The Carlyle Group L.P. — 2Q18 Form 10-Q Summary
Business context and reporting period
Carlyle is a global alternative asset manager operating through Corporate Private Equity, Real Assets, Global Credit, and Investment Solutions. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, with comparisons to the prior-year periods. Carlyle reported $209.7 billion of total AUM and $146.5 billion of fee-earning AUM at quarter-end. The consolidated financial statements include certain CLOs and other consolidated funds, which materially gross up assets, liabilities, and cash flows but generally have limited impact on income attributable to Carlyle.
Financial performance and key metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenues | $893.6 million, down 1.6% | $1,596.4 million, down 21% |
| Fund management fees | $301.3 million, up 26% | $565.8 million, up 17% |
| Investment income | $503.3 million, down $88.2 million | $865.5 million, down $448.3 million |
| Income before taxes | $252.8 million | $378.3 million |
| Net income | $241.2 million | $358.9 million |
| Net income attributable to common unitholders | $63.5 million; $0.62 basic, $0.56 diluted per unit | $97.3 million; $0.96 basic, $0.87 diluted per unit |
| Economic Income | $272.1 million | $441.1 million |
| Fee Related Earnings | $57.8 million | $86.0 million |
| Distributable Earnings | $114.5 million | $253.4 million |
GAAP net income margins were approximately 27.0% for the quarter and 22.5% for the six-month period. Income before tax margins were approximately 28.3% and 23.7%, respectively. Performance allocations were $425.1 million in the quarter and $733.2 million year to date, compared with $532.5 million and $1.21 billion in the prior-year periods. Realized performance allocations declined materially, while unrealized performance allocations increased year over year in the second quarter.
- Carry fund appreciation was 5% in the second quarter and 9% for the first half, compared with 5% and 11% in the prior-year periods.
- Management reported more than $12 billion of fundraising in the quarter and approximately $30 billion expected for full-year 2018. Carlyle stated that it had reached 77% of its four-year, $100 billion fundraising target.
- Fee-earning AUM increased from $116.1 billion at June 30, 2017 to $146.5 billion at June 30, 2018. Pending fee-earning AUM declined to $10 billion after fee activation on new U.S. and Asia buyout funds.
- Six-month operating cash flow was negative $538.2 million on a consolidated basis, versus positive $373.1 million in the prior-year period. The result was affected by purchases and sales of investments and the cash flows of consolidated CLOs. Excluding consolidated funds, operating cash flow was positive $153.6 million versus $79.9 million.
- Cash and cash equivalents were $876.8 million, corporate treasury investments were $343.5 million, and management estimated approximately $1.1 billion of remaining cash and treasury liquidity after amounts allocated to specific purposes.
- Debt obligations were $1.59 billion, including $25.0 million outstanding under the senior credit facility and no revolver borrowings. The facility had $750.0 million of revolving availability and matures May 5, 2020. Carlyle was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Revenue decreased primarily because performance allocations were lower, particularly in Corporate Private Equity, and because 2017 included revenue from the real estate VIE later deconsolidated. The six-month comparison was also affected by the absence of 2017 Urbplan-related revenue and expenses.
- Fund management fees grew substantially because of new fund launches and fee activation, especially CP VII and CAP V. This growth was partly offset by fee step-downs and distributions from older funds.
- Economic Income fell to $272.1 million from $300.1 million in the quarter and to $441.1 million from $700.2 million for six months. Distributable Earnings declined to $114.5 million from $198.9 million in the quarter but were essentially flat year to date at $253.4 million versus $254.3 million.
- Fee Related Earnings improved in the quarter to $57.8 million from $20.2 million and for six months to $86.0 million from $57.3 million, although higher fundraising-related compensation and general and administrative costs limited operating leverage. Corporate Private Equity six-month FRE was negative $9.6 million.
- Adoption of the new revenue recognition standard reclassified performance-based capital allocations into investment income and presented certain reimbursed costs gross. The filing states that the adoption did not materially change the historical revenue recognition pattern.
- Carlyle repurchased approximately 2.3 million common units for $51.0 million during the first six months, leaving approximately $89.8 million available under the authorized $200 million repurchase program at June 30.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fee-earning AUM and Fee Related Earnings to increase in the second half of 2018 as fees were activated on newly raised funds. It also expected fundraising to decelerate after reloading major flagship funds.
- Management expected 2018 realized net performance revenue to be lower than in 2017, with improvement expected in 2019.
- Carlyle identified competition, high asset valuations, a stronger U.S. dollar, a flattening yield curve, higher interest rates, tariffs, inflation, wage and input-cost pressure, credit conditions, foreign exchange, and investment liquidity as material business risks.
- Accrued performance allocations were $3.90 billion, offset by $63.2 million of accrued giveback obligations. If all fund investments were deemed worthless, potential realized and distributed carried-interest givebacks were estimated at approximately $0.7 billion after tax, although management viewed that scenario as remote.
- The Partnership had $4.05 billion of unfunded commitments to Carlyle funds, of which approximately $3.5 billion was subscribed individually by senior professionals and other professionals. Legal and regulatory contingencies accrued were approximately $35 million.
- Pending legal and regulatory matters included the Foy v. Austin Capital appeal, the Carlyle Capital Corporation appeal, Cobalt-related securities litigation, a French tax dispute involving CEREP I, Urbplan-related claims, and SEC inquiries regarding historical monitoring-fee acceleration practices and other matters. Management did not believe existing matters were likely to have a material effect beyond recorded accruals, but acknowledged that adverse outcomes could materially affect a particular period.
- Subsequent events included a $60 million expected charge related to assignment of a New York office lease, payable over approximately 15 years; the charge was expected in third-quarter 2018 and excluded from non-GAAP results. Carlyle also agreed to acquire a 19.9% interest in Fortitude Holdings for $381 million in cash at closing, plus potential deferred consideration, alongside a strategic asset-management relationship involving at least $6 billion of targeted asset allocations. The transaction remained subject to regulatory and other closing conditions.
- Subsequent declared distributions were $0.22 per common unit and $0.367188 per preferred unit. Preferred distributions are discretionary and non-cumulative.
Most important facts for investors to verify
- Whether new fund fee activation and the $10 billion of pending fee-earning AUM translate into sustained second-half FRE growth after higher fundraising costs.
- The timing and quality of realized performance allocations, including the expected 2018 decline and potential 2019 recovery.
- The sensitivity of accrued performance allocations, fair values, and giveback obligations to market declines and valuation assumptions.
- Liquidity available after restricted or earmarked cash, the $4.05 billion of unfunded fund commitments, debt maturities, and potential Fortitude funding requirements.
- Progress, regulatory approvals, economics, and asset-management commitments associated with the Fortitude Holdings transaction.
- Developments in SEC inquiries, litigation, the French tax appeal, Urbplan claims, and the potential for recorded contingencies to increase.
- The comparability of GAAP results with Economic Income, Fee Related Earnings, and Distributable Earnings, which exclude or adjust for consolidated funds, equity compensation, performance revenue, and other items.