KKR & Co. Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Amounts below are U.S. dollars; financial statement amounts are GAAP unless identified otherwise. KKR is a global alternative investment manager, and its consolidated statements include funds and financing vehicles in which outside investors bear much of the economics.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| GAAP revenue | $790.5m | $1,129.7m | $3,157.8m | $2,573.9m |
| Net income attributable to KKR | $249.6m | $648.5m | $1,481.6m | $1,515.7m |
| Net income attributable to Class A common stockholders | $241.2m | $640.2m | $1,456.6m | $1,490.7m |
| Diluted GAAP EPS | $0.43 | $1.17 | $2.63 | $2.83 |
| After-tax distributable earnings (non-GAAP) | $388.8m | $496.7m | $1,030.2m | $1,137.1m |
| Distributable operating margin (non-GAAP) | 50.5% | 52.8% | 49.7% | 50.6% |
Q3 GAAP revenue included $374.3m of capital allocation-based income; fees and other were $416.2m. Nine-month capital allocation-based income was $1,849.6m and fees and other were $1,308.2m. Q3 investment income was $218.8m, versus $833.3m a year earlier, reflecting the swing in investment gains to a $4.6m loss from a $666.7m gain. Nine-month net gains from investment activities were $2.237b, roughly level with the prior year.
- Cash flow, nine months: Operating cash flow was negative $3.513b, investing cash flow negative $163.8m, and financing cash flow positive $4.680b. Reported cash, cash equivalents and restricted cash ended at $3.626b, up from $2.642b at year-end 2018. Operating cash flow is significantly affected by investment purchases and proceeds at consolidated funds.
- Balance sheet, September 30: Total assets were $57.645b, including $50.845b of investments; total liabilities were $29.060b. Debt obligations were $25.281b, compared with $22.341b at year-end 2018. These totals include substantial fund/CFE debt that is generally non-recourse to KKR; reported cash likewise includes cash held at consolidated entities.
- Liquidity and capital: KKR reported $2.687b of corporate cash and $855m held at consolidated entities. It had $1.0b available under its corporate revolving facility, with no borrowing outstanding, in addition to separate capital-markets facilities. Non-GAAP book value was $15.353b, or $18.22 per adjusted share, versus $12.981b and $15.57 at year-end.
- Assets under management: AUM was $208.4b, fee-paying AUM $153.0b, and uncalled commitments $56.6b at September 30. Approximately 77% of fee-paying AUM was not subject to redemption for at least eight years from inception.
Material changes versus comparable periods
- Q3 revenue fell 30%, and Class A stockholder income and diluted EPS declined substantially. Management attributed the decline principally to lower investment gains and lower carried-interest/general-partner income; Q3 2018 had marked investment appreciation.
- For the nine-month period, revenue rose 23%, primarily on higher capital allocation-based income, while Class A stockholder income fell modestly. Higher compensation, interest expense, and income tax expense offset revenue growth. Comparisons are affected by KKR’s July 2018 conversion from a partnership to a corporation and the associated tax effects.
- Non-GAAP after-tax distributable earnings declined 22% in Q3 and 9% year to date. The nine-month decline reflected lower realized performance and investment income, partly offset by higher management fees.
- Debt increased partly following new 2029 note issuances and growth in consolidated fund financing. KKR issued €650m of 1.625% notes due 2029 and $500m of 3.75% notes due 2029, and redeemed $500m of 6.375% notes due 2020, paying a $22.8m make-whole premium.
- Private Markets AUM growth was supported by fundraising and portfolio appreciation; Public Markets AUM increased more moderately, with fundraising partly offset by redemptions. Q3 capital invested and syndicated capital together were $5.044b, down from $7.076b.
Outlook, commentary, and risks
- KKR did not provide formal earnings guidance. It said certain completed or expected realization activity could produce about $925m of realized performance and investment income in Q4 2019 and early 2020, including approximately $375m expected in Q4; some transactions remained subject to closing conditions.
- Management identified slower U.S. growth, trade and political uncertainty, market volatility, foreign-exchange movements, interest-rate and credit-spread changes, and lower oil and gas prices as factors that could affect investment valuations, realizations, fundraising, deployment and earnings. The long-term WTI and natural-gas price assumptions cited fell about 6% and 4%, respectively, in Q3.
- Valuation sensitivity is significant: 55.4% of investments measured at fair value were Level III, relying on significant management judgment and unobservable inputs. India credit-market weakness produced approximately $110m of Q3 unrealized losses at KKR’s India debt finance company and cumulative unrealized losses of approximately $155m; KKR estimated about $79m attributable to its 51% interest could become future realized losses if values did not recover.
- As of September 30, no carried interest was subject to clawback assuming funds were liquidated at reported fair values; a hypothetical liquidation at zero value would imply an approximately $2.4b clawback. KKR also disclosed $5.277b of unfunded commitments to active funds, plus $398m of investment/asset purchase commitments and $690m of capital-markets commitments.
- Legal matters include a Kentucky Retirement Systems lawsuit; plaintiffs appealed after the Kentucky Court of Appeals vacated the trial court’s denial of a dismissal motion. KKR could not estimate a potential loss range. Management said it had not concluded pending matters would materially affect the statements, while noting adverse outcomes could affect results in a particular period.
- KKR expected to acquire an additional 5% interest in Marshall Wace in Q4 2019 using cash and Class A shares. The company also expected KKR Capstone acquisition and consolidation of the KKR Group Partnerships around January 1, 2020. The board declared a $0.125 quarterly Class A dividend after quarter-end; future dividends remain discretionary.
Management reported disclosure controls were effective as of September 30, 2019, and no material change in internal control over financial reporting during the period.
Investor verification priorities
- Separate KKR’s own cash, debt and operating results from consolidated fund/CFE balances, noncontrolling interests and non-recourse obligations.
- Review the composition and valuation assumptions of Level III assets, including energy and India credit exposures, and assess how unrealized gains affect carried interest and reported earnings.
- Track realized versus unrealized performance income, fund netting holes, and the conditions required for carried-interest distributions or potential clawbacks.
- Confirm whether the stated $925m realization estimate and expected Marshall Wace acquisition were completed, and assess related cash, share issuance and earnings impacts.
- Evaluate capital commitments, repurchase authorization, declared dividends, tax receivable agreement obligations and the outcomes of disclosed litigation and regulatory matters.
- Interpret non-GAAP distributable earnings and margins alongside GAAP results; KKR cautions these measures are not substitutes for GAAP and may not be comparable across managers.