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HF > SEC Filings for HF > Form 10-Q on 1-Aug-2013All Recent SEC Filings

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Form 10-Q for HFF, INC.


1-Aug-2013

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 June 30, 2013, and the results of our operations for the three and six month periods ended June 30, 2013, 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, 2012.

Overview

Our Business

We are, based on transaction volume, 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 607 associates including approximately 244 transaction professionals as of June 30, 2013.

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 and platform services, 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, distressed debt and real estate owned advisory services, structured finance, private equity placements, investment banking and capital market advisory services, loan sales and loan sale advisory services and commercial loan servicing.

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 recession in either the global economy and/or the domestic economy, including even a regional economic downturn or slowdown, could adversely affect our business. A general decline in acquisition and disposition activity, as well as a general decline in commercial real estate investment 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. 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 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. 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. These restrictions 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 and could lead to decreases in purchase and sale activities, thereby reducing the amount of investment sales, loan originations and related servicing fees. If our investment sales, loan 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.


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• 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 and could lead to decreases in purchase and sale activities, thereby reducing the amount of investment sales, loan originations and related servicing fees. If our investment sales, loan 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.

• 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. 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 (including our servicing revenues).

The factors discussed above have 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 conditions in 2011, 2012 and to-date in 2013 have generally improved, the global and domestic credit and liquidity issues, coupled with the global and domestic economic recession/slow down, reduced in 2008, 2009 and 2010, when compared to 2011, 2012 and to-date 2013, and prior periods during 2002 through 2007, and may reduce in the future the number of acquisitions, dispositions and loan originations, as well as the respective number of transactions and transaction volumes. This has had, and may have in the future, a significant adverse effect on our capital markets services revenues (including our servicing revenues). The recent significant balance sheet issues of many of the CMBS lenders, the Agencies (Freddie Mac® and Fannie Mae®), 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 June 30, 2013 and June 30, 2012. 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, 2012.

                                                 For the Three Months Ended
                                                          June 30,
                                              2013                         2012
                                                                                                Total           Total
                                                     % of                         % of          Dollar        Percentage
                                     Dollars       Revenue        Dollars       Revenue         Change          Change
                                                          (dollars in thousands, unless percentages)
Revenues
Capital markets services revenue     $ 79,999          98.8 %     $ 64,895          97.2 %     $ 15,104              23.3 %
Interest on mortgage notes
receivable                                475           0.6 %        1,332           2.0 %         (857 )           (64.3 )%
Other                                     534           0.7 %          527           0.8 %            7               1.3 %

Total revenues                         81,008         100.0 %       66,754         100.0 %       14,254              21.4 %
Operating expenses
Cost of services                       46,592          57.5 %       37,487          56.2 %        9,105              24.3 %
Personnel                               8,462          10.4 %        5,595           8.4 %        2,867              51.2 %
Occupancy                               2,159           2.7 %        2,171           3.3 %          (12 )            (0.6 )%
Travel and entertainment                2,249           2.8 %        1,950           2.9 %          299              15.3 %
Supplies, research and printing         1,273           1.6 %        1,275           1.9 %           (2 )            (0.2 )%
Other                                   4,863           6.0 %        4,810           7.2 %           53               1.1 %

Total operating expenses               65,598          81.0 %       53,288          79.8 %       12,310              23.1 %

Operating income                       15,410          19.0 %       13,466          20.2 %        1,944              14.4 %
Interest and other income, net          6,424           7.9 %        5,300           7.9 %        1,124              21.2 %
Interest expense                           (9 )        (0.0 )%         (12 )        (0.0 )%           3             (25.0 )%
(Increase) decrease in payable
under tax receivable agreement           (339 )        (0.4 )%          -            0.0 %         (339 )           100.0 %

Income before income taxes             21,486          26.5 %       18,754          28.1 %        2,732              14.6 %
Income tax expense                      8,386          10.4 %        7,824          11.7 %          562               7.2 %

Net income                             13,100          16.2 %       10,930          16.4 %        2,170              19.9 %
Net income attributable to
noncontrolling interest                    -            0.0 %           75           0.1 %          (75 )           100.0 %

Net income attributable to
controlling interest                 $ 13,100          16.2 %     $ 10,855          16.3 %     $  2,245              20.7 %

Adjusted EBITDA (1)                  $ 23,097          28.5 %     $ 18,489          27.7 %     $  4,608              24.9 %

(1) The Company defines Adjusted EBITDA as net income attributable to controlling interest before (i) interest expense, (ii) income tax expense,
(iii) depreciation and amortization, (iv) net income attributable to the noncontrolling interest, (v) stock-based compensation expense, which is a non-cash charge, (vi) 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 (vii) 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 based in the Company's consolidated statement of income in any individual period. The Company uses 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 Adjusted EBITDA as a supplemental measure to evaluate its overall operating performance. However, Adjusted EBITDA has material limitations as an analytical tool 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 Adjusted EBITDA as a useful tool to assist in evaluating performance because it eliminates items related to capital structure and taxes, including 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 Adjusted EBITDA. Some of the items that the Company has eliminated from net income attributable to controlling interest in determining 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.


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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 Adjusted EBITDA as a performance measure and also considers its GAAP results. Adjusted EBITDA is not a measurement of the Company's financial performance under GAAP and should not be considered as an alternative to net income, operating income or any other measures derived in accordance with GAAP. Because Adjusted EBITDA is not calculated in the same manner by all companies, it 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 Adjusted EBITDA for the Company for the three months ended June 30, 2013 and 2012:

Adjusted EBITDA for the Company is calculated as follows:

(dollars in thousands)

                                                       For the Three Months Ended June 30,
                                                        2013                         2012
Net income attributable to controlling
interest                                          $          13,100            $          10,855
Add:
Interest expense                                                  9                           12
Income tax expense                                            8,386                        7,824
Depreciation and amortization                                 2,008                        1,318
Net income attributable to noncontrolling
interest                                                         -                            75
Stock-based compensation (a)                                    670                          195
Initial recording of mortgage servicing
rights                                                       (1,415 )                     (1,790 )
Increase (decrease) in payable under the tax
receivable agreement                                            339                           -

Adjusted EBITDA                                   $          23,097            $          18,489

(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 June 30, 2013 reflects $0.3 million expense recognized during such period that was associated with restricted stock granted in March 2013 under the Company's firm profit participation bonus plan or office profit participation bonus plans in respect of 2012. Stock-based compensation expense for the three months ended June 30, 2012 reflects $0.3 million 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.

Revenues. Our total revenues were $81.0 million for the three months ended June 30, 2013 compared to $66.8 million for the same period in 2012, an increase of $14.3 million, or 21.4%. The increase in revenues is primarily due to the 27.4% increase in total production volumes as compared to the second quarter of 2012.

• The revenues we generated from capital markets services for the three months ended June 30, 2013 increased $15.1 million, or 23.3%, to $80.0 million from $64.9 million for the same period in 2012. The increase is primarily attributable to the 27.4% increase in total production volumes during the second quarter of 2013 compared to the second quarter of 2012.


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• The revenues derived from interest on mortgage notes receivable were $0.5 million for the three months ended June 30, 2013 compared to $1.3 million for the same period in 2012, a decrease of approximately $0.9 million. Revenues decreased primarily as a result of a decrease in the number of loans originated in the second quarter of 2013 compared to the second quarter of 2012 in connection with our services as a Freddie Mac Multifamily Program Plus® Seller/Servicer.

• 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 $0.5 million for each of the three month periods ended June 30, 2013 and June 30, 2012.

Total Operating Expenses. Our total operating expenses were $65.6 million for the three months ended June 30, 2013 compared to $53.3 million for the same period in 2012, an increase of $12.3 million, or 23.1%. Expenses increased primarily due to increased cost of services and increased personnel costs resulting primarily from an increase in capital markets services revenue and increased headcount.

• The cost of services for the three months ended June 30, 2013 increased $9.1 million, or 24.3%, to $46.6 million from $37.5 million for the same period in 2012. The increase is primarily the result of the increase in commissions and other incentive compensation directly related to the increase in capital markets services revenues. Also contributing to the increase in cost of services are higher salary and fringe benefit costs from increased headcount. Cost of services as a percentage of capital markets services revenues was approximately 58.2% and 57.8% for the three month periods ended June 30, 2013 and June 30, 2012, respectively.

• Personnel expenses that are not directly attributable to providing services to our clients increased $2.9 million, or 51.2%, to $8.5 million for the three months ended June 30, 2013 from $5.6 million for the same period in 2012. The increase is primarily related to an increase in salaries and incentive compensation costs of $1.0 million and the non-cash mark-to-market adjustment on the existing restricted stock awards accounted for as liability awards which are revalued each quarter and resulted in increased expense of $0.4 million during the second quarter 2013 as compared to the second quarter 2012. Personnel expenses are also 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 $0.7 million and $0.2 million for the three months ended June 30, 2013 and 2012, respectively. The increase in stock compensation costs is primarily due to the non-cash mark-to-market adjustment on existing restricted stock awards accounted for as liability awards which resulted in $0.1 million of expense (or a $0.4 million increase as compared to the second quarter of 2012 benefit of $0.4 million). At June 30, 2013, there was approximately $2.8 million of unrecognized compensation cost related to share based awards. The weighted average remaining contractual term of the unvested restricted stock units is 0.7 years as of June 30, 2013. There are no unvested options as of June 30, 2013. The weighted average remaining contractual term of the vested options is 5.2 years as of June 30, 2013.

• Travel and entertainment expenses for the three months ended June 30, 2013 increased $0.3 million, or 15.3%, to $2.2 million compared to the same period in 2012. This increase is primarily due to increased costs stemming from the increase in headcount and higher production volume. Occupancy and supplies, research and printing costs were $3.4 million in each of the three months ended June 30, 2013 and June 30, 2012.

• Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $4.9 million in the three months ended June 30, 2013, an increase of $0.1 million, or 1.1%, versus $4.8 million in the three months ended June 30, 2012. Depreciation and amortization increased $0.7 million due to increased amortization of $0.7 million due to a higher balance of mortgage servicing rights, which was partially offset by lower interest on warehouse line of credit of $0.5 million and lower professional fees of $0.1 million.

Net Income. Our net income for the three months ended June 30, 2013 was $13.1 million, an increase of $2.2 million versus $10.9 million for the same fiscal period in 2012. This increase is primarily due to the increase in capital markets services revenue net of the increased commissions and other incentive compensation as described above.

• Interest and other income, net for the three months ended June 30, 2013 was $6.4 million, an increase of $1.1 million as compared to $5.3 million for the same fiscal period in 2012 primarily due to a larger gain on sale of servicing rights on certain loans and higher securitization compensation from the sale of servicing rights.


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• The interest expense we incurred in the three months ended June 30, 2013 was $9,000 as compared to $12,000 in the three months ended June 30, 2012.

• (Increase) decrease in payable under the tax receivable agreement reflects the change in the estimated tax benefits owed to HFF Holdings under the tax receivable agreement. The $339,000 increase in payable under the tax receivable agreement for the three month period ended June 30, 2012 represents 85% of the increase in the related deferred tax asset of $399,000.

• Income tax expense was approximately $8.4 million for the three months ended June 30, 2013, as compared to $7.8 million in the three months ended June 30, 2012. This increase is primarily due to the higher income before income taxes during the three months ended June 30, 2013 compared to the same period of the prior year. During the three months ended June 30, 2013, the Company recorded current income tax expense of $3.3 million and deferred income tax expense of $5.1 million.

• There was no net income attributable to noncontrolling interest, representing the ownership interest of HFF Holdings in the Operating Partnerships, for the three months ended June 30, 2013, a decrease of $0.1 million from the same period of the prior year, as a result of the exchange of all of the remaining partnership units in the Operating Partnerships owned by HFF Holdings pursuant to the Exchange Right as of August 31, 2012.

Following is a discussion of our results of operations for the six months ended June 30, 2013 and June 30, 2012. 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, 2012.

                                                   For the Six Months Ended
                                                           June 30,
                                              2013                          2012
                                                                                                  Total           Total
                                                      % of                          % of          Dollar        Percentage
                                      Dollars       Revenue         Dollars       Revenue         Change          Change
                                                           (dollars in thousands, unless percentages)
Revenues
Capital markets services revenue     $ 132,963          98.3 %     $ 115,450          97.3 %     $ 17,513              15.2 %
. . .
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