KKR & Co. L.P. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited GAAP financial statements; comparative periods ended September 30, 2013. KKR is a global alternative investment manager spanning private equity, real assets, credit, hedge funds and capital markets. Consolidated results include funds and CLOs in which outside investors hold substantial interests, so reported consolidated totals are not equivalent to amounts economically attributable to KKR.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Fees | $344.8m | $220.0m | $897.1m | $537.6m |
| Total expenses | $504.4m | $455.5m | $1,562.9m | $1,186.8m |
| Net gains from investment activities | $298.3m | $2,230.4m | $4,242.3m | $4,598.8m |
| Income before taxes | $901.3m | $2,205.8m | $4,985.9m | $4,599.1m |
| Net income attributable to KKR | $89.9m | $204.7m | $478.2m | $413.3m |
| Diluted earnings per common unit | $0.20 | $0.66 | $1.21 | $1.40 |
| Economic net income (ENI), non-GAAP | $508.7m | $613.7m | $1,640.6m | $1,405.9m |
| Fee-related earnings (FRE), non-GAAP | $125.6m | $106.0m | Not stated here | Not stated here |
| Total distributable earnings, non-GAAP | $504.8m | $251.1m | $1,652.6m | $945.5m |
Amounts are in U.S. dollars; financial statement figures are converted from thousands. KKR reported net income of $872.0m for Q3 and $4.93bn for the nine months, but most was allocated to noncontrolling interests and appropriated capital. A conventional operating margin is not presented; GAAP fees alone do not capture eliminated fees, carried interest or investment income. ENI and FRE are management-defined non-GAAP measures.
- Cash flow, nine months: operating cash flow was $1.52bn, investing cash flow was $165.9m and financing cash flow was negative $1.52bn. Cash and cash equivalents increased $166.4m to $1.47bn. These consolidated cash flows include funds and CLOs and should not be read as cash generated solely for KKR.
- Balance sheet at September 30: total assets were $66.33bn, total liabilities $14.22bn and total equity $51.81bn. Cash and cash equivalents held at consolidated entities were an additional $1.75bn, generally subject to the needs and restrictions of those entities.
- Debt and liquidity: reported debt obligations were $10.31bn, including $7.23bn of consolidated CLO debt, which is collateralized by CLO assets and has no recourse to KKR’s general assets. Segment cash and short-term investments were approximately $2.14bn. The company had $1.25bn available under revolving credit facilities at quarter-end; no borrowings were outstanding under the corporate revolver, apart from a letter of credit. KKR said liquidity sources were expected to meet working-capital needs for at least 12 months.
- Assets under management: Private Markets AUM was $59.2bn and fee-paying AUM (FPAUM) $45.6bn; Public Markets AUM was $37.0bn and FPAUM $35.8bn. Combined AUM was approximately $96.1bn and FPAUM approximately $81.4bn.
- Distributions: the filing reports a $0.45-per-unit Q3 distribution, announced October 23 and payable November 18, 2014. The distribution policy is discretionary, and future distributions are not assured.
Material changes versus comparable periods
- Q3 fees rose 57% year over year, mainly from KFN-related oil and gas revenue, higher transaction fees and a roughly $43m fee from First Data equity syndication. Q3 expenses increased 11%, principally from acquired oil and gas operations, Avoca and newly consolidated CLOs.
- Q3 income before taxes fell to $901m from $2.21bn, and net income attributable to KKR declined to $89.9m from $204.7m. The main driver was the sharp decrease in investment gains: $298m versus $2.23bn in Q3 2013. Higher dividends and interest income and increased fees partly offset this decline.
- For the nine months, fees increased 67% and income before taxes increased 8%; net income attributable to KKR rose 16%. Diluted earnings per unit nevertheless declined, reflecting a substantially larger unit count, including 104.3m units issued in the KFN acquisition.
- ENI declined in Q3 but increased for the nine-month period. Q3 total distributable earnings roughly doubled, reflecting higher realized carry and realized investment income; these items are variable and do not imply recurring quarterly results.
- Total investments rose to $59.9bn from $47.4bn at December 31, 2013. The comparison reflects acquisitions and consolidation changes, including KFN and Avoca, as well as investment activity and valuation movements.
- Debt obligations increased to $10.3bn from $1.9bn, largely because KFN and CLO debt were consolidated. KKR also issued $500m of 5.125% senior notes due 2044. KFN debt is generally non-recourse to KKR beyond KFN’s assets; CLO debt is supported solely by each CLO’s collateral.
Outlook, risks and unusual items
- Management cited volatile deal and exit activity, which can change transaction fees, realized carry and distributions. It reported continued realization activity and noted post-quarter sales of Versatel and WILD Flavors; other announced transactions remained subject to closing conditions.
- Management highlighted uneven global growth, slower European recovery, China and emerging-market risks, foreign exchange movements, interest-rate uncertainty, credit spreads and market volatility. These conditions can affect portfolio-company performance, investment valuations, financing access and realizations. Falling oil and gas prices had a modest quarter-over-quarter valuation effect, but KKR noted growing exposure to commodity prices.
- Approximately 68.7% of investments measured at fair value were Level III, using significant unobservable inputs. Valuations depend on management judgments and could differ materially from realized proceeds; a 10% decline in private-equity fund investment values would generally produce a commensurate change in investment gains, though the effect on KKR-attributable income would be smaller because most gains are allocated to noncontrolling interests.
- At September 30, no carried interest was subject to clawback based on reported fair values; a hypothetical liquidation of applicable funds at zero value would imply a $2.12bn clawback. A separate net-loss-sharing obligation was nil at reported fair values but would have been approximately $284m in a zero-value liquidation scenario.
- KKR estimated approximately $80m of aggregate losses for matters where loss was both probable and reasonably estimable; actual outcomes could vary. The antitrust litigation settlement was preliminarily approved, subject to final court approval, and management did not expect its payment to materially affect results. Other legal proceedings and regulatory inquiries remain subject to uncertainty.
- Unfunded commitments included $862m to active investment funds, plus capital-markets and other commitments. The consolidated commitment schedule also includes substantial fund and CLO obligations that are not equivalent to direct obligations of KKR.
- Following quarter-end, KKR entered a new $1.0bn five-year unsecured revolving credit agreement, with an option to seek an increase to $1.25bn. The prior facility was terminated. The filing provides no earnings or AUM guidance.
Important facts for investors to verify
- Separate KKR-attributable earnings, ENI, FRE and distributable earnings; confirm the non-GAAP definitions and reconcile them with GAAP results.
- Assess the recurring versus episodic contribution of transaction fees, large dividends, realized carry and investment marks, including the First Data syndication fee.
- Review the KFN and Avoca acquisition contribution, purchase accounting, integration costs, resulting dilution and non-recourse debt structure.
- Evaluate Level III valuation assumptions and concentration in large holdings, including Alliance Boots and First Data, and whether post-quarter sales support quarter-end marks.
- Monitor AUM and FPAUM changes, fund distributions and redemptions, unfunded commitments, debt maturities and the availability of cash held at consolidated entities.
- Track litigation and regulatory developments, potential carry clawbacks and net-loss-sharing exposure, and the sustainability of distributions under the discretionary policy.