KKR & Co. L.P. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. The filing is for KKR & Co. L.P. (NYSE: KKR), a global investment firm providing investment management and capital markets services. Financial statements are unaudited. Unless noted, amounts below are in U.S. dollars.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Fees | $117.6 million | $87.1 million | $349.5 million | $193.1 million |
| Net gains from investment activities | $1,319.1 million | $1,031.6 million | $3,806.3 million | $3,318.1 million |
| Total investment income | $1,421.7 million | $1,225.0 million | $3,961.8 million | $3,988.9 million |
| Net income attributable to KKR & Co. L.P. | $39.6 million | $29.9 million | $199.2 million | $143.7 million |
| Economic net income (ENI), non-GAAP | $315.0 million | $433.1 million | $1,057.5 million | $1,107.9 million |
| Fee-related earnings (FRE), non-GAAP | $76.1 million | $63.3 million | $202.3 million | $153.7 million |
| Distribution declared per common unit | $0.11 | $0.08 | $0.32 | $0.16 |
Q2 segment FRE was 38.9% of segment fees, versus 39.2% a year earlier; first-half segment FRE was 46.0% of segment fees, versus 44.0%. These are calculated from KKR’s segment measures, not GAAP operating margins. Consolidated GAAP results include substantial investment-fund activity and noncontrolling interests, so reported income and cash flows should not be read as wholly attributable to KKR.
- Assets and liquidity: June 30 total assets were $40.6 billion, including $38.6 billion of investments. Cash and cash equivalents were $933.5 million, with a further $472.3 million held at consolidated entities and $92.8 million restricted. Management cited approximately $1.0 billion of available cash and stated liquidity sources should meet working-capital needs for the next 12 months.
- Debt: Consolidated debt obligations were $1.530 billion, versus $1.487 billion at year-end 2010, including $498.1 million carrying value of Senior Notes and $1.032 billion of investment financing. The $500 million notes carry a 6.375% coupon and mature in 2020. Corporate and capital-markets revolving facilities had no borrowings outstanding at June 30; KKR reported compliance with debt covenants.
- Cash flow, first half: Operating activities provided $2.200 billion, investing activities used $33.4 million, and financing activities used $1.971 billion; cash increased $194.8 million to $933.5 million. Operating cash flow includes consolidated funds’ investment purchases and sales and is not a straightforward measure of cash generated by KKR’s management business.
- Scale and portfolio: AUM was $61.9 billion at June 30. Private Markets AUM was $47.1 billion and Public Markets AUM $14.9 billion. Of investments measured at fair value, 57.2% were Level III, requiring significant management judgment.
Material changes versus comparable periods
- Q2 fees rose 35% year over year, helped by monitoring-fee termination payments, consulting fees from an entity newly consolidated in 2011, and higher KFN incentive fees. First-half fees rose 81%, including $76.6 million of monitoring-fee termination payments related to portfolio-company IPOs or sales.
- Q2 GAAP net income attributable to KKR increased to $39.6 million from $29.9 million; first-half income increased to $199.2 million from $143.7 million. However, first-half ENI declined to $1.058 billion from $1.108 billion, and Q2 ENI fell to $315.0 million from $433.1 million, primarily reflecting lower segment investment income.
- Investment gains increased, but dividend income fell sharply: Q2 dividends were $31.2 million versus $147.4 million, and first-half dividends were $36.0 million versus $590.3 million, reflecting unusually large prior-year portfolio-company dividends. First-half investment income was slightly lower despite higher net investment gains.
- Total expenses declined year over year, mainly from lower equity-based compensation expense; cash compensation and operating costs increased with hiring and business expansion. Segment FRE improved for the first half, while Private Markets Q2 FRE declined to $37.8 million from $42.1 million.
- Total assets increased from $38.4 billion at December 31, 2010 to $40.6 billion. Common units outstanding increased to 222.5 million from 212.8 million, including exchanges of KKR Holdings units.
Outlook, risks and unusual items
- No formal earnings or AUM guidance is provided. Management expects liquidity to be sufficient for working-capital requirements over the next 12 months and intends quarterly distributions broadly linked to specified cash earnings, subject to board discretion and business needs.
- Management described increased market volatility and concerns about economic growth, unemployment, inflation, European sovereign debt and the U.S. debt ceiling. Equity and credit-market conditions affect portfolio valuations, realizations, fundraising, financing access and capital-markets fees.
- After quarter-end, HCA’s share price had fallen approximately 25% as of August 3, 2011. HCA was a significant holding; the filing does not quantify the resulting subsequent-period valuation impact.
- Uncalled commitments to KKR’s funds were $835.3 million on an unconsolidated basis. Separately, consolidated fund commitments were $13.699 billion, largely obligations of funds and their investors rather than direct KKR obligations. KKR also reported $113.6 million of lending commitments and $227.0 million of underwriting commitments; $43.5 million of the latter remained as of August 3.
- At June 30 fair values, the estimated carried-interest clawback obligation was $59.8 million, of which $6.4 million was KKR’s obligation. If applicable funds were liquidated at zero value, carried interest subject to clawback would be $753.6 million. No net-loss-sharing obligation was indicated at fair values, but the zero-value scenario was approximately $968.5 million.
- Several litigation matters and regulatory inquiries remain unresolved, including proceedings involving PRIMEDIA, Del Monte, and alleged private-equity antitrust conduct, as well as SEC and DOJ inquiries. No loss contingency was recorded; management said a potential loss range could not be estimated and had not concluded whether resolution could materially affect the financial statements.
- KKR recognized substantial unrealized investment gains and carried interest, which can reverse if valuations or fund performance weaken. The filing notes that fair values for private investments rely significantly on unobservable inputs. A previously executed agreement to sell Hilcorp was expected to close in Q4 2011, subject to completion.
- A $0.11-per-unit distribution was announced August 3, payable August 30 to holders of record August 15. The filing states disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of fee growth and FRE reflects recurring management activity versus infrequent monitoring-fee termination payments and transaction-dependent revenue.
- The sensitivity of Level III valuations, carried interest, ENI and distributions to weaker public markets and portfolio-company performance, particularly the post-quarter HCA decline.
- The distinction between KKR-attributable results and consolidated fund results, including noncontrolling interests and fund-level cash flows and commitments.
- Potential cash exposure from clawbacks, net-loss-sharing provisions, unfunded commitments, underwriting and lending commitments, and pending legal or regulatory matters.
- Whether management’s liquidity expectations, undrawn credit facilities, distribution policy and pending portfolio realizations remain supportable as market conditions evolve.