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HF > SEC Filings for HF > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for HFF, INC.


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion summarizes the financial position of HFF, Inc. and its subsidiaries as of September 30, 2012, and the results of our operations for the three and nine month periods ended September 30, 2012, and should be read in conjunction with (i) the unaudited consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (ii) the consolidated financial statements and accompanying notes to our Annual Report on Form 10-K for the year ended December 31, 2011.

Overview

Our Business

We are, based on transaction value, one of the leading providers of commercial real estate and capital markets services to both the users and providers of capital in the U.S. commercial real estate industry and are one of the largest full-service commercial real estate financial intermediaries in the country. We operate out of 21 offices nationwide with approximately 226 transaction professionals and 333 support associates as of September 30, 2012.

Substantially all of our revenues are in the form of capital markets services fees collected from our clients, usually negotiated on a transaction-by-transaction basis. We also earn fees from commercial loan servicing activities. We believe that our multiple product offerings, diverse client mix, expertise in a wide range of property types and national platform have the potential to create a diversified revenue stream within the U.S. commercial real estate sector.

We operate in one reportable segment, the commercial real estate financial intermediary segment, and offer debt placement, investment sales, structured finance, private equity placements, investment banking and advisory services, loan sales and loan sale advisory services, commercial loan servicing, commercial real estate structured financing placements and capital markets advice.

Our business may be significantly affected by factors outside of our control, particularly including:

Economic and commercial real estate market downturns. Our business is dependent on international and domestic economic conditions and the demand for commercial real estate and related services in the markets in which we operate. A slow-down, a significant downturn and/or a recession in either the global economy and/or the domestic economy, including even a regional economic downturn, could adversely affect our business as was the case during 2008 and 2009. A general decline in acquisition and disposition activity can lead to a reduction in fees and commissions for arranging such transactions, as well as in fees and commissions for arranging financing for acquirers and property owners that are seeking to recapitalize their existing properties. Likewise, a general decline in commercial real estate investment activity can lead to a reduction in fees and commissions for arranging acquisitions, dispositions and financings for acquisitions as well as for recapitalizations for existing property owners. Such a general decline can also lead to a significant reduction in our loan servicing activities, due to increased delinquencies and defaults and lack of additional loans that we would have otherwise added to our loan servicing portfolio.

Global and domestic credit and liquidity issues. Global and domestic credit and liquidity issues have recently contributed and/or led to an economic downturn, including a commercial real estate market downturn. This downturn in turn led to a decrease in transaction activity and lower values. The recent situation in the global credit markets, whereby many world governments (including the U.S., where the Company transacts virtually all of its business) have taken unprecedented and uncharted steps to provide the markets with liquidity as well as to either support the financial institutions in their respective countries from collapse or have taken direct ownership of the same, was unprecedented in the Company's history. Restrictions on the availability of capital, both debt and/or equity, created significant reductions and could in the future cause further reductions of the liquidity in and the flow of capital to the commercial real estate markets which adversely affected transaction volumes and could do so again in the future. These restrictions in capital flows also caused, and could in the future cause, commercial real estate prices to decrease due to the reduced amount of equity capital and debt financing available. In particular, the above issues did and may reduce the number of acquisitions, dispositions and loan originations, as well as the respective number of transactions and transaction volumes, which did adversely affect and in the future could adversely affect our capital markets services revenues, including our servicing revenue.

Decreased investment allocation to commercial real estate class. Allocations to commercial real estate as an asset class for investment portfolio diversification may decrease for a number of reasons beyond our control, including poor performance of the asset class relative to other asset classes or the superior performance of other asset classes when compared with continued good performance of the commercial real estate asset class or the poor performance of all asset classes. In addition, while commercial real estate is now viewed as an accepted and valid class for portfolio diversification, if this perception changes, there could be a significant reduction in the amount of debt and equity capital available in the commercial real estate sector. In particular, reductions in debt and/or equity allocations to commercial real estate may reduce the number of acquisitions, dispositions and loan originations, as well as the respective number of transactions and transaction volumes, which could in turn adversely affect our capital markets services revenues (including our servicing revenue).


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Fluctuations in interest rates. Significant fluctuations in interest rates as well as steady and protracted movements of interest rates in one direction (increases or decreases) could adversely affect the operation and income of commercial real estate properties as well as the demand from investors for commercial real estate investments. Both of these events could adversely affect investor demand and the supply of capital for debt and equity investments in commercial real estate. In particular, increased interest rates may cause prices to decrease due to the increased costs of obtaining financing and could lead to decreases in purchase and sale activities, thereby reducing the amounts of investment sales and loan originations and related servicing fees. Additionally, continually decreasing interest rates and low "all in coupon rates" may cause capital sources to re-allocate resources to other asset classes, thereby reducing the amounts of investment sales and loan originations and related servicing fees. If our investment sales origination and servicing businesses are negatively impacted, it is likely that our other lines of business would also suffer due to the relationship among our various capital markets services.

The factors discussed above have in the past adversely affected and continue to be a risk to our business, as evidenced by the effects of the significant recent disruptions in the global capital and credit markets, and in particular the domestic capital markets. While these conditions in 2011 and 2012 have generally improved compared to 2008, 2009 and 2010, they remain fragile and a risk to our business. Also the global and domestic credit and liquidity issues, coupled with the global and domestic economic recession/slow down, reduced transaction volumes in 2008, 2009 and 2010, when compared to 2011 and year-to-date 2012 as well as prior periods in 2002 through 2007, and they may reduce in the future the number of acquisitions, dispositions and loan originations, as well as the respective number of transactions and transaction volumes. The above has had, and in the future may have a significant adverse effect on our capital markets services revenues. The significant balance sheet issues faced by many of the CMBS lenders, banks, life insurance companies, mortgage REITS and debt funds, captive finance companies and other financial institutions have adversely affected, and could again in the future adversely affect, the global and domestic economies and the flow of commercial mortgage debt to the U.S. capital markets and, in turn, could potentially adversely affect all of our capital markets services platforms and resulting revenues.

The recent economic slowdown and domestic and global recession also continue to be a risk, not only due to the potential negative adverse impacts on the performance of global economies including the U.S. and its commercial real estate markets, but also due to the ability of lenders and equity investors to generate significant funds to continue to make loans and equity available to the commercial real estate market and, in particular, in the U.S., where we operate.

Other factors that may adversely affect our business are discussed under the heading "Forward-Looking Statements" and under the caption "Risk Factors" in this Quarterly Report on Form 10-Q.


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Results of Operations

Following is a discussion of our results of operations for the three months ended September 30, 2012 and September 30, 2011. The table included in the period comparisons below provides summaries of our results of operations. The period-to-period comparisons of financial results are not necessarily indicative of future results. For a description of the key financial measures and indicators included in our consolidated financial statements, refer to the discussion under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Key Financial Measures and Indicators" in our Annual Report on Form 10-K for the year ended December 31, 2011.

                                                 For the Three Months Ended
                                                        September 30,
                                              2012                         2011                 Total           Total
                                                     % of                         % of          Dollar        Percentage
                                     Dollars       Revenue        Dollars       Revenue         Change          Change
                                                          (dollars in thousands, unless percentages)
Revenues
Capital markets services revenue     $ 66,944          97.0 %     $ 62,841          98.3 %     $  4,103               6.5 %
Interest on mortgage notes
receivable                              1,543           2.2 %          578           0.9 %          965             167.0 %
Other                                     552           0.8 %          488           0.8 %           64              13.1 %

Total revenues                         69,039         100.0 %       63,907         100.0 %        5,132               8.0 %
Operating expenses
Cost of services                       40,187          58.2 %       36,259          56.7 %        3,928              10.8 %
Personnel                               6,334           9.2 %        5,216           8.2 %        1,118              21.4 %
Occupancy                               2,043           3.0 %        1,815           2.8 %          228              12.6 %
Travel and entertainment                1,627           2.4 %        1,355           2.1 %          272              20.1 %
Supplies, research and printing         1,286           1.9 %        1,288           2.0 %           (2 )            (0.2 )%
Other                                   5,231           7.6 %        4,033           6.3 %        1,198              29.7 %

Total operating expenses               56,708          82.1 %       49,966          78.2 %        6,742              13.5 %

Operating income                       12,331          17.9 %       13,941          21.8 %       (1,610 )           (11.5 )%
Interest and other income, net          4,407           6.4 %        3,036           4.8 %        1,371              45.2 %
Interest expense                          (11 )        (0.0 )%          (5 )        (0.0 )%          (6 )          (120.0 )%
Increase in payable under tax
receivable agreement                   (1,204 )        (1.7 )%      (3,680 )        (5.8 )%       2,476              67.3 %

Income before income taxes             15,523          22.5 %       13,292          20.8 %        2,231              16.8 %
Income tax expense                      5,392           7.8 %        2,353           3.7 %        3,039             129.2 %

Net income                             10,131          14.7 %       10,939          17.1 %         (808 )            (7.4 )%
Net income attributable to
noncontrolling interest                    47           0.1 %          488           0.8 %         (441 )           (90.4 )%

Net income attributable to
controlling interest                 $ 10,084          14.6 %     $ 10,451          16.4 %     $   (367 )            (3.5 )%

EBITDA (1)                           $ 16,953          24.6 %     $ 14,488          22.7 %     $  2,465              17.0 %

Adjusted EBITDA (1)                  $ 16,413          23.8 %     $ 16,737          26.2 %     $   (324 )            (1.9 )%

(1) The Company defines EBITDA as net income attributable to controlling interest before interest expense, income tax expense, depreciation and amortization and net income attributable to the noncontrolling interest. The items that the Company has eliminated from EBITDA in determining Adjusted EBITDA are:
(i) stock-based compensation expense, which is a non-cash charge, (ii) income recognized on the initial recording of mortgage servicing rights that are acquired with no initial consideration, which is also a non-cash income amount that can fluctuate significantly based on the level of mortgage servicing right volumes, and (iii) the increase (decrease) in payable under the tax receivable agreement which represents changes in a liability recorded on the Company's consolidated balance sheet determined by the ongoing remeasurement of related deferred tax assets and, therefore, can be income or expense in the Company's consolidated statement of income in any individual period. The Company uses EBITDA and Adjusted EBITDA in its business operations to, among other things, evaluate the performance of its business, develop budgets and measure its performance against those budgets. The Company also believes that analysts and investors use


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EBITDA and Adjusted EBITDA as supplemental measures to evaluate its overall operating performance. However, both EBITDA and Adjusted EBITDA have material limitations as analytical tools and should not be considered in isolation, or as a substitute for analysis of the Company's results as reported under U.S. generally acceptable accounting principles (GAAP). The Company finds EBITDA and Adjusted EBITDA as useful tools to assist in evaluating performance because they eliminate items related to capital structure and taxes, including, with respect to Adjusted EBITDA, the Company's tax receivable agreement. Note that the Company classifies the interest expense on its warehouse lines of credit as an operating expense and, accordingly, it is not eliminated from net income attributable to controlling interest in determining EBITDA and Adjusted EBITDA. Some of the items that the Company has eliminated from net income attributable to controlling interest in determining EBITDA and Adjusted EBITDA are significant to the Company's business. For example, (i) interest expense is a necessary element of the Company's costs and ability to generate revenue because it incurs interest expense related to any outstanding indebtedness, (ii) payment of income taxes is a necessary element of the Company's costs, and (iii) depreciation and amortization are necessary elements of the Company's costs.

Any measure that eliminates components of the Company's capital structure and costs associated with the Company's operations has material limitations as a performance measure. In light of the foregoing limitations, the Company does not rely solely on EBITDA and/or Adjusted EBITDA as a performance measure and also considers its GAAP results. EBITDA and Adjusted EBITDA are not measurements of the Company's financial performance under GAAP and should not be considered as alternatives to net income, operating income or any other measures derived in accordance with GAAP. Because EBITDA and Adjusted EBITDA are not calculated in the same manner by all companies, they may not be comparable to other similarly titled measures used by other companies. Set forth below is a reconciliation of consolidated net income attributable to controlling interest to EBITDA and Adjusted EBITDA for the Company for the three months ended September 30, 2012 and 2011:

EBITDA and Adjusted EBITDA for the Company are calculated as follows:

(dollars in thousands)

                                                            For the Three Months Ended
                                                                  September 30,
                                                             2012                 2011
Net income attributable to controlling interest          $      10,084          $  10,451
Add:
Interest expense                                                    11                  5
Income tax expense                                               5,392              2,353
Depreciation and amortization                                    1,419              1,191
Net income attributable to noncontrolling interest                  47                488

EBITDA                                                   $      16,953          $  14,488
Adjustments:
Stock-based compensation (a)                                       856                 10
Initial recording of mortgage servicing rights                  (2,600 )           (1,441 )
Increase (decrease) in payable under the tax
receivable agreement                                             1,204              3,680

Adjusted EBITDA                                          $      16,413          $  16,737

(a) Amounts do not reflect expense associated with the stock component of estimated incentive payouts under the Company's firm profit participation bonus plan or office profit participation bonus plans that are anticipated to be paid in respect of the applicable year. Such expense is recorded as incentive compensation expense within personnel expenses in the Company's consolidated statements of income during the year to which the expense relates. Following the award, if any, of the related incentive payout, the stock component expense is reclassified as stock compensation costs within personnel expenses. See Note 2 to the Company's consolidated financial statements for further information regarding the Company's accounting policies relating to its firm profit participation bonus plan and office profit participation bonus plans. Stock-based compensation expense for the three months ended September 30, 2012 reflects $0.2 million of expense recognized during such period that was associated with restricted stock granted in March 2012 under the Company's firm profit participation bonus plan or office profit participation bonus plans in respect of 2011. Stock-based payments under such plans were first made in 2012 in respect of 2011. See Note 3 to the Company's consolidated financial statements for further information regarding the Company's accounting policies relating to its stock compensation.


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Revenues. Our total revenues were $69.0 million for the three months ended September 30, 2012 compared to $63.9 million for the same period in 2011, an increase of $5.1 million, or 8.0%. Revenues increased primarily as a result of more transactions and a higher average basis points per transaction.

The revenues we generated from capital markets services for the three months ended September 30, 2012 increased $4.1 million, or 6.5%, to $66.9 million from $62.8 million for the same period in 2011. The increase is primarily attributable to a 12.4% higher number of transactions with a higher average basis points per transaction offset by 1.5% lower production volume closed during the third quarter of 2012 compared to the third quarter of 2011. During the third quarter of 2011 there was one usually large loan sale transaction, and if the production volume was adjusted to exclude this transaction in 2011, third quarter 2012 production volume would have increased 10.9% as compared to the adjusted third quarter of 2011 production volume.

The revenues derived from interest on mortgage notes receivable were $1.5 million for the three months ended September 30, 2012 compared to $0.6 million for the same period in 2011, an increase of $1.0 million. Revenues increased primarily as a result of an increase in loan originations made in connection with our services as a Freddie Mac Multifamily Program Plus Seller/Servicer during the third quarter of 2012 compared to the third quarter of 2011.

The other revenues we earned, which include expense reimbursements from clients related to out-of-pocket costs incurred and vary on a transaction-by-transaction basis, were approximately $0.6 million for the three month period ended September 30, 2012 and $0.5 million for the three month period ended September 30, 2011, an increase of approximately $0.1 million, or 13.1%.

Total Operating Expenses. Our total operating expenses were $56.7 million for the three months ended September 30, 2012 compared to $50.0 million for the same period in 2011, an increase of $6.7 million, or 13.5%. Expenses increased primarily due to increased cost of services from an increase in capital markets services revenue and a growth in headcount and increased personnel costs from an increase in equity compensation expense.

The cost of services for the three months ended September 30, 2012 increased $3.9 million, or 10.8%, to $40.2 million from $36.3 million for the same period in 2011. The increase is primarily the result of the increase in commissions and other incentive compensation directly related to the 6.5% increase in capital markets services revenues, higher salary and fringe benefit costs from a net growth in headcount of 71 associates from September 30, 2011 to September 30, 2012 and compensation expense directly tied to perfomance-based metrics achieved by certain transaction professionals recruited in 2010 and 2011. Cost of services as a percentage of capital markets services revenues was approximately 60.0% and 57.7% for the three month periods ended September 30, 2012 and September 30, 2011, respectively.

Personnel expenses that are not directly attributable to providing services to our clients increased $1.1 million, or 21.4%, to $6.3 million for the three months ended September 30, 2012 from $5.2 million for the same period in 2011. The increase is primarily related to the mark-to-market adjustment on the existing restricted stock awards accounted as liability awards which are revalued each quarter and resulted in increased expense of $0.7 million during the third quarter 2012 as compared to the third quarter 2011 and by the continued vesting of the 2011 firm and office profit participation plan awards of $0.5 million of which there was no such comparable expense in 2011. Personnel expenses are impacted quarterly by the adjustments made to accrue for the estimated expense associated with the performance-based firm and office profit participation plans. Both the firm and office profit participation plans allow for payments in the form of both cash and share-based awards based on the decision of the Company's board of directors. The stock compensation cost included in personnel expenses was $0.9 million and $9,000 for the three months ended September 30, 2012 and 2011, respectively. This increase is primarily due to the mark-to-market adjustment on the restricted stock awards accounted for as liability awards and $0.2 million of expense for the 2011 firm and office profit participation plan stock awards. At September 30, 2012, there was approximately $2.9 million of unrecognized compensation cost related to share based awards. The weighted average remaining contractual term of the unvested restricted stock units is 1.1 years as of September 30, 2012. The weighted average remaining contractual term of the unvested options is 10.4 years as of September 30, 2012.

Occupancy, travel and entertainment, and supplies, research and printing expenses for the three months ended September 30, 2012 increased $0.5 million, or 11.2%, to $5.0 million compared to the same period in 2011. These increases are primarily due to increased occupancy costs and travel and entertainment costs related, in part, to the Company's headcount growth.

Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $5.2 million in the three months ended September 30, 2012, an increase of $1.2 million, or 29.7%, versus $4.0 million in the three months ended September 30, 2011. This increase is primarily related to increased interest on warehouse line of credit of $0.7 million, outsourcing and licensing of $0.2 million and depreciation and amortization of $0.2 million.

Net Income. Our net income for the three months ended September 30, 2012 was $10.1 million, a decrease of $0.8 million versus $10.9 million for the same fiscal period in 2011. This decrease is primarily due to higher costs of services and personnel costs and was partially offset by higher revenues as described above.


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Interest and other income, net for the three months ended September 30, 2012 was $4.4 million, an increase of $1.4 million as compared to $3.0 million for the same fiscal period in 2011, primarily as a result of increased income recognized on the Company's initial recording of mortgage servicing rights as well as other income earned in connection with the Company's Freddie Mac Program Plus Seller Servicer business.

The interest expense we incurred in the three months ended September 30, 2012 totaled $11,000, an increase of $6,000 from $5,000 of expenses incurred in the three months ended September 30, 2011.

Income tax expense was approximately $5.4 million for the three months ended September 30, 2012, as compared to $2.4 million in the three months ended September 30, 2011. This increase is primarily due to a smaller upwards adjustment in the third quarter of 2012 (as compared to the third quarter of 2011) to the Company's deferred tax assets due to a change in the tax rate used to measure such assets. The Company's adjustment was to increase the deferred tax asset by $1.4 million and $4.3 million in 2012 and 2011, respectively, and to correspondingly decrease income tax expense by $1.4 million and $4.3 million in the third quarter of 2012 and 2011, respectively, resulting in a net year-over-year increase to income tax expense of $2.9 million. During the three months ended September 30, 2012, the Company recorded a current income tax expense of $3.7 million and deferred income tax expense of $1.7 million.

Net income attributable to noncontrolling interest, representing the ownership interest of HFF Holdings in the Operating Partnerships, equaled $47,000 for the three months ended September 30, 2012, a decrease of approximately $0.4 million from the same period of the prior year. This decrease is due to the lower average ownership interest of HFF Holdings in the Operating Partnerships during the respective periods as a result of exercises of the Exchange Right.

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