KKR & Co. Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. KKR is a global alternative investment firm spanning private equity, real assets, credit, capital markets and related strategies. Amounts below are in U.S. dollars; financial-statement figures are generally in millions.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| GAAP revenue | $1,179.9 | $971.6 | $2,367.3 | $1,444.2 |
| Income before taxes | $1,527.1 | $1,627.4 | $3,321.8 | $2,247.9 |
| Net income | $1,361.7 | $1,566.4 | $2,988.8 | $2,169.3 |
| Net income attributable to Class A common stockholders | $514.4 | $680.4 | $1,215.4 | $850.5 |
| Diluted EPS | $0.93 | $1.24 | $2.20 | $1.57 |
| Segment after-tax distributable earnings | $327.3 | $404.7 | $641.4 | $640.4 |
Q2 revenue growth reflected higher fees and capital-allocation income, while common-stockholder income and diluted EPS declined year over year. For the first half, higher capital-allocation income and investment gains lifted GAAP results; segment after-tax distributable earnings was nearly unchanged. KKR reported $1,037.9 million of net investment gains in Q2, mostly unrealized, and $2,241.9 million for the first half, including $2,037.9 million of unrealized gains. Private equity was the largest source of first-half investment gains.
- Revenue composition: Q2 fees and other were $519.4 million, up from $413.8 million; capital-allocation-based income was $660.4 million, up from $557.8 million. First-half capital-allocation-based income rose to $1,475.4 million from $636.0 million.
- Expenses and taxes: Q2 compensation and benefits rose to $609.0 million from $472.5 million, largely reflecting carried-interest compensation and higher cash compensation. GAAP income tax expense was $165.4 million in Q2 and $333.0 million for the first half. Effective tax rates were 10.83% and 10.02%, respectively.
- Segment margin: Segment operating earnings were $445.2 million on segment revenue of $907.5 million in Q2, versus $479.4 million on $926.2 million a year earlier. The resulting operating margin was approximately 49.1%, compared with 51.8%.
- Cash flow: First-half operating cash flow was negative $3,113.8 million, investing cash flow negative $145.1 million and financing cash flow positive $3,805.6 million. Cash, cash equivalents and restricted cash ended at $3,190.6 million, up from $2,641.5 million at year-end 2018. Operating cash flow includes consolidated funds’ investment purchases and proceeds and should not be read as a standalone measure of parent-company cash generation.
- Debt and liquidity: GAAP debt obligations were $25,685.8 million at June 30, up from $22,341.2 million at December 31. This includes substantial debt of consolidated CLOs, CMBS vehicles and funds; much of that debt is non-recourse to KKR beyond the relevant vehicle’s assets. KKR reported $3,110.3 million of segment cash and short-term investments and $4,061.6 million of segment debt, including KFN debt. The $1.0 billion corporate revolver and capital-markets credit facilities had no borrowings outstanding.
- Assets under management: AUM was $205.7 billion, FPAUM $151.5 billion and uncalled commitments $56.5 billion at quarter-end. AUM and FPAUM increased from year-end, while uncalled commitments declined. KKR’s segment book value was $15.0 billion, or $17.81 per adjusted share, up from $13.0 billion and $15.57 at year-end.
Material changes and comparability
- Q2 fees and other increased mainly from transaction fees and management fees; fee credits also increased. Transaction fees reflected more fee-generating investments and capital-markets activity. Management fees benefited from funds entering investment periods, including Global Infrastructure Investors III and European Fund V.
- Q2 capital-allocation-based income rose with private-equity portfolio appreciation. However, realized carried interest in KKR’s segment results fell to $211.9 million from $342.1 million, contributing to lower Q2 segment distributable earnings.
- For the first half, net investment gains increased year over year, but GAAP comparisons are affected by KKR’s July 2018 conversion from a partnership to a corporation. The conversion changed tax treatment; prior-period investment income and carried interest generally were not subject to U.S. corporate income tax. The 2019 first-half tax provision also included an approximately $45 million additional benefit from finalizing the conversion-related tax-basis step-up.
- KKR issued €650 million of 1.625% senior notes due 2029 in May. Subsequent to quarter-end, it issued $500 million of 3.750% notes due 2029 and redeemed $500 million of 6.375% notes due 2020 on July 31, paying a $22.1 million make-whole premium.
Outlook, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management says fundraising is competitive, investment deployment and realizations vary with market conditions, and transaction activity can be uneven. It expects corporate tax expense and taxes paid to be higher following the conversion; the timing and pace depend on asset realizations and their tax bases.
- Management reported approximately $600 million of expected realized performance and investment income from certain realization activities in 2019 and 2020, with approximately $350 million expected after Q3 2019. Some transactions remained incomplete and subject to closing conditions; completion and timing were not assured.
- Risks include market and valuation volatility, slower growth, trade and political uncertainty, interest-rate and credit-spread changes, currency and commodity-price movements, fundraising and deployment challenges, and reliance on realizations. At June 30, 55.8% of investments measured at fair value were Level III, where significant unobservable inputs and management judgment are used.
- KKR had $5.3 billion of unfunded commitments to active investment vehicles, plus $735.2 million of capital-markets underwriting, financing and syndication commitments and $17.4 million of other purchase commitments. The company also disclosed various guarantees and indemnifications whose maximum exposure was not then known.
- No carried interest was subject to clawback assuming applicable funds were liquidated at quarter-end fair values; a hypothetical liquidation of those investments at zero value would produce an estimated clawback of approximately $2.2 billion.
- A Kentucky lawsuit involving KKR, its co-CEOs and others remained pending after plaintiffs appealed an appellate ruling on standing. KKR said it could not estimate potential losses for the disclosed legal matters; it had not concluded that their resolution would materially affect the financial statements, while acknowledging an adverse outcome could materially affect results in a particular period.
- KKR declared a $0.125 per-share Class A dividend after quarter-end, consistent with its stated annual aggregate policy of $0.50 per share, subject to board discretion. Preferred dividends were also declared. The filing cautions that future dividends are not assured.
Investor verification priorities
- Separate recurring fee-related earnings and realized income from unrealized marks and carried-interest accruals; verify how much reported investment appreciation is ultimately realized.
- Reconcile GAAP debt and cash to parent/segment liquidity, distinguishing KKR obligations from non-recourse consolidated-vehicle and fund debt; review maturities, covenants and post-quarter-end refinancing.
- Assess the sensitivity of Level III valuations, carried interest and book value to valuation assumptions, public-market prices, credit conditions and commodity forecasts.
- Track fundraising, FPAUM conversion into fee revenue, redemptions, uncalled commitments and the timing of investment deployment and exits.
- Monitor post-conversion taxes and tax-receivable-agreement obligations, the disclosed litigation and guarantees, and the completion and timing of expected realization transactions.