologies to arrive at fair value. Investments that are included in this category generally include distressed debt, less liquid corporate debt securities, non-investment grade residual interests in securitizations, collateralized debt obligations, collateralized loan obligations and certain derivative contracts. The hierarchy gives the lowest priority to Level 3.

 

The Company has established a valuation process that applies for all levels of investments in the valuation hierarchy to ensure that the valuation techniques are consistent and verifiable. The valuation process includes discussions between the valuation team, portfolio management team and the valuation committee (the “Valuation Committee”). The Valuation Committee consists of senior members of ZAIS Group and is chaired by the Chief Financial Officer of ZAIS Group. The Valuation Committee meets to review and approve the results of the valuation process which are used in connection with the preparation of quarterly and annual financial statements. The Valuation Committee is responsible for oversight and review of the written valuation policies and procedures and ensuring that they are applied consistently.

 

 15 

 

 

The lack of an established, liquid secondary market for some of the Company’s holdings may have an adverse effect on the fair value of those holdings and on the Company’s ability to dispose of them. Additionally, the public markets for the Company’s holdings may experience periods of volatility and periods of reduced liquidity and the Company’s holdings may be subject to certain other transfer restrictions that may further contribute to illiquidity. Such illiquidity may adversely affect the price and timing of liquidations of the Company’s holdings.

 

The following is a description of the valuation techniques used to measure fair value:

 

Investments in Affiliated Securities, at fair value

 

CLOs - Senior Notes, Mezzanine Notes and Subordinated Notes

 

ZAIS determined the fair value of the investments in CLOs generally with input from a third party pricing source. ZAIS verifies that the quotes received from the valuation source are reflective of fair value as defined in U.S. GAAP, generally by comparing trading activity for similar asset classes, pricing research provided by banks and brokers, indicative broker quotes and results from an external cash flows analytics tool.

 

CLO Warehouses

 

A collateralized loan obligation vehicle is an entity formed for the issuance of securities backed by first lien, senior secured loans, also known as leveraged loans. Prior to the issuance of the securities, the collateralized loan obligation vehicle enters into a financing arrangement with a bank (the “CLO Warehouse”).  During the warehouse period, a CLO Warehouse will secure investments and build a portfolio of primarily leveraged loans and other debt obligations. The warehouse period terminates when the collateralized loan obligation vehicle issues various tranches of securities to the market and the underlying assets held by the CLO Warehouse are securitized. At this time, financing through the issuance of debt and equity securities is used to repay the bank financing.

 

The fair value of a CLO Warehouse is determined by adding the excess spread (accrued interest and delayed compensation plus interest received and any realized gain/(loss) from the sale of any loan positions during the warehouse period less financing cost, cost of carry and any applicable warehouse expenses) to the CLO Warehouse equity contributions. If it is determined, at any given time, that the securitization will not be achieved, the fair value of the CLO Warehouse will be determined based on the fair value of the underlying loan positions which are valued in a manner consistent with ZAIS Group’s valuation policy and procedures.  CLO warehouses can be exposed to credit events, mark to market changes, rating agency downgrades and financing cost changes.

 

Investment in Affiliates, at fair value

 

Under U.S. GAAP, the Company is permitted, as a practical expedient, to estimate the fair value of its investments in other investment companies using the net asset value (or its equivalent) of the related investment company. Accordingly, the Company utilizes the net asset value in valuing its investments in the unconsolidated ZAIS Managed Entities (excluding CLOs), which is an amount equal to the sum of the Company’s proportionate interest in the capital accounts of the affiliated entities at fair value. The fair value of the assets and liabilities of the ZAIS Managed Entities are determined by the Company in accordance with its valuation policies described above. Investments measured at fair value using the practical expedient are not required to be categorized within the fair value hierarchy.

 

ZAIS Group has the ability to liquidate its investments according to the provisions of the respective entities’ operating agreements.

 

 16 

 

 

Notes payable of Consolidated CLO, at fair value

 

The fair value of Notes payable of consolidated CLO is determined by applying the Measurement Alternative.

 

The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy levels or based on net asset values, as applicable:

 

   March 31, 2018 
   (Dollars in thousands) 
   Level 1   Level 2   Level 3   Net Asset
 Value
   Total 
Assets, at fair value:                         
Cash equivalents  $30,019   $   $   $   $30,019 
                          
Investments in affiliates, at fair value               158    158 
                          
Assets of Consolidated VIEs:                         
Investments in affiliated securities, at fair value:                         
ZAIS CLOs:                         
Senior notes           48,836        48,836 
Mezzanine notes           31,563        31,563 
Subordinated notes           6,675        6,675 
Warehouse           30,121        30,121 
Total – investments in affiliated securities, at fair value           117,195        117,195 
Total assets, at fair value  $30,019   $   $117,195   $158   $147,372 

 

   December 31, 2017 
   (Dollars in thousands) 
   Level 1   Level 2   Level 3   Net Asset
 Value
   Total 
Assets, at fair value:                         
Cash equivalents  $38,980   $   $   $   $38,980 
                          
Investments in affiliates, at fair value               10,151    10,151 
                          
Assets of Consolidated VIEs:                         
Investments in affiliated securities, at fair value:                         
ZAIS CLOs:                         
Senior notes           34,588        34,588 
Mezzanine notes           24,695        24,695 
Subordinated notes           4,876        4,876 
Warehouse           50,752        50,752 
Total – investments in affiliated securities, at fair value           114,911        114,911 
Total assets, at fair value  $38,980   $   $114,911   $10,151   $164,042 

 

 17 

 

  

The following tables summarize the changes in the Company’s Level 3 assets and liabilities:

 

           Three Months Ended March 31, 2018 
           (Dollars in thousands) 
           Beginning
Balance
January 1,
2018
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Amortization
of Discounts/
Premiums
   Transfers
to (from)
Level 3
   Ending
Balance
March
31, 2018
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
March 31, 2018
 
Assets:                                                
ZAIS CLOs:                                                
Senior notes          $34,588   $14,174   $   $74   $   $   $48,836   $(74)
Mezzanine notes           24,695    6,825        (99)   142        31,563    (99)
Subordinated notes           4,876    1,851        219    (271)       6,675    179 
Warehouse           50,752    32,500    (55,067)   1,936            30,121    (631)
Total investments in affiliated securities, at fair value          $114,911   $55,350   $(55,067)  $2,130   $(129)  $   $117,195   $(477)
     
   Three Months Ended March 31, 2017 
   (Dollars in thousands) 
   Beginning
Balance
January 1,
2017
   Initial
Consolidation
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Amortization
of Discounts/
Premiums
   Transfers
to (from)
Level 3
   Ending
Balance
March 31, 2017
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
March 31, 2017
 
Assets:                                             
First lien, senior secured loans  $389,329   $   $93,951   $(78,690)  $(1,122)  $340   $   $403,808   $(240)
ZAIS CLOs:                                             
Warehouse   15,036        30,000        1,107            46,143    1,107 
Total investments  $404,365   $   $123,951   $(78,690)  $(15)  $340   $   $449,951    867 
                                              
Liabilities:                                             
Notes payable of Consolidated CLO, at fair value  $384,901   $   $   $   $6,727   $   $   $391,628   $6,727 
Total liabilities, at fair value  $384,901   $   $   $   $6,727   $   $   $391,628   $6,727 

 

The Company’s policy is to record transfers between Level 1, Level 2 and Level 3, if any, at the end of the period. There were no transfers between Level 1, Level 2 and Level 3 during the three months ended March 31, 2018 or March 31, 2017.

 

 18 

 

 

The tables below summarize information about the significant unobservable inputs used in determining the fair value of the Level 3 assets and liabilities held by the Consolidated Funds:

 

Investment Type  Fair Value at
March 31,
2018
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
   Min   Max   Weighted
Average
 
   (Dollars in
Thousands)
                       
Assets of Consolidated Variable Interest Entities:                               
ZAIS CLOs:                               
Warehouse  $30,121   Cost plus excess spread  Excess spread   0.40%   0.40%   0.40%   0.40%
Total – Investments in affiliated securities, at fair value  $30,121                           

 

Investment Type  Fair Value at
December 31,
2017
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
   Min   Max   Weighted
Average
 
   (Dollars in
Thousands)
                       
Assets of Consolidated Variable Interest Entities:                               
ZAIS CLOs:                               
Warehouse  $50,752   Cost plus excess spread  Excess spread   1.5%   1.5%   1.5%   1.5%
Total – Investments in affiliated securities, at fair value  $50,752                           

 

At March 31, 2018 and December 31, 2017, the senior notes, mezzanine notes and subordinated notes of the ZAIS CLOs which were held by the Company were valued using independent third party pricing sources.

  

5. Variable Interest Entities

 

In the ordinary course of business, ZAIS Group sponsors the formation of VIEs and VOEs that can be broadly classified into the following categories: hedge funds, hybrid private equity funds and CLOs. ZAIS Group generally serves as the investment advisor or collateral manager with certain investment-related, decision-making authority for these entities. The Company has not recorded any liabilities with respect to VIEs that are not consolidated.

 

Risk Retention

 

The Dodd-Frank credit risk retention rules (the “U.S. Risk Retention Rules”), which became effective on December 24, 2016, apply by their terms to any newly issued CLOs or certain cases in which an existing CLO is refinanced, issues additional securities or is otherwise materially amended. The U.S. Risk Retention Rules specify that for each CLO, the relevant collateral manager must purchase and hold, unhedged, directly or through a majority-owned affiliate, either (i) 5% of the face amount of each tranche of the CLO’s securities, (ii) an amount of the CLO’s equity equal to 5% of the aggregate fair value of all of the CLO’s securities or (iii) a combination of the two for a total of 5%. The required risk must be retained until the latest of (i) the date that the CLO has paid down its securities to 33% of their original principal amount, (ii) the date that the CLO has sold down its assets to 33% of their original principal amount or (iii) the date that is two years after closing.

 

 19 

 

 

On February 9, 2018, the U.S. Court of Appeals for the District of Columbia Circuit held (the “DC Circuit Ruling”) that the federal agencies responsible for the U.S. risk retention rules (the “Applicable Agencies”) exceeded their statutory authority when designating the collateral manager of an open-market CLO as the securitizer of the open-market CLO. The DC Circuit Ruling became effective on April 5, 2018, after the Applicable Agencies failed to seek a rehearing from the Court of Appeals. Although the Applicable Agencies could still file a petition with the Supreme Court to review the DC Circuit Ruling no later than May 10, 2018, the Supreme Court does not grant most petitions for review and the mere filing of such a petition does not stay the effectiveness of a lower court’s ruling. Accordingly, the U.S. Risk Retention Rules do not now apply to open-market CLOs.

 

There have also been proposals to modify the U.S. Risk Retention Rules legislatively to eliminate their application to CLO transactions. Notwithstanding the foregoing, Congress could legislatively reverse the DC Circuit Ruling. If the U.S. Risk Retention Rules were reapplied to open-market CLOs, it can be anticipated that various unresolved questions and interpretive ambiguities would exist in their application.

 

The impact of the U.S. Risk Retention Rules on the loan securitization market and the leveraged loan market generally has been uncertain due to the unpredictable effects of the Rules on market expectations and the relative appeal of alternative investments not impacted by the Rules. The Rules may have resulted in a reduction of the number of collateral managers active in managing open-market CLOs, which may have resulted in fewer new issue CLOs and a reduction in the liquidity provided by CLOs to the leveraged loan market generally. However, as a result of the DC Circuit Ruling, the barriers to entry for becoming a CLO manager may be reduced. This could result in more CLO managers and increased competition for ZAIS Group. ZAIS Group is evaluating the potential impact of the DC Circuit Ruling on its business and operations.

 

Zephyr A-6 was formed to invest predominantly in ZAIS CLOs, including during the related warehouse period of such CLOs, in a manner compliant with the U.S. Risk Retention Rules. These CLOs are entities that issue collateralized notes which offer investors the opportunity for returns that vary commensurately with the risks they assume. The notes issued by the CLOs are generally backed by asset portfolios consisting of loans. For acting as the collateral manager for these structures, ZAIS Group receives collateral management fees comprised of senior collateral management fees, subordinated collateral management fees and incentive collateral management fees (subject to hurdle rates).

 

Structure

 

ZAIS Group owned 51% of Zephyr A-6, a “majority-owned affiliate” (as such term is defined in the Dodd-Frank Act), at December 31, 2016. On October 12, 2017 (the “Restructuring Date”), ZAIS Group and the non-ZAIS partner in Zephyr A-6 entered into an Agreement of Purchase and Sale whereby the non-ZAIS partner purchased a portion of ZAIS Group’s interest in Zephyr A-6, including a portion of its unfunded capital commitments. The total purchase price was approximately $25.0 million based on the net asset value of Zephyr A-6 as of the Restructuring Date.

 

In connection with the restructuring of Zephyr A-6, the limited partners of Zephyr A-6 also amended the limited partnership agreement. The partners’ ownership interests and capital commitments were as follows:

 

 20 

 

 

   

As of

October 11,

2017

    As of the
Restructuring
Date
 
Ownership Interest:                
ZAIS Group     51.00 %     13.33 %
Non-ZAIS Partner     49.00 %     86.67 %
                 
Capital Commitments:                
ZAIS Group   $ 51.0 million     $ 20.0 million  
Non-ZAIS Partner   $ 49.0 million     $ 130.0 million  
                 
Capital Commitments funded:                
ZAIS Group   $ 26.6 million     $ 7.0 million  
Non-ZAIS Partner   $ 25.6 million     $ 45.2 million  
                 
Remaining Capital Commitments to be funded:                
ZAIS Group   $ 24.4 million     $ 13.0 million  
Non-ZAIS Partner   $ 23.4 million     $ 84.8 million  

 

During the three months ended March 31, 2018 and March 31, 2017, Zephyr A-6 received capital contributions from ZAIS Group and the Non-Controlling Interest in Zephyr A-6 as follows:

 

Three Months Ended March 31, 2018  ZAIS
Group
   Non-
Controlling
Interest
   Total 
   (Dollars in thousands) 
             
Unfunded capital commitments as of December 31, 2017  $11,714   $76,135   $87,849 
                
Capital contributions   2,667    17,333    20,000 
                
Unfunded capital commitments as of March 31, 2018  $9,047   $58,802   $67,849 

 

Three Months Ended March 31, 2017  ZAIS
Group
   Non-
Controlling
Interest
   Total 
   (Dollars in thousands) 
             
Unfunded capital commitments as of December 31, 2016  $30,523   $29,326   $59,849 
                
Capital contributions   6,120    5,880    12,000 
                
Unfunded capital commitments as of March 31, 2017  $24,403   $23,446   $47,849 

 

Pursuant to the terms of the limited partnership agreement of Zephyr A-6, a portion of the senior fees and all of the subordinate fees and the incentive fees paid to ZAIS Group by the ZAIS CLOs in which Zephyr A-6 invests are subsequently paid to Zephyr A-6 by ZAIS Group (the “Rebated Fees”) and allocated among the limited partners of Zephyr A-6 pro rata based on their percentage interests in Zephyr A-6. The senior fees which will be paid to Zephyr A-6 by the Company are as follows:

 

 21 

 

 

    Prior to the
Restructuring
Date
 

As of and

Subsequent

to the

Restructuring

Date

Senior Fee   In excess of 0.15%   In excess of 0.20%

 

The Company has determined that Zephyr A-6 is a VIE and that ZAIS Group is the primary beneficiary of Zephyr A-6 at March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017. Therefore the Company consolidated Zephyr A-6 in its condensed consolidated financial statements during these periods. ZAIS Group is the primary beneficiary because it is deemed to have (i) the power to direct activities of Zephyr A-6 that most significantly impacts its economic performance and (ii) the obligation to absorb losses of Zephyr A-6 and the right to receive benefits from Zephyr A-6 that could potentially be significant to Zephyr A-6.

 

Investments in ZAIS CLOs

 

As of March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017, all of Zephyr A-6’s investments consisted of ZAIS CLOs. The ZAIS CLOs invest primarily in first lien, senior secured loans.

 

The following is a summary of Zephyr A-6’s investments in ZAIS CLOs at the respective closing date of the ZAIS CLO:

 

               Economic Interest at the 
Closing Date
 
CLO  Warehouse
Period Start
Date
  Pricing 
Date
  Closing 
Date
  CLO 
Maturity 
Date
  Senior
Notes and
Mezzanine
Notes
   Subordinate
Notes
   Weighted
Average
 
                         
ZAIS CLO 5  October 1, 2015  September 23, 2016  October 26, 2016  October 2028   2.1%   31.8%   5.0%
                            
ZAIS CLO 6, Ltd. (“ZAIS CLO 6”)  November 18, 2016  May 3, 2017  June 1, 2017  July 2029   5.0%   5.0%   5.0%
                            
ZAIS CLO 7, Ltd. (“ZAIS CLO 7”)  June 12, 2017  September 11, 2017  October 19, 2017  April 2030   7.0%   5.0%   6.8%
                            
ZAIS CLO 8, Ltd. (“ZAIS CLO 8”)  October 16, 2017  February 6, 2018  March 8, 2018  April 2029   5.1%   5.0%   5.1%
                            
ZAIS CLO 9, Ltd. (“ZAIS CLO 9”)  January 29, 2018                  

 

In February 2018, Zephyr A-6 sold its preferred shares of ZAIS CLO 8 which it held during the warehouse period. On March 8, 2018, Zephyr A-6 received sales proceeds of $50.0 million and a dividend of approximately $2.6 million relating to income and gains during the ZAIS CLO 8 warehouse period.

 

 22 

 

 

The Company determined that ZAIS CLO 6, ZAIS CLO 7 and ZAIS CLO 8 were VIEs and that the Company is not the primary beneficiary of these ZAIS CLOs based on Zephyr A-6’s minimal investment in the subordinated notes of the ZAIS CLOs and the fee arrangement not constituting a variable interest. Therefore, the Company was not required to consolidate these ZAIS CLOs in its financial statements as of March 31, 2018 and December 31, 2017 or for the three months ended March 31, 2018 and March 31, 2017.

 

ZAIS CLO 5

 

Zephyr A-6 had an investment in ZAIS CLO 5 during the three months ended March 31, 2017.

 

The Company determined that ZAIS CLO 5 was a VIE and that it was the primary beneficiary of ZAIS CLO 5 based on (i) its ability to impact the activities which most significantly impact ZAIS CLO 5’s economic performance as collateral manager and (ii) Zephyr A-6’s significant investment in the subordinated notes of ZAIS CLO 5. Therefore, the Company initially consolidated ZAIS CLO 5 in its financial statements on the ZAIS CLO 5 closing date.

   

In February 2017 Zephyr A-6 sold its interest in the Class A-1 tranche of ZAIS CLO 5 for a sales price of approximately $5.4 million and recognized a loss of approximately $81,000. Such amount is included in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2017. The sale was not to a related party.

 

The Company consolidated ZAIS CLO 5 in its financial statements for the period from October 26, 2016 through August 10, 2017. On August 10, 2017 Zephyr A-6 sold all of its remaining interests in ZAIS CLO 5, to an unrelated party. Subsequent to the sale, a wholly owned subsidiary of ZAIS continued as the collateral manager for ZAIS CLO 5. Since the fee arrangement with ZAIS CLO 5 does not constitute a variable interest on its own, ZAIS Group deconsolidated ZAIS CLO 5 as of August 10, 2017, the date on which ZAIS sold its remaining interests in the entity.

 

Warehouse Periods

 

During the warehouse periods, the ZAIS CLOs finance the majority of their loan purchases using warehouse facilities. The Company determined that it is not the primary beneficiary of CLO Warehouses, which are VIEs, because the financing counterparty must approve all significant financing requests and, as a result, the Company does not have the power to direct activities of the entity that most significantly impacts its economic performance. Therefore, Zephyr A-6’s investments in the ZAIS CLOs did not meet the consolidation criteria during the respective warehouse periods.

 

ZAIS Upsize Acquisition 1, Ltd. (“ZAIS Upsize Acquisition 1”)

 

ZAIS Upsize Acquisition 1 was formed on January 10, 2018 for the purpose of refinancing the notes issued by an existing ZAIS CLO 1, Limited. ZAIS Upsize Acquisition 1, which invests primarily in first lien senior secured loans, was in the warehouse phase from its inception date, through May 10, 2018. During this period, ZAIS Upsize Acquisition 1 financed the majority of its loan purchases using its warehouse facility. On January 24, 2018, Zephyr A-6 contributed $2.5 million to ZAIS Upsize Acquisition 1 and on March 15, 2018 it sold its interest in ZAIS Upsize Acquisition 1 to the other initial investor in ZAIS Upsize Acquisition 1 and as a result received proceeds of $2.5 million. The sale was not to a related party.

 

Zephyr A-6 contributed the following amounts to the following ZAIS CLOs during their warehouse periods:

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
ZAIS CLO 6  $   $30,000 
ZAIS CLO 9   30,000     
ZAIS Upsize Acquisition 1   2,500     
Total  $32,500   $30,000 

 

 23 

 

 

Master Repurchase Agreement

 

On October 16, 2017, Zephyr A-6 entered into a master repurchase agreement with a single counterparty for a maximum of $200.0 million of financing (the “Master Repurchase Agreement”). Subject to the terms and conditions of the Master Repurchase Agreement, the parties may enter into transactions for the counterparty to purchase eligible securities from Zephyr A-6 on such terms agreed upon by the parties. During the term of a transaction entered into under the Master Repurchase Agreement, Zephyr A-6 will deliver cash or additional securities acceptable to the counterparty if the securities sold are in default. Upon termination of a transaction, Zephyr A-6 will repurchase the previously sold securities from the counterparty at a previously determined repurchase price. Upfront fees associated with the Master Repurchase Agreement in the amount of approximately $459,000 were prepaid of which approximately $9,000 was expensed during the three months ended March 31, 2018. The unamortized upfront fees of approximately $443,000 are reported as a direct deduction from the outstanding borrowings of the repurchase agreement in the Consolidated Statements of Financial Condition at March 31, 2018. The Master Repurchase Agreement may be terminated at any time by either party upon providing the requisite notice to the other party.

 

As of March 31, 2018 and December 31, 2017, the available funding under the Master Repurchase Agreement was approximately $154.1 million.

 

The following table presents the remaining contractual maturity of Zephyr A-6’s Master Repurchase Agreement and the amounts outstanding as of March 31, 2018 and December 31, 2017:

 

Remaining
Contractual Maturity of the
Master Repurchase Agreement
  March 31,
2018
   December 31,
2017
 
   (Dollars in thousands) 
Collateralized Loan Obligations(1):          
Senior debt tranches  $34,431   $34,431 
Mezzanine debt tranches   11,512    11,512 
Total (2)  $45,943   $45,943 

 

(1) Maturities are set to match the maturities of the underlying collateral and are greater than one year.

(2) Amounts represent the outstanding borrowings before deducting unamortized upfront fees.

 

The fair value of the securities pledged as collateral under the Master Repurchase Agreement was approximately $46.2 million and $46.1 million at March 31, 2018 and December 31, 2017, respectively. The Company includes the fair value of the securities pledged by Zephyr A-6 in Investments in affiliated securities, at fair value in the Consolidated Statements of Financial Condition. Zephyr A-6 receives the coupon payments for the pledged securities.

 

Due to the short term nature of these borrowings at variable interest rates, the carrying amount approximates fair value (if fair valued, the carrying amount would be classified as level 2 in the fair value measurement hierarchy described above). Zephyr A-6 pays interest to the counterparties at a rate based on the weighted average interest rate of the underlying securities that have been pledged as collateral plus a spread of 0.50% on the periodic roll over dates.  As of March 31, 2018 and December 31, 2017, the accrued interest due to the counterparty was approximately $369,000 and $299,000, respectively. Such amounts are included in Liabilities of Consolidated Variable Interest Entities – Other Liabilities in the Consolidated Statements of Financial Condition.

 

In general, Zephyr A-6 can sell any of the underlying securities that have been pledged as collateral at any time, subject to certain fees.  Other than margin requirements, the Master Repurchase Agreement is not subject to additional terms or contingencies which would expose Zephyr A-6 to additional obligations based upon the performance of the securities pledged as collateral. The weighted average effective interest rate for repurchase agreements entered into under the Master Repurchase Agreement was approximately 3.9% and 3.6% at March 31, 2018 and December 31, 2017, respectively.

 

 24 

 

 

The following tables present both gross and net information regarding the repurchase agreements, entered into under the Master Repurchase Agreement including amounts eligible for offset with the related collateral in the Consolidated Statements of Financial Condition in the event of default:

  

As of March 31, 2018
               Gross amounts not offset in the
Consolidated Statements of
Financial Condition (a)
     
Description  Gross
amounts
of
recognized
assets
(liabilities)
   Gross
amounts
offset in the
Consolidated
Statements of
Financial
Condition
   Net amount
of assets
(liabilities)
presented in
the
Consolidated
Statements of
Financial
Condition
   Financial
Instruments
   Cash
Collateral
   Net
Amount
 
                               
Repurchase agreement  $(45,943)  $   $(45,943)  $45,943   $   $ 

 

As of December 31, 2017
               Gross amounts not offset in the
Consolidated Statements of
Financial Condition (a)
     
Description  Gross
amounts
of
recognized
assets
(liabilities)
   Gross
amounts
offset in the
Consolidated
Statements of
Financial
Condition
   Net amount
of assets
(liabilities)
presented in
the
Consolidated
Statements of
Financial
Condition
   Financial
Instruments
   Cash
Collateral
   Net
Amount
 
                               
Repurchase agreement  $(45,943)  $   $(45,943)  $45,943   $   $ 

 

  (a) The sum of the financial instruments and cash collateral not offset in the Consolidated Statements of Financial Condition may exceed the repurchase balance. Where this is the case, the total amounts reported in these two columns are limited to the outstanding balance of the repurchase agreement.

 

Consolidated VIEs

 

At March 31, 2018 and December 31, 2017 the Consolidated Funds consist of only Zephyr A-6. All of the assets and liabilities of the Consolidated Funds are presented separately in the Consolidated Statements of Financial Condition.

 

The assets presented belong to the investors of Zephyr A-6 and are available for its use. These assets are not available for use by the Company. Zephyr A-6 does not have recourse to the general credit of ZAIS Group with respect to any liability.

  

 25 

 

 

Net gain (loss) of Consolidated Funds’ Investments

 

Net gain (loss) related to Zephyr A-6’s investments in ZAIS CLOs include the following:

  

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
Distributions of income and gains during the warehouse period upon closing of ZAIS CLOs  $2,567   $ 
Net Change in unrealized gain or loss and net realized gains   (437)   1,107 
           
Net gain (loss) of Consolidated Funds’ investments in affiliated securities  $2,130   $1,107 

 

Unconsolidated VIEs

 

At March 31, 2018 and December 31, 2017, the Company’s unconsolidated VIEs consist of the Company’s investments in certain ZAIS Managed Entities as well as the Consolidated Fund’s investments in certain ZAIS CLOs.

 

The assets recognized in the Company’s Consolidated Statements of Financial Condition for unconsolidated VIEs in which the Company has a variable interest and the Company’s maximum exposure to loss from these entities are as follows:

 

Financial Statement Line Item  March 31,
2018
   December 31,
2017
 
   (Dollars in thousands) 
Income and fees receivable  $944   $1,082 
Investments in affiliates, at fair value   158    5,150 
Due from related parties   9    24 
           
Assets of Consolidated Variable Interest Entities:          
Investments in affiliated securities, at fair value   117,195    114,911 
Maximum exposure to loss  $118,306   $121,167 

 

Such amounts are included in the Consolidated Statements of Financial Condition.

 

ZAIS Group has a minimal direct ownership in the unconsolidated VIEs and its involvement is generally limited to providing asset management services. ZAIS Group’s exposure to loss from these entities is limited to a decrease in the management fee income and incentive income that has been earned and accrued, as well as any change in fair value of its direct equity ownership in the VIEs.

 

6. Management Fee Income and Incentive Income

 

The Company’s management fee income and incentive income are recognized in accordance with its revenue recognition policies disclosed in Note 2 – “Basis of Presentation and Summary of Significant Accounting Policies”. The amounts of revenue recognized for the three months ended March 31, 2018 under the new revenue standard adopted on January 1, 2018 were the same as those that would have been recognized under the previous revenue recognition guidance.

 

 26 

 

 

The following tables present the general fee ranges earned, the gross amounts of management fee income and incentive income earned prior to eliminations due to consolidation of the Consolidated Funds and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss):

 

     

Three Months Ended

March 31, 2018

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income(1)(3)                  
Funds and accounts   0.50% - 1.25%  $2,723   $   $2,723 
CLOs   0.15% - 0.50%   2,340        2,340 
Total     $5,063   $   $5,063 
                   
Incentive Income(1)(2)(3)                  
Funds and accounts   10% - 20%  $134   $   $134 
CLOs  20%   12        12 
Total     $146   $   $146 

 

     

Three Months Ended

March 31, 2017

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income(1)(3)                  
Funds and accounts  0.50% - 1.25%  $2,613   $   $2,613 
CLOs  0.15% - 0.50%   494        494 
Total     $3,107   $   $3,107 
                   
Incentive Income(1)(2)(3)                  
Funds and accounts  10% - 20%  $287   $   $287 
CLOs  20%   10        10 
Total     $297   $   $297 

 

  (1) Certain management and incentive fees have been and may in the future be waived and therefore the actual fees rates may be lower than those reflected in the range.

 

  (2) Incentive income earned for certain of the ZAIS Managed entities is subject to a hurdle rate of return as specified in each respective ZAIS Managed Entity’s operative agreement.

 

  (3) ZAIS Group does not earn management fee income on certain ZAIS Managed Entities in which it had made investments that carried first loss risk. ZAIS Group receives distributions of its pro rata share of the gains and losses related to its investments in these ZAIS Managed Entities and incentive income equal to 50% of the net investment gains for the management of these ZAIS Managed Entities. The Company recognized incentive fee income from these ZAIS Managed Entities of approximately $117,000 and $276,000 for the three months ended March 31, 2018 and March 31, 2017, respectively. As a result of the termination of these management contracts, the Company will no longer earn incentive income from the two ZAIS Managed Entities effective April 1, 2018.

 

 27 

 

 

Management fee income and incentive income which was accrued, but not received is as follows:

 

  

March 31,

2018

  

December 31,

2017

 
   (Dollars in thousands) 
         
Accrued Management fee income  $2,942   $2,837 
Accrued Incentive income   5    6,026 
Total  $2,947   $8,863 

 

Such amounts are included in Income and fees receivable in the Consolidated Statements of Financial Condition. 

 

The Company did not recognize any bad debt expense related to the management fee income or incentive income for the three months ended March 31, 2018 and March 31, 2017. The Company believes all income and fees receivable balances are deemed to be fully collectible.

 

Fee Rebates

 

The following tables present the gross amount of the Rebated Fees prior to eliminations due to the consolidation of Zephyr A-6 and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss):

 

 

  

Three Months Ended

March 31, 2018

 
   ( Dollars in thousands) 
   Gross
Amount
   Elimination   Net
Amount
 
Rebated Fees  $530   $(530)  $ 
Total  $530   $(530)  $ 

 

There were no Rebated Fees for the three months ended March 31, 2017.

 

As a result of its ownership interest in Zephyr A-6, ZAIS Group is allocated a portion of the Rebated Fees. The fee rebate income and related expense are eliminated in consolidation. The amounts allocable to the non-ZAIS partner of Zephyr A-6 are included in Non-controlling interest in Consolidated Funds in the Consolidated Statements of Comprehensive Income (Loss).

   

Fees Payable

 

Fees payable represents a fee credit due to an investor in one of the ZAIS Managed Entities for the fees charged to that investor on their investment balance in another ZAIS Managed Entity. The following credits are recorded as a direct reduction to Management fee income and Incentive income in the Consolidated Statements of Comprehensive Income (Loss):

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
         
Management fee income credit  $64   $63 
Total  $64   $63 

 

 28 

 

 

7. Notes Payable

 

On March 17, 2015, in conjunction with the contribution of cash by HF2 Financial Management, Inc. to ZGP in exchange for newly issued Class A Units, representing a majority financial interest in ZGP (the “Business Combination”), ZAIS issued two promissory notes with an aggregate principal balance of $1.25 million to EarlyBirdCapital, Inc. and Sidoti & Company, LLC. The notes accrued interest at an annual rate equal to the annual applicable federal rate as published by the Internal Revenue Service until the principal amount of, and all accrued interest on, the notes were paid in full. The notes matured on March 17, 2017 at which time the principal balance and accrued interest was paid in full. The notes were issued in lieu of paying certain underwriting costs at the closing of the Business Combination and, accordingly, treated as a direct cost attributable to the Business Combination and capitalized to equity.

 

Total interest expense is included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss) and was as follows:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$   $3 

 

8. Compensation

 

The following table presents a detailed breakout of the Company’s compensation expense:

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
         
Salaries  $2,357   $2,336 
Bonus   2,725    3,177 
Severance   202    72 
Equity-Based Compensation   71    1,112 
Payroll taxes and benefits   731    727 
Total  $6,086   $7,424 

 

A summary of the Company’s compensation arrangements are as follows:

 

Bonus

 

Incentive Cash Compensation

 

Employees are eligible to receive discretionary incentive cash compensation (the “Bonus Award”) on an annual basis and certain employees may also be eligible to receive guaranteed incentive compensation (the “Guarantees”). The amount of the Bonus Award is based on, among other factors, both individual performance and the financial results of ZAIS Group. For certain employees, as documented in an underlying agreement (the “Bonus Agreements”), the Bonus Award may be further subject to a retention-based payout schedule that generally provides for 30% of the Bonus Award to vest and be paid incrementally over a three-year period. The Company expenses all current cash incentive compensation award payments ratably in the first year. All future payments are amortized equally over the required service period over the remaining term of the Bonus Award as defined in the Bonus Agreements. Any Guarantees that are paid upon an employee commencing employment are expensed immediately by the Company. All future payments related to Guarantees are amortized equally over the required service period over the remaining term as defined in the agreements for the Guarantees (“Guarantee Agreements”). In the event an award is forfeited pursuant to the terms of the Bonus Agreements or Guarantee Agreements, the corresponding accruals will be reversed.

 

 29 

 

 

Levels of incentive compensation will vary to the extent they are tied to the performance of certain ZAIS Managed Entities or the financial and operating performance of the Company. The compensation payable balance includes accrued incentive compensation and severance, if applicable.

 

On May 9, 2017, the Board of Directors approved an amendment to the charter of the Compensation Committee of the Board of Directors of the Company (the “Compensation Committee”) to better enable the Company to retain its employees and to attract additional employees. The amendment removed the prior compensation guidelines set forth in the charter that by its terms applied to compensation paid through 2019. These compensation guidelines had provided that, subject to modification or waiver by the Compensation Committee, the Company’s total compensation expense on a consolidated basis calculated in accordance with U.S. GAAP for all cash and non-cash compensation paid to employees of the Company and its operating subsidiaries and affiliates for any given year would not exceed a certain percentage of the Company’s consolidated revenue for such year calculated in accordance with U.S. GAAP.

 

Aggregate future payments pursuant to the Bonus Agreements and Guarantee Agreements for the period from April 1, 2018 to December 31, 2018 and the three years subsequent to December 31, 2018, are approximately as follows:

 

   (Dollars in
thousands)
 
     
Period from April 1, 2018 to December 31, 2018  $ 
      
Year ended December 31,     
2019   1,360 
2020   1,360 
2021   903 
Total  $3,623 

 

As of March 31, 2018, there are no future payments due subsequent to February 2021.

 

The amount to be paid during 2019 in the table above includes approximately $0.11 million which has been recognized as an expense for the three months ended March 31, 2018. Such amount is included in Compensation payable in the Consolidated Statements of Financial Condition and Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss). The remaining balance of approximately $1.25 million will be recognized as an expense during the period from April 1, 2018 through February 28, 2019 subject to forfeitures as described above.

 

 Other

 

Pursuant to the Legal Advisor Agreement (see Note 12 – “Commitments and Contingencies”), Howard Steinberg, the Company’s former General Counsel, received a payment of $450,000 on February 28, 2017. This payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2017.

  

 30 

 

 

On April 5, 2017, the Company provided a retention award (the “Retention Award”) to Michael Szymanski, the Company’s Chief Executive Officer in recognition of the importance of retaining his services as the Chief Executive Officer of the Company and its operating subsidiary, ZAIS Group, and in connection with the Company’s review of strategic alternatives to enhance shareholder value. Under the Retention Award, which was approved by the Compensation Committee, Mr. Szymanski received a cash retention payment of $500,000 on each of June 30, 2017 and September 30, 2017 and was entitled to receive a cash retention payment of $500,000 on a date within five business days following the closing date of a “Transaction” as defined in the Retention Award or otherwise as determined by the Board of Directors of the Company. On November 7, 2017, the Compensation Committee determined that Mr. Szymanski would receive the final $500,000 Retention Award payment on February 28, 2018. Mr. Szymanski would be entitled to such payments provided he remained employed by the Company on such dates, or if he had been removed as the Company’s Chief Executive Officer or his employment terminated for reasons other than for cause prior to such dates. Effective January 5, 2018, Mr. Szymanski resigned as Chief Executive Officer, President and a Director of the Company. In connection with his resignation, Mr. Szymanski entered into a Release Agreement with ZAIS Group (the “Szymanski Release Agreement”) wherein he agreed to a full release of claims against, and covenant not to sue, ZAIS Group and its affiliates, in exchange for the Company’s agreement to (i) pay the last installment of Mr. Szymanski’s Retention Award which he would have otherwise forfeited and (ii) waive the six-month covenant not to compete and modify the 12-month covenant not to solicit otherwise applicable to Mr. Szymanski. The aggregate amount of retention payments paid to Mr. Szymanski under the Retention Award was $1.5 million. The last installment of $500,000 was paid on February 28, 2018 and the portion related to the service period from January 1, 2018 to February 28, 2018, approximately $200,000, is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2018.

 

Points

 

ZAIS Group had entered into agreements in previous years with certain of its employees whereby certain current and former employees were granted rights to participate in a portion of the incentive income received from certain ZAIS Managed Entities (referred to as “Points Agreements”). There are currently outstanding Points Agreements relating to one ZAIS Managed Entity and ZAIS Group does not anticipate awarding additional Points Agreements. The Company did not incur any compensation expense relating to the Points Agreements for the three months ended March 31, 2018 and March 31, 2017.

 

Equity-Based Compensation

 

Class B-0 Units

 

ZGP authorized 1,600,000 Class B-0 Units eligible to be granted to certain employees of ZAIS Group. The Class B-0 Units were subject to a two year cliff-vesting provision, whereby all Class B-0 Units granted to an employee would be forfeited if the employee resigned or was terminated prior to March 17, 2017. Subsequent to this date, an employee would only forfeit vested Class B-0 Units if the employee was terminated for cause. Until the time that such Class B Units became vested, the Class B-0 Units were not entitled to any distributions from ZGP (and thus would not participate in, or be allocated any, income or loss) or other material rights. Upon vesting, the Class B-0 Units would have had the same rights as Class A Units and were exchangeable on a one for one basis for shares of Class A Common Stock or cash (or a combination of shares and cash), at the Company’s election, subject to certain restrictions.

 

The Company measures the expense associated with these awards based on the fair value on the grant date adjusted for estimated forfeitures. This expense is being amortized equally over the vesting periods and adjusted on a cumulative basis for changes in estimated forfeitures at each reporting date. The grant date fair value of these B-0 Units is based on the market value of the Company’s shares on the grant date.

  

During December 2016, all holders of Class B-0 Units accepted an offer made by ZGP on December 1, 2016 (the “Proposal”) whereby holders of unvested Class B-0 Units could receive in consideration for the cancellation of their Class B-0 Units, at the holder’s option, either (a) RSUs of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (the “Cash Amount”) equal to $1.92, which was the average of the daily closing prices of Class A Common Stock of ZAIS for the three calendar months ended November 30, 2016. On December 30, 2016, the expiration of the Proposal, 899,674 unvested Class B-0 Units were cancelled in consideration for 899,674 RSUs under the 2015 Stock Plan and 133,559 unvested Class B-0 Units were cancelled in consideration for the right to receive approximately $256,000 in cash.

 

These RSUs vested on March 17, 2017, the same date that the Class B-0 Units were scheduled to vest. The RSUs entitled the holders to receive ZAIS Class A Common Stock, which was issued, subject to applicable wage withholding requirements, immediately upon the vesting of the RSUs. In consideration of the issuance of such stock by ZAIS to the employees of ZGP’s subsidiary, ZAIS Group, ZGP issued a number of Class A Units to ZAIS equal to the number of shares of stock that were issued to the holders of RSUs.

 

 31 

 

  

The Cash Amount was paid by ZAIS Group to the holders, subject to applicable wage withholding requirements, on March 22, 2017.

 

 The Company incurred the following compensation expense relating to the Class B-0 Units cancelled in consideration for the receipt of RSUs or cash by amortizing the remaining expense over the remaining vesting period which ended on March 17, 2017:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$   $1,059 

  

This expense is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

RSUs

 

Non-employee directors of ZAIS receive RSUs pursuant to the 2015 Stock Plan as a component of their annual compensation for their service as directors of ZAIS. The awards are unvested at the time they are granted and, as such, are not entitled to any dividends or distributions from ZAIS or other material rights until such RSUs vest. The RSUs vest in full on the one-year anniversary of the grant date. Upon vesting ZAIS will issue the recipient shares of Class A Common Stock equal to the number of vested RSUs. The Company is measuring the expense associated with these awards based on the fair value on the grant date adjusted for estimated forfeitures. This expense is being amortized equally over the one-year vesting period and adjusted on a cumulative basis for changes in estimated forfeitures at each reporting date. The grant date fair value of these RSUs is based on the fair value of the Company’s shares on the grant date.

  

The following table presents the RSUs granted to non-employee directors during the period from January 1, 2016 through March 31, 2018 and the corresponding grant date fair value and vesting date:

 

RSU Grant Date   Number of
RSUs Issued
    Fair Value per
RSU on
Grant Date
    RSU Vesting Date
April 21, 2016     30,942     $ 3.22     April 21, 2017
November 1, 2016     74,331     $ 1.73     November 1, 2017
May 9, 2017     63,219     $ 2.19     May 9, 2018
November 7, 2017     40,464     $ 3.67     November 7, 2018

 

On March 17, 2017, the 899,674 RSUs granted in connection with the Proposal (see “Class B-0 Units” above) vested. The fair value of the consideration was $2.1 million based on the closing stock price of the Company’s Class A Common Stock on March 17, 2017 and the gross amount of RSUs that vested. The Company issued 548,923 shares of its Class A Common Stock, on a net basis (to account for applicable wage withholding requirements), to the holders who elected to cancel their Class B-0 Units in substitution for RSUs. The applicable wage withholding requirement of approximately $0.8 million was recorded as a reduction of Additional paid-in-capital in the Consolidated Statements of Changes in Equity and Non-controlling Interests.

 

 32 

 

 

The following table presents the RSU activity:

 

  

Three Months Ended

March 31,

 
   2018   2017 
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period:   103,683   $2.77    1,004,947   $8.60 
Vested           (899,674)   9.33 
Balance at end of period   103,683    2.77    105,273    2.17 

  

The Company incurred compensation expense relating to the non-employee RSUs as follows:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$71   $53 

  

The remaining expense and vesting periods for the RSUs outstanding at March 31, 2018 are as follows:

 

Grant Date  Number of
RSUs
Outstanding
   Remaining
Expense
   Remaining
Vesting
Period
 
       (in thousands)   (in years) 
             
May 9, 2017   63,219   $15    0.11 
November 7, 2017   40,464    90    0.61 
Total   103,683   $105      

 

The expense relating to these RSUs is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

9. Income Taxes

 

ZAIS is taxable as a corporation for U.S. tax purposes while ZGP and its subsidiaries operate as pass-through entities for U.S. income tax purposes not subject to entity level income taxes. Accordingly, the Company’s condensed consolidated financial statements include U.S. federal, state and local income taxes on ZAIS’s allocable share of the consolidated results of operations, as well as taxes payable to jurisdictions outside the U.S related to the foreign subsidiaries.

 

On December 22, 2017, new tax reform legislation became effective for January 1, 2018. The new legislation, among other things, reduced the corporate tax rate from a graduated set of rates with a maximum 35 percent tax rate to a flat 21 percent tax rate and also made changes to the net operating loss (NOL) utilization rules.

 

Under U.S. GAAP, changes in tax rates and tax law are accounted for in the period of enactment and the enactment date for U.S. GAAP is the date a new bill is signed into law. Deferred tax assets and liabilities are measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. Thus, at the date of enactment of the new tax reform legislation, ZAIS measured its deferred tax balances based upon the new 21% tax rate and re-assessed its valuation allowance due to tax reform to continuing operations in the tax provision.

 

 33 

 

 

The Company recorded an income tax (benefit) expense of $4,000 and $5,000 for the three months ended March 31, 2018 and March 31, 2017 respectively, related solely to foreign taxes payable to jurisdictions outside the U.S. related to Company’s foreign subsidiary.  

 

As a result of the variations each quarter in the relationship between pre-tax income and income tax expense, the Company utilizes the actual effective tax rate for each interim period being presented to calculate the tax (benefit) or expense. The following is a reconciliation of the U.S. statutory federal income tax to the Company’s effective tax:

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
Income tax (benefit) expense at the US federal statutory income tax rate  $(593)  $(1,846)
State and local income tax, net of federal benefit   (242)   (233)
Foreign Tax   4    5 
Effect of permanent differences   329    1 
Income attributable to non-controlling interests in Consolidated Funds not subject to tax   (581)   (275)
Income attributable to non-controlling interests in ZGP not subject to tax   381    707 
Equity compensation shortfall adjustment        1,948 
Valuation Allowance   706    (302)
Total  $4   $5 

 

The Company’s effective tax for the periods presented above includes a benefit attributable to the fact that the Company’s subsidiaries operate as limited liability companies and limited partnerships which are treated as pass-through entities for U.S. federal and state income tax purposes. Accordingly, the Company’s condensed consolidated financial statements include U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations. The tax liability or benefit related to the partnership income or loss not allocable to the Company rests with the equity holders owning such non-controlling interests in ZAIS subsidiaries. The effective tax for the period is also impacted by permanent differences for transaction related costs that are not deductible for tax. Due to the full valuation allowance, the net effective tax represents the taxes accrued related only to the Company’s operations in jurisdictions outside the U.S.

 

Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and are reported in the accompanying Consolidated Statements of Financial Condition. These temporary differences result in taxable or deductible amounts in future years. The Company's deferred tax assets and liabilities were measured at the enacted rate of 21%., As of March 31, 2018 and December 31, 2017, the Company had total deferred tax assets (“DTA”) of approximately $5.2 and $4.5 million respectively related to net operating losses and other temporary differences related to the Company’s allocable share of the consolidated results of operations as well as Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. The Company has established a full valuation allowance on the DTA at March 31, 2018 and December 31, 2017.

   

The Company’s net operating loss (“NOL”) as of December 31, 2017 can be carried forward for 20 years. Federal NOLs for tax years beginning Jan 1, 2018 can be carried forward indefinitely although there are limitations on the amounts of these NOLs that a corporation may deduct in a single tax year. As of March 31, 2018, the Company has estimated federal and state income tax NOL carryforwards, which will expire as follows:

 

 34 

 

 

   (Dollars in
thousands)
 
2032  $1 
2033   83 
2034   122 
2035   5,990 
2036   1,703 
2037   4,773 
Indefinite carry forward - Federal   2,571 
Total  $15,243 

 

As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. As of March 31, 2018, the Company has determined that the current management business forecasts do not support the realization of net deferred tax assets recorded for the Company. The Company has reported a net book loss for the three months ended March 31, 2018 and it is anticipated that expenses will exceed revenues for the remainder of 2018 as was the case in each of the tax years 2015, 2016 and 2017. While the Company continues to work to grow its AUM, explore business development opportunities, and intends to pursue various initiatives with potential to alter the operating loss trend, including closing the going private transaction, there is no specific plan that has been implemented at this point in time that will alter the negative earnings trend.

 

Accordingly, management believes that it is not more likely than not that the Company’s deferred tax asset will be realized, and the Company has established a full valuation allowance against the deferred tax asset as of March 31, 2018.

 

The Company intends to continue maintaining a full valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of the allowance.

 

The Company’s primary jurisdictions in which it and its subsidiaries file tax returns are the United States, New Jersey, New York, California and the United Kingdom. In the normal course of business, the Company is subject to examination by federal and certain state, local and foreign tax authorities. With a few exceptions, as of March 31, 2018, the Company’s U.S. federal, state, local and foreign income tax returns for the years 2014 through 2017 are open under the general statute of limitations provisions and therefore subject to examination. Currently, the Company is not under examination of any tax authorities.

 

The Company does not believe it has any significant uncertain tax positions. Accordingly, the Company did not record any adjustments or recognize interest expense for uncertain tax positions for the three months ended March 31, 2018 and 2017, respectively. In the future, if uncertain tax positions arise, interest and penalties will be accrued and included in the Income tax (benefit) expense on the Consolidated Statements of Comprehensive Income (Loss).

 

In connection with the Business Combination and pursuant to the Exchange Agreement by and among the Company, ZGP, the Company Unitholders and Christian M. Zugel, as trustee of the ZGH Class B Voting Trust (the "Exchange Agreement"), holders of Class A Units and any vested ZGP Class B Units (collectively, the "Units") (other than the Company) may, subject to certain conditions and transfer restrictions, exchange their Units for Class A Common Stock or cash or a combination of stock and cash at the election of ZAIS. These exchanges may result in increases in the Company’s allocable share of the tax basis of the tangible and intangible assets of ZGP. These increases in tax basis may increase (for tax purposes) depreciation and amortization deductions and therefore reduce the amount of income or franchise tax that the Company would otherwise be required to pay in the future.

 

In connection with the Business Combination, the Company also entered into the Tax Receivable Agreement (the "Tax Receivable Agreement"), which provides for payment by the Company to exchanging holders of Units of 85% of income or franchise tax benefits, if any, that the Company realizes as a result of these increases in tax basis and of certain other tax benefits related to entering into the Tax Receivable Agreement, including income or franchise tax benefits attributable to payments under the Tax Receivable Agreement. This payment obligation is an obligation of the Company and not of ZGP.

 

 35 

 

  

As of March 31, 2018 there have been no exchanges of Units for Class A common stock and the Company has not recorded a deferred tax asset for the future amortization of tax basis of the tangible and intangible assets of ZGP. Accordingly, the Company has not recorded a related tax receivable agreement liability in due to related parties in the consolidated statements of financial condition for the expected payments under the Tax Receivable Agreement.

 

10. Related Party Transactions

 

ZAIS Managed Entities

 

ZAIS Group offers a range of alternative and traditional investment strategies through the ZAIS Managed Entities. ZAIS Group earns all of its management fee income and incentive income from the ZAIS Managed Entities, which are considered related parties as the Company manages the operations of, and makes investment decisions for, these entities. The Company considers ZAIS Group’s principals, executives, employees and all ZAIS Managed Entities to be affiliates and related parties.

 

ZAIS Group invests in its subsidiaries and some of the ZAIS Managed Entities. Investments in subsidiaries and certain ZAIS Managed Entities that are consolidated are eliminated. Investments in certain ZAIS Managed Entities that are not consolidated are further described in Note 3 - “Investments in Affiliates” and Note 5 – “Variable Interest Entities and Voting Interest Entities”.

 

ZAIS Group did not charge management fees or incentive fees on investments made in the ZAIS Managed Entities (excluding CLOs) by ZAIS Group’s principals, executives, employees and other related parties. The total amount of investors’ capital balances that are not being charged management fees or incentive fees were approximately as follows:

 

March 31,

2018

  

December 31,

2017

 
(Dollars in thousands) 
        
$7,427(1)(2)  $12,610(1)

 

(1) In order to finance a portion of the purchase of the Company’s Class A Common Stock pursuant to the Share Purchase Agreement, Mr. Zugel and various trusts for which relatives of Mr. Zugel are the beneficiaries have withdrawn approximately $4.3 million and $5.5 million of interests from the Domestic Feeder on March 31, 2018 and December 31, 2017, respectively.

 

(2) In order to finance a portion of the purchase of the Company’s Class A Common Stock pursuant to the Share Purchase Agreement, Sonia Zugel, Mr. Zugel’s spouse, has indicated an intention to withdraw approximately $1.7 million of interests from the Domestic Feeder effective September 30, 2018. The capital balance presented has not been reduced for this withdrawal request.

 

Additionally, certain ZAIS Managed Entities, with existing fee arrangements, have investments representing 100% of the subordinated notes of (i) ZAIS CLO 2, Limited (“ZAIS CLO 2”) at March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017 and (ii) ZAIS CLO 1, Limited (“ZAIS CLO 1”) for the three months ended March 31, 2017. Therefore, ZAIS Group did not earn management fees or incentive fees from these ZAIS CLOs for these periods. The total amounts of CLO AUM that are not being charged fees were approximately as follows:

 

March 31,

2018

  

December 31,

2017

 
(Dollars in thousands) 
        
$296,633   $296,413 

 

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The amounts due from the ZAIS Managed Entities for Research Costs and Other Direct Costs are as follows:

 

   March 31,
2018
  

December 31,

2017

 
   (Dollars in thousands) 
         
Research Costs  $256   $464 
Other Direct Costs   338    334 
Total  $594   $798 

 

These amounts are included in Due from related parties in the Consolidated Statements of Financial Condition.

 

Consulting Agreements

 

RQSI, Ltd.

 

Certain affiliates of Mr. Neil Ramsey (“Mr. Ramsey”) are significant stockholders of ZAIS.

  

ZGP entered into a two-year Consulting Agreement (the “Consulting Agreement”) with Mr. Ramsey through RQSI, Ltd., an entity controlled by Mr. Ramsey. Under the terms of the Consulting Agreement, Mr. Ramsey provided consulting services to ZGP, ZAIS Group’s senior management team and ZAIS, from time to time during the 24-month period beginning on the closing of the Business Combination and ending on March 17, 2017. Mr. Ramsey agreed not to compete against ZGP during the term of the Consulting Agreement, and for two years following its termination. In consideration for his undertakings under the Consulting Agreement, ZGP agreed to pay Mr. Ramsey a consulting fee of $500,000 per annum payable in monthly installments. The Consulting Agreement terminated on March 17, 2017.

 

The Company has recorded the following expense related to the Consulting Agreement:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$   $105 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

There were no amounts payable to Mr. Ramsey pursuant to the Consulting Agreement at March 31, 2018 or December 31, 2017.

 

ZAIS Group had agreed to use certain statistical data generated by RQSI, Ltd. models. ZAIS Group had used this information for trading futures on behalf of the ZAIS Managed Entities through August 2017.

 

ZAIS Group entered into a month to month lease agreement with an affiliate of RQSI, Ltd dated February 1, 2016 to occupy space in the Company’s London office. The agreement was terminable upon 30 days’ notice. There was no charge to RQSI, Ltd. or its affiliate for use of the space prior to March 1, 2017. From March 1, 2017 through May 31, 2017, the date the lease was terminated, the monthly rate was approximately $5,300.

 

Ms. Tracy Rohan

 

ZAIS Group is a party to a consulting agreement with Ms. Tracy Rohan (“Ms. Rohan”), Mr. Zugel’s sister-in-law, pursuant to which Ms. Rohan provides services to ZAIS Group relating to event planning, promotion, web and print branding and related services. Pursuant to the consulting agreement, Ms. Rohan earns approximately $106,000 annually (based on the GBP conversion rate as of March 31, 2018). The Company recognized the following amounts for her services:

  

 37 

 

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$27   $24 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

Amounts payable to Ms. Rohan pursuant to the consulting agreement are as follows:

 

March 31,

2018

  

December 31,

2017

 
(Dollars in thousands) 
        
$9   $17 

 

Such amounts are included in Other liabilities in the Consolidated Statements of Financial Condition.

 

11. Property and Equipment

 

Property and equipment consist of the following:

 

  

March 31,

2018

  

December 31,

2017

 
   (Dollars in thousands) 
         
Office equipment  $3,380   $3,277 
Leasehold improvements   1,883    606 
Furniture and fixtures   721    573 
Software   412    412 
    6,396    4,868 
Less accumulated depreciation and amortization   (4,605)   (4,590)
Total  $1,791   $278 

 

 The Company recognized depreciation and amortization expense as follows:

 

Three Months Ended
March 31,
 

2018

  

2017

 
(Dollars in thousands) 
        
$16   $40 

 

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12. Commitments and Contingencies

 

Engagement Agreement with Berkshire Capital

 

On April 22, 2016, the Company entered into an investment banking engagement agreement with Berkshire Capital Securities, LLC (“Berkshire Capital”), an affiliate of Mr. R. Bruce Cameron, a former director of the Company, pursuant to which Berkshire Capital was to provide financial advisory services in connection with the Company’s strategic planning. Pursuant to the engagement letter, Berkshire Capital received a $100,000 retainer and was entitled to receive a monthly retainer of $15,000 beyond the initial three month term of the engagement, in certain circumstances, reimbursements for its expenses and in the event a covered transaction was consummated, a success fee equal to no more than the greater of $750,000 and 2% of the total consideration paid.  The Company is no longer paying the monthly retainer as of October 2017.

 

The Company incurred the following expenses pursuant to the engagement agreement:

 

Three Months Ended March 31, 

2018

  

2017

 
(Dollars in thousands) 
        
$   $46 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

Legal Advisor Agreement

 

On February 27, 2017, ZAIS Group entered into an agreement (the “Legal Advisor Agreement”) with Howard Steinberg, the Company’s former General Counsel, pursuant to which Mr. Steinberg resigned as General Counsel effective March 31, 2017 and was retained as Senior Legal Advisor to the Company effective April 1, 2017. Under the Legal Advisor Agreement, which was approved by the Compensation Committee, Mr. Steinberg receives $150,000 per calendar quarter for his services, plus additional compensation of $900 per hour if he is requested to devote more than 20 hours during any week to advising the Company. In addition, under the Legal Advisor Agreement, Mr. Steinberg is entitled to reimbursement of reasonable out-of-pocket expenses incurred in connection with performing services for the Company, an allowance or reimbursement for the reasonable cost of suitable office space in Manhattan should Mr. Steinberg require it, 70% of the premiums for COBRA health and medical insurance coverage for Mr. Steinberg and his spouse paid for by the Company and, after COBRA coverage lapses, up to 70% of the costs of Medicare supplementary health insurance coverage for Mr. Steinberg and his spouse, for as long as he provides legal advisory services to the Company, capped at $3,450 per quarter. Pursuant to the Legal Advisor Agreement, Mr. Steinberg also received a payment of $450,000 on February 28, 2017 (the “February 2017 Payment”). The Legal Advisor Agreement is terminable by the Company or Mr. Steinberg on 30 days’ prior written notice. If the Legal Advisor Agreement is terminated by the Company other than due to Mr. Steinberg’s failure to perform services, Mr. Steinberg is entitled to a payment of $300,000.

 

The Company incurred the following expenses pursuant to the Legal Advisor Agreement:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$157   $450 

 

Such amounts (excluding the February 2017 Payment) are included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). The February 2017 Payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

Engagement Agreement with Houlihan Lokey Capital, Inc.

 

On September 27, 2017, the Company and the Special Committee of the Board of Directors entered into an investment banking agreement (the “Investment Banking Agreement”) with Houlihan Lokey, Inc. (“Houlihan Lokey”) pursuant to which the Special Committee of the Board of Directors retained Houlihan Lokey as its financial adviser in connection with the potential transaction between the Company and Z Acquisition. Pursuant to the Investment Banking Agreement, Houlihan Lokey is entitled to an aggregate fee of $800,000 for its services, of which $250,000 was paid to Houlihan Lokey upon its engagement (the “Houlihan Lokey Retainer Payment”), and $350,000 (plus $15,990 in expense reimbursement) was paid to Houlihan Lokey upon delivery of its opinion, dated January 11, 2018, to the Special Committee (the “Houlihan Lokey Opinion Payment”). An additional $200,000 payment is contingent upon consummation of the Merger. In addition, the Company has agreed to reimburse Houlihan Lokey for certain expenses and to indemnify Houlihan Lokey, its affiliates and certain related parties against certain liabilities and expenses, including certain liabilities under the federal securities laws, arising out of or related to Houlihan Lokey’s engagement.

 

 39 

 

  

The Houlihan Lokey Opinion Payment is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2018.

 

Consulting Agreement

 

On January 4, 2018, the Company entered into a Consulting Agreement with Mr. Szymanski pursuant to which, effective January 6, 2018, Mr. Szymanski commenced providing consulting services to the Company and ZAIS Group to be provided through February 28, 2018 for a monthly consulting fee equal to $50,000 payable in advance and the reimbursement of all reasonable expenses. For the three months ended March 31, 2018 the Company paid Mr. Szymanski $100,000 pursuant to the agreement. Such amount is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss).

 

Capital Commitments

 

At each of March 31, 2018 and December 31, 2017, the Company had committed a total of $20.0 million of equity capital to Zephyr A-6, a Consolidated Fund that was established to invest predominantly in ZAIS CLOs in compliance with the risk retention requirements of the Dodd-Frank Act, effective at the time of the formation of Zephyr A-6. The Company’s total contributions to Zephyr A-6 as of December 31, 2017 and March 31, 2018 were as follows: 

 

March 31,

2018

  

December 31,

2017

 
(Dollars in thousands) 
        
$10,954   $8,287 

 

 In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of May 10, 2018.

 

There is no assurance that the full commitments will be required to be funded by ZAIS Group or as to the period of time during which these commitments may be required to be funded. ZAIS Group serves as the investment manager to these ZAIS Managed Entities and determines when, and to what extent, capital will be called.

    

Lease Obligations

 

ZAIS Group currently leases office space in New Jersey and London under operating lease agreements.

 

New Jersey

    

On August 31, 2017, ZAIS Group executed a lease for new office space in Holmdel, New Jersey (the “New Lease”). The Company took possession of the space on April 15, 2018 at which time rent commenced. The lease has an expiration date of April 2025 and provides for the Company to extend the lease term for one five year period commencing on the first day following the expiration of the lease. The fixed rent during the renewal period will be based on the fair market rent at the time of the renewal. The Company expects to move into the space during the second quarter of 2018.

 

 40 

 

 

London

 

On June 5, 2017, ZAIS Group (UK) Limited, the Company’s London subsidiary, provided notice that the lease of its London office premises would terminate on September 7, 2017. On July 26, 2017, ZAIS Group (UK) Limited entered into an agreement to license alternative office space in London. The license for the alternative office space commenced on September 11, 2017 and may be terminated on each anniversary of the commencement date thereafter subject to the provision of at least three months’ notice.

 

Rent Expense

 

The Company recognizes rent expense related to its operating leases on a straight-line basis over the lease term and is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). The Company incurred rent expense as follows:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$179   $215 

 

Aggregate future minimum annual rental payments for the period from April 1, 2018 to December 31, 2018 and the five years subsequent to December 31, 2018 and thereafter, including rental payments due under the New Lease, are approximately as follows:

 

Period  (Dollars in
thousands)
 
     
Period from April 1, 2018 through December 31, 2018:   286 
      
Year Ending December 31,     
2019   326 
2020   398 
2021   405 
2022   412 
2023   418 
Thereafter   550 
Total   2,795 

 

Litigation

 

From time to time, ZAIS Group may become involved in various claims, formal regulatory inquiries and legal actions arising in the ordinary course of business. The Company discloses information regarding such inquiries if disclosure is required pursuant to accounting and financial reporting standards.

 

Other Contingencies

 

In the normal course of business, ZAIS Group enters into contracts that provide a variety of indemnifications. Such contracts include those with certain service providers, brokers and trading counterparties. Any exposure to ZAIS Group under these arrangements could involve future claims that may be made against ZAIS Group. The Company has received a claim for indemnification from R. Bruce Cameron, a former director of the Company, in connection with a complaint that was filed by Parsifal Partners B, LP against Mr. Zugel, Mr. Szymanski, R. Bruce Cameron, the Company and Berkshire Capital Securities LLC.

 

 41 

 

 

The Company incurred the following expenses related to the indemnification claim:

 

Three Months Ended

March 31,

 
2018   2017 
(Dollars in thousands) 
        
$3   $ 

 

Such amounts are included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). 

  

13. Segment Reporting

 

The Company currently is comprised of one reportable segment, the investment management segment, and substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities.

 

14. Stockholders’ Equity

 

Preferred Stock

 

The Company is authorized to issue 2,000,000 shares of preferred stock with a par value of $0.0001 per share with such designation, rights and preferences as may be determined time to time by the Board of Directors. No shares of preferred stock have been issued or are outstanding.

 

Class A Common Stock

 

The Company is authorized to issue 180,000,000 shares of Class A Common Stock with a par value of $0.0001 per share. Holders of record of Class A Common Stock are entitled to one vote for each share held on all matters to be voted on by stockholders.

 

The Company issued the following Class A Common Stock related to RSUs which vested:

 

Three Months Ended

March 31,

 
2018   2017 
        
     548,923 

 

2015 Stock Plan

 

A summary of the Class A Common Stock which the Company may issue pursuant to the 2015 Stock Plan is as follows:

 

Total shares which may be issued pursuant to the plan   2,080,637 
      
Total shares issued through March 31, 2018   684,196 
      
Total shares available for issuance at March 31, 2018   1,396,441 

 

Class B Common Stock

 

The Company is authorized to issue 20,000,000 shares of Class B Common Stock with a par value of $0.000001 per share, all of which are issued and outstanding. The Class B Common Stock has no economic rights and therefore is not considered participating securities for purposes of allocation of net income (loss). Holders of record of Class B Common Stock are entitled to ten votes for each share held on all matters to be voted on by stockholders.

 

 42 

 

 

At each of March 31, 2018 and December 31, 2017, 20,000,000 shares of Class B Common Stock were held by an irrevocable voting trust of which Mr. Zugel is the sole trustee (the “ZGH Class B Voting Trust”). Consequently, in his capacity as trustee of the ZGH Class B Voting Trust, Mr. Zugel has effective voting control over the election of directors and generally on all other matters submitted for approval by the Company’s stockholders.

 

Class A Units

 

At each of March 31, 2018 and December 31, 2017, ZAIS’s ownership of the Class A Units was 67.5%. The remaining Class A Units of ZGP are held by the ZGP Founder Members.

 

During the first five years following the closing of the Business Combination, ZGP will release up to an additional 2,800,000 Class A Units to the ZGP Founder Members if the sum of the average per share closing price over any 20 trading-day period of the Class A Common Stock plus cumulative dividends paid on the Class A Common Stock between the closing of the Business Combination and the day prior to such 20 trading-day period meets or exceeds specified thresholds, ranging from $12.50 to $21.50.

   

There were no Class A Units issued to ZAIS during the three months ended March 31, 2018 and 548,923 Class A Units issued to ZAIS during the three months ended March 31, 2017.

 

Subject to certain restrictions, the ZGP Founder Members’ Class A Units may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement that ZAIS entered into with ZGP, the ZGP Founder Members and the other parties thereto (the “Exchange Agreement”).

 

Class B Units

 

ZGP may issue up to 6,800,000 Class B units (“Class B Units”) at any time during the five year period following the closing of the Business Combination. These units are comprised of 1,600,000 Class B-0 and 5,200,000 Class B units which are designated as Class B-1, Class B-2, Class B-3 and Class B-4 Units. A portion of the Class B-0 Units were awarded but subsequently (i) forfeited or (ii) cancelled (see Note 8 – “Compensation”) in consideration for the right to receive RSUs or cash. These Class B-0 Units are still available for re-issuance. The Class B-1, Class B-2, Class B-3 and Class B-4 Units, once issued, vest in three equal installments only if the Class A Common Stock of ZAIS achieves certain average closing price thresholds within five years after the closing of the Business Combination ranging from $12.50 to $21.50 as follows: one-third of such award vests upon achieving the applicable threshold, one-third of such award vests upon the first anniversary of such achievement and the final one-third of such award vests upon the second anniversary of such achievement, unless otherwise provided in the restricted unit agreement granting the Class B unit. Although the Class B Units are outstanding when issued, the Class B Units are not entitled to any distributions from ZGP (and thus will not participate in, or be allocated any, income or loss) or other material rights until such Class B Units vest.

 

Subject to certain restrictions, all of the vested Class B Units (but not any unvested Class B Units) may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement.

 

There were no Class B-1, Class B-2, Class B-3 or Class B-4 Units awarded during the three months ended March 31, 2018 or March 31, 2017 and no Class B Units currently are issued and outstanding.

 

On December 1, 2016, the Board of Directors authorized ZGP to offer the employees who agreed to the cancellation of their unvested Class B-0 Units the right to receive in substitution for the cancellation of their Class B-0 Units, at the holder’s option, either (a) RSUs of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled. Both were subject to vesting requirements. When the RSUs issued in substitution for the Class B-0 Units vested on March 17, 2017, the Company issued 548,923 shares of Class A Common Stock to the RSU holders (See Note 8 – “Compensation”).

 

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15. Earnings Per Share

 

Shares of Class B Common Stock have no impact on the calculation of consolidated net income (loss) per share of Class A Common Stock as holders of Class B Common Stock do not participate in net income or dividends, and thus, are not participating securities.

   

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted earnings per share:

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands, except
shares and per share amounts)
 
Numerator:          
Consolidated Net Income (Loss), attributable to ZAIS Group Holdings, Inc. Class A common stockholders (Basic)  $(3,777)  $(4,162)
Effect of dilutive securities:          
Consolidated Net Income (Loss), attributable to non-controlling interests in ZGP   (1,816)   (2,083)
Income tax (benefit) expense (1)        
Consolidated Net Income (Loss), attributable to stockholders, after effect of dilutive securities  $(5,593)  $(6,245)
Denominator:          
Weighted average number of shares of Class A Common Stock   14,555,113    13,986,305 
Effect of dilutive securities:          
Weighted average number of Class A Units  (3)   7,000,000    7,000,000 
Dilutive number of Class B-0 Units and RSUs (2)        
Diluted weighted average shares outstanding   21,555,113    20,986,305 
Consolidated Net Income (Loss),  per Class A common share – Basic  $(0.26)  $(0.30)
Consolidated Net Income (Loss),  per Class A common share – Diluted  $(0.26)  $(0.30)

 

(1)Income tax (benefit) expense is calculated using an assumed tax rate of 18.69% and 5.56% for the three months ended March 31, 2018 and March 31, 2017, respectively, which is fully offset by a 100% valuation allowance in each year. See Note 9 – “Income Taxes” for details surrounding income taxes.

 

(2)The treasury stock method is used to calculate incremental Class A common shares on potentially dilutive Class A common shares resulting from unvested Class B-0 Units granted in connection with and subsequent to the Business Combination and unvested RSUs granted to non-employee directors of ZAIS and employees of ZAIS Group. These Class B-0 Units and RSUs are anti-dilutive and, consequently, have been excluded from the computation of diluted weighted average shares outstanding.

 

(3)Number of diluted shares outstanding takes into account non-controlling interests of ZGP that may be exchanged for Class A Common Stock under certain circumstances.

 

 44 

 

 

16. Supplemental Financial Information

 

The following supplemental financial information illustrates the consolidating effects of the Consolidated Funds on the Company’s financial condition and results of operations:

 

   March 31, 2018 
   ZAIS   Consolidated
Funds
  

Consolidating

Entries

   Consolidated 
   ( Dollars in thousands ) 
Assets                    
Cash and cash equivalents  $30,906   $   $   $30,906 
Income and fees receivable   2,947            2,947 
Investments in affiliates, at fair value   13,768        (13,610)   158 
Due from related parties   594            594 
Property and equipment, net   1,791            1,791 
Prepaid expenses   786            786 
Withdrawals receivable   9,380            9,380 
Other assets   1,570            1,570 
Assets of Consolidated Variable Interest Entities                    
Cash       29,762        29,762 
Investments in affiliated securities, at fair value       117,195        117,195 
Other assets       1,067    (448)   619 
Total Assets  $61,742   $148,024   $(14,058)  $195,708 
Liabilities and Equity                    
Liabilities                    
Compensation payable  $2,427   $   $   $2,427 
Due to related parties                
Fees payable   2,683        (448)   2,235 
Other liabilities   1,686            1,686 
Liabilities of Consolidated Variable Interest Entities                    
Repurchase Agreements       45,500        45,500 
Other liabilities       451        451 
Total Liabilities   6,796    45,951    (448)   52,299 
                     
Commitments and Contingencies (Note 12)                    
                     
Equity                    
Preferred Stock                
Class A Common Stock   1            1 
Class B Common Stock                
Additional paid-in-capital   64,436            64,436 
Retained earnings (Accumulated deficit)   (27,191)           (27,191)
Accumulated  other comprehensive income (loss)   (55)           (55)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   37,191            37,191 
Non-controlling interests in ZAIS Group Parent, LLC   17,755            17,755 
Non-controlling interests in Consolidated Funds       102,073    (13,610)   88,463 
Total Equity   54,946    102,073    (13,610)   143,409 
Total Liabilities and Equity  $61,742   $148,024   $(14,058)  $195,708 

 

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   December 31, 2017 
   ZAIS   Consolidated
Funds
  

Consolidating

Entries

   Consolidated 
   ( Dollars in thousands ) 
Assets                
Cash and cash equivalents  $41,619   $   $   $41,619 
Income and fees receivable   8,863            8,863 
Investments in affiliates, at fair value   20,669        (10,518)   10,151 
Due from related parties   798            798 
Property and equipment, net   278            278 
Prepaid expenses   967            967 
Other assets   359            359 
Assets of Consolidated Variable Interest Entities                    
Cash       8,975        8,975 
Investments in affiliated securities, at fair value       114,911        114,911 
Other assets       1,353    (385)   968 
Total Assets  $73,553   $125,239   $(10,903)  $187,889 
Liabilities and Equity                    
Liabilities                    
Compensation payable  $9,222   $   $   $9,222 
Due to related parties   31            31 
Fees payable   2,556        (385)   2,171 
Other liabilities   1,285            1,285 
Liabilities of Consolidated Variable Interest Entities                    
Repurchase Agreements       45,943        45,943 
Other liabilities       415        415 
Total Liabilities   13,094    46,358    (385)   59,067 
                     
Commitments and Contingencies (Note 12)                    
                     
Equity                    
Preferred Stock                
Class A Common Stock   1            1 
Class B Common Stock                
Additional paid-in-capital   64,365            64,365 
Retained earnings (Accumulated deficit)   (23,414)           (23,414)
Accumulated  other comprehensive income (loss)   (61)           (61)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   40,891            40,891 
Non-controlling interests in ZAIS Group Parent, LLC   19,568            19,568 
Non-controlling interests in Consolidated Funds       78,881    (10,518)   68,363 
Total Equity   60,459    78,881    (10,518)   128,822 
Total Liabilities and Equity  $73,553   $125,239   $(10,903)  $187,889 

 

 46 

 

 

  

Three Months Ended

March 31, 2018

 
   ZAIS   Consolidated
Funds
  

Consolidating

Entries

   Consolidated 
   ( Dollars in thousands ) 
Revenues                
Management fee income  $5,063   $   $   $5,063 
Incentive income   146            146 
Reimbursement revenue   309            309 
Other revenues   77            77 
Income of Consolidated Funds       4,109    (3,096)   1,013 
Total Revenues   5,595    4,109    (3,096)   6,608 
Expenses                    
Compensation and benefits   6,086            6,086 
General, administrative and other   5,026        (530)   4,496 
Depreciation and amortization   16            16 
Expenses of Consolidated Funds       480        480 
Total Expenses   11,128    480    (530)   11,078 
Other Income (loss)                    
Net gain (loss) on investments in affiliates   (160)       (426)   (586)
Other income (expense)   104            104 
Net gain (loss) of Consolidated Funds’ investments       (437)   2,567    2,130 
Total Other Income (Loss)   (56)   (437)   2,141    1,648 
Income (loss) before income taxes   (5,589)   3,192    (425)   (2,822)
Income tax (benefit) expense   4            4 
Consolidated net income (loss)   (5,593)   3,192    (425)   (2,826)
Other Comprehensive Income (Loss), net of tax                    
Foreign currency translation adjustment   9            9 
Total Comprehensive Income (Loss)  $(5,584)  $3,192   $(425)  $(2,817)

   

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Three Months Ended

March 31, 2017

 
   ZAIS   Consolidated
Funds
  

Consolidating

Entries

   Consolidated 
   ( Dollars in thousands ) 
Revenues                
Management fee income  $3,107   $   $   $3,107 
Incentive income   297            297 
Reimbursement revenue   494            494 
Other revenues   93            93 
Income of Consolidated Funds       205    (205)    
Total Revenues   3,991    205    (205)   3,991 
Expenses                    
Compensation and benefits   7,424            7,424 
General, administrative and other   3,669            3,669 
Depreciation and amortization   40            40 
Expenses of Consolidated Funds       43        43 
Total Expenses   11,133    43        11,176 
Other Income (loss)                    
Net gain (loss) on investments in affiliates   918        (843)   75 
Other income (expense)   (16)           (16)
Net gain (loss) of Consolidated Funds’ investments       1,492    (385)   1,107 
Net gain (loss) on beneficial interest of consolidated collateralized financing entity           589    589 
Total Other Income (Loss)   902    1,492    (639)   1,755 
Income (loss) before income taxes   (6,240)   1,654    (844)   (5,430)
Income tax (benefit) expense   5            5 
Consolidated net income (loss)   (6,245)   1,654    (844)   (5,435)
Other Comprehensive Income (Loss), net of tax                    
Foreign currency translation adjustment   30            30 
Total Comprehensive Income (Loss)  $(6,215)  $1,654   $(844)  $(5,405)

 

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17. Subsequent Events

 

On April 13, 2018 and April 26, 2018, ZAIS Group received proceeds in the aggregate amount of approximately $9.1 million from the complete withdrawals of its investments, which carried first loss risk, in two ZAIS Managed Entities (see Note 4 – “Investments in Affiliates, at fair value”). The Company expects to receive the remaining proceeds of approximately $0.2 million by May 31, 2018.

 

During the period from April 1, 2018 through May 10, 2018, Zephyr A-6 contributed $15.0 million to the ZAIS CLO 9 Warehouse (see Note 5 – “Variable Interest Entities”). On May 8, 2018, Zephyr A-6 received notification from ZAIS Group, as collateral manager for ZAIS CLO 9, for a contribution of $5.0 million to ZAIS CLO 9 which will be funded on May 14, 2018.

 

On May 1, 2018, pursuant to the Share Purchase Agreement, Z Acquisition (i) purchased 6,500,000 million shares of Class A Commons Stock of the Company at a purchase price of $4.10 per share from Ramguard, (ii) made a cash payment of $10,250,000 together with interest in the amount of $125,000 to Ramguard and (iii) issued a promissory note to Ramguard in the principal amount of $13,325,000 with an interest rate of 8% per annum, payable quarterly in cash, and a maturity date of December 31, 2019. An additional cash payment to Ramguard of $3,075,000 together with interest in the amount of $125,000 is required to be made under the Share Purchase Agreement on or before August 1, 2018 by Z Acquisition or Mr. Zugel.

 

On May 8, 2018, the Compensation Committee and the Board of Directors authorized the Company to pay each of its non-employee directors $50,000 in cash for their service as non-employee directors on or about May 9, 2018.

 

On May 9, 2018 the Company issued 63,219 shares of Class A Common Stock to the Company’s non-employee directors in connection with the vesting of the RSUs which were issued on May 9, 2017 (see Note 8 – “Compensation”).

 

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Item 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In this Quarterly Report on Form 10-Q, references to (i) the “Company”, “we” or “our” refer to ZAIS Group Holdings, Inc. (“ZAIS”), together, as the context may require, with its consolidated subsidiaries, (ii) “ZAIS Group” refer to ZAIS Group, LLC, and (iii) “ZGP” refer to ZAIS Group Parent, LLC.

 

This discussion contains forward-looking statements and involves numerous known and unknown risks and uncertainties, including, but not limited to, those described in “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “Annual Report on Form 10-K”) and in other reports filed with the U.S Securities and Exchange Commission (“SEC”). Actual results and the timing of events may differ materially from those contained in any forward-looking statements due to a number of factors, including those in the section entitled “Risk Factors” in the Annual Report on Form 10-K and in other SEC reports describing key risks associated with ZAIS and its subsidiaries’ business, operations and industry. Amounts and percentages presented throughout this management’s discussion and analysis of financial condition and results of operations may reflect rounding adjustments and as a result, totals may not appear to sum. The following discussion and analysis should be read in conjunction with the historical consolidated financial statements and related notes of the Company included elsewhere in this Quarterly Report on Form 10-Q.

 

Overview

 

General

 

ZAIS is a holding company conducting substantially all of its operations through ZAIS Group, a wholly-owned subsidiary of ZAIS’s majority-owned subsidiary, ZGP. ZAIS is the managing member of ZGP. ZAIS Group commenced operations in July 1997 and is headquartered in Red Bank, New Jersey but expects to move its operations to Holmdel, New Jersey during the second quarter of 2018. ZAIS Group also maintains an office in London.

 

ZAIS Group is an investment advisory and asset management firm focused on specialized credit. ZAIS Group is an investment advisor registered with the SEC under the Investment Advisers Act of 1940 and with the Commodity Futures Trading Commission as a Commodity Pool Operator and Commodity Trading Advisor. ZAIS Group provides investment advisory and asset management services to private funds, separately managed accounts and structured vehicles (collateralized debt obligation vehicles and collateralized loan obligation vehicles, together referred to as “CLOs”) (collectively, the “ZAIS Managed Entities”). The ZAIS Managed Entities predominantly invest in a variety of specialized credit instruments including corporate credit instruments such as leveraged bank loans and CLOs, real estate, securities backed by residential and commercial mortgage loans and asset backed securities collateralized by a range of consumer loan products. ZAIS Group also serves as the general partner to certain ZAIS Managed Entities, which are generally organized as pass-through entities for U.S. federal income tax purposes.

 

Pursuant to accounting principles generally accepted in the United States (“U.S. GAAP”), the Company is required to consolidate certain of the ZAIS Managed Entities (the “Consolidated Funds”) in which we hold a variable interest and is deemed to be the primary beneficiary (“VIEs”). 

 

ZAIS Group’s “majority-owned affiliate” (as such term is defined in the Dodd-Frank Act), Zephyr A-6, LP (“Zephyr A-6”), was formed to invest predominantly in CLOs managed by ZAIS Group (the “ZAIS CLOs”), including during the related warehouse period of such CLOs, in a manner compliant with the Dodd-Frank credit risk retention rules. The Company consolidated Zephyr A-6 in its condensed consolidated financial statements at March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017.

 

ZAIS Group had approximately $4.793 billion of assets under management (“AUM”) at March 31, 2018 and $4.512 billion at December 31, 2017 which is primarily comprised of (i) total assets for mark-to-market funds and separately managed accounts; (ii) uncalled capital commitments, if any, for funds that are not in liquidation; and (iii) for issued structured vehicles, all assets being managed calculated per the management fee basis methodology defined in the respective vehicles’ indenture, although in certain circumstances some or all of the referenced management fees may be waived.  AUM also includes assets in the warehouse phase for new structured credit vehicles and is based on actual assets managed without reductions for leverage and most other liabilities and includes all assets regardless of whether management fees are being earned.

 

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On January 11, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Z Acquisition LLC, a Delaware limited liability company (“Z Acquisition”), and ZGH Merger Sub, Inc., a wholly-owned subsidiary of the Company (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a subsidiary of Z Acquisition. Christian Zugel, the Company’s Chairman and Chief Investment Officer, the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group (“Mr. Zugel”), is the sole managing member of Z Acquisition, and Daniel Curry, the Company’s Chief Executive Officer, President and a Director (“Mr. Curry”), is a member of Z Acquisition. At the effective time of the Merger, shares of Class A common stock (“Class A Common Stock”), other than shares held by Mr. Zugel, affiliates of Mr. Zugel, and certain other shareholders, will be converted into the right to receive $4.10 per share in cash without interest, subject to any required withholding taxes. All outstanding restricted stock units (“RSUs”) are held by the Company’s independent directors and will also be converted in the Merger into the right to receive $4.10 per share in cash for the number of shares of Class A Common Stock underlying such RSUs. The proposed Merger is a “going private transaction” under SEC rules. There is no assurance that the Merger will be consummated. The Company is required to reimburse Z Acquisition, Mr. Zugel, Mr. Curry and other members of Z Acquisition, Mr. Zugel’s spouse, and certain trusts for members of Mr. Zugel’s family (collectively, the “Parent Group”) for all documented fees and expenses incurred by them (including reasonable attorneys’ fees) in connection with the Merger Agreement and the transactions contemplated thereby, up to a maximum of $1.5 million in the aggregate, if the Company or Z Acquisition terminates the Merger Agreement because of an Adverse Company Recommendation (as defined in the Merger Agreement).

 

On January 5, 2018, the Company announced that Michael Szymanski had tendered his resignation as Chief Executive Officer, President and a Director and that the Company’s board of directors (“Board of Directors”) had elected Daniel Curry to succeed Mr. Szymanski in these positions. Mr. Szymanski’s resignation was effective as of the close of business on January 5, 2018 and the election of Mr. Curry was effective as of January 8, 2018.

  

Our primary sources of revenues are (i) management fee income, which is based predominantly on the net asset values of the funds and accounts managed by ZAIS Group or par values of the collateral and cash held by ZAIS CLOs and (ii) incentive income, which is based on the investment performance of the ZAIS Managed Entities.

 

Additionally, a significant source of our revenues and other income is derived from our Consolidated Funds which invest in CLOs. This income is comprised of interest, dividends and net gains from the Consolidated Funds’ investments and net gains on beneficial interests of consolidated collateralized financing entities which invest in first lien, senior secured loans. A portion of income of Consolidated Funds and net gains of Consolidated Funds’ investments are allocated to non-controlling interests in Consolidated Funds.

  

Capitalization

 

Preferred Stock

 

ZAIS is authorized to issue 2,000,000 shares of preferred stock with a par value of $0.0001 per share with such designation, rights and preferences as may be determined time to time by the Board of Directors. No shares of preferred stock have been issued or are outstanding.

 

Class A Common Stock

 

ZAIS is authorized to issue 180,000,000 shares of Class A Common Stock with a par value of $0.0001 per share. Holders of record of Class A Common Stock are entitled to one vote for each share held on all matters to be voted on by stockholders. At each of March 31, 2018 and December 31, 2017, the Company had 14,555,113 shares of Class A Common Stock issued and outstanding.

 

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Class B Common Stock

 

ZAIS is authorized to issue 20,000,000 shares of our Class B Common Stock with a par value of $0.000001 per share, all of which are issued and outstanding. The Class B Common Stock has no economic rights and therefore is not considered participating securities for purposes of allocation of net income (loss). Holders of record of Class B Common Stock are entitled to ten votes for each share held on all matters to be voted on by stockholders.

 

At each of March 31, 2018 and December 31, 2017, 20,000,000 shares of Class B Common Stock were held by an irrevocable voting trust of which Mr. Zugel is the sole trustee (the “ZGH Class B Voting Trust”). Consequently, in his capacity as trustee of the ZGH Class B Voting Trust, Mr. Zugel has effective voting control over the election of directors and generally on all other matters submitted for approval by the Company’s stockholders.

 

Class A Units

 

At each of March 31, 2018 and December 31, 2017, ZAIS’s ownership of the Class A Units of ZGP was 67.5%. The remaining Class A Units of ZGP are held by Mr. Zugel and certain related parties (collectively, the “ZGP Founder Members”).

 

During the first five years following the contribution of cash by HF2 Financial Management, Inc. to ZGP in exchange for newly issued Class A Units, representing a majority financial interest in ZGP (the “Business Combination”), ZGP will release up to an additional 2,800,000 Class A Units to the ZGP Founder Members if the sum of the average per share closing price over any 20 trading-day period of the Class A Common Stock plus cumulative dividends paid on the Class A Common Stock between the closing of the Business Combination and the day prior to such 20 trading-day period meets or exceeds specified thresholds, ranging from $12.50 to $21.50.

 

There were no Class A Units issued to ZAIS during the three months ended March 31, 2018 and 548,923 Class A Units issued to ZAIS during the three months ended March 31, 2017. 

 

Subject to certain restrictions, the ZGP Founder Members’ Class A Units may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement that ZAIS entered into with ZGP, the ZGP Founder Members and the other parties thereto (the “Exchange Agreement”).

 

Class B Units

 

ZGP may issue up to 6,800,000 Class B units (“Class B Units”) at any time during the five year period following the closing of the Business Combination. These units are comprised of 1,600,000 Class B-0 Units and 5,200,000 Class B Units which are designated as Class B-1, Class B-2, Class B-3 and Class B-4 Units. A portion of the Class B-0 Units were awarded but subsequently (i) forfeited or (ii) cancelled in consideration for the right to receive RSUs or cash. These Class B-0 Units are still available for re-issuance. The Class B-1, Class B-2, Class B-3 and Class B-4 Units, once issued, vest in three equal installments only if the Class A Common Stock of ZAIS achieves certain average closing price thresholds within five years after the closing of the Business Combination ranging from $12.50 to $21.50 as follows: one-third of such award vests upon achieving the applicable threshold, one-third of such award vests upon the first anniversary of such achievement and the final one-third of such award vests upon the second anniversary of such achievement, unless otherwise provided in the restricted unit agreement granting the Class B Unit. Although the Class B Units are outstanding when issued, the Class B Units are not entitled to any distributions from ZGP (and thus will not participate in, or be allocated any, income or loss) or other material rights until such Class B Units vest.

 

Subject to certain restrictions, all of the vested Class B Units (but not any unvested Class B Units) may be exchanged for shares of Class A Common Stock of ZAIS on a one-for-one basis (subject to certain, if any, adjustments to the exchange ratio) or, at ZAIS’s option, cash or a combination of Class A Common Stock and cash, pursuant to the Exchange Agreement.

 

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There were no Class B-0, Class B-1, Class B-2, Class B-3 or Class B-4 Units awarded during the three months ended March 31, 2018 or three months ended March 31, 2017. No Class B Units currently are issued and outstanding.

 

Organization Structure

 

The following diagram illustrates our corporate structure at March 31, 2018:

 

 

Investments

 

Unconsolidated ZAIS Managed Entities

 

Investment activity during the three months ended March 31, 2018 and March 31, 2017 was as follows:

 

·In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of May 10, 2018.

  

·On March 12, 2018, we sent notice to terminate the management contracts, effective March 16, 2018, for the two ZAIS Managed Entities in which we had made investments that carried first loss risk. In connection with the termination of these management contracts, we also requested a complete withdrawal of its investment amounts as of March 30, 2018. Our aggregate investment in these entities as of December 31, 2017 was approximately $10.0 million.  In April 2018, we received proceeds in the aggregate amount of approximately $9.1 million. We expect to receive the remaining proceeds of approximately $0.2 million by May 31, 2018. In connection with the termination of the management contracts for these two ZAIS Managed Entities, our assets under management decreased by approximately $0.109 billion during the period beginning December 31, 2017 through March 31, 2018.

 

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Consolidated ZAIS Managed Entities

 

As discussed in the “Overview – General” section above, pursuant to U.S. GAAP, the Company is required to consolidate the Consolidated Funds. Generally the assets, liabilities and cash flows of the Consolidated Funds are reported on a gross basis. Except for CLOs, the condensed consolidated financial statements also reflect the investment income and expenses of the Consolidated Funds on a gross basis. For Consolidated Funds that are CLOs, our share of the net income of the CLOs is reported in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).The earnings of the consolidated entities not attributable to us are allocated to the non-controlling interests in the consolidated entities. Additionally, the presentation of compensation expense and other expenses associated with generating such revenue is not affected by the consolidation process.

 

The Dodd-Frank credit risk retention rules (the “U.S. Risk Retention Rules”), which became effective on December 24, 2016, apply by their terms to any newly issued CLOs or certain cases in which an existing CLO is refinanced, issues additional securities or is otherwise materially amended. However, a ruling by the U.S. Court of Appeals for the District of Columbia Circuit in February 2018, which became effective on April 5, 2018, determined that federal agencies responsible for the U.S. Risk Retention Rules exceeded their statutory authority when designating the collateral manager of an open-market CLO as the securitizer of an open-market CLO. Although the agencies could still file a petition with the Supreme Court to review the DC Circuit Ruling no later than May 10, 2018, the Supreme Court does not grant most petitions for review and the mere filing of such a petition does not stay the effectiveness of a lower court’s ruling. Accordingly, the U.S. Risk Retention Rules do not now apply to open-market CLOs, and ZAIS Group may retain or dispose of the applicable risk retention interests in its discretion. ZAIS Group is evaluating the potential impact of the DC Circuit Ruling on its business and operations.

 

On October 12, 2017 (the “Restructuring Date”), ZAIS Group and the non-ZAIS partner in Zephyr A-6 entered into an Agreement of Purchase and Sale whereby the non-ZAIS partner purchased a portion of ZAIS Group’s interest in Zephyr A-6, including a portion of its unfunded capital commitments. The total purchase price was approximately $25.0 million based on the net asset value of Zephyr A-6 as of the Restructuring Date.

 

In connection with the restructuring of Zephyr A-6, the limited partners of Zephyr A-6 also amended the limited partnership agreement. The partners’ ownership interests and capital commitments were as follows:

 

  

As of

October 11,

2017

  

As of the

Restructuring

Date

 
Ownership Interest:          
ZAIS Group   51.00%   13.33%
Non-ZAIS Partner   49.00%   86.67%
           
Capital Commitments:          
ZAIS Group  $51.0 million   $20.0 million 
Non-ZAIS Partner  $49.0 million   $130.0 million 
           
Capital Commitments funded:          
ZAIS Group  $26.6 million   $7.0 million 
Non-ZAIS Partner  $25.6 million   $45.2 million 
           
Remaining Capital Commitments to be funded:          
ZAIS Group  $24.4 million   $13.0 million 
Non-ZAIS Partner  $23.4 million   $84.8 million 

 

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Zephyr A-6 currently invests in ZAIS CLOs. A portion of the senior fees and all of the subordinate fees and the incentive fees paid to the Company by the ZAIS CLOs in which Zephyr A-6 invests are subsequently paid to Zephyr A-6 by ZAIS and allocated among the limited partners of Zephyr A-6 pro rata based on their percentage interests in Zephyr A-6. The senior fees which will be paid to Zephyr A-6 by us are as follows:

 

  

Prior to the

Restructuring

Date

 

As of and

Subsequent

to the

Restructuring

Date

Senior Fees  In excess of 0.15%  In excess of 0.20%

 

During the three months ended March 31, 2018 and March 31, 2017, Zephyr A-6 received capital contributions from ZAIS Group and the Non-Controlling Interest in Zephyr A-6 as follows:

 

Three Months Ended March 31, 2018  ZAIS
Group
   Non-
Controlling
Interest
   Total 
   (Dollars in thousands) 
             
Unfunded capital commitments as of December 31, 2017  $11,714   $76,135   $87,849 
                
Capital contributions   2,667    17,333    20,000 
                
Unfunded capital commitments as of March 31, 2018  $9,047   $58,802   $67,849 

 

Three Months Ended March 31, 2017  ZAIS
Group
   Non-
Controlling
Interest
   Total 
   (Dollars in thousands) 
             
Unfunded capital commitments as of December 31, 2016  $30,523   $29,326   $59,849 
                
Capital contributions   6,120    5,880    12,000 
                
Unfunded capital commitments as of March 31, 2017  $24,403   $23,446   $47,849 

 

Zephyr A-6’s investments were as follows:

 

CLOs

 

As of March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and March 31, 2017, all Zephyr A-6’s investments consisted of ZAIS CLOs. The ZAIS CLOs invest primarily in first lien, senior secured loans.

 

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The following is a summary of Zephyr A-6’s investments in ZAIS CLOs at the respective closing date of the ZAIS CLO:

 

              

Economic Interest at the Closing Date

 
CLO  Warehouse
Period Start
Date
 

Pricing

Date

 

Closing

Date

 

CLO

Maturity

Date

 

Senior

Notes and
Mezzanine
Notes

   Subordinate
Notes
   Weighted
Average
 
                         
ZAIS CLO 5, Ltd.  October 1, 2015  September 23, 2016  October 26, 2016  October 2028   2.1%   31.8%   5.0%
                            
ZAIS CLO 6, Ltd.  November 18, 2016  May 3, 2017  June 1, 2017  July 2029   5.0%   5.0%   5.0%
                            
ZAIS CLO 7. Ltd.  June 12, 2017  September 11, 2017  October 19, 2017  April 2030   7.0%   5.0%   6.8%
                            
ZAIS CLO 8, Ltd.  October 16, 2017  February 6, 2018  March 8, 2018  April 2029   5.1%   5.0%   5.1%
                            
ZAIS CLO 9, Ltd.  January 29, 2018                  

 

In February 2018, Zephyr A-6 sold its preferred shares of ZAIS CLO 8 which it held during the warehouse period. On March 8, 2018, Zephyr A-6 received sales proceeds of $50.0 million and received a dividend of approximately $2.6 million relating to income and gains during the warehouse period.

 

We determined that ZAIS CLO 6, ZAIS CLO 7 and ZAIS CLO 8 were VIEs but that we were not the primary beneficiary of these ZAIS CLOs based on Zephyr A-6’s minimal investment in the subordinated notes of these ZAIS CLOs. Therefore, we were not required to consolidate these ZAIS CLOs in our financial statements as of March 31, 2018 and December 31, 2017 or for the three months ended March 31, 2018 and March 31, 2017.

 

ZAIS CLO 5

 

We determined that ZAIS CLO 5 was a VIE and that we were the primary beneficiary of ZAIS CLO 5 based on (i) its ability to impact the activities which most significantly impact ZAIS CLO 5’s economic performance as collateral manager and (ii) Zephyr A-6’s significant investment in the subordinated notes of ZAIS CLO 5. Therefore, we initially consolidated ZAIS CLO 5 in our financial statements on the ZAIS CLO 5 closing date. 

  

In February 2017 Zephyr A-6 sold its interest in the Class A-1 tranche of ZAIS CLO 5 for a sales price of approximately $5.4 million and recognized a loss of approximately $81,000. Such amount is included in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

The Company consolidated ZAIS CLO 5 in its financial statements for the period from October 26, 2016 through August 10, 2017. On August 10, 2017, Zephyr A-6 sold all of its remaining interests in ZAIS CLO 5, to an unrelated party. Subsequent to the sale, a wholly owned subsidiary of ZAIS continued as the collateral manager for ZAIS CLO 5. Since the fee arrangement with ZAIS CLO 5 does not constitute a variable interest on its own, ZAIS Group deconsolidated ZAIS CLO 5 as of August 10, 2017.

 

Warehouse Periods

 

During the warehouse periods, the ZAIS CLOs financed the majority of its loan purchases using their warehouse facilities. We determined that the Company is not the primary beneficiary of CLO Warehouses, which are VIEs, because the financing counterparty must approve all significant financing requests and, as a result, the Company does not have the power to direct activities of the entity that most significantly impacts its economic performance. Therefore, Zephyr A-6’s investments in the ZAIS CLOs did not meet the consolidation criteria during the respective warehouse periods.

 

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ZAIS Upsize Acquisition 1, Ltd. (“ZAIS Upsize Acquisition 1”)

 

ZAIS Upsize Acquisition 1 was formed on January 10, 2018 for the purpose of refinancing the notes issued by ZAIS CLO 1, Limited. ZAIS Upsize Acquisition 1, which invests primarily in first lien senior secured loans, was in the warehouse phase from its inception date through May 10, 2018. On January 24, 2018, Zephyr A-6 contributed $2.5 million to ZAIS Upsize Acquisition 1 and on March 15, 2018 it sold its interest in ZAIS Upsize Acquisition 1 to the other initial investors in ZAIS Upsize Acquisition 1 and as a result received proceeds of $2.5 million.

 

Zephyr A-6 contributed the following amounts to the ZAIS CLO warehouses:  

 

  

Three Months Ended

March 31,

 
   2018   2017 
   (Dollars in thousands) 
ZAIS CLO 6  $   $30,000 
ZAIS CLO 9   30,000     
ZAIS Upsize Acquisition 1   2,500     
Total  $32,500   $30,000 

 

During the period from April 1, 2018 through May 10, 2018, Zephyr A-6 contributed an additional $15.0 million to ZAIS CLO 9. On May 8, 2018, Zephyr A-6 received notification from ZAIS Group, as collateral manager for ZAIS CLO 9, for a contribution of $5.0 million to ZAIS CLO 9 which will be funded on May 14, 2018.

 

Master Repurchase Agreement

 

On October 16, 2017, Zephyr A-6 entered into a Master Repurchase Agreement with a single counterparty for a maximum of $200.0 million of financing (the “Master Repurchase Agreement”). Subject to the terms and conditions of the Master Repurchase Agreement, the parties may enter into transactions for the counterparty to purchase eligible securities from Zephyr A-6 on such terms agreed upon by the parties. During the term of a transaction entered into under the Master Repurchase Agreement, Zephyr A-6 will deliver cash or additional securities acceptable to the counterparty if the securities sold are in default. Upon termination of a transaction, Zephyr A-6 will repurchase the previously sold securities from the counterparty at a previously determined repurchase price. Upfront fees associated with the Master Repurchase Agreement in the amount of approximately $459,000 were prepaid of which approximately $9,000 was expensed during the three months ended March 31, 2018. The unamortized upfront fees of approximately $443,000 are reported as a direct deduction from the outstanding borrowings of the repurchase agreement in the Consolidated Statements of Financial Condition at March 31, 2018. The Master Repurchase Agreement may be terminated at any time by either party upon providing the requisite notice to the other party.

 

As of March 31, 2018 and December 31, 2017, the available funding under the Master Repurchase Agreement was approximately $154.1 million.

 

The following table presents the remaining contractual maturity of Zephyr A-6’s Master Repurchase Agreement and the amounts outstanding as of March 31, 2018 and December 31, 2017:

  

Remaining
Contractual Maturity of the
Master Repurchase Agreement
 

 

March 31,

2018

  

December 31,

2017

 
   (Dollars in thousands) 
Collateralized Loan Obligations(1):          
Senior debt tranches  $34,431   $34,431 
Mezzanine debt tranches   11,512    11,512 
Total (2)  $45,943   $45,943 

 

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(1)Maturities are set to match the maturities of the underlying collateral and are greater than one year.
(2)Amounts represent the outstanding borrowings before deducting unamortized upfront fees.

 

The fair value of the securities pledged as collateral under the Master Repurchase Agreement was approximately $46.2 million and $46.1 million at March 31, 2018 and December 31, 2017, respectively. The Company includes the fair value of the securities pledged by Zephyr A-6 in Investments in affiliated securities, at fair value in the Consolidated Statements of Financial Condition. Zephyr A-6 receives the coupon payments for pledged securities.

 

Due to entering into these repurchase agreements close to year-end and due to the short term nature of these repurchase agreements and their variable interest rates, the carrying amounts approximate fair value. Zephyr A-6 pays interest to the counterparty at a rate based on the weighted average interest rate of the underlying securities that have been pledged as collateral plus a spread of 0.50% on the periodic roll over dates.  As of March 31, 2018 and December 31, 2017, the accrued interest due to the Counterparty was approximately $369,000 and $299,000, respectively. In general, Zephyr A-6 can sell any of the underlying securities that have been pledged as collateral at any time, subject to certain fees.  Other than margin requirements, the Master Repurchase Agreement is not subject to additional terms or contingencies which would expose Zephyr A-6 to additional obligations based upon the performance of the securities pledged as collateral. The weighted average effective interest rate for the repurchase agreements entered into under the Master Repurchase Agreement was approximately 3.9% and 3.6% at March 31, 2018 and December 31, 2017, respectively.

 

Core Business

 

Revenues

 

Our principal sources of revenues are management fee income and incentive income for investment advisory services provided to the ZAIS Managed Entities, which ZAIS considers to be its clients. For any given period, our revenues are influenced by the amount of AUM, the investment performance and the timing of when incentive income is recognized for certain of the ZAIS Managed Entities, as discussed below.

 

Management fee income. Management fee income earned by ZAIS Group for funds and accounts is generally based on a fixed percentage of (i) the net asset value of these funds and accounts prior to the accrual of incentive fees/allocations or (ii) drawn capital during the investment period.

 

Management fee income earned from the ZAIS CLOs is generally based on a fixed percentage of the par value of the collateral and cash held in the CLOs. Additionally, subordinated management fee income may be earned from CLOs for which ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager. Subordinated management fees are additional payments, but have a lower priority in the CLOs’ cash flows than non-subordinated management fees and are contingent upon the economic performance of the respective CLO. If a CLO experiences a certain level of asset defaults, these subordinated management fees may not be paid. There is no recovery by the CLOs of previously paid subordinated fees.

 

Management fees are accrued as earned and are calculated and collected on a monthly or quarterly basis, depending on the applicable agreement.

 

A fixed percentage asset-based management fee is considered a type of variable consideration. The amount of revenue recognized is limited to the amount for which it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur in future periods. ZAIS Group updates its estimate of the variable consideration each reporting period. Any uncertainty related to the variable consideration will be resolved as of the end of each reporting period. ZAIS Group attributes the management fee income to the services provided during the period because the fee relates specifically to the entity’s efforts to transfer the services for that period.

 

In the event management fee income is received before it is earned, deferred revenue is recorded and is included in Other liabilities in the Consolidated Statements of Financial Condition.

 

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Incentive income. Incentive income typically arises from investment management activities that were initially undertaken in prior reporting periods and is recognized when it is (i) contractually receivable and (ii) ZAIS Group concludes that it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur when any uncertainty, which existed at the time the revenue was recognized, is resolved, which generally occurs in the quarter of, or the quarter immediately prior to, payment of the incentive income to ZAIS Group by the ZAIS Managed Entities. The criteria for revenue recognition are typically met only after (i) any profits exceed a high-water mark for vehicles with hedge fund-style fee arrangements, (ii) all contributed capital and the preferred return, if any, have been distributed to the investors in vehicles with private equity-style fee arrangements and (iii) all contributed capital and the preferred return, if any, have been distributed to the investors and subordinate management fees (if any) have been paid to the collateral manager for CLOs.

 

We primarily consider the type of assets held by each ZAIS Managed Entity, cash held by the entity, estimated future expenses and potential fluctuations in the expected realizable value of investments held by the ZAIS Managed Entity when determining whether or not it is probable that a significant reversal in the cumulative amount of revenue recognized from the entity will not occur when the uncertainty is resolved.

 

ZAIS Managed Entities with hedge fund-style fee arrangements are those that pay ZAIS Group, generally, on an annual basis, an incentive fee/allocation based on a percentage of net realized and unrealized profits attributable to each investor, subject to a hurdle (if any) set forth in each respective entity’s operative agreement. Additionally, ZAIS Managed Entities with hedge fund-style fee arrangements are subject to a perpetual loss carry forward, or perpetual “high-water mark,” meaning that the funds and accounts will not pay incentive fees/allocations with respect to positive investment performance generated for an investor in any year following negative investment performance until that loss is recouped, at which point an investor’s capital balance surpasses the high-water mark. ZAIS Managed Entities with private equity-style fee arrangements are those that pay an incentive fee/allocation based on a priority of payments under which investor capital must be returned and a preferred return, as specified in each fund’s operative agreement, must be paid to the investor prior to any payments of incentive-based income to ZAIS Group. For CLOs, incentive income is earned based on a percentage of cumulative profits, subject to the return of contributed capital (and subordinate management fees, if any), and a preferred inception to date return as specified in the respective CLO’s collateral management agreements.

 

The management fee income and incentive income from the Consolidated Funds are eliminated in consolidation, and therefore are not reflected as revenue in our condensed consolidated financial statements. ZAIS Group’s share of the earnings from the consolidated ZAIS Managed Entities is increased by the amount of the management fee income and incentive income that are eliminated in consolidation.

 

The following table presents the range of management and incentive fee rates generally charged on the ZAIS Managed Entities during the respective periods presented: 

 

  

Three Months Ended

March 31,

 
   2018   2017 
Management Fee Income(1)(3)          
Funds and accounts   0.50% - 1.25%    0.50% - 1.25% 
CLOs   0.15% - 0.50%    0.15% - 0.50% 
           
Incentive Income(1)(2)(3)          
Funds and accounts   10% - 20%    10% - 20% 
CLOs   20%    20% 

 

(1)Certain management and incentive fees have been and may in the future be waived and therefore the actual fee rates may be lower than those reflected in the range.

 

(2)Incentive income earned for certain of the ZAIS Managed Entities may be subject to a hurdle rate of return as specified in each respective ZAIS Managed Entity’s operative agreement.

 

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(3)ZAIS Group does not earn management fee income on certain ZAIS Managed Entities in which it had made investments that carried first loss risk. ZAIS Group receives distributions of its pro rata share of the gains and losses related to its investments in these ZAIS Managed Entities and incentive income equal to 50% of the net investment gains for the management of these ZAIS Managed Entities. As a result of the termination of these management contracts, we will no longer earn incentive income from the two ZAIS Managed Entities effective April 1, 2018.

 

Other revenues. Fees for consulting, data, funding and analytical services provided to outside parties and affiliated funds are accrued as earned.

 

 Expenses

 

Compensation and benefits. Compensation and benefits expense is comprised of salaries, payroll taxes, employer contributions to welfare plans and discretionary and guaranteed cash bonuses, stock compensation, severance and other contractual compensation programs payable to employees and non-employee directors. Compensation and benefits expense is generally recognized over the related service period. On an annual basis, compensation and benefits comprise a significant portion of total expenses. Discretionary and guaranteed cash bonuses, stock compensation and other contractual compensation programs generally comprise a significant portion of total compensation and benefits. Levels of incentive compensation will vary to the extent they are tied to financial and operating performance of the Company and in some cases, to the performance of certain ZAIS Managed Entities.

 

Our compensation plans include the following:

 

Cash and Equity Based Awards

 

Compensation and benefits relating to the issuance of cash-based and equity-based awards to certain employees and non-employee directors is measured at fair value on the grant date. Compensation expense for awards that vest over a future service period is recognized over the relevant service period on a straight-line basis, adjusted for estimated forfeitures of awards not expected to vest. The compensation expense for awards that do not require future service is recognized immediately. Upon the end of the service period, compensation expense is adjusted to account for actual forfeiture rates.

 

On February 27, 2017, Howard Steinberg, our former General Counsel, resigned effective March 31, 2017 and has been retained as Senior Legal Advisor to the Company and ZAIS effective April 1, 2017. Mr. Steinberg received a payment of $450,000 on February 28, 2017 pursuant to the Legal Advisor Agreement.

 

On April 5, 2017, we provided a retention award (the “Retention Award”) to Michael Szymanski, the Company’s Chief Executive Officer in recognition of the importance of retaining his services as the Chief Executive Officer of the Company and its operating subsidiary, ZAIS Group, and in connection with our review of strategic alternatives to enhance shareholder value. Under the Retention Award, which was approved by the Compensation Committee, Mr. Szymanski received a cash retention payment of $500,000 on each of June 30, 2017 and September 30, 2017 and was entitled to receive a cash retention payment of $500,000 on a date within five business days following the closing date of a “Transaction” as defined in the Retention Award or otherwise as determined by our Board of Directors. On November 7, 2017, the Compensation Committee determined that Mr. Szymanski would receive the final $500,000 Retention Award payment on February 28, 2018. Mr. Szymanski would be entitled to such payments provided he remained employed by the Company on such dates, or if he had been removed as our Chief Executive Officer or his employment terminated for reasons other than for cause prior to such dates. Effective as of January 5, 2018, Mr. Szymanski resigned as Chief Executive Officer, President and a Director of the Company. In connection with his resignation, Mr. Szymanski entered into a Release Agreement with ZAIS Group wherein he agreed to a full release of claims against, and covenant not to sue, ZAIS Group and its affiliates, in exchange for the Company’s agreement to (i) pay the last installment of Mr. Szymanski’s Retention Award which he would have otherwise forfeited and (ii) waive the six-month covenant not to compete and modify the 12-month covenant not to solicit otherwise applicable to Mr. Szymanski. The aggregate amount of retention payments that may be paid to Mr. Szymanski under the Retention Award is $1.5 million. The final payment of the Retention Award for $500,000 was paid on February 28, 2018.

 

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On January 4, 2018, the Company entered into a Consulting Agreement with Mr. Szymanski pursuant to which, effective January 6, 2018, Mr. Szymanski commenced providing consulting services to the Company and ZAIS Group through February 28, 2018 for a monthly consulting fee equal to $50,000 payable in advance and the reimbursement of all reasonable expenses. For the three months ended March 31, 2018 the Company paid Mr. Szymanski $100,000 pursuant to the agreement. Such amount is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss).

 

Compensation Directly Related to Incentive Income (also referred to as “Points”)

 

ZAIS Group previously entered into agreements with employees to share with them a percentage of income generated from certain ZAIS Managed Entities (“Points Agreements”). Under these existing Points Agreements, ZAIS Group has an obligation to pay a fixed percentage of the incentive income earned from one of the ZAIS Managed Entities to certain employees and former employees. Amounts payable pursuant to the Points Agreements are recorded as compensation expense when they become probable and reasonably estimable. The determination of when the Points become probable and reasonably estimable so that Points expense should be recorded is based on the assessment of numerous factors, particularly those related to the profitability, realizations, distribution status, investment profile and commitments or contingencies of certain ZAIS Managed Entities for which Points Agreements have been awarded. Points are expensed no later than the period in which the underlying income is recognized. Payment of the Points generally occurs later than when the related income is received. Recipients’ rights to receive payments related to their Points Agreement are subject to forfeiture risks. ZAIS Group does not anticipate entering into additional Points Agreements. We did not incur any compensation expense relating to the Points Agreements during the three months ended March 31, 2018 or March 31, 2017.

 

General, administrative and other. General, administrative and other expenses are related to professional services, insurance, information technology, rent and other operating expenses.

 

Net gain (loss) on investments in affiliates. Net gain (loss) on investments consists of net realized and unrealized gains and losses on our investments in the unconsolidated ZAIS Managed Entities.

 

Allocation of consolidated net income (loss) to non-controlling interests in Consolidated Funds. The portion of consolidated net income (loss) attributable to investors in the Consolidated Funds that do not have the right to redeem their interests.

 

Consolidated Funds

  

Income of Consolidated Funds. Income consists of interest and dividend income on investments held by Zephyr A-6.

 

Expenses of Consolidated Funds. Expenses consist of interest expense, fund operating expenses and other miscellaneous expenses of Zephyr A-6.

 

Net gain (loss) of Consolidated Funds’ investments. Net gain (loss) consists of net realized and unrealized gains and losses on investments held by Zephyr A-6.

 

Net gain (loss) on beneficial interest of consolidated collateralized financing entity. Net gain (loss) includes changes in the fair value of (i) beneficial interests retained by the Company; (ii) beneficial interests that represent compensation for collateral management services and (iii) realized gains resulting from the sale of our beneficial interests in the consolidated collateralized financing entity.

 

Trends Affecting Our Business

 

From 2015 through 2016, AUM trended downward due to the wind-up and liquidation of a number of private equity-style and structured vehicles as well as certain withdrawals by investors from the ZAIS Managed Entities that were either voluntary or driven by regulatory constraints. The decrease in AUM was also a result of the termination of the management agreement between ZAIS Financial Corp (“ZFC REIT”), a publicly traded mortgage real estate investment trust, and ZAIS REIT Management, LLC, a majority owned consolidated subsidiary of ZAIS Group that was the external investment advisor to ZFC REIT, upon completion of the merger between ZFC REIT and Sutherland Asset Management Corp. The termination resulted in a decrease of $0.589 billion to ZAIS Group’s AUM during the fourth quarter ended December 31, 2016.

 

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Although AUM continued to decrease during the first quarter of 2017 by approximately $0.08 billion from approximately $3.444 billion as of December 31, 2016, AUM has subsequently increased from approximately $3.360 billion at March 31, 2017 to approximately $4.793 billion at March 31, 2018. The increase in AUM of approximately $1.433 billion during this period is mostly attributable to the formation of new CLOs managed by ZAIS which accounted for approximately $1.393 billion of the increase. The environment for raising new capital remains challenging as lower interest rates, tight credit spreads and changing regulations continue to put pressure on structured credit products. European investors have generally reduced investments in certain securitized investment vehicles due to increased regulatory capital requirements. 

 

During the three months ended March 31, 2018 as compared to the same period in 2017, total consolidated management fee income increased by approximately $2.0 million which was primarily driven by the increase in the AUM of CLOs managed by ZAIS Group, total consolidated revenue increased by approximately $2.6 million, and total consolidated expenses decreased by approximately $0.1 million.

 

The current recurring revenue base does not cover the current run-rate of total expenses. We currently anticipate that our expenses for the remainder of 2018 will again exceed our revenues as they did during the quarter ended March 31, 2018 and since 2015. If the Company is unable to continue increasing our assets under management and thereby generate additional revenue from management fee income and potentially, incentive income, or develop new sources of revenue, it is likely that we will continue incurring operating losses. In that event, we may need to sell assets to raise cash and/or curtail certain business activities, including foregoing additional investments in newly formed ZAIS Managed Entities. There is no assurance that ZAIS Group will be able to increase its assets under management or develop new sources of revenue.

  

Strategic Review

 

Commencing in 2015, the Company’s management and the Board of Directors conducted periodic strategic reviews of the Company’s business in order to enhance shareholder value. On February 15, 2017, the Board of Directors formed a special committee of independent and disinterested directors (the “Special Committee”) to consider proposals for strategic transactions, as well as to consider all other strategic options for the Company. Subsequently, the Special Committee’s review of potential strategic alternatives included capital raising, asset sales, strategic partnerships, a sale of the entire Company, a sale of component parts of the Company, acquisitions and other options, including continuing operating as a public company. Thereafter, Mr. Zugel reported to the Board of Directors of the Company that he was considering making a proposal that would be beneficial to the Company’s stockholders and which would result in the Company going private. Mr. Zugel made a proposal for a take private transaction to the Special Committee on September 5, 2017. Over the next several months Mr. Zugel and the Special Committee negotiated his proposal. On September 27, 2017, the Special Committee engaged Houlihan Lokey, Inc. (“Houlihan Lokey”) as its financial adviser in connection with the Special Committee’s evaluation and negotiation of the financial aspects of Mr. Zugel’s proposal.

 

On January 11, 2018, we entered into the Merger Agreement. At the effective time of the Merger, shares of Class A Common Stock, other than shares held by Mr. Zugel, affiliates of Mr. Zugel, and certain other shareholders, will be converted into the right to receive $4.10 per share in cash without interest, subject to any required withholding taxes. All outstanding RSUs are held by the Company’s independent directors and will also be converted in the Merger into the right to receive $4.10 per share in cash for the number of shares of Class A Common Stock underlying such RSUs. The proposed Merger is a “going private transaction” under SEC rules. The Merger is subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, including approval by a majority of the aggregate voting power of all of the shares of capital stock of the Company and approval by the holders of a majority of the outstanding shares of Class A Common Stock, other than shares held by (i) any member of the Parent Group, (ii) any director or officer of the Company, (iii) holders of Rollover Shares or Exchange Shares (each, as defined in the Merger Agreement), (iv) Ramguard LLC (“Ramguard”), and (v) any affiliate of any of the foregoing persons. There is no assurance that the Merger will be consummated. The Company is required to reimburse the Parent Group for all documented fees and expenses incurred by them (including reasonable attorneys’ fees) in connection with the Merger Agreement and the transactions contemplated thereby, up to a maximum of $1.5 million in the aggregate, if the Company or Z Acquisition terminates the Merger Agreement because of an Adverse Company Recommendation (as defined in the Merger Agreement). For a discussion of various risks relating to the Merger, see “Item 1A Risk Factors—Risks Related to the Merger” in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on March 19, 2018, and for additional information regarding the Merger, see our Current Report on Form 8-K filed with the SEC on January 12, 2018. 

 

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Houlihan Lokey is entitled to an aggregate fee of $800,000 for its services, of which $250,000 was paid to Houlihan Lokey upon its engagement, and $350,000 was paid to Houlihan Lokey upon delivery of its opinion, dated January 11, 2018, to the Special Committee. An additional $200,000 payment is contingent upon consummation of the Merger. In addition, the Company has agreed to reimburse Houlihan Lokey for certain expenses and to indemnify Houlihan Lokey, its affiliates and certain related parties against certain liabilities and expenses, including certain liabilities under the federal securities laws, arising out of or related to Houlihan Lokey’s engagement.

 

In addition, Z Acquisition agreed to purchase 6,500,000 shares owned by Ramguard at a price of $4.10 per share (the “Share Purchase”) pursuant to the Amended and Restated Share Purchase Agreement, dated as of January 11, 2018, by and among Z Acquisition, Ramguard and Mr. Zugel (the “Share Purchase Agreement”). On May 1, 2018, Z Acquisition (i) purchased 6,500,000 million shares of Class A Commons Stock of the Company at a purchase price of $4.10 per share from Ramguard, (ii) made a cash payment of $10,250,000 together with interest in the amount of $125,000 to Ramguard and (iii) issued a promissory note to Ramguard in the principal amount of $13,325,000 with an interest rate of 8% per annum, payable quarterly in cash, and a maturity date of December 31, 2019. An additional cash payment to Ramguard of $3,075,000 together with interest in the amount of $125,000 is required to be made under the Share Purchase Agreement on or before August 1, 2018 by Z Acquisition or Mr. Zugel.

 

In order to finance a portion of the purchase of 6,500,000 shares of the Company’s Class A Common Stock pursuant to the Share Purchase Agreement, (i) Mr. Zugel and various trusts for which relatives of Mr. Zugel are the beneficiaries withdrew approximately $4.3 million and $5.5 million of interests effective March 31, 2018 and December 31, 2017, respectively, from the Domestic Feeder and (ii) Sonia Zugel, Mr. Zugel’s spouse, has indicated an intention to withdraw approximately $1.7 million of interests from the Domestic Feeder effective September 30, 2018.

  

The Company established April 2, 2018 as the record date for stockholders entitled to vote at its 2017 Annual Meeting of Stockholders (the “Annual Meeting”), which has been scheduled for May 17, 2018. Stockholders of record at the close of business on April 2, 2018 may vote at the Annual Meeting. At the Annual Meeting, stockholders will be asked to consider and vote upon a proposal to adopt the Merger Agreement. Stockholders will also be asked to elect the Company’s Board of Directors, approve the adjournment of the Annual Meeting, if necessary, to solicit additional proxies if there are insufficient votes at the time of the Annual Meeting to approve adoption of the Merger Agreement, and vote on any other matter properly brought before the Annual Meeting.

 

See "Item 1A. Risk Factors" included in our Annual Report on Form 10-K for a discussion of the risks to which our businesses are subject.

 

Non-U.S. GAAP Financial Measures

 

Net income (loss) (excluding Consolidated Funds of ZAIS Group) and Adjusted EBITDA

 

Our management reviews its results on both a Net income (loss) (excluding Consolidated Funds of ZAIS Group) and an Adjusted EBITDA basis. These are key performance measures used by management when making operating decisions, assessing financial performance and allocating capital resources. Net income (loss) (excluding Consolidated Funds of ZAIS Group) and Adjusted EBITDA are non-U.S. GAAP financial measures that exclude the adjustments described below that are required for presentation of our results on a U.S. GAAP basis. These measures supplement and should be considered in addition to and not in lieu of the results of operations prepared in accordance with U.S. GAAP:

 

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Adjustments to Net income (loss) to derive Net income (loss) (excluding Consolidated Funds of ZAIS Group):

 

·Consolidating effects of the Consolidated Funds. Amounts related to the Consolidated Funds, including the related eliminations of revenues, expenses and other income (loss).

 

Adjustments to Net income (loss) (excluding Consolidated Funds of ZAIS Group) to derive Adjusted EBITDA:

 

·Equity-based compensation. Management does not consider these non-cash expenses to be reflective of operating performance.

 

·Severance. Management does not consider severance costs to be reflective of ongoing operating performance.

 

·Depreciation and amortization. Management does not consider these non-cash expenses to be reflective of operating performance.

 

·Any applicable taxes and foreign currency translation adjustments. Management does not consider these amounts to be reflective of operating performance.

 

The calculations described above may not be directly comparable to other similar non-U.S. GAAP financial measures reported by other asset managers. We believe that these measures are a useful benchmark for measuring our performance. We also believe that investors should review the same supplemental non-U.S. GAAP financial measures that management uses to analyze the business in conjunction with our results of operation prepared in accordance with U.S. GAAP. See “Reconciliations of Non-U.S. GAAP Financial Measures” below.

  

Results of Operations

 

Three Months Ended March 31, 2018 Compared to Three Months Ended March 31, 2017

 

   Three Months Ended
March 31,
   Change 
   2018   2017   $   % 
   (Dollars in thousands)         
Consolidated net income (loss)  $(2,826)  $(5,435)  $2,609    48%
                     
Net income (loss) (excluding Consolidated Funds of ZAIS Group) – Non-U.S. GAAP  $(5,593)  $(6,245)  $652    10%
                     
Adjusted EBITDA - Non-U.S. GAAP  $(5,300)  $(5,016)  $(284)   -6%

 

Revenues

 

   Three Months Ended
March 31,
   Change 
   2018   2017   $   % 
   (Dollars in thousands)     
Management fee income  $5,063   $3,107   $1,956    63%
Incentive income   146    297    (151)   -51%
Reimbursement revenue   309    494    (185)   -37%
Other revenues   77    93    (16)   -17%
Income of Consolidated Funds   1,013        1,013     
Total Revenues  $6,608   $3,991   $2,617    66%

 

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Total revenues increased by $2.6 million primarily due to:

 

  · A $2.0 million increase in management fee income due to an increase of $1.9 million related to ZAIS CLOs which was primarily driven by the increase in the number of CLOs managed by ZAIS and fees earned from a certain ZAIS CLO beginning in June 2017 which previously had its fees waived because all of its subordinated notes were collectively owned by ZAIS Managed Entities.

 

  · A $1.0 million increase in income of Consolidated Funds related to Zephyr A-6’s investments in unconsolidated ZAIS CLOs.

 

  · A $0.2 million decrease in incentive income primarily due to a decrease in crystalized fees related to a ZAIS Managed Entity in which our investment carried first loss risk.

  

  · A $0.2 million decrease in reimbursement revenue which relates to the reimbursement from certain ZAIS Managed Entities for research and data services expenses incurred by us and paid directly to vendors by us (the related expenses are included in General, administrative and other expenses). The net effect of the reimbursement revenue and related expenses has no impact on our Consolidated net income (loss).

 

The following table details the changes to our AUM:

 

   Three Months Ended March 31, 2018 
   (dollars in billions) 
   Corporate
Credit
Funds
   Mortgage
Related
Strategies
   Multi-Strategy
Funds and
Accounts
   Total 
Beginning of Period AUM (1)  $3.163   $0.102   $1.247   $4.512 
Contributions (2)   0.457(3)       0.033    0.490 
Distributions (2)   (0.024)   (0.002)       (0.026)
Redemptions (4)   (0.100)       (0.006)   (0.106)
Gain & Loss (4)   0.003    0.010    0.012    0.025 
Other (5)   (0.097)   (0.009)   0.004    (0.102)
End of Period AUM (6)  $3.402   $0.101   $1.290   $4.793 
                     
Average AUM (7)  $3.283   $0.101   $1.268   $4.652 

 

   Three Months Ended March 31, 2017 
   (dollars in billions) 
   Corporate
Credit
Funds
   Mortgage
Related
Strategies
   Multi-Strategy
Funds and
Accounts
   Total 
Beginning of Period AUM (8)  $2.072   $0.576   $0.796   $3.444 
Contributions (2)   0.014        0.001    0.015 
Distributions (2)   (0.008)   (0.308)       (0.316)
Redemptions (4)           (0.001)   (0.001)
Gain & Loss (4)   0.007    0.017    0.033    0.057 
Other (5)   (0.084)   0.279    (0.034)   0.161 
End of Period AUM (9)  $2.001   $0.564   $0.795   $3.360 
                     
Average AUM (7)  $2.037   $0.570   $0.796   $3.402 

 

(1)AUM uses values for certain structured vehicles that have been determined prior to December 31, 2017 based on the most recent trustee report received as of December 31, 2017 for each respective vehicle.

 

(2)Amounts are related to funds, managed accounts and structured vehicles.

 

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(3)Amount includes $426.5 million of assets of ZAIS CLO 8. In connection with the pricing of ZAIS CLO 8, ZAIS CLO 8 warehouse was repaid resulting in approximately $201.9 million reduction in leverage, aggregate principal balance and other items.   This amount is included in the Other row in the table above.

  

(4)Amounts are related to funds and managed accounts.

 

(5)Other represents changes primarily related to (i) leverage and other operating liabilities for funds and managed accounts, (ii) leverage, aggregate principal balance and other items for structured vehicles and (iii) uncalled capital commitments. Change in aggregate principal balance is primarily due to defaults, write downs, pay downs and collateral purchase/sales.

 

(6)AUM uses values for certain structured vehicles that have been determined prior to March 31, 2018 based on the most recent trustee report received as of March 31, 2018 for each respective vehicle.

 

(7)Average is based on the beginning balance and ending balance for the period presented.

 

(8)AUM uses values for certain structured vehicles that have been determined prior to December 31, 2016 based on the most recent trustee report received as of December 31, 2016 for each respective vehicle.

 

(9)AUM uses values for certain structured vehicles that have been determined prior to March 31, 2017 based on the most recent trustee report received as of March 31, 2017 for each respective vehicle.

 

 Expenses

 

   Three Months Ended
March 31,