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HF > SEC Filings for HF > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for HFF, INC.

Form 10-Q for HFF, INC.


8-Aug-2014

Quarterly Report


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

The following discussion summarizes the financial position of the Company and its subsidiaries as of June 30, 2014, and the results of our operations for the three and six month periods ended June 30, 2014, 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, 2013.

Overview

Our Business

We are, based on transaction volume, one of the largest full-service commercial real estate financial intermediaries in the U.S. providing commercial real estate and capital markets services to both the consumers and providers of capital to the U.S. commercial real estate industry. We operate out of 23 offices nationwide with approximately 682 associates including approximately 267 transaction professionals as of June 30, 2014.

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 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, equity placements, investment banking and advisory services, loan sales and loan sale advisory services, commercial loan servicing 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 recession in either the global economy and/or the domestic economy, including but not limited to even a regional economic downturn, 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 in the recent past 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 which can lead to a reduction in our revenues.

• 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 but not limited to poor performance of the asset class relative to other asset classes or the superior performance of other asset classes when compared with the performance of the commercial real estate asset class. 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 which could therefore, result in decreased transactional volume.

• 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


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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 debt placement and 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 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 through year to date 2014 have generally improved, the global and domestic credit and liquidity issues, coupled with the global and domestic economic recession/slow down as well as other global and domestic macro events beyond our control, could 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 but not limited to our servicing revenues). The significant balance sheet issues of 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.

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, 2014 and June 30, 2013. 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, 2013.

                                                For the Three Months Ended
                                                         June 30,
                                             2014                         2013
                                                                                               Total           Total
                                                    % of                         % of          Dollar        Percentage
                                    Dollars       Revenue        Dollars       Revenue         Change          Change
                                                         (dollars in thousands, unless percentages)
Revenues
Capital markets services revenue    $ 93,579          98.7 %     $ 79,999          98.8 %     $ 13,580              17.0 %
Interest on mortgage notes
receivable                               708           0.7 %          475           0.6 %          233              49.1 %
Other                                    500           0.5 %          534           0.7 %          (34 )            (6.4 )%

Total revenues                        94,787         100.0 %       81,008         100.0 %       13,779              17.0 %
Operating expenses
Cost of services                      53,343          56.3 %       46,592          57.5 %        6,751              14.5 %
Personnel                             11,134          11.7 %        8,462          10.4 %        2,672              31.6 %
Occupancy                              2,332           2.5 %        2,159           2.7 %          173               8.0 %
Travel and entertainment               3,075           3.2 %        2,249           2.8 %          826              36.7 %
Supplies, research and printing        1,622           1.7 %        1,273           1.6 %          349              27.4 %
Other                                  5,275           5.6 %        4,863           6.0 %          412               8.5 %

Total operating expenses              76,781          81.0 %       65,598          81.0 %       11,183              17.0 %

Operating income                      18,006          19.0 %       15,410          19.0 %        2,596              16.8 %
Interest and other income, net         3,241           3.4 %        6,424           7.9 %       (3,183 )           (49.5 )%
Interest expense                          (9 )        (0.0 )%          (9 )        (0.0 )%          -                0.0 %
(Increase) decrease in payable
under tax receivable agreement            -            0.0 %         (339 )        (0.4 )%         339             100.0 %

Income before income taxes            21,238          22.4 %       21,486          26.5 %         (248 )            (1.2 )%
Income tax expense                     8,630           9.1 %        8,386          10.4 %          244               2.9 %

Net income                          $ 12,608          13.3 %     $ 13,100          16.2 %     $   (492 )            (3.8 )%

Adjusted EBITDA (1)                 $ 23,121          24.4 %     $ 23,097          28.5 %     $     24               0.1 %

(1) The Company defines Adjusted EBITDA as net income before (i) interest expense, (ii) income tax expense, (iii) depreciation and amortization,
(iv) stock-based compensation expense, which is a non-cash charge, (v) 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 (vi) 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 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 in determining Adjusted EBITDA. Some of the items that the Company has eliminated from net income 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 to Adjusted EBITDA for the Company for the three months ended June 30, 2014 and 2013:

Adjusted EBITDA for the Company is calculated as follows:

(dollars in thousands)

                                                              For the Three Months Ended
                                                                       June 30,
                                                                2014                2013
Net income                                                  $      12,608         $  13,100
Add:
Interest expense                                                        9                 9
Income tax expense                                                  8,630             8,386
Depreciation and amortization                                       1,883             2,008
Stock-based compensation (a)                                        1,920               670
Initial recording of mortgage servicing rights                     (1,929 )          (1,415 )
Increase (decrease) in payable under the tax receivable
agreement                                                              -                339

Adjusted EBITDA                                             $      23,121         $  23,097

(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, 2014 reflects $0.5 million expense recognized during such period that was associated with restricted stock granted in March 2014 under the Company's firm profit participation bonus plan or office profit participation bonus plans in respect of 2013. 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 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 $94.8 million for the three months ended June 30, 2014 compared to $81.0 million for the same period in 2013, an increase of $13.8 million, or 17.0%. Revenues increased primarily due to a 13.1% increase in total production volumes as compared to the second quarter of 2013.

• The revenues we generated from capital markets services for the three months ended June 30, 2014 increased $13.6 million, or 17.0%, to $93.6 million from $80.0 million for the same period in 2013. The increase is primarily attributable to a 13.1% increase in the total production volume during the second quarter of 2014 compared to the second quarter of 2013. During the second quarter of 2014, there was one unusually large transaction. If the Company's production volumes were adjusted to exclude this transaction in 2014, the second quarter of 2014 adjusted production volumes would have increased 4.0% as compared to the second quarter of 2013.


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• The revenues derived from interest on mortgage notes receivable were $0.7 million for the three months ended June 30, 2014 compared to $0.5 million for the same period in 2013, an increase of approximately $0.2 million. Revenues increased primarily as a result of an increase in the number of loan originations and weighted average balance outstanding in the second quarter of 2014 compared to the second quarter of 2013 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 both the three month period ended June 30, 2014 and the three month period ended June 30, 2013.

Total Operating Expenses. Our total operating expenses were $76.8 million for the three months ended June 30, 2014 compared to $65.6 million for the same period in 2013, an increase of $11.2 million, or 17.0%. 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, 2014 increased $6.8 million, or 14.5%, to $53.3 million from $46.6 million for the same period in 2013. 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 57.0% and 58.2% for the three month periods ended June 30, 2014 and June 30, 2013, respectively.

• Personnel expenses that are not directly attributable to providing services to our clients increased $2.7 million, or 31.6%, to $11.1 million for the three months ended June 30, 2014 from $8.5 million for the same period in 2013. The increase is primarily related to an increase in salaries and incentive compensation costs of $0.5 million, an increase in profit participation costs of $0.9 million, and an increase in equity compensation costs (excluding profit participation equity costs) of $1.1 million during the second quarter 2014 as compared to the second quarter 2013. 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 $1.9 million and $0.7 million for the three months ended June 30, 2014 and 2013, respectively. The increase in stock compensation costs is primarily due to the restricted stock awards granted in January 2014 of $1.1 million, of which there was no such cost in the second quarter of 2013, slightly offset by the mark-to-market adjustment in the second quarter of 2013 on restricted stock awards accounted for as liability awards which resulted in $0.1 million of expense, of which there was no such expense in the second quarter of 2014 as the liability awards fully vested in the first quarter of 2014. At June 30, 2014, there was approximately $21.8 million of unrecognized compensation cost related to share based awards. The weighted average remaining contractual term of the unvested restricted stock units is 4.0 years as of June 30, 2014. The weighted average remaining contractual term of the vested options is 4.2 years as of June 30, 2014.

• Occupancy, travel and entertainment and supplies, research and printing expenses for the three months ended June 30, 2014 increased $1.3 million, or 23.7%, to $7.0 million compared to the same period in 2013. These increases are primarily due to increased travel and entertainment costs stemming from the increase in headcount and production volumes, increased occupancy costs from office expansions and increased supplies, research and printing costs from the increase in production volumes and the number of transactions.

• Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $5.3 million in the three months ended June 30, 2014, an increase of $0.4 million, or 8.5%, versus $4.9 million in the three months ended June 30, 2013. This increase is primarily related to higher professional fees and other operating costs. These costs were slightly offset by lower amortization costs.

Net Income. Our net income for the three months ended June 30, 2014 was $12.6 million, a decrease of $0.5 million versus $13.1 million for the same fiscal period in 2013. This decrease is primarily due to the decrease in interest and other income, net as described below.

• Interest and other income, net for the three months ended June 30, 2014 was $3.2 million, a decrease of $3.2 million as compared to $6.4 million for the same fiscal period in 2013 primarily due to lower gains on sale of servicing rights on certain loans of $1.8 million and lower securitization compensation from the securitization of certain loans of $1.9 million. These decreases were partially offset by higher income from the initial recording of mortgage servicing rights of $0.5 million.


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• The interest expense we incurred in both of the three months ended June 30, 2014 and 2013 was $9,000.

• (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, 2013 represents 85% of the increase in the related deferred tax asset of $399,000.

• Income tax expense was approximately $8.6 million for the three months ended June 30, 2014, as compared to $8.4 million in the three months ended June 30, 2013. Although income before income taxes is $0.2 million lower for the three months ended June 30, 2014 as compared to the same period in the prior year, income tax expense is $0.2 million higher for the three months ended June 30, 2014 primarily due to a slightly higher effective tax rate as compared to the effective tax rate for the three months ended June 30, 2013. During the three months ended June 30, 2014, the Company recorded a current income tax expense of $1.2 million and deferred income tax expense of $7.4 million.

Following is a discussion of our results of operations for the six months ended June 30, 2014 and June 30, 2013. 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, 2013.

                                                   For the Six Months Ended
                                                           June 30,
                                              2014                          2013
                                                                                                  Total           Total
                                                      % of                          % of          Dollar        Percentage
                                      Dollars       Revenue         Dollars       Revenue         Change          Change
                                                           (dollars in thousands, unless percentages)
Revenues
Capital markets services revenue     $ 168,720          98.8 %     $ 132,963          98.3 %     $ 35,757              26.9 %
Interest on mortgage notes
receivable                               1,133           0.7 %         1,320           1.0 %         (187 )           (14.2 )%
Other                                      965           0.6 %           940           0.7 %           25               2.7 %

Total revenues                         170,818         100.0 %       135,223         100.0 %       35,595              26.3 %
Operating expenses
Cost of services                        99,417          58.2 %        81,434          60.2 %       17,983              22.1 %
Personnel                               25,075          14.7 %        17,194          12.7 %        7,881              45.8 %
Occupancy                                4,683           2.7 %         4,295           3.2 %          388               9.0 %
Travel and entertainment                 6,071           3.6 %         4,568           3.4 %        1,503              32.9 %
Supplies, research and printing          3,020           1.8 %         2,403           1.8 %          617              25.7 %
Other                                   10,728           6.3 %        10,040           7.4 %          688               6.9 %

Total operating expenses               148,994          87.2 %       119,934          88.7 %       29,060              24.2 %

Operating income                        21,824          12.8 %        15,289          11.3 %        6,535              42.7 %
Interest and other income, net           6,151           3.6 %        10,611           7.8 %       (4,460 )           (42.0 )%
Interest expense                           (16 )        (0.0 )%          (18 )        (0.0 )%           2             (11.1 )%
(Increase) decrease in payable
under tax receivable agreement             501           0.3 %          (339 )        (0.3 )%         840                NM
. . .
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