KKR

Business Context and Reporting Period

Company: KKR & Co. Inc. (KKR & Co. L.P.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: KKR is a global alternative asset manager with $55.5 billion in assets under management (AUM) as of September 30, 2010. The firm operates through three segments: Private Markets, Public Markets, and Capital Markets and Principal Activities. The reporting period follows the firm's reorganization and combination with KKR Private Equity Investors (KPE) in October 2009 and its subsequent listing on the NYSE in July 2010.

Key Financial Metrics

Note: Consolidated Net Income is significantly higher than Net Income Attributable to KKR & Co. L.P. due to the consolidation of funds where the majority of economic interests are held by noncontrolling interests.

Material Changes vs. Prior Period

• Revenue: Fees decreased by $14.9 million (13.4%) in the three months ended September 30, 2010, compared to the same period in 2009, primarily due to a $25.2 million decrease in gross monitoring fees. However, for the nine-month period, fees increased by $87.7 million (43.5%) driven by higher capital markets transaction fees and incentive fees from KKR Financial Holdings (KFN).
• Expenses: Total expenses increased significantly by $295.3 million (191%) in the quarter and $986.7 million (276%) for the nine months. This increase is largely attributable to non-cash equity-based charges ($277.3 million in the quarter) and allocations to the carry pool, which were not present or were structured differently in the prior period due to the 2009 Transactions.
• Investment Income: Net gains from investment activities decreased by $2.6 billion in the quarter compared to 2009, driven by lower unrealized gains on the investment portfolio. For the nine months, net gains decreased by $0.8 billion.
• Net Income Attributable to KKR: Net income attributable to KKR & Co. L.P. dropped to $8.9 million in the quarter from $616.7 million in the prior year quarter, reflecting the shift in accounting structure and the allocation of income to noncontrolling interests and KKR Holdings.

Guidance, Outlook, and Risks

• Management Commentary: Management highlights a sluggish U.S. economic recovery but notes strong performance in global equity markets and below-investment-grade credit markets in Q3 2010. The firm continues to focus on aligning interests with investors and expanding its global platform.
• Contingencies:
  • Clawback Provision: If all private equity funds were liquidated at no value, the clawback obligation would be $686.8 million. Based on fair values as of September 30, 2010, the obligation is $61.5 million.
  • Net Loss Sharing: If vehicles were liquidated at zero value, the contingent repayment obligation would be approximately $1.1 billion. Based on fair values, there is currently no obligation.
• Litigation: KKR is involved in various legal proceedings, including antitrust investigations by the DOJ and SEC examinations regarding trading procedures and valuation practices. The firm believes these actions are without merit and intends to defend them vigorously.
• Subsequent Events: A distribution of $0.15 per common unit was declared on November 3, 2010. Additionally, KKR Holdings exchanged 4.2 million units for common units of KKR & Co. L.P. on November 5, 2010.

Key Facts for Investor Verification

• Noncontrolling Interests Impact: Verify the distinction between Consolidated Net Income ($1.35 billion for the quarter) and Net Income Attributable to KKR & Co. L.P. ($8.9 million). The vast majority of consolidated income belongs to third-party investors in consolidated funds.
• Non-Cash Expenses: Confirm the impact of non-cash equity-based compensation charges ($238 million in the quarter) on reported expenses and net income, as these do not affect distributable cash earnings.
• Debt Structure: Review the $500 million Senior Notes issued in September 2010 and the utilization of revolving credit facilities ($98 million outstanding under Corporate Credit Agreement as of period end).
• Assets Under Management (AUM): Verify the $55.5 billion AUM figure, noting that $41.9 billion is in Private Markets and $13.6 billion in Public Markets.
• Carried Interest Recognition: Understand that carried interest is recognized based on the contractual formula as if the fund were terminated at the reporting date, which can lead to volatility in earnings based on fair value changes.