KKR & Co. Inc. Form 10-Q Summary
Reporting period: Quarter ended June 30, 2018; comparisons are with the second quarter and first six months of 2017, unless stated otherwise. The statements report KKR & Co. L.P. as a limited partnership because the conversion to KKR & Co. Inc. took effect July 1, 2018.
Business context
KKR is a global alternative investment manager active in private equity, credit, real assets, capital markets and strategic manager partnerships. It earns management and transaction fees, carried interest and investment income, and invests its own capital alongside fund investors. KKR completed its BDC advisory partnership with FS Investments on April 9, 2018.
Key financial metrics
Amounts below are in millions, except per-unit data and AUM. GAAP consolidated results include funds and financing entities that may be largely owned by third parties; they are not the same as KKR’s segment measures.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| GAAP revenue | $971.6 | $1,015.8 | $1,444.2 | $1,783.6 |
| GAAP net income | $1,566.4 | $868.5 | $2,169.3 | $1,666.4 |
| Net income attributable to common unitholders | $680.4 | $405.6 | $850.5 | $665.0 |
| Diluted income per common unit | $1.24 | $0.81 | $1.57 | $1.33 |
| After-tax distributable earnings, non-GAAP | $404.7 | $276.9 | $640.4 | $573.5 |
- Q2 GAAP revenue fell 4%; higher fees and other revenue were outweighed by lower capital allocation-based income. For the first half, revenue fell 19%, principally reflecting lower carried interest and general partner capital income.
- GAAP net income rose in both comparison periods, led by investment gains. Q2 net gains from investment activities were $1,116.6 million, including $961.8 million of unrealized gains; first-half investment gains were $1,589.4 million, including $1,404.2 million unrealized. Results therefore remain sensitive to investment valuations and realization timing.
- After-tax distributable earnings increased 46% in Q2 and 12% for the first half. KKR revised this non-GAAP measure in Q2 to include equity-based compensation and exclude mark-to-market gains and losses; prior periods were recast. It is not a measure of actual dividends.
- At June 30, AUM was $191.3 billion and fee-paying AUM was $138.8 billion. Both increased substantially from year-end, with the FS Investments transaction contributing $13.2 billion of AUM and FPAUM. Uncalled commitments were $57.4 billion.
- Six-month operating cash flow was negative $4.5 billion versus negative $2.1 billion in 2017, substantially reflecting investment purchases net of proceeds and consolidated fund activity. Financing cash flow was positive $4.1 billion. Cash, cash equivalents and restricted cash, including balances held at consolidated entities, totaled $3.28 billion at June 30.
- Consolidated debt obligations were $20.0 billion, down from $21.2 billion at year-end. This includes substantial nonrecourse debt of consolidated CLOs, CMBS vehicles and funds. On KKR’s segment balance sheet, debt was $2.36 billion for KKR excluding KFN and $0.95 billion for KFN; segment cash and short-term investments were $2.77 billion.
Material changes and unusual items
- In April, KKR sold controlling interests in four consolidated CMBS vehicles, removing approximately $4.1 billion of investments and $4.0 billion of debt from consolidation.
- KKR recorded a gain related to the FS Investments transaction. Separately, its segment results excluded approximately $729.4 million of investment losses realized in Q2 ahead of the conversion; this exclusion is an important distinction between segment and GAAP results. Conversion-related nonrecurring costs were approximately $11.5 million.
- KKR converted from a partnership to a corporation on July 1. Management expects corporate income taxes to increase: KKR reported a 3.5% effective GAAP tax rate for the first half and estimated approximately 10% for that period on an illustrative basis had the conversion occurred January 1. Actual post-conversion tax rates may differ.
- Management changed segment reporting to one reportable segment and made after-tax distributable earnings the principal profitability measure, with retrospective presentation of comparative periods. This affects comparability with previously filed segment results.
- KKR repurchased approximately 2.2 million common units in Q2 for about $50 million. Approximately $450 million remained available under the repurchase program at quarter-end.
Outlook, liquidity, risks and contingencies
- No specific earnings or investment-return guidance is provided. Management cites competitive fundraising, the ability to deploy capital at attractive valuations, and the ability to exit investments profitably as key drivers. Q2 capital invested and syndicated capital totaled $4.8 billion, down from $5.4 billion a year earlier; management noted announced private-market transactions remained subject to closing conditions.
- KKR anticipated an initial annual Class A dividend of $0.50 per share, or $0.125 quarterly, beginning with the third quarter, subject to board discretion and legal requirements. This is below the former partnership distribution policy of $0.68 per unit annually. A $0.17 per-share dividend was separately declared in July for payment in August.
- KKR had $5.26 billion of unfunded commitments to active investment vehicles, plus $508.9 million of purchase commitments and $992.5 million of capital-markets underwriting and lending commitments. The much larger consolidated contractual-obligation total of $45.5 billion includes fund and CFE obligations; the filing states that many are supported only by those vehicles’ assets or are otherwise limited in recourse.
- Carried-interest clawbacks were $10.1 million assuming applicable funds were liquidated at June 30 fair values; the hypothetical amount would be approximately $1.9 billion if investments were liquidated at zero. Two funds had netting holes above $50 million, which can delay cash carry distributions.
- More than half of investments measured at fair value were Level III, requiring significant unobservable inputs and management judgment. Market, credit-spread, interest-rate, foreign-exchange and commodity movements may materially affect valuations, income and carried interest. KKR specifically noted exposure to energy prices and currency weakness.
- KKR disclosed a Kentucky Retirement Systems lawsuit alleging fiduciary and other duty violations related to separately managed accounts. Management could not estimate potential losses for the discussed proceedings; it had not concluded that their resolution would materially affect the financial statements, but adverse outcomes could affect results in a period.
- The conversion brings material governance risks: Class A common stock is generally non-voting, the Class B stockholder has substantial control, and KKR elected certain NYSE controlled-company exemptions. The tax receivable agreement generally gives KKR Holdings or transferees 85% of specified realized tax savings; payments could affect liquidity, including in certain change-of-control or termination scenarios.
Investor facts to verify
- Reconcile GAAP earnings with after-tax distributable earnings, especially the $729.4 million of investment losses excluded from segment results and the impact of unrealized gains.
- Assess the durability of fee growth and the contribution, economics and integration of the FS Investments BDC partnership.
- Review the post-conversion tax burden, dividend policy, and potential tax receivable agreement payments against available cash and commitments.
- Distinguish KKR’s own debt and liquidity from nonrecourse fund/CFE balances; examine commitment funding needs and the potential timing of carried-interest cash receipts.
- Evaluate Level III valuation assumptions, portfolio concentration and downside sensitivity, together with litigation developments and the governance rights of Class A stockholders.