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KKR > SEC Filings for KKR > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for KKR & CO. L.P.


2-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements of KKR & Co. L.P., together with its consolidated subsidiaries, and the related notes included elsewhere in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, filed with the Securities and Exchange Commission on February 22, 2013, including the audited consolidated and financial statements and the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained therein. The historical condensed consolidated financial data discussed below reflects the historical results and financial position of KKR. In addition, this discussion and analysis contains forward looking statements and involves numerous risks and uncertainties, including those described under "Cautionary Note Regarding Forward-looking Statements" and "Risk Factors." Actual results may differ materially from those contained in any forward looking statements.

Overview

Led by Henry Kravis and George Roberts, we are a leading global investment firm with $78.3 billion in AUM as of March 31, 2013 and a 37-year history of leadership, innovation and investment excellence. When our founders started our firm in 1976, they established the principles that guide our business approach today, including a patient and disciplined investment process; the alignment of our interests with those of our fund investors, portfolio companies and other stakeholders; and a focus on attracting world class talent.

Our business offers a broad range of investment management services to our fund investors and provides capital markets services to our firm, our portfolio companies and other third parties. Throughout our history, we have consistently been a leader in the private equity industry, having completed more than 200 private equity investments in portfolio companies with a total transaction value in excess of $470 billion. In recent years, we have grown our firm by expanding our geographical presence and building businesses in new areas, such as fixed income, equity strategies, hedge fund solutions, capital markets, infrastructure, natural resources and real estate. Our new efforts build on our core principles and industry expertise, allowing us to leverage the intellectual capital and synergies in our businesses, and to capitalize on a broader range of the opportunities we source. Additionally, we have increased our focus on servicing our existing fund investors and have increased our investment in developing relationships with new investors in our funds.

We conduct our business with offices throughout the world, providing us with a pre-eminent global platform for sourcing transactions, raising capital and carrying out capital markets activities. Our growth has been driven by value that we have created through our operationally focused investment approach, the expansion of our existing businesses, our entry into new lines of business, innovation in the products that we offer investors in our funds, an increased focus on providing tailored solutions to our clients and the integration of capital markets distribution activities.

As a global investment firm, we earn management, monitoring, transaction and incentive fees for providing investment management, monitoring and other services to our funds, vehicles, managed accounts, specialty finance company and portfolio companies, and we generate transaction-specific income from capital markets transactions. We earn additional investment income from investing our own capital alongside that of our fund investors and from the carried interest we receive from our funds and certain of our other investment vehicles. A carried interest entitles the sponsor of a fund to a specified percentage of investment gains that are generated on third-party capital that is invested.


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We seek to consistently generate attractive investment returns by employing world-class people, following a patient and disciplined investment approach and driving growth and value creation in the assets we manage. Our investment teams have deep industry knowledge and are supported by a substantial and diversified capital base, an integrated global investment platform, the expertise of operating consultants and senior advisors and a worldwide network of business relationships that provide a significant source of investment opportunities, specialized knowledge during due diligence and substantial resources for creating and realizing value for stakeholders. We believe that these aspects of our business will help us continue to expand and grow our business and deliver strong investment performance in a variety of economic and financial conditions.

Business Segments

Private Markets

Through our Private Markets segment, we manage and sponsor a group of private equity funds and co-investment vehicles that invest capital for long-term appreciation, either through controlling ownership of a company or strategic minority positions. We also manage and source investments in real assets, like infrastructure, natural resources and real estate. These funds, vehicles and accounts are managed by Kohlberg Kravis Roberts & Co. L.P., an SEC registered investment adviser. As of March 31, 2013, the segment had $50.3 billion of AUM and our actively investing funds included geographically differentiated investment funds and vehicles.

The table below presents information as of March 31, 2013 relating to our active private equity funds and other Private Markets investment vehicles for which we have the ability to earn carried interest. This data does not reflect acquisitions or disposals of investments, changes in investment values or distributions occurring after March 31, 2013.


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                         Investment Period                                                        Amount
                                                                                     Percentage
                      Commencement                                   Uncalled       Committed by                                 Remaining     Remaining
                        Date (1)     End Date    Commitment (2)     Commitments    General Partner      Invested     Realized     Cost (3)     Fair Value

Private Equity
Funds
North America Fund
XI                       9/2012       9/2018    $        7,230.7   $     6,784.4        3.5%           $    446.3   $        -   $     446.3   $     473.4
China Growth Fund       11/2010      11/2016             1,010.0           692.4        1.0%                317.6            -         317.6         331.6
E2 Investors (Annex
Fund)                    8/2009      11/2013               345.0           190.8        4.3%                154.2            -         154.2         314.2
European Fund III        3/2008       3/2014             6,065.5         2,361.6        4.6%              3,703.9            -       3,703.9       4,526.6
Asian Fund               7/2007       4/2013             3,983.2           584.0        2.5%              3,399.2        793.3       2,926.2       5,325.7
2006 Fund                9/2006       9/2012            17,642.2         1,293.5        2.1%             16,348.7      9,668.9      10,330.0      15,028.7
European Fund II        11/2005      10/2008             5,750.8               -        2.1%              5,750.8      2,390.2       3,975.2       4,867.2
Millennium Fund         12/2002      12/2008             6,000.0               -        2.5%              6,000.0      9,148.5       2,302.5       3,620.3
European Fund           12/1999      12/2005             3,085.4               -        3.2%              3,085.4      8,720.0             -          51.6
Total Private
Equity Funds                                            51,112.8        11,906.7                         39,206.1     30,720.9      24,155.9      34,539.3

Co-Investment
Vehicles                Various      Various             2,133.5           207.1       Various            1,926.4      2,080.8       1,352.9       1,944.3
Total Private
Equity                                                  53,246.3        12,113.8                         41,132.5     32,801.7      25,508.8      36,483.6

Energy &
Infrastructure
Natural Resources
Fund                    Various      Various             1,222.6           649.7       Various              572.9         35.2         559.1         387.3
Global Energy
Opportunities           Various      Various             1,011.0           900.3       Various              110.7            -         110.7          97.7
Infrastructure Fund     Various      Various             1,041.2           644.5        4.8%                396.7          1.7         396.7         415.1
Infrastructure
Co-Investments          Various      Various             1,357.1           252.6       Various            1,104.5        167.8       1,104.5       1,378.5
Energy &
Infrastructure
Total                                                    4,631.9         2,447.1                          2,184.8        204.7       2,171.0       2,278.6

Total                                           $       57,878.2   $    14,560.9                       $ 43,317.3   $ 33,006.4   $  27,679.8   $  38,762.2



(1) The commencement date represents the date on which the general partner of the applicable fund commenced investment of the fund's capital for our private equity funds and the date of the first closing for our other Private Markets funds and investment vehicles. The end date represents the earlier of
(i) the date on which the general partner of the applicable fund was or will be required by the fund's governing agreement to cease making investments on behalf of the fund, unless extended by a vote of the fund investors, or (ii) the date on which the last investment was made.

(2) The commitment represents the aggregate capital commitments to the fund, including capital commitments by third-party fund investors and the general partner. Foreign currency commitments have been converted into U.S. dollars based on (i) the foreign exchange rate at the date of purchase for each investment and (ii) the exchange rate that prevailed on March 31, 2013, in the case of unfunded commitments.

(3) The remaining cost represents fund investors' initial investment reduced for any return of capital and realized gains from which the general partner did not receive a carried interest.


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The tables below present information as of March 31, 2013 relating to the historical performance of certain of our Private Markets investment vehicles since inception, which we believe illustrates the benefits of our investment approach. The information presented under Total Investments includes all of the investments made by the specified investment vehicle, while the information presented under Realized/Partially Realized Investments includes only those investments for which realized proceeds, excluding current income like dividends and interest, are a material portion of invested capital. This data does not reflect additional capital raised since March 31, 2013 or acquisitions or disposals of investments, changes in investment values or distributions occurring after that date. Past performance is not a guarantee of future results.

                                                                                                                                          Multiple of
                                             Amount                Fair Value of Investments                       Gross                   Invested
Private Markets Investment Funds    Commitment      Invested        Realized       Unrealized     Total Value       IRR*      Net IRR*     Capital**
                                                         ($ in Millions)
Total Investments
Legacy Funds (1)
1976                                $      31.4    $     31.4    $        537.2    $         -    $      537.2        39.5 %      35.5 %         17.1
1980                                      356.8         356.8           1,827.8              -         1,827.8        29.0 %      25.8 %          5.1
1982                                      327.6         327.6           1,290.7              -         1,290.7        48.1 %      39.2 %          3.9
1984                                    1,000.0       1,000.0           5,963.5              -         5,963.5        34.5 %      28.9 %          6.0
1986                                      671.8         671.8           9,080.7              -         9,080.7        34.4 %      28.9 %         13.5
1987                                    6,129.6       6,129.6          14,949.2              -        14,949.2        12.1 %       8.9 %          2.4
1993                                    1,945.7       1,945.7           4,143.3              -         4,143.3        23.6 %      16.8 %          2.1
1996                                    6,011.6       6,011.6          12,476.9              -        12,476.9        18.0 %      13.3 %          2.1
Subtotal - Legacy Funds                16,474.5      16,474.5          50,269.3              -        50,269.3        26.1 %      19.9 %          3.1
Included Funds
European Fund (1999) (2)                3,085.4       3,085.4           8,720.0           51.6         8,771.6        27.0 %      20.3 %          2.8
Millennium Fund (2002)                  6,000.0       6,000.0           9,148.5        3,620.3        12,768.8        22.5 %      16.3 %          2.1
European Fund II (2005) (2)             5,750.8       5,750.8           2,390.2        4,867.2         7,257.4         4.5 %       2.9 %          1.3
2006 Fund (2006)                       17,642.2      16,348.7           9,668.9       15,028.7        24,697.6        10.3 %       7.5 %          1.5
Asian Fund (2007)                       3,983.2       3,399.2             793.3        5,325.7         6,119.0        20.5 %      14.1 %          1.8
European Fund III (2008) (2)            6,065.5       3,703.9                 -        4,526.6         4,526.6         9.4 %       3.1 %          1.2
E2 Investors (Annex Fund) (2009)
(2)                                       345.0         154.2                 -          314.2           314.2        28.3 %      23.2 %          2.0
China Growth Fund (2010) (3)            1,010.0         317.6                 -          331.6           331.6         N/A         N/A            N/A
Natural Resources Fund (2010)
(3)                                     1,222.6         572.9              35.2          387.3           422.5         N/A         N/A            N/A
Infrastructure Fund (2010) (3)          1,041.2         396.7               1.7          415.1           416.8         N/A         N/A            N/A
North America Fund XI (2012) (3)        7,230.7         446.3                 -          473.4           473.4         N/A         N/A            N/A
Subtotal - Included Funds              53,376.6      40,175.7          30,757.8       35,341.7        66,099.5        14.9 %      10.5 %          1.6

All Funds                           $  69,851.1    $ 56,650.2    $     81,027.1    $  35,341.7    $  116,368.8        25.7 %      19.0 %          2.1

Realized/Partially Realized
Investments (4)
Legacy Funds (1)
1976                                $      31.4    $     31.4    $        537.2    $         -    $      537.2        39.5 %      35.5 %         17.1
1980                                      356.8         356.8           1,827.8              -         1,827.8        29.0 %      25.8 %          5.1
1982                                      327.6         327.6           1,290.7              -         1,290.7        48.1 %      39.2 %          3.9
1984                                    1,000.0       1,000.0           5,963.5              -         5,963.5        34.5 %      28.9 %          6.0
1986                                      671.8         671.8           9,080.7              -         9,080.7        34.4 %      28.9 %         13.5
1987                                    6,129.6       6,129.6          14,949.2              -        14,949.2        12.1 %       8.9 %          2.4
1993                                    1,945.7       1,945.7           4,143.3              -         4,143.3        23.6 %      16.8 %          2.1
1996                                    6,011.6       6,011.6          12,476.9              -        12,476.9        18.0 %      13.3 %          2.1
Subtotal - Legacy Funds                16,474.5      16,474.5          50,269.3              -        50,269.3        26.1 %      19.9 %          3.1
Included Funds
European Fund (1999) (2)                3,085.4       2,681.1           8,720.0           51.6         8,771.6        29.7 %      25.9 %          3.3
Millennium Fund (2002)                  6,000.0       4,024.5           8,734.8        2,232.2        10,967.0        38.5 %      29.7 %          2.7
European Fund II (2005) (2)             5,750.8       2,322.8           2,252.1        2,569.2         4,821.3        14.9 %      13.2 %          2.1
2006 Fund (2006)                       17,642.2       4,424.4           9,418.8        4,082.7        13,501.5        27.1 %      24.5 %          3.1
Asian Fund (2007)                       3,983.2         688.3             793.3          669.0         1,462.3        21.2 %      18.5 %          2.1
European Fund III (2008) (2) (4)        6,065.5             -                 -              -               -           -           -              -
E2 Investors (Annex Fund) (2009)
(2) (4)                                   345.0             -                 -              -               -           -           -              -
China Growth Fund (2010) (4)            1,010.0             -                 -              -               -           -           -              -
Natural Resources Fund (2010)
(4)                                     1,222.6             -                 -              -               -           -           -              -
Infrastructure Fund (2010) (4)          1,041.2             -                 -              -               -           -           -              -
North America Fund XI (2012) (4)        7,230.7             -                 -              -               -           -           -              -
Subtotal - Included Funds              53,376.6      14,141.1          29,919.0        9,604.7        39,523.7        28.8 %      24.5 %          2.8
All Realized/Partially Realized
Investments                         $  69,851.1    $ 30,615.6    $     80,188.3    $   9,604.7    $   89,793.0        26.2 %      21.4 %          2.9


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(1) These funds were not contributed to KKR as part of the KPE Transaction.

(2) The capital commitments of the European Fund, the European Fund II, the European Fund III and the Annex Fund include euro-denominated commitments of 196.5 million, 2,597.5 million, 2,842.6 million and 103.7 million, respectively. Such amounts have been converted into U.S. dollars based on (i) the foreign exchange rate at the date of purchase for each investment and (ii) the exchange rate prevailing on March 31, 2013 in the case of unfunded commitments.

(3) The gross IRR, net IRR and multiple of invested capital are calculated for our investment funds that have invested for at least 36 months prior to March 31, 2013. None of the China Growth Fund, Natural Resources Fund, Infrastructure Fund or North America Fund XI have invested for at least 36 months as of March 31, 2013. We therefore have not calculated gross IRRs, net IRRs and multiples of invested capital with respect to those funds.

(4) Investments are considered partially realized when realized proceeds, excluding current income like dividends and interest, are a material portion of invested capital. None of the European Fund III, Annex Fund, China Growth Fund, Natural Resources Fund, Infrastructure Fund or North America Fund XI have realized a material portion of invested capital. We therefore have not calculated gross IRRs, net IRRs and multiples of invested capital with respect to the investments of those funds.

* IRRs measure the aggregate annual compounded returns generated by a fund's investments over a holding period. Net IRRs presented under Total Investments are calculated after giving effect to the allocation of realized and unrealized carried interest and the payment of any applicable management fees. Net IRRs presented under Realized/Partially Realized Investments are calculated after giving effect to the allocation of realized and unrealized carried interest, but before payment of any applicable management fees as management fees are applied to funds, not investments. Gross IRRs are calculated before giving effect to the allocation of carried interest and the payment of any applicable management fees.

** The multiples of invested capital measure the aggregate returns generated by a fund's investments in absolute terms. Each multiple of invested capital is calculated by adding together the total realized and unrealized values of a fund's investments and dividing by the total amount of capital invested by the fund. Such amounts do not give effect to the allocation of any realized and unrealized returns on a fund's investments to the fund's general partner pursuant to a carried interest or the payment of any applicable management fees.

As of March 31, 2013, we raised approximately $5 billion of capital for our Asian Fund II, inclusive of general partner commitments. Such amounts are not reflected in the tables above, as such commitments will not contribute to AUM until we are entitled to receive fees or a carried interest in accordance with our definition of AUM and consequently are not included in AUM as of March 31, 2013.


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Public Markets

Through the Public Markets segment, we manage KKR Financial Holdings LLC, or KFN, which is a specialty finance company, as well as a number of investment funds, structured finance vehicles and separately managed accounts that invest capital in (i) leveraged credit strategies, such as leveraged loans and high yield bonds, (ii) liquid long/short equity strategies, (iii) alternative credit strategies such as mezzanine investments, special situations investments and direct senior lending and (iv) hedge fund solutions. These funds, vehicles and accounts, including three management investment companies registered under the Investment Company Act of 1940 (the "1940 Act"), are managed by KKR Asset Management LLC, or KAM, and Prisma Capital Partners LP, or Prisma. Both KAM and Prisma are SEC registered investment advisers. On January 23, 2013, we acquired a 24.9% interest in Nephila Capital Ltd. ("Nephila"), an investment manager focused on investing in natural catastrophe and weather risk. We intend to grow the Public Markets business by leveraging our global investment platform and experienced investment professionals.

We generally review our performance in the Public Markets segment by investment strategy. Our leveraged credit strategies invest in leveraged loans and high yield bonds, or a combination of both. The following chart presents information regarding these leveraged loan and high yield bond strategies from inception to March 31, 2013. Our other credit and equity strategies managed by KAM have begun investing more recently and therefore have not yet developed meaningful track records, and thus their performance is not included below. Past performance is no guarantee of future results.

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(1) The Benchmarks referred to herein include the S&P/LSTA Leveraged Loan Index (the "S&P/LSTA Loan Index") and the Bank of America Merrill Lynch High Yield Master II Index (the "BoAML HY Master II Index" and, together with the S&P/LSTA Loan Index, the "Indices"). The S&P/LSTA Loan Index is an index that comprises all loans that meet the inclusion criteria and that have marks from the LSTA/LPC mark-to-market service. The inclusion criteria consist of the following: (i) syndicated term loan instruments consisting of term loans (both amortizing and institutional), acquisition loans (after they are


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drawn down) and bridge loans; (ii) secured; (iii) U.S. dollar denominated;
(iv) minimum term of one year at inception; and (v) minimum initial spread of LIBOR plus 1.25%. The BoAML HY Master II Index is a market value weighted index of below investment grade U.S. dollar denominated corporate bonds publicly issued in the U.S. domestic market. "Yankee" bonds (debt of foreign issuers issued in the U.S. domestic market) are included in the BoAML HY Master II Index provided that the issuer is domiciled in a country having investment grade foreign currency long-term debt rating. Qualifying bonds must have maturities of one year or more, a fixed coupon schedule and minimum outstanding of US$100 million. In addition, issuers having a credit rating lower than BBB3, but not in default, are also included. While the returns of KAM strategies reflect the reinvestment of income and dividends, none of the indices presented in the chart above reflect such reinvestment. Furthermore, these indices are not subject to management fees, incentive allocations or expenses. It is not possible to invest directly in unmanaged indices.

(2) The Secured Credit Unlevered model performance track record is presented as supplemental information. The Secured Credit Unlevered model represents performance of KKR's Secured Credit Levered composite calculated on an unlevered basis. KKR's Secured Credit Levered composite has an investment objective that allows it to invest in assets other than senior secured term loans and high yield securities, which includes asset backed securities, commercial mortgage backed securities, preferred stock, public equity, private equity and certain freestanding derivatives. In addition, KKR's Secured Credit Levered composite has employed leverage in its respective portfolios as part of its investment strategy. Gains realized with borrowed funds may cause returns to increase at a faster rate than would be the case without borrowings. If, however, investment results fail to cover the principal, interest and other costs of borrowings, returns could also decrease faster than if there had been no borrowings. Accordingly, the unlevered returns contained herein do not reflect the actual returns, and are not intended to be indicative of the future results of KKR's Secured Credit Levered composite. It is not expected that KKR's Secured Credit Levered composite will achieve comparable results. The Benchmark used for purposes of comparison for the Secured Credit strategy presented herein is the S&P/LSTA Loan Index. There are differences, in some cases, significant differences, between KKR's investments and the investments included in the Indices. For instance, KKR's composite may invest in securities that have a greater degree of risk and volatility, as well as liquidity risk, than those securities contained in the Indices.

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