Business Context and Reporting Period
The filing is The Carlyle Group L.P.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets and Solutions. The financial statements consolidate certain sponsored funds, CLOs and the Urbplan real estate variable-interest entity, creating significant gross-up effects that generally do not affect net income attributable to Carlyle.
At September 30, 2014, total AUM was approximately $202.6 billion and fee-earning AUM was approximately $140.2 billion. Common units outstanding were 67.4 million.
Financial Performance and Key Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 | ||
|---|---|---|---|---|
| 2014 | 2013 | 2014 | 2013 | |
| Total revenues | $755.0 million | $888.1 million | $3,041.2 million | $2,802.4 million |
| Fund management fees | $307.4 million | $257.9 million | $885.0 million | $731.5 million |
| Total performance fees | $187.4 million | $320.5 million | $1,350.3 million | $1,222.0 million |
| Income before taxes | $175.4 million | $(8.6) million | $1,189.0 million | $729.7 million |
| Net income | $181.3 million | $(26.5) million | $1,125.1 million | $670.3 million |
| Net income attributable to Carlyle | $25.4 million | $2.3 million | $69.5 million | $32.8 million |
| Diluted earnings per common unit | $0.35 | $0.04 | $1.01 | $0.65 |
| Fee-related earnings | $61.9 million | $44.1 million | $179.3 million | $113.5 million |
| Distributable earnings | $158.6 million | $104.7 million | $665.5 million | $438.7 million |
- GAAP pretax margin was approximately 23.2% in the quarter and 39.1% for the nine months. Net income attributable to Carlyle represented approximately 3.4% and 2.3% of consolidated revenue, respectively.
- Operating cash flow was $2.5 billion for the nine months, compared with $2.6 billion in the prior-year period. Consolidated-fund activity materially affects this figure.
- Cash and cash equivalents were $1.4 billion, compared with $966.6 million at December 31, 2013. Management stated that approximately $880 million remained after amounts reserved or allocated for specific purposes.
- Corporate debt included $500 million of 3.875% senior notes due 2023, $600 million of 5.625% senior notes due 2043, $25 million of term-loan borrowings and $15.9 million of a separate CLO-related term loan. No revolving-credit borrowings were outstanding; $750 million remained available under the revolving facility.
- Consolidated-fund loans payable were $16.4 billion and generally non-recourse to Carlyle. Consolidated-fund assets were approximately $30.3 billion.
- Accrued performance fees were $3.7 billion, while accrued performance-fee compensation was $1.8 billion. Accrued giveback obligations were $42.1 million.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue declined 15%, primarily because performance fees decreased $133.1 million and consolidated-fund interest and other income decreased $67.9 million. Fund management fees increased 19%.
- Third-quarter performance fees were affected by approximately $76.7 million of reversed hedge-fund incentive fees and a $75.8 million reversal from two AlpInvest vehicles that fell below their performance threshold. The AlpInvest reversal had corresponding reductions in performance-fee compensation and taxes and did not materially affect net income attributable to Carlyle.
- Nine-month revenue increased 9%, driven by higher management fees, performance fees, investment income and the newly consolidated Urbplan revenue, partially offset by lower consolidated-fund interest and other income.
- Nine-month fee-related earnings increased 58% and distributable earnings increased 52%, reflecting higher management-fee revenue, realized performance fees and lower relative fundraising expenses.
- The March 2014 public offering issued 13.8 million common units and generated $449.5 million of net proceeds. Carlyle also issued $200 million of additional 5.625% senior notes due 2043, generating $210.8 million of net proceeds.
- DGAM was acquired in February 2014 for approximately $31.1 million of initial consideration, including cash and common units, with additional contingent consideration possible. DGAM added approximately $2.9 billion of fee-earning AUM.
- Management recorded a $30.6 million intangible-asset impairment during the nine months. New equity compensation grants and acquisitions also increased ongoing compensation and amortization obligations.
Guidance, Outlook, Risks and Unusual Items
- Management expected cash on hand, operating cash flows, accumulated earnings and the undrawn revolving facility to be sufficient for at least the next 12 months. The general partner declared a $0.16 per-unit distribution payable November 21, 2014.
- Management noted heightened market volatility, declining public-market valuations, widening credit spreads, geopolitical concerns and weaker global growth expectations. Carlyle reported that its carry-fund portfolio increased approximately 3% during the quarter, while reported hedge funds declined 2.1% and subsequently declined further after quarter-end.
- During the quarter, Carlyle invested approximately $3.7 billion and realized approximately $4.5 billion from 146 investments and 38 funds. Future exits and realizations may accelerate or be delayed depending on market conditions.
- Urbplan remained a significant contingency. It was expected to require approximately $80 million to $130 million of additional funding, potentially more, despite no contractual obligation to provide further support. Substantially all Urbplan loans were in covenant violation or technical default, although no acceleration notices were outstanding and the loans were contractually non-recourse to Carlyle.
- Carlyle and certain affiliates settled a class-action lawsuit concerning alleged anticompetitive “club” bidding practices, subject to final court approval. CP IV and its affiliates were expected to bear settlement costs not covered by insurance; Carlyle’s CP IV performance fees were reduced by $19.3 million.
- Other contingencies include the CEREP I French tax assessment, for which approximately €75.0 million was accrued by the fund, ongoing litigation related to Carlyle Capital Corporation, and a New Mexico placement-agent-related lawsuit. Management could not estimate reasonably possible losses for certain matters.
- Performance fees and investment values rely substantially on Level III valuations and may reverse materially. If all fund investments were deemed worthless at September 30, 2014, potentially repayable realized and distributed carried interest was estimated at $1.1 billion after tax where applicable.
- Management disclosed that adoption of the future revenue-recognition standard could materially delay performance-fee revenue recognition, although the standard was not effective for the period reported.
Important Facts for Investors to Verify
- Reconcile GAAP results with fee-related earnings, distributable earnings and economic net income; these non-GAAP measures exclude or adjust for significant items.
- Assess the sustainability and cash conversion of the $3.7 billion accrued performance-fee balance, including the $42.1 million giveback accrual and potential $1.1 billion downside exposure.
- Separate Carlyle’s corporate liquidity and debt from the substantially larger, generally non-recourse liabilities of consolidated CLOs and other funds.
- Monitor Urbplan’s funding requirements, covenant defaults, asset values, litigation and potential additional Carlyle support.
- Review the sensitivity of Level III valuations, performance fees and AUM to public-market prices, credit spreads, foreign exchange rates, discount rates, defaults and recovery assumptions.
- Evaluate dilution and future obligations from common-unit issuance, equity compensation, contingent consideration, the tax receivable agreement and approximately $3.0 billion of unfunded fund commitments.
- Confirm final approval and financial impact of the CP IV litigation settlement and the status of the remaining legal and French tax contingencies.