KKR & Co. L.P. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. The registrant is KKR & Co. L.P. (the request metadata identifies KKR & Co. Inc.). KKR is a global investment manager and capital-markets firm. Its consolidated statements include investment funds in which third-party investors hold most of the economic interests; consequently, consolidated totals are not equivalent to earnings attributable to KKR unitholders.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Fees | $166.4 million | $112.4 million | $317.6 million | $228.7 million |
| Total expenses | $292.0 million | $348.7 million | $731.4 million | $794.0 million |
| Net gains from investment activities | $98.5 million | $1,601.7 million | $2,368.4 million | $4,688.6 million |
| Net income attributable to KKR & Co. L.P. | $15.1 million | $146.3 million | $208.6 million | $336.7 million |
| Diluted earnings per common unit | $0.05 | $0.58 | $0.72 | $1.37 |
| Fee related earnings (FRE; non-GAAP) | $98.2 million | $69.8 million | $186.2 million | $143.1 million |
| Economic net income (ENI; non-GAAP) | $144.4 million | $546.1 million | $792.2 million | $1,273.3 million |
Q2 fee growth reflected higher management, transaction and incentive fees, including the Prisma acquisition and new capital raised. FRE improved, while ENI and GAAP income attributable to KKR fell sharply as investment appreciation and carried interest were lower than in the unusually strong prior-year quarter. Q2 dividend income increased to $209.5 million from $79.9 million, including a $139.7 million distribution from Pets at Home; management cautioned that significant portfolio-company dividends are variable and generally not recurring quarterly payments.
Cash flow, balance sheet and liquidity
- At June 30, 2013, total assets were $44.8 billion and total liabilities were $3.9 billion. Cash and cash equivalents were $1.17 billion; segment cash and short-term investments, including liquid short-term investments, were $1.99 billion.
- Debt obligations were $1.71 billion, up from $1.12 billion at year-end 2012, principally reflecting issuance of $500 million of 5.50% senior notes due 2043. A further $500 million of 6.375% notes due 2020 remained outstanding. No borrowings were outstanding under the $1.25 billion revolving credit arrangements.
- For the first half, operating cash flow was $2.34 billion, investing cash flow was $61.6 million and financing cash flow was negative $2.46 billion; cash declined $63.1 million to $1.17 billion. These consolidated cash flows include fund activity and should not be read as cash generation solely available to KKR.
- KKR reported $83.5 billion of AUM at quarter-end. Private Markets had $54.5 billion AUM and $45.9 billion fee-paying AUM; Public Markets had $29.0 billion AUM and $22.0 billion fee-paying AUM. Private Markets reported $20.0 billion of uncalled commitments and Public Markets $1.4 billion.
- Common units outstanding were 277.8 million at June 30. KKR declared a $0.42 per-unit distribution, compared with $0.13 in Q2 2012; the Q2 2013 distribution was announced July 26 and scheduled for payment August 20.
Material changes, outlook and risks
- First-half GAAP net income attributable to KKR fell to $208.6 million from $336.7 million; the decline in investment gains was partly offset by stronger fee revenue and lower expenses. Private Markets ENI declined year over year, while Public Markets ENI increased, with the Prisma acquisition contributing to its fee growth. Capital Markets and Principal Activities ENI also fell substantially as principal investment income declined.
- Management said its liquidity sources should cover working-capital requirements for at least the next 12 months. It provided no formal earnings guidance. It noted that transaction activity is volatile; as of July 26, Private Markets had invested or committed approximately $3.0 billion in new transaction activity, nearly matching full-year 2012 committed dollars invested.
- Management cited uncertainty in global growth, European sovereign-debt and banking conditions, U.S. monetary-policy changes and possible higher interest rates, market volatility, credit availability, refinancing risk and commodity-price movements as factors that can affect investment valuations, realizations, fees and returns.
- Valuation sensitivity is notable: 73.2% of investments measured at fair value were Level III, based on significant unobservable inputs. Management estimated an immediate 10% decline in fund investment values would generally cause a commensurate change in investment gains, with carried interest potentially more affected; the impact on KKR-attributable income would generally be smaller because most changes belong to noncontrolling interests.
- Potential fund clawbacks were not indicated at June 30 assuming liquidation at reported fair values; under a zero-value liquidation scenario, the estimated clawback would be $1.20 billion. A separate net-loss-sharing obligation would be approximately $578.3 million under a zero-value liquidation scenario. Neither scenario represented an obligation based on reported fair values.
- KKR recorded an estimated $32.5 million aggregate loss for matters considered probable and reasonably estimable; actual outcomes may differ and some losses may be insured or indemnified. The Bruno’s litigation was settled and dismissed without admission of wrongdoing, with no material financial effect. Primedia shareholder litigation and several regulatory inquiries remained pending; management could not estimate potential losses for many matters.
- Other material commitments include $786.6 million of unfunded commitments to active investment vehicles, capital-markets underwriting and lending commitments, and a $150 million commitment to MerchCap Solutions. The Prisma contingent-consideration liability was $86.9 million in the financial statements; MD&A reported total recorded contingent consideration obligations of approximately $120.8 million, so the scope of those figures should be checked.
Most important facts for investors to verify
- Separate KKR-attributable earnings and segment non-GAAP measures from consolidated fund results, and review the reconciliation of FRE and ENI to GAAP.
- Assess the sustainability of fees and distributions, particularly variable transaction income, carried interest and large portfolio-company dividends; the distribution policy is discretionary.
- Review Level III valuation assumptions, realization prospects, fund netting holes and the potential effects of weaker portfolio values on carried interest and clawbacks.
- Confirm the nature and amount of contingent consideration, unfunded commitments, debt obligations and pending litigation exposures, including the differing contingent-consideration figures disclosed.
- Consider unit dilution: common units increased from 253.4 million at year-end 2012 to 277.8 million at June 30, 2013, including exchanges and equity issuance.