Carlyle Group L.P. — 2018 Q1 Form 10-Q Summary
Business context and reporting period
The filing covers the unaudited three months ended March 31, 2018, compared primarily with the three months ended March 31, 2017. The registrant is The Carlyle Group L.P., a global alternative asset manager operating through Corporate Private Equity, Real Assets, Global Credit and Investment Solutions. Carlyle reported $201.5 billion of total AUM and $125.8 billion of fee-earning AUM at March 31, 2018.
The financial statements consolidate certain CLOs and other funds. This materially increases reported assets, liabilities and cash flows, while generally having no material effect on income attributable to Carlyle because the economic interests of other investors are recorded as non-controlling interests.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenues | $702.8 million | $1,120.1 million | Down 37% |
| Income before taxes | $125.5 million | $327.7 million | Down 62% |
| Net income | $117.7 million | $321.9 million | Down 63% |
| Net income attributable to common unitholders | $33.8 million | $83.0 million | Down 59% |
| Diluted earnings per common unit | $0.30 | $0.90 | Down 67% |
| Economic Income | $169.0 million | $400.1 million | Down 58% |
| Fee Related Earnings | $28.2 million | $37.1 million | Down 24% |
| Distributable Earnings | $138.9 million | $55.4 million | Up 151% |
| Operating cash flow | $(22.6) million | $514.9 million | Decrease of $537.5 million |
Fund management fees increased 7% to $264.5 million, while incentive fees were $6.3 million. Investment income declined to $362.2 million from $722.3 million, primarily because performance allocations fell to $308.1 million from $676.0 million. Total expenses declined 28% to $579.3 million, led by lower performance-related compensation and the absence of 2017 real estate VIE expenses.
Overall carry-fund appreciation was 3% in Q1 2018, compared with 6% in Q1 2017. Segment AUM at March 31, 2018 was $75.0 billion for Corporate Private Equity, $44.0 billion for Real Assets, $33.8 billion for Global Credit and $48.7 billion for Investment Solutions.
Balance sheet, debt and liquidity
- Total assets were $12.9 billion, up from $12.3 billion at December 31, 2017, primarily because of higher consolidated-fund investments and receivables.
- Cash and cash equivalents were $1.1 billion; corporate treasury investments were $375.9 million. Management indicated approximately $1.3 billion remained after deducting cash allocated to specific purposes, before ordinary-course payables and reserves.
- Total debt obligations were $1.6 billion, including $500 million of 3.875% senior notes due 2023, $600 million of 5.625% senior notes due 2043, $331.5 million of CLO term loans and $149.2 million of promissory notes.
- The $750 million revolving credit facility was undrawn; the senior credit facility matures May 5, 2020. Carlyle was in compliance with its financial and non-financial covenants at March 31, 2018.
- Consolidated CLO liabilities were $4.6 billion and generally non-recourse to Carlyle, being secured by the CLO assets.
- Unfunded commitments to Carlyle funds totaled $3.85 billion, of which approximately $3.4 billion was subscribed individually by senior professionals and other professionals rather than funded directly by the Partnership.
- Cash flow was affected by $911.1 million of purchases and $529.9 million of sales and settlements by consolidated funds. Excluding consolidated-fund effects, operating cash flow was $166.8 million in Q1 2018 versus $187.5 million in Q1 2017.
Material changes versus the prior comparable period
- Reported revenue and GAAP earnings fell sharply because Q1 2017 benefited from unusually high unrealized performance allocations, particularly in Corporate Private Equity and Real Assets.
- Performance allocations declined by $367.9 million, while realized performance revenues increased substantially. This mix shift contributed to Distributable Earnings rising to $138.9 million from $55.4 million despite lower GAAP earnings.
- Base compensation increased $41.3 million, or 28%, because of higher headcount, bonuses and fundraising activity. Equity-based compensation increased to $84.9 million from $72.8 million.
- The 2017 real estate VIE, including Urbplan, was no longer consolidated in 2018, removing $92.6 million of revenue and $119.6 million of expenses recorded in Q1 2017.
- Fee-earning AUM rose 9% year over year to $125.8 billion. Pending fee-earning AUM increased to $27 billion from $22 billion at year-end 2017, but fees had not yet been activated on that amount.
- Carlyle adopted the revenue recognition standard ASU 2014-9 on January 1, 2018. Certain carried-interest amounts were reclassified from performance fees to investment income; the adoption reduced opening partners’ capital by $0.8 million and caused certain reimbursed costs to be presented gross.
- The Partnership issued approximately 400,528 common units to an NGP affiliate under an existing arrangement and facilitated 917,549 Carlyle Holdings unit exchanges for common units. No units were repurchased during the quarter.
Guidance, outlook, management commentary and risks
- Management expected approximately $25 billion of fundraising during 2018 and reported that $7.7 billion had been raised in Q1. Carlyle had reached 65% of its four-year $100 billion fundraising target as of March 31, 2018.
- Management expected fees on the new U.S. Buyout fund to activate in Q2 2018 and fees on the new Asia Buyout fund in the second half of 2018, supporting future fee-earning AUM and Fee Related Earnings.
- Management expected 2018 realized net performance revenue to be lower than 2017, before increasing again in 2019.
- Carlyle planned to continue investing in Global Credit. Management expected additional compensation and operating expenses as the business adds talent and strategies, with potential future improvement if AUM growth is achieved.
- Management viewed the Tax Cuts and Jobs Act as generally positive for portfolio companies, although interest-expense deductibility limitations could offset part of the benefit.
- Management cited elevated asset prices and acquisition multiples, increased volatility, higher interest-rate expectations, flattening yield curves and trade tensions as risks. The filing stated that announced tariffs had not materially affected any known portfolio company at the filing date.
- Performance allocations depend heavily on fair-value estimates and may reverse if fund values decline. Accrued giveback obligations were $64.8 million; the filing estimated potential after-tax giveback exposure of approximately $0.7 billion if all fund investments were deemed worthless, a scenario management considered remote.
- Legal and regulatory matters include appeals and claims related to Carlyle Capital Corporation, Cobalt, Foy v. Austin Capital, CEREP and other matters. Recorded liabilities for litigation, regulatory examinations and other matters totaled approximately $35 million. The SEC was seeking information regarding historical monitoring-fee acceleration practices and relationships involving a third-party investment adviser.
- The French tax authorities appealed a decision awarding a €117.5 million refund related to CEREP. The refund was received but had not been recognized as income pending final resolution.
- The U.S. Court of Appeals ruled that U.S. risk-retention rules do not apply to managers of open-market CLOs; the filing noted that the decision could be challenged and that European risk-retention requirements remain applicable.
Most important facts for investors to verify
- Whether future fundraising and activation of the $27 billion pending fee-earning AUM convert into sustained management-fee growth and improved FRE.
- The composition and realizability of the $3.65 billion accrued performance allocations and the sensitivity of those amounts to public and private-market valuations.
- The timing and ultimate amount of any carried-interest givebacks, including the $64.8 million recorded obligation and broader potential exposure.
- Actual cash available for distributions after compensation obligations, fund commitments, debt service, tax receivable agreement payments and regulatory or litigation reserves.
- Progress, costs and profitability of the Global Credit expansion.
- Outcomes of the CEREP tax appeal, SEC inquiries, Cobalt litigation, Carlyle Capital Corporation appeal and other regulatory proceedings.
- The distinction between GAAP earnings and management’s non-GAAP Economic Income, Fee Related Earnings and Distributable Earnings, particularly given the large quarter-to-quarter volatility in realized and unrealized performance revenues.
- The April 2018 declared distributions of $0.27 per common unit and $0.367188 per preferred unit, noting that preferred distributions are discretionary and non-cumulative.