KKR & Co. L.P. — Q1 2013 Form 10-Q
Business context and period. The filing is for the three months ended March 31, 2013; the registrant is KKR & Co. L.P. (NYSE: KKR). KKR is a global investment firm operating across Private Markets, Public Markets, and Capital Markets and Principal Activities. Reported consolidated figures include funds in which most economic interests belong to third-party investors, so consolidated totals are not equivalent to amounts attributable to KKR. KKR reported $78.3 billion of AUM at quarter-end.
Key financial results
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Consolidated fees | $151.2 million | $116.3 million | +30% |
| Total expenses | $439.3 million | $445.3 million | −1% |
| Investment income | $2.396 billion | $3.318 billion | −28% |
| Income before taxes | $2.108 billion | $2.989 billion | −29% |
| Net income attributable to KKR | $193.4 million | $190.4 million | +2% |
| Diluted earnings per common unit | $0.69 | $0.80 | −14% |
| Distribution declared per common unit | $0.27 | $0.15 | +80% |
- Investment gains drove consolidated earnings and were lower year over year, primarily because private-equity appreciation was lower. Dividend income fell to $39.5 million from $172.9 million, while interest income rose to $109.4 million from $76.2 million. Interest expense increased to $23.0 million from $18.0 million.
- Management’s non-GAAP segment measures: fee-related earnings (FRE) were $88.0 million versus $73.4 million; economic net income (ENI) was $647.7 million versus $727.2 million. FRE was about 40% of reportable-segment fees of $221.1 million, compared with about 39% a year earlier.
- By segment, Q1 2013 FRE / ENI were: Private Markets $40.7 million / $266.7 million; Public Markets $37.2 million / $49.1 million; Capital Markets and Principal Activities $10.1 million / $331.9 million. ENI is a non-GAAP measure and is not directly comparable to attributable GAAP net income.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $1.501 billion at March 31, 2013, up from $1.230 billion at year-end; a further $470.6 million was held at consolidated entities and $25.9 million was restricted. KKR reported segment cash and short-term investments of $1.996 billion, including $495.6 million of liquid short-term investments.
- Operating cash flow was $1.510 billion, investing cash flow was $60.4 million, and financing cash flow was negative $1.300 billion. Operating cash flow includes investment purchases and sales by consolidated funds and is not a clean measure of cash generated by KKR’s management business. Financing outflows principally reflected distributions to noncontrolling interests and partners.
- Total assets were $45.543 billion, including $41.778 billion of investments. Total liabilities were $3.766 billion. Debt obligations were $1.634 billion, up from $1.123 billion at year-end, mainly reflecting issuance of $500 million of 5.50% senior notes due 2043. The balance includes $640.8 million of investment financing arrangements, generally non-recourse beyond pledged assets; the notes are guaranteed by KKR and the KKR Group Partnerships.
- KKR said available liquidity was expected to meet working-capital requirements for at least the next 12 months. Its corporate and capital-markets revolving facilities had no borrowings outstanding, although a $20 million letter of credit was issued under the corporate facility.
- Uncalled commitments to active funds were $653.3 million; additional disclosed commitments included $100 million to Asian Fund II and $384.8 million for capital-markets activities, plus a $150 million MerchCap commitment. Consolidated-fund commitments are much larger and include third-party investor obligations.
Material changes and management commentary
- Fees rose mainly from Prisma (acquired in October 2012), increased Public Markets capital and incentive fees, and higher monitoring fees. Transaction fees declined, including lower syndicated equity activity.
- Private Markets AUM increased to $50.3 billion from $49.1 billion at year-end, reflecting $2.1 billion of appreciation and $1.0 billion of new capital, partly offset by $1.8 billion of distributions. Public Markets AUM increased to $27.9 billion from $26.4 billion, including $1.5 billion of fundraising; redemptions and distributions partly offset growth.
- Capital Markets and Principal Activities syndicated capital declined to $61.0 million from $250.6 million. KKR completed more capital-markets transactions (32 versus 25), but lower syndicated equity and smaller transaction sizes reduced fees.
- Equity markets rose in Q1, supporting portfolio valuations; management nevertheless described the global outlook as uncertain. It highlighted subdued or uneven economic growth, European sovereign-debt and banking stresses, fiscal tightening, volatile transaction activity, credit-market access and refinancing risks, and sensitivity to interest rates, equity prices, and commodity prices.
- No numerical earnings or operating guidance was provided. KKR stated that fund-raising, investment realizations, market conditions and valuations can materially affect results and that interim results are not necessarily indicative of the full year.
Risks, contingencies and unusual items
- About 72.6% of investments measured at fair value were Level III, relying on significant unobservable inputs and management estimates. A 10% decrease in fund investment fair values would generally produce a commensurate change in investment gains, though the effect on KKR-attributable earnings would be smaller because most fund economics belong to noncontrolling investors. Alliance Boots was a concentrated position valued at $3.7 billion.
- Potential carried-interest clawbacks were $0 based on March 31 fair values, but could have been $966.9 million if applicable funds were liquidated at zero value. Certain legacy funds also had no net-loss-sharing obligation at reported values, but a zero-value liquidation scenario implied approximately $611.5 million of exposure.
- KKR disclosed $45.1 million of estimated aggregate losses for matters where loss was considered probable and reasonably estimable, potentially partly covered by insurance or indemnity. The estimate was subject to significant judgment; other proceedings could not be reliably quantified. The Bruno’s litigation settlement agreement was reached April 22, 2013; KKR said the settlement had no material effect on financial results.
- Other commitments and obligations include $77.2 million recorded under the tax receivable agreement and $115.5 million of recorded contingent consideration, including Prisma-related contingent payments. Unfunded commitments, underwriting and lending commitments, and future debt service also affect liquidity.
- KKR was cooperating with SEC, DOJ and New York Attorney General inquiries, including matters concerning Del Monte, sovereign wealth fund relationships, private-equity conduct and management-fee waivers. Management had not concluded that the ultimate resolution of these matters would materially affect the consolidated statements, but noted adverse outcomes could affect results in a particular period.
- KKR reported compliance in all material respects with debt covenants. Approximately $49.4 million of broker-dealer cash could be restricted from dividend payments or advances. Disclosure controls were deemed effective; Prisma’s internal controls were excluded from the assessment while being evaluated.
Most important facts for investors to verify
- How much of reported investment appreciation and carried interest is unrealized, Level III-valued, or not yet distributable because of fund-level netting holes?
- How do KKR’s attributable cash, debt, liquidity and commitments compare with consolidated amounts that include fund assets and third-party obligations?
- Can fee growth from Prisma, new fundraising and Asian Fund II offset variable transaction, incentive-fee and realization activity?
- What are the eventual cash costs and timing of litigation, tax-receivable payments, contingent acquisition consideration, clawbacks and net-loss-sharing provisions?
- The filing states that a $0.27 distribution was announced April 25, 2013, payable May 21 to holders of record May 6; verify the distribution policy and subsequent declarations, which remain subject to board discretion.