KKR & Co. L.P. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012, compared with the three months ended March 31, 2011. The filing registrant is KKR & Co. L.P. Figures below are in U.S. dollars; financial-statement amounts are generally in millions. KKR consolidates investment funds, so reported totals include substantial amounts attributable to outside investors.
Business context and key financial metrics
- KKR is a global investment manager and capital-markets firm. It reported $62.3 billion of AUM at March 31, 2012.
- GAAP fees were $116.3 million, down from $231.8 million. Expenses were $445.3 million, versus $423.8 million.
- Investment income was $3.318 billion, up from $2.540 billion, chiefly reflecting investment gains. Net gains from investment activities were $3.087 billion, including $2.534 billion of unrealized gains. Dividend income was $172.9 million, including $168.9 million from HCA.
- Consolidated net income was $2.972 billion, compared with $2.317 billion; $2.776 billion was attributable to noncontrolling interests. Net income attributable to KKR & Co. L.P. was $190.4 million, versus $159.6 million. Diluted earnings per common unit were $0.80, compared with $0.75.
- Management’s non-GAAP measures showed fee related earnings (FRE) of $73.4 million, down from $126.2 million, and economic net income (ENI) of $727.2 million, down from $742.5 million. Segment fee revenue was $189.1 million; FRE was about 39% of that amount. These measures are not GAAP measures.
- Operating cash flow was $364.5 million, versus $1.580 billion; investing cash outflow was $26.4 million and financing cash outflow was $570.1 million. Cash and cash equivalents were $611.2 million at quarter-end. KKR reported $855.5 million of segment cash and short-term investments, including $244.3 million of short-term investments.
- Total assets were $43.520 billion and total liabilities were $3.505 billion. Debt obligations were $1.721 billion, including $498.2 million of Senior Notes and investment-vehicle financing. The notes are guaranteed by KKR and the KKR Group Partnerships; much of the vehicle financing is non-recourse beyond pledged assets. KKR reported no outstanding borrowings under its corporate or capital-markets revolving credit agreements and compliance with debt covenants.
- KKR declared a $0.15 per-unit distribution for the quarter, down from $0.21 in Q1 2011. A subsequent $0.15 distribution was announced for payment in May 2012.
Material changes versus Q1 2011
- Fee revenue fell by $115.5 million, mainly because Q1 2011 included $68.8 million of monitoring-fee termination payments associated with the HCA and Nielsen IPOs, and because transaction-fee-generating investments were smaller. KKR completed two such investments with a combined value of about $1.2 billion, versus about $5.7 billion a year earlier.
- Despite lower fees, investment gains increased by about $599.7 million. The increase reflected stronger private-equity appreciation; much of the reported income was unrealized and subject to valuation changes.
- Expenses rose $21.5 million, including higher compensation and carry-pool expense. Cash and cash equivalents decreased $232.0 million during the quarter.
- Private Markets FRE declined to $37.7 million from $90.6 million, while Private Markets ENI was $265.3 million versus $276.7 million. Public Markets ENI rose to $23.9 million from $15.9 million; Capital Markets and Principal Activities ENI was $438.0 million versus $449.9 million.
- Total investments rose to $41.263 billion from $37.495 billion at December 31, 2011. Private Markets AUM was $46.0 billion and Public Markets AUM was $16.3 billion at quarter-end.
Outlook, risks, contingencies and unusual items
- KKR provided no specific earnings or revenue guidance. Management said available liquidity sources should fund working-capital needs for at least the next 12 months. It also described a mixed global environment: growth and market appreciation supported valuations, while European sovereign-debt concerns, developed-market austerity, potential volatility and lower transaction volume could pressure activity and fees.
- Fair-value estimates are a major source of earnings uncertainty: 60.8% of investments measured at fair value were Level III, using significant unobservable inputs. The independent valuation firm concluded reviewed values were reasonable after limited procedures, not an audit or attestation. Management estimated an immediate 10% decrease in fund investment values would produce a roughly 10% change in fund investment gains or losses, with a smaller impact on KKR-attributable net income due to noncontrolling interests.
- Carried interest can be reversed if fund returns deteriorate. At March 31, $66.0 million of carried interest was subject to potential management-fee refunds. Carried interest subject to clawback was $813.5 million assuming relevant funds were liquidated at zero value; estimated clawback at reported fair values was $73.2 million, of which $11.5 million was KKR’s obligation. Net-loss-sharing obligations were zero at reported fair values but estimated at about $1.054 billion under a zero-value liquidation scenario.
- KKR had $594.9 million of its own unfunded investment commitments and $69.9 million of lending commitments. Consolidated contractual obligations were $11.817 billion, including $9.185 billion of fund commitments; these consolidated amounts include obligations attributable to fund investors and are not equivalent to KKR’s direct obligations.
- Litigation and regulatory matters included shareholder, antitrust and SEC investigations. For matters assessed as probable and reasonably estimable, KKR estimated aggregate losses attributable to it at approximately $32.5 million, subject to significant judgment and believed partly subject to insurance or indemnity. Management had not concluded whether final outcomes would materially affect the financial statements.
Important facts for investors to verify
- How much of Q1 investment income and ENI reflects realized cash gains versus unrealized fair-value marks, and whether portfolio valuations remain supportable.
- Whether fee-generating transaction activity and monitoring fees recover after the unusually strong prior-year comparison, and the trajectory of FRE.
- The availability of reported liquidity, distinguishing KKR’s segment cash and short-term investments from cash held by consolidated funds or otherwise restricted.
- Potential exposure from carried-interest clawbacks, net-loss-sharing provisions, fund commitments and litigation or regulatory matters.
- The effect of unit exchanges, equity awards and distributions on diluted ownership and per-unit returns.