KKR & Co. Inc. annual report, FY2014

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KKR & Co. L.P. — FY 2014 Form 10-K

Reporting period: Year ended December 31, 2014; signed February 27, 2015. This is an annual filing, not a standalone fourth-quarter report. The registrant is KKR & Co. L.P. (NYSE: KKR), a global alternative investment manager and capital markets firm. Results include KFN from its April 30, 2014 acquisition and Avoca from February 19, 2014. KKR reported Private Markets, Public Markets, and Capital Markets and Other segments.

Financial results and key metrics

  • Fees and other: $1.110 billion, up 45.6% from $762.5 million. Growth reflected acquisitions, higher transaction activity, and consolidated oil and gas revenue.
  • GAAP earnings: Net income attributable to KKR & Co. L.P. was $477.6 million, down 30.9% from $691.2 million. Diluted earnings per unit fell to $1.16 from $2.30. Consolidated net income was $5.395 billion, but most was attributable to noncontrolling interests and appropriated capital.
  • Investment income: $6.545 billion, down from $8.897 billion. Net gains from investment activities declined to $4.778 billion from $7.826 billion; dividend and interest income rose, while interest expense increased to $317.2 million from $99.6 million.
  • Expenses: Total expenses rose 24.3% to $2.196 billion. General, administrative and other expense more than doubled to $869.7 million, including a roughly $220 million impairment charge on oil and gas long-lived assets.
  • Cash flow: Consolidated operating cash flow was $1.489 billion, versus $2.578 billion in 2013; investing cash flow was negative $22.9 million and financing cash flow was negative $1.854 billion. These consolidated cash flows include substantial fund and CLO activity and are not a direct measure of cash available to KKR.
  • Liquidity and debt: Segment cash and short-term investments were $1.121 billion, down from $2.161 billion. Segment debt obligations were $1.527 billion for KKR excluding KFN; KFN had $657.3 million of debt and $373.8 million of preferred shares, generally non-recourse beyond KFN’s assets. Consolidated debt obligations totaled $10.838 billion, including $7.615 billion of CLO debt and fund-level obligations. KKR said it expected available liquidity to meet working capital needs for at least 12 months and reported compliance with debt covenants.
  • Assets under management: Total AUM was approximately $98.6 billion at year-end, up from $94.3 billion; fee-paying AUM was approximately $83.0 billion. Private Markets AUM was $61.5 billion and Public Markets AUM $37.1 billion. Public Markets growth included Avoca, partly offset by KFN-related presentation changes, distributions, and redemptions.
  • Non-GAAP performance measures: Economic net income (ENI) was $1.727 billion, down from $2.196 billion. Fee-related earnings (FRE) rose to $460.1 million from $412.3 million; total distributable earnings increased to $2.029 billion from $1.456 billion. The filing reports annual distributions of $1.90 per common unit versus $1.40. These measures are not GAAP and have company-specific definitions.

Material changes versus 2013

  • KKR acquired KFN for approximately $2.37 billion in KKR common units, issuing about 104.3 million units. KFN added specialty finance, CLO, debt, energy, and real estate assets and increased reported assets and liabilities.
  • KKR acquired Avoca, adding European credit capabilities and approximately $8.2 billion of AUM at acquisition. Prisma contingent consideration was partly settled for $123.6 million, including $84.1 million in issued KKR units.
  • Private Markets ENI fell to $1.337 billion from $1.827 billion, mainly on lower unrealized carried interest and investment income. Public Markets ENI fell to $240.1 million from $259.5 million; Capital Markets and Other ENI increased to $149.6 million from $109.4 million.
  • Private Markets AUM was nearly flat as new fundraising and portfolio appreciation were largely offset by distributions. Its fee-paying AUM declined by $2.9 billion, including from fund fee-base step-downs and distributions. Public Markets fee-paying AUM increased, with acquisition and fundraising gains partly offset by redemptions and distributions.
  • KKR changed segment reporting in 2014 following the KFN acquisition and recast prior periods. Segment comparisons use the revised presentation and may not match previously reported segment figures.

Outlook, commentary, risks and contingencies

  • Outlook: KKR stated it does not intend to provide earnings guidance. Management cited competitive fundraising and said AUM, fee-paying AUM, and associated fee growth could be lower after flagship funds completed fundraising. It plans to grow existing strategies and pursue new products, geographies, and acquisitions.
  • Market and valuation risks: Results depend on investment realizations, market values, financing availability, fundraising, interest rates, foreign exchange, and commodity prices. Falling oil and gas prices reduced energy asset values in late 2014; KKR cited approximately $149 million of unrealized losses on working-interest energy investments and roughly $352 million of losses in certain energy funds. Around 60.1% of fair-value investments were Level III, involving significant unobservable inputs and judgment.
  • Variable earnings and distributions: Carried interest and investment gains are volatile and may reverse; fee income and realizations can vary materially by quarter. Distributions are discretionary and may change. The declared fourth-quarter 2014 distribution was $0.45 per unit; a further $0.35 per unit was announced for payment in March 2015.
  • Commitments and contingencies: KKR had $1.231 billion of unfunded commitments to active investment vehicles, plus other capital markets, joint venture, and investment commitments. At reported year-end fair values, no carry was subject to clawback; a zero-value liquidation scenario would imply a $2.289 billion clawback. Certain legacy funds also had a potential $277.4 million net loss-sharing obligation under a zero-value scenario.
  • Litigation and regulation: KKR disclosed ongoing Primedia shareholder litigation and a pending appeal in litigation relating to the KFN merger. It had reached a private-equity antitrust settlement, with final court approval subject to entry of a final order and appeal. KKR also reported discussions with the SEC about expense allocation between flagship funds and co-investment and employee vehicles for 2006–2011; no resolution was assured. Accrued probable and estimable losses across specified matters were approximately $25 million; outcomes could differ.
  • Other risks: Key-person dependence, conflicts between funds and KKR, leverage and CLO exposures, acquisitions and integration, redemptions, regulatory changes, tax treatment, and the potential for dilution are prominent risks. KKR’s limited partnership structure also limits common unitholder voting rights and remedies.
  • Controls: Management and Deloitte concluded that internal control over financial reporting was effective as of December 31, 2014; Deloitte issued an unqualified opinion on the financial statements and controls.

Important facts for investors to verify

  • Reconcile GAAP earnings, segment ENI, FRE, distributable earnings, and distributions; assess how much performance depends on realized versus unrealized gains and carried interest.
  • Review the KFN and Avoca acquisition effects, including acquired debt, preferred shares, integration costs, and the change in KKR’s common-unit count.
  • Assess liquidity using cash available to KKR rather than consolidated fund and CLO balances; check unfunded commitments, debt maturities, and distribution flexibility.
  • Examine Level III valuation assumptions, oil and gas price sensitivities, and the concentration in First Data and Walgreens Boots Alliance.
  • Track the SEC expense-allocation inquiry, litigation and appeals, potential clawback exposure, and any changes in regulatory or tax requirements.