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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-33280
HFF, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 51-0610340 | |
| (State of incorporation) | (I.R.S. Employer Identification No.) | |
| One Oxford Centre | ||
| 301 Grant Street, Suite 600 | ||
| Pittsburgh, Pennsylvania 15219 | (412) 281-8714 | |
| (Address of principal executive offices, including zip code) |
(Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Name of Exchange on which | |
| to be registered | class is to be registered | |
| Class A Common Stock, par value $.01 per share | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes o No þ
Indicate by checkmark if the Registrant is not required to file report pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by checkmark whether the Registrant is a shell company (as defined in Exchange Act Rule
12b-2). Yes o No þ
As of
March 9, 2007, there were 16,445,000 shares of Class A common stock, par value $0.01 per share, of the
Registrant outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the document listed below have been incorporated by reference into the indicated parts
of this Form 10-K, as specified in the responses to the item numbers involved.
| Part III | The Registrant’s definitive proxy statement, for use in connection with the Annual Meeting of Stockholders, to be filed within 120 days after the Registrant’s fiscal year ended December 31, 2006. |
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements, which reflect our current
views with respect to, among other things, our operations and financial performance. You can
identify these forward-looking statements by the use of words such as “outlook,” “believes,”
“expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,”
“intends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other
comparable words. Such forward-looking statements are subject to various risks and uncertainties.
Accordingly, there are or will be important factors that could cause actual outcomes or results to
differ materially from those indicated in these statements. We believe these factors include, but
are not limited to, those described under “Risk Factors.” These factors should not be construed as
exhaustive and should be read in conjunction with the other cautionary statements that are included
in Annual Report on Form 10-K. We undertake no obligation to publicly update or review any
forward-looking statement, whether as a result of new information, future developments or
otherwise.
SPECIAL NOTE REGARDING THE REGISTRANT
In connection with our initial public offering of our Class A common stock in February 2007,
we effected a reorganization of our business, which had previously been conducted through HFF
Holdings LLC (“HFF Holdings”) and certain of its wholly owned subsidiaries, including Holliday
Fenoglio Fowler, L.P. and HFF Securities L.P. (together, the “Operating Partnerships”) and Holliday
GP Corp. (“Holliday GP”). In the reorganization, HFF, Inc., a newly-formed Delaware corporation,
purchased from HFF Holdings all of the shares of Holliday GP, which is the sole general partner of
each of the Operating Partnerships, and approximately 45% of the partnership units in each of the
Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday
GP) in exchange for the net proceeds from the initial public offering and one share of Class B
common stock of HFF, Inc. Following this reorganization and as of the closing of the initial public
offering on February 5, 2007, HFF, Inc. is a holding company holding partnership units in the
Operating Partnerships and all of the outstanding shares of Holliday GP. HFF Holdings and HFF,
Inc., through their wholly-owned subsidiaries, are the only limited partners of the Operating
Partnerships. We refer to these transactions collectively in this Annual Report on Form 10-K as
the “Reorganization Transactions.” Unless we state otherwise, the information in this Annual
Report on Form 10-K gives effect to these Reorganization Transactions.
Unless the context otherwise requires, references to (1) ”HFF Holdings” refer solely to HFF
Holdings LLC, a Delaware limited liability company that was previously the holding company for our
consolidated subsidiaries, and not to any of its subsidiaries, (2) ”HFF LP” refer to Holliday
Fenoglio Fowler, L.P., a Texas limited partnership, (3) ”HFF Securities” refer to HFF Securities
L.P., a Delaware limited partnership and registered broker-dealer, (4) ”Holliday GP” refer to
Holliday GP Corp., a Delaware corporation and the general partner of HFF LP and HFF Securities, (5)
”HoldCo LLC” refer to HFF Partnership Holdings LLC, a Delaware limited liability company and a
wholly-owned subsidiary of HFF, Inc. and (6) ”Holdings Sub” refer to HFF LP Acquisition LLC, a
Delaware limited liability company and wholly-owned subsidiary of HFF Holdings. Our business
operations are conducted by HFF LP and HFF Securities which are sometimes referred to in this
Annual Report on Form 10-K as the “Operating Partnerships.” Also, except where specifically noted,
references in this Annual Report on Form 10-K to “the Company,” “we” or “us” mean HFF, Inc. , the
newly formed Delaware corporation and its consolidated subsidiaries after giving effect to the
reorganization transactions.
PART I
Item 1. Business
Overview
We are a leading provider of commercial real estate and capital markets services to the U.S.
commercial real estate industry based on transaction volume and are one of the largest full-service
commercial real estate financial intermediaries in the country. We operate out of 18 offices
nationwide with more than 130 transaction professionals and approximately 270 support associates.
In 2006, we advised on approximately $36.4 billion of completed commercial real estate
transactions, more than a 14.5% increase compared to the
approximately $31.8 billion of completed
transactions we advised on in 2005.
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Our fully-integrated national capital markets platform, coupled with our knowledge of the
commercial real estate markets, allows us to effectively act as a “one-stop shop” for our clients,
providing a broad array of capital markets services including:
| • | Debt placement; |
| • | Investment sales; |
| • | Structured finance; |
| • | Private equity, investment banking and advisory services; |
| • | Note sale and note sales advisory services; and |
| • | Commercial loan servicing. |
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 believe that our
multiple product offerings, diverse client mix, expertise in a wide range of property types and our
national platform create a stable and diversified revenue stream. Furthermore, we believe our
business mix, operational expertise and the leveragability of our platform have enabled us to
achieve profit margins that are among the highest of our public company peers. Our revenues and net
income were $229.7 million and $51.6 million, respectively, for the year ended December 31, 2006,
compared to $205.8 million and $48.1 million, respectively, for the year ended December 31, 2005.
We have established strong relationships with our clients. Our clients are both users of
capital, such as property owners, and providers of capital, such as lenders and equity investors.
Many of our clients act as both users and providers of capital in different transactions, which
enables us to leverage our existing relationships and execute multiple transactions across multiple
services with the same clients.
We believe we have a reputation for high ethical standards, dedicated teamwork and a strong
focus on serving the interests of our clients. We take a long-term view of our business and client
relationships, and our culture and philosophy are firmly centered on putting the client’s interests
first. Furthermore, through their ownership of HFF Holdings, approximately 40 of our senior
transaction professionals in the aggregate own a majority interest in the Operating Partnerships.
We believe this further aligns their individual interests with those of the Company, our clients
and now our stockholders.
Reportable Segments
We operate in one reportable segment, the commercial real estate financial intermediary
segment and offer debt placement, investment sales, note sales, structured finance, equity
placement, investment banking service and commercial loan servicing.
Our Competitive Strengths
We attribute our success and distinctiveness to our ability to leverage a number of key
competitive strengths, including:
People, Expertise and Culture
We and our predecessor companies have been in the commercial real estate business for over 25
years, and our transaction professionals have significant experience and long-standing
relationships with our clients. We employ over 130 transaction professionals with an average of
nearly 16 years of commercial real estate transaction experience. The transaction history
accumulated among our transaction professionals ensures a high degree of market knowledge on a
macro level, intimate knowledge of local commercial real estate markets, long term relationships
with the most active investors, and a comprehensive understanding of
capital markets products. Our
employees come from a wide range of real estate related backgrounds, including investment advisors
and managers, investment bankers, attorneys, brokers and mortgage bankers.
Our culture is governed by our commitment to high ethical standards, putting the client’s
interest first and treating clients and our own associates fairly and with respect. These
distinctive characteristics of our culture are highly evident in our ability to retain and attract
employees. The average tenure for our senior transaction professionals is 10 years and the average
production tenure for the top 25 senior transaction professionals compiled by initial leads during
the last five years was 14 years (including tenure with predecessor companies). Furthermore,
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many
of our senior transaction professionals have a significant economic interest in our firm, which
aligns their
individual interests with those of the company as a whole and our clients. Following the
completion of our initial public offering, through their ownership of HFF Holdings, approximately
40 senior transaction professionals will in the aggregate own a majority interest in the company
which we believe will continue to align their interests with the company.
Integrated Capital Markets Services Platform
In the increasingly competitive commercial real estate and capital markets industry, we
believe our key differentiator is our ability to analyze all commercial real estate product types
and markets as well as our ability to provide clients with comprehensive analysis, advice and
execution expertise on all types of debt and equity capital markets solutions. Because of our broad
range of execution capabilities, our clients rely on us not only to provide capital market
alternatives but, more importantly, to advise them on how to optimize value by uncovering
inefficiencies in the non-public capital markets to maximize their commercial real estate
investments. Our capabilities provide our clients with the flexibility to pursue multiple capital
market options simultaneously so that, upon conclusion of our efforts, they can choose the best
risk-adjusted based solution.
Independent Objective Advice
Unlike many of our competitors, we do not currently offer services that compete with services
provided by our clients such as leasing or property management, nor do we currently engage in
principal capital investing activities. This allows us to offer independent objective advice to our
clients. We believe our independence distinguishes us from our competitors, enhances our reputation
in the market and allows us to retain and expand our client base.
Extensive Cross-Selling Opportunities
As some participants in the commercial real estate market are frequently buyers, sellers,
lenders and borrowers at various times, our relationships with these participants across all
aspects of their businesses provide us with multiple revenue opportunities throughout the life
cycle of their commercial real estate investments. In addition, we often provide more than one
service in a particular transaction, such as in an investment sale or note sale assignment where we
not only represent the seller of a commercial real estate investment but also represent the buyer
in arranging acquisition financing. From 2003 through 2005, we executed multiple transactions
across multiple platform services with 24 of our top 25 clients. In 2006, we executed multiple
transactions with all 25 of our top clients.
Broad and Deep Network of Relationships
We have developed broad and deep-standing relationships with the users and providers of
capital in the industry and have completed multiple transactions for many of the top institutional
commercial real estate investors in the U.S. as well as several global investors who invest in the
U.S. Importantly, our transaction professionals, analysts and closing specialists foster
relationships with their respective counterparts within each client’s organization. This provides,
in our opinion, a deeper relationship with our firm relative to our competitors. In 2005 and 2006,
no one borrower or no one seller client, respectively, represented more than 4% of our total
capital markets services revenues. The combined fees from our top 25 seller clients for the years
2005 and 2006, respectively, were less than 20% of our capital markets services revenues for each
year, and the combined fees from our top 25 borrower clients were less than 20% of our capital
markets services revenues for each year.
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Proprietary Transaction Database
We believe that the extensive volume of commercial real estate transactions that we advise on
throughout the U.S. and across multiple property type and capital market service lines provides our
transaction professionals with valuable, real-time market information. We maintain a proprietary
database on over 6,000 clients and potential clients as well as databases that track key terms and
provisions of all closed and pending transactions for which we are involved as well as historic and
current flows and the pricing of debt, structured finance, investment sales, note sales and equity
transactions. Included in the databases are real-time quotes and bids on pipeline transactions,
status reports on all current transactions as well as historic information on clients, lenders and
buyers. Furthermore, our internal databases maintain current and historical information on our loan
servicing portfolio, which enables us to track real-time property level performance and market
trends. These internal databases are updated regularly and are available to our transaction
professionals, analysts and other internal support groups to share client contact information and
real-time market information. We believe this information strengthens our competitive position by
enhancing the advice we provide to clients and improving the probability of successfully closing a
transaction. Our associates also understand the confidential nature of this information, and if it
is misused and depending on the circumstances, it can be cause for immediate dismissal from the
Company.
Our Strategic Growth Plan
We seek to improve our market position by focusing on the following strategic growth
initiatives:
Expand Our Geographic Footprint
We believe that opportunities exist to establish and increase our presence in several key
domestic, and potentially, international markets. While our transactional professionals, located in
18 offices throughout the U.S., advised clients on transactions in 45 states (and the District of
Columbia, Puerto Rico, and Canada) and in more than 550 cities in 2006, there are a number of major
metropolitan areas where we do not maintain an office, and we have no overseas offices. By
comparison, many of our large public competitors have over 100 offices worldwide. We constantly
review key demand drivers of commercial real estate by market, including growth in population,
households, employment, commercial real estate inventory by product type, and new construction. By
doing so, we can determine not only where future strategic growth should occur, but more
importantly, we can also ensure our transaction professionals are constantly calling on the most
attractive markets where we do not have offices. Since 1998, we have opened offices in Washington,
D.C., Los Angeles, San Francisco (opened in October 2006) and Chicago. In addition, during this
same period, we have significantly added to the platform services in our Miami, New York City, New
Jersey, Washington, D.C., Los Angeles and Chicago offices. While historical performance does not
assure similar results, the combined revenues from these new offices (Washington, D.C., Los Angeles
and Chicago) in the offices’ respective third year of operation were approximately 2.6 times higher
than these same offices’ respective first year of operation.
We expect to achieve future strategic geographic expansion through a combination of
recruitment of key transaction professionals, organic growth and possible acquisitions of smaller
local and regional firms across all services in both new and existing markets. However, in all
cases our strategic growth will be focused on serving our clients’ interests and predicated on
finding the most experienced professionals in the market who have the highest integrity, work ethic
and reputation, while fitting into our culture and sharing our philosophy and the way we conduct
our business.
Increase Market Share Across Each of our Capital Market Services
We have achieved significant growth in each of the services we provide through our integrated
capital markets platform. We believe that we have the opportunity to continue to increase our market
share in each of the various capital markets services we provide to our clients by penetrating
deeper into our national, regional and local client relationships. We also intend to increase our
market shares by selectively hiring transaction professionals in our existing offices and in new
locations, predicated on finding the most experienced professionals in the market who have the
highest integrity, work ethic and reputation, while fitting into our culture and sharing our
philosophy and the way we conduct our business. For example, since 1998, in addition to opening
offices in Washington, D.C., Los Angeles, San Francisco (opened in October 2006) and Chicago, we
have significantly added to the platform services in our Miami, New York City, New Jersey,
Washington, D.C., Los Angeles and Chicago offices. While historical performance does not assure
similar results, the combined additional platform services revenue in the third year were
approximately 5.6 times higher than the combined additional platform services revenue in the first
year.
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| • | Debt Placement. Our transaction value in debt placements were approximately $22.1 billion and $22.0 billion in 2006 and 2005, respectively. According to the Mortgage Bankers Association’s “Commercial Real Estate/Multifamily Finance: Annual Origination Volume Summation” report, debt issuances in 2005 and 2004 were $345 billion and $230 billion, respectively. | |
| • | Investment Sales. In 2006, we completed investment sales in excess of $10.1 billion, an increase of approximately 32.9% over $7.6 billion completed in 2005. According to Real Capital Analytics, commercial real estate sales volume for office, industrial, multifamily and retail properties in the U.S. in 2006 and 2005 were $312.7 billion and $276.6 billion, respectively. | |
| • | Structured Finance, Private Equity and Advisory Services. In 2006 and 2005, we completed approximately $3.8 billion and $2.1 billion of structured finance, private equity and advisory services transactions (which includes amounts that we internally allocate to the structured finance reporting category, even though the transaction may have been funded through a single mortgage note) for our clients. In April 2004, we formed our broker-dealer subsidiary, HFF Securities, to undertake both discretionary and non-discretionary private equity raises, select property specific joint ventures, and select investment banking activities for our clients. | |
| • | Note sale and note sales advisory. Since formalizing our note sales and note sales advisory services platform in 2004, we have consummated over $698 million in note sale and note sales advisory transactions. We see growth in this market as well due to the desire of lenders to seek to diversify concentration risk (geographic, borrower or product type), manage potential problems in their loan portfolios or sell loans rejected from Commercial Mortgage Backed Securities (CMBS) securitization pools. | |
| • | Loan servicing. The principal balance of HFF’s loan servicing portfolio increased nearly 21% from $14.9 billion at December 31, 2005, to over $18.0 billion at December 31, 2006. Currently, we have 33 formal correspondent lender relationships with life insurers and 17 CMBS sub servicing agreements. The majority of the CMBS contracts having been put in place over the past 18 months due to our increased focus on growing our servicing platform to better serve our clients. As a result of our continued debt placements with correspondent lenders as well as our new sub servicing relationships with CMBS lenders, our loan servicing portfolio has grown from $14.9 billion in 2005 to $18.0 billion at December 31, 2006 with a large percentage of this growth coming from CMBS sub servicing contracts we have been executing since early 2005. |
Continue to Capitalize on Cross-Selling Opportunities
Participants in the commercial real estate market increasingly are buyers, sellers, lenders
and borrowers at various times. We believe our relationships with these participants across all
aspects of their businesses provide us with multiple revenue opportunities throughout the lifecycle
of their commercial real estate investments. Many of our clients are both users and providers of
capital. Our clients typically execute transactions throughout the U.S. utilizing the wide spectrum
of our services. By maintaining close relationships with these clients, we intend to continue to
generate significant repeat business across all of our business lines.
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Our debt transaction professionals originated approximately $2.2 billion and $1.4 billion of
debt for clients that purchased properties sold by our investment sales professionals for their
clients in 2006 and 2005, respectively. Our investment sales professionals also referred clients to
our debt transaction professionals who arranged debt financings totaling approximately $664 million
and $475 million in 2006 and 2005, respectively. Our debt professionals also referred clients to
our investment sales transaction professionals who sold approximately $2.1 billion and $1.8 billion
and of properties in 2006 and 2005, respectively. Also, from its inception in late 2004 through the
December 31, 2006, our HFF Securities subsidiary originated debt volumes of approximately $434
million, in addition to their other equity placement activities.
Our Services
Debt Placement Services
We offer our clients a complete range of debt instruments, including but not limited to
construction and construction/mini-permanent loans, adjustable and fixed rate mortgages, entity
level debt, mezzanine debt, forward delivery loans, tax exempt financing, and sale/leaseback
financing.
Our clients are owners of various types of property, including, but not limited to, office,
retail, industrial, hotel, multi-family, self-storage, assisted living, nursing homes, condominium
conversions, mixed-use properties and land. Our clients range in size from individual entrepreneurs
who own a single property to the largest real estate funds and institutional property owners
throughout the world who invest in the United States. Debt is placed with all major capital funding
sources, both domestic and foreign, including but not limited to life insurance companies,
conduits, investment banks, commercial banks, thrifts, agency lenders, pension funds, pension fund
advisors, REITs, credit companies, opportunity funds and individual investors.
Investment Sales Services
We provide investment sales services to commercial real estate owners who are seeking to sell
one or more properties or property interests. We seek to maximize proceeds and certainty of closure
for our clients through our knowledge of the commercial real estate and capital markets, our
extensive database of potential buyers, with whom we have deep and long-standing relationships, and
our experienced transaction professionals. Real time data on comparable transactions, recent
financings of similar assets and market trends, enable our transaction professionals to better
advise our clients on valuation and certainty of execution based on a prospective buyer’s proposed
capital structure.
Structured Finance Services
We offer a wide array of structured finance alternatives and solutions at both the property
and ownership entity level. This allows us to provide financing alternatives at every level of the
capital structure, including but not limited to mezzanine and equity, thereby providing potential
buyers and existing owners with the highest appropriate leverage at the lowest blended cost of
capital to purchase properties or recapitalize existing ones versus an out-right sales alternative.
By focusing on the inefficiencies in the structured finance capital markets, such as mezzanine,
preferred equity, participating and/or convertible debt structures, pay and accrual debt
structures, pre-sales, stand-by commitments and bridge loans, we are able to access capital for
properties in transition, predevelopment and development loans and/or joint ventures and/or
structured transactions, which provide maximum flexibility for our clients.
Private Equity, Investment Banking and Advisory Services
Through HFF Securities, our licensed broker-dealer subsidiary, we offer our clients the
ability to access the private equity markets for an identified commercial real estate asset and
discretionary and non-discretionary joint ventures, funds marketing, private equity placements, and
advisory services. HFF Securities’ services to its clients include:
| • | Joint Ventures. Equity capital for our commercial real estate clients to establish joint ventures relating to either identified properties or properties to be acquired by a fund sponsor. These joint ventures typically involve the acquisition, development, recapitalization or restructuring of multi-asset commercial real estate portfolios, and include a variety of property types and geographic areas. |
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| • | Private Placements. Private placements of common, perpetual preferred and convertible preferred securities. Issuances involve primary or secondary shares that may be publicly registered, listed and traded. | |
| • | Advisory Services. Entity-level advisory services for various types of transactions including mergers and acquisition, sales and divestitures, management buyouts, and recapitalizations and restructurings. | |
| • | Marketing and Fund-Raising. Institutional marketing and fund-raising for public and private commercial real estate companies, with a focus on opportunity and value-added commercial real estate funds. In this capacity, we undertake private equity raises, both discretionary and non-discretionary, and offer advisory services. |
Note Sale and Note Sales Advisory Services
We assist our clients in their efforts to sell all or portions of their commercial real estate
debt note portfolios. We are actively marketing our note sale and note sales advisory services to
our clients.
Commercial Loan Servicing
We provide commercial loan servicing (primary and sub-servicing) for life insurance companies
and CMBS originators. Our servicing platform, experienced personnel and hands-on service allow us
to maintain close contact with both borrowers and lenders. As a result, we are often the first
point of contact in connection with refinancing, restructuring or sales of commercial real estate
assets. Revenue is earned primarily from servicing fees charged to the lender, as well as from
investment income earned on escrow balances.
To avoid potential conflicts, our transaction professionals do not share in servicing revenue,
eliminating conflicts which can occur with serviced versus non-serviced lenders. However,
throughout the servicing life of a loan, the transaction professional who originated the loan
usually remains the main contact for both the borrower and lender, or the master servicer, as the
case may be, to assist our servicing group with annual inspections, operating statement reviews and
other major servicing issues affecting a property or properties.
Competition
The commercial real estate services industry, and all of the services that we provide, are
highly competitive, and we expect them to remain so. We compete on a national, regional and local
basis as well as on a number of other critical factors, including but not limited to the quality of
our people and client service, historical track record and expertise and range of services and
execution skills, absence of conflicts and business reputation. Depending on the product or
service, we face competition from other commercial real estate service providers, institutional
lenders, insurance companies, investment banking firms, investment managers and accounting firms,
some of which may have greater financial resources than we do. Consistently, the top competitors we
face on national, regional and local levels include, but are not limited to, CBRE Capital Markets
(formerly L.J. Melody & Company and recently combined with Trammell Crow), Cushman & Wakefield,
Eastdil Secured, Jones Lang LaSalle, Northmarq Capital (Marquette) and CapMark (formerly GMAC).
There are numerous other local and regional competitors in each of the local markets where we are
located as well as the markets we do business in.
Competition to attract and retain qualified employees is also intense in each of the capital
markets services we provide to our clients. We compete by offering a competitive compensation
package to our transaction professionals and our other associates as well as equity-based
incentives for key associates who lead our efforts in terms of running our offices or leading our
efforts in each of our capital markets services. Our ability to continue to compete effectively will
depend upon our ability to retain and motivate our existing transaction professionals and other key
associates as well as our ability to attract new ones, all predicated on finding the most
experienced professionals in the market who have the highest integrity, work ethic and reputation,
while fitting into our culture and sharing our philosophy and the way we conduct our business.
Regulation
Our U.S. broker-dealer subsidiary, HFF Securities, is subject to regulation. HFF Securities is
currently registered as a broker-dealer with the SEC and the NASD. HFF Securities is registered as
a broker dealer in California and is considering in which additional states it may register as a
broker-dealer. HFF Securities is subject to regulations governing effectively every aspect of the
securities business, including the effecting of securities transactions, minimum capital
requirements, record-keeping and reporting procedures, relationships with customers,
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experience and
training requirements for certain employees and business procedures with firms that are not subject
to regulatory controls. Violation of applicable regulations can result in the revocation of
broker-dealer licenses, the imposition of censures or fines and the suspension, expulsion or other
disciplining of a firm, its officers or employees.
Our broker-dealer subsidiary is also subject to the SEC’s uniform net capital rule, Rule
15c3-1, and the net capital rules of the NYSE and the NASD, which may limit our ability to make
withdrawals of capital from our broker-dealer subsidiary. The uniform net capital rule sets the
minimum level of net capital a broker-dealer must maintain and also requires that a portion of its
assets be relatively liquid. The NYSE and the NASD may prohibit a member firm from expanding its
business or paying cash dividends if resulting net capital falls below its requirements. In
addition, our broker-dealer subsidiary is subject to certain notification requirements related to
withdrawals of excess net capital. Our broker-dealer subsidiary is also subject to several new laws
and regulations that were recently enacted. The USA Patriot Act of 2001 has imposed new obligations
regarding the prevention and detection of money-laundering activities, including the establishment
of customer due diligence and other compliance policies and procedures. Additional obligations
under the USA Patriot Act regarding procedures for customer verification became effective on
October 1, 2003. Failure to comply with these new requirements may result in monetary, regulatory
and, in the case of the USA Patriot Act, criminal penalties.
HFF LP is licensed (in some cases, through our employees or its general partner) as a mortgage
broker and a real estate broker in multiple jurisdictions. Generally we are licensed in each state
where we have an office as well as where we frequently do business.
History
We have grown through the combination of several prominent commercial real estate brokerage
firms. Our namesake dates back to Holliday Fenoglio & Company, which was founded in Houston in
1982. Although our predecessor companies date back to the 1970s, our recent history began in 1994
when Holliday Fenoglio Dockerty & Gibson, Inc. was purchased by AMRESCO, Inc. to create Holliday
Fenoglio Inc. In 1998, Holliday Fenoglio acquired Fowler Goedecke Ellis & O’Connor, to create
Holliday Fenoglio Fowler, L.P. Later that year Holliday Fenoglio Fowler, L.P. acquired PNS Realty
Partners, LP and Vanguard Mortgage.
In March 2000, AMRESCO sold its commercial mortgage banking businesses, Holliday Fenoglio
Fowler, L.P., to Lend Lease (US) Inc., the U.S. subsidiary of the Australian real estate services
company. Finally, in June 2003, HFF Holdings completed an agreement for a management buyout from
Lend Lease. In April 2004, we established our broker-deal subsidiary, HFF Securities L.P.
As previously discussed, in connection with our initial public offering of our common stock in
February 2007, we effected a reorganization of our business. As a result of this reorganization
and as of the closing of the initial public offering on February 5, 2007, HFF, Inc. is a holding
company holding partnership units in the Operating Partnerships and all of the outstanding shares
of Holliday GP. HFF Holdings and HFF, Inc., through their wholly-owned subsidiaries, are the only
limited partners of the Operating Partnerships.
Available Information
We file electronically with the SEC annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read and copy any
materials we have filed with or furnished to the SEC at the SEC’s Public Reference Room at 100 F
Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-3330. The SEC maintains an Internet site
(www.sec.gov) that contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. Copies of our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, ownership reports for insiders and any
amendments to these reports filed or furnished with the SEC are available free of charge through
our Internet site (www.hfflp.com) as soon as reasonably practicable after filing with the SEC.
Additionally, we make available free of charge on our internet website:
| • | our Code of Conduct and Ethics; | ||
| • | the charter of its Nominating and Governing Committee; |
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| • | the charter of its Compensation Committee; | ||
| • | the charter of its Audit Committee; and | ||
| • | our Corporate Governance Guidelines. |
Item 1A. Risk Factors
Investing in our securities involves a high degree of risk. You should consider carefully the
following risk factors and the other information in this Annual Report on Form 10-K, including our
consolidated financial statements and related notes, before making any investment decisions
regarding our securities. If any of the following risks actually occur, our business, financial
condition and operating results could be adversely affected. As a result, the trading price of our
securities could decline and you may lose part or all of your investment.
Risks Related to Our Business
General economic conditions and commercial real estate market conditions, both globally and
domestically, can have a negative impact on our business.
We have experienced in past years, and expect in the future to be negatively impacted by,
periods of economic slowdowns, recessions and disruptions in the capital markets, including
international, national, regional and local markets, and corresponding declines in the demand for
commercial real estate and related services, within one or more of the markets in which we operate.
Historically, commercial real estate markets, and in particular the U.S. commercial real estate
market, have tended to be cyclical and related to the condition of the economy as a whole and to
the perceptions of the market participants as to the relevant economic outlook. Negative economic
conditions, changes in interest rates, disruptions in capital markets and declines in the demand
for commercial real estate and related services in international or domestic markets or in
significant markets in which we do business could have a material adverse effect on our business,
results of operations and/or financial condition, including as a result of the following factors.
For example:
• Slowdowns in economic activity could cause tenant demand for space to decline, which would
adversely affect the operation and income of commercial real estate properties and thereby affect
investor demand and the supply of capital for debt and equity investments in commercial real
estate.
• Declines in the regional or local demand for commercial real estate, or significant
disruptions in other segments of the real estate market, could adversely affect our results of
operations. During 2006, approximately 21.0%, 8.4%, 10.8% and 8.4% of
our capital markets services
revenues was derived from transactions involving commercial real estate located in Texas,
California, Florida and the region consisting of the District of Columbia, Maryland and Virginia,
respectively. As a result, a significant portion of our business is dependent on the economic
conditions in general and the markets for commercial real estate in these areas, which, like other
commercial real estate markets, have experienced price volatility or economic downturns in the
past.
• Significant fluctuations in interest rates as well as steady and protracted increases or
decreases of interest rates 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 reduce
the number of acquisitions, dispositions and loan originations, as well as the respective
transaction volumes, which could also adversely affect our servicing revenue. All of the above
could cause prices to decrease due to the reduced amount of financing available as well as the
increased cost of obtaining financing and could lead to a decrease in purchase and sale activity.
• Significant disruptions or changes in capital market flows, regardless of their duration,
could adversely affect the supply and/or demand for capital from investors for commercial real
estate investments. In particular, while commercial real estate is now viewed as an accepted asset
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.
These and other types of events could lead to a general decline in transaction activity, which
would likely lead to a reduction in fees and commissions relating to such transactions, as well as
a significant reduction in our loan
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servicing activities as a result of increased delinquencies and
the lack of additional loans that we would have otherwise added to our servicing portfolio. These
effects would likely cause us to realize lower revenues from our transaction service fees,
including debt placement fees and investment sales commissions, which fees usually are tied to the
transaction value and are payable upon the successful completion of a particular transaction, and
from our loan servicing revenues due to reduced financing and refinancing transactions as well as
higher delinquencies.
If we are unable to retain and attract qualified and experienced transaction professionals and
associates, our growth may be limited and our business and operating results could suffer.
Our most important asset is our people, and our continued success is highly dependent upon the
efforts of our transaction professionals and other associates, including our analysts and
production coordinators as well as our key servicing and company overhead support associates. Our
transaction professionals generate a significant majority of our revenues. If any of these key
transaction professionals or other important associates leave, or if we lose a significant number
of transaction professionals, or if we are unable to attract other qualified transaction
professionals, our business, financial condition and results of operations may suffer. We have
experienced in the past, and expect to experience in the future, the negative impact of the
inability to retain and attract associates, analysts and experienced transaction professionals.
Additionally, such events may have a disproportionate adverse effect to our operations if they
occur in geographic areas where substantial amounts of our capital
markets services revenues are
generated.
As part of our transformation to a public company, we may also face additional retention
pressures as a result of reductions in distributions from HFF Holdings to approximately 40 of our
most valuable transaction professionals who are the members of HFF Holdings. Following the
termination of their employment contracts and expiration of their lock-ups, we may not be able to
retain these members of HFF Holdings. Even if we are able to retain them, we may not be able to
retain them at compensation levels that will allow us to achieve our target ratio of compensation
expense-to-operating revenue. We intend to use a combination of cash compensation, equity,
equity-based incentives and other employee benefits rather than solely cash compensation to
motivate and retain our transaction professionals. Our compensation mechanisms as a public company
may not be effective, especially if the market price of our Class A common stock declines.
In addition, our competitors may attempt to recruit our transaction professionals. The
employment arrangements, non-competition agreements and retention agreements we have entered into
with respect to the members of HFF Holdings or may enter into with our key associates may not
prevent our transaction professionals and other key associates from resigning or competing against
us. Any such arrangements and agreements will expire after a certain period of time, at which point
each such person would be free to compete against us and solicit our clients and employees.
A significant component of our growth has also occurred through the recruiting and hiring of
key experienced transaction professionals. Any future growth through recruiting these professionals
will be partially dependent upon the continued availability of attractive candidates fitting the
culture of our firm at advantageous terms and conditions. However, individuals whom we would like
to hire may not be available upon advantageous terms and conditions. In addition, the hiring of new
personnel involve risks that the persons acquired will not perform in accordance with expectations
and that business judgments concerning the value, strengths and weaknesses of persons acquired will
prove incorrect.
Our business could be hurt if we are unable to retain our business philosophy and partnership
culture as a result of becoming a public company, and efforts to retain our philosophy and culture
could adversely affect our ability to maintain and grow our business.
We are deeply committed to maintaining the philosophy and culture which we have built. Our
Mission and Vision Statement defines our business philosophy as well as the emphasis that we place
on our clients, our people and our culture. We seek to reinforce to each of our associates our
commitment to our clients, our culture and values by sharing with everyone in the firm what is
expected from each of them. We strive to maintain a work environment that reinforces our
owner-operator culture and the collaboration, motivation, alignment of interests and sense of
ownership and reward associates based on their value-added performance who adhere to this culture.
Our status as a public company, including potential changes in our compensation structure, could
adversely affect this culture. If we do not continue to develop and implement the right processes
and tools to manage our changing enterprise and
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maintain this culture, our ability to compete
successfully and achieve our business objectives could be impaired, which could negatively impact
our business, financial condition and results of operations.
In addition, in an effort to preserve our strong partnership culture, our process for hiring
new transaction professionals is lengthy and highly selective. In the past, we have interviewed a
significant number of individuals for each transaction professional that we hired, and we have in
the past and may in the future subordinate our growth plans to our objective of hiring transaction
professionals whom we think will adhere to and contribute to our culture. Our ability to maintain
and grow our business could suffer if we are not able to identify, hire and retain new
transaction professionals meeting our high standards, which could negatively impact our
business, financial condition and results of operations.
We have numerous significant competitors and potential future competitors, some of which may
have greater resources than we do, and we may not be able to continue to compete effectively.
We compete across a variety of businesses within the commercial real estate industry. In
general, with respect to each of our businesses, we cannot give assurance that we will be able to
continue to compete effectively or maintain our current fee arrangements or margin levels or that
we will not encounter increased competition. Each of the services we provide to our clients is
highly competitive on an international, national, regional and local level. Depending on the
product or service, we face competition from, including but not limited to, commercial real estate
service providers, private owners and developers, institutional lenders, insurance companies,
investment banking firms and investment managers, some of whom are clients and many of whom may
have greater financial resources than we do. In addition, future changes in laws and regulations
could lead to the entry of other competitors. Many of our competitors are local, regional, national
or international firms. Although some are substantially smaller than we are, some of these
competitors are larger on a local, regional, national or international basis. We may face increased
competition from even stronger competitors in the future due to a trend toward consolidation. In
recent years, there has been substantial consolidation and convergence among companies in our
industry. We are also subject to competition from other large national and multi-national firms as
well as regional and local firms that have similar service competencies to ours. Our existing and
future competitors may choose to undercut our fees, increase the levels of compensation they are
willing to pay to their employees and either recruit our employees or cause us to increase our
level of compensation necessary to retain our own employees or recruit new employees. These
occurrences could cause our revenue to decrease or negatively impact our target ratio of
compensation-to-operating revenue, both of which could have an adverse effect on our business,
financial condition and results of operations.
We could be adversely affected if the Terrorism Risk Insurance Act of 2002 is not renewed
beyond 2007, or is adversely amended, or if insurance for other natural or manmade disasters is
interrupted or constrained.
Our business could be adversely affected if the Terrorism Risk Insurance Act of 2002, or TRIA,
is not renewed beyond 2007, or is adversely amended, or if insurance for other natural and manmade
disasters is interrupted or constrained. In response to the tightening of supply in certain
insurance and reinsurance markets resulting from, among other things, the September 11, 2001
terrorist attack, the Terrorism Risk Insurance Act of 2002 was enacted to ensure the availability
of commercial insurance coverage for terrorist acts in the United States. This law established a
federal assistance program through the end of 2005 to help the commercial property and casualty
insurance industry cover claims related to future terrorism-related losses and required that
coverage for terrorist acts be offered by insurers. Although TRIA recently has been amended and
extended through 2007, it is possible that TRIA will not be renewed beyond 2007, or could be
adversely amended, which could adversely affect the commercial real estate markets and capital
markets if a material subsequent event occurred. Lenders generally require owners of commercial
real estate to maintain terrorism insurance. In the event TRIA is not renewed, terrorism insurance
may become difficult or impossible to obtain. Natural disasters such as Katrina and the lack of
commercially available wind damage and flood insurance could also have a negative impact on the
acquisition, disposition and financing of the commercial properties in certain areas. Any of these
events could result in a general decline in acquisition, disposition and financing activities,
which could lead to a reduction in our fees for arranging such transactions as well as a reduction
in our loan servicing activities due to increased delinquencies and lack of additional loans that
we would have otherwise added to our portfolio, all of which could adversely affect our business,
financial condition and results of operation.
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We have experienced significant growth over the past several years, which may be difficult to
sustain and which may place significant demands on our administrative, operational and financial
resources.
We expect our significant growth to continue, which could place additional demands on our
resources and increase our expenses. Our future growth will depend, among other things, on our
ability to successfully identify experienced transaction professionals to join our firm. It may
take years for us to determine whether new transaction professionals will be profitable or
effective. During that time, we may incur significant expenses and expend significant time and
resources toward training, integration and business development. If we are unable to hire and
retain profitable transaction professionals, we will not be able to implement our growth strategy,
which could adversely affect our business, financial condition and results of operations.
Sustaining our growth will also require us to commit additional management, operational and
financial resources to maintain appropriate operational and financial systems to adequately support
expansion. There can be no assurance that we will be able to manage our expanding operations
effectively or that we will be able to maintain or accelerate our growth, and any failure to do so
could adversely affect our ability to generate revenue and control our expenses which could
adversely affect our business, financial condition and results of operations.
If we acquire companies in the future, we may experience high transaction and integration
costs, the integration process may be disruptive to our business and the acquired businesses may
not perform as we expect.
Future acquisitions and any necessary related financings may involve significant
transaction-related expenses. Transaction-related expenditures include severance costs, lease
termination costs, transaction costs, deferred financing costs, possible regulatory costs and
merger-related costs, among others. We may also experience difficulties in integrating operations
and accounting systems acquired from other companies. These challenges include the diversion of
management’s attention from the regular operations of our business and the potential loss of our
key clients, our key associates or those of the acquired operations, each of which could harm our
financial condition and results of operation. We believe that most acquisitions will initially have
an adverse impact on revenues, expenses, operating income and net income. Acquisitions also
frequently involve significant costs related to integrating information technology, accounting,
reporting and management services and rationalizing personnel levels. If we are unable to fully
integrate the accounting, reporting and other systems of the businesses we acquire, we may not be
able to effectively manage them and our financial results may be materially affected. Moreover, the
integration process itself may be disruptive to our business as it requires coordination of
geographically diverse organizations and implementation of new accounting and information
technology systems.
In addition, acquisitions of businesses involve risks that the businesses acquired will not
perform in accordance with expectations, that the expected synergies associated with acquisitions
will not be achieved and that business judgments concerning the value, strengths and weaknesses of
businesses acquired will prove incorrect, which could have an adverse affect on our business,
financial condition and results of operations.
A failure to appropriately deal with actual or perceived conflicts of interest could adversely
affect our businesses.
Outside of our people, our reputation is one of our most important assets. As we have expanded
the scope of our businesses and our client base, we increasingly have to address potential actual
or perceived conflicts of interest relating to the capital markets services we provide to our
existing and potential clients. For example, conflicts may arise between our position as an advisor
to both the buyer and seller in commercial real estate sales transactions or in instances when a
potential buyer requests that we represent it in securing the necessary capital to acquire an asset
we are selling for another client. In addition, certain of our employees hold interests in real
property as well as invest in pools of funds outside of their capacity as our employees, and their
individual interests could be perceived to or actually conflict with the interests of our clients.
While we have attempted to adopt various policies, controls and procedures to address or limit
actual or perceived conflicts, these policies and procedures may not be adequate or carry attendant
costs and may not be adhered to by our employees. Appropriately dealing with conflicts of interest
is complex and difficult and our reputation could be damaged and cause us to lose existing clients
or fail to gain new clients if we fail, or appear to fail, to deal appropriately with conflicts of
interest, which could have an adverse affect on our business, financial condition and results of
operations.
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A
majority of our revenue is derived from capital markets services transaction fees, which are
not long-term contracted sources of revenue and are subject to intense competition, and declines in
those engagements could have a material adverse effect on our financial condition and results of
operations.
We
historically have earned over 90% of our revenue from capital markets services transaction
fees. We expect that we will continue to rely heavily on capital
markets services transaction fees
for a substantial portion of our revenue for the foreseeable future. A decline in our engagements
or in the value of the commercial real estate we sell or finance could significantly decrease our
capital markets services revenues which would adversely affect our business, financial condition and
results of operations. In addition, we operate in a highly competitive environment where typically
there are no long-term contracted sources of revenue; each revenue-generating engagement typically
is separately awarded and negotiated on a transaction-by-transaction basis, and the inability to
continue to be paid for services at the current levels or the loss of clients would adversely
affect our business, financial condition and results of operation.
Additional indebtedness may make us more vulnerable to economic downturns and limit our
ability to withstand competitive pressures.
We may require additional financing to fund our on-going capital needs as well as to fund our
working capital needs. Any additional indebtedness that we incur will make us more vulnerable to
economic downturns and limit our ability to withstand competitive pressures.
The level of our indebtedness could have important consequences, including:
• a substantial portion of our cash flow from operations will be dedicated to debt service and
may not be available for other purposes;
• making it more difficult for us to satisfy our obligations;
• limiting our flexibility in planning for, or reacting to, changes in our business and the
industry in which we operate;
• obtaining financing in the future for working capital, capital expenditures and general
corporate purposes, including acquisitions, and may impede our ability to secure favorable lease
terms;
• making us more vulnerable to economic downturns and may limit our ability to withstand
competitive pressures;
• making it more difficult to continue to fund our strategic growth initiatives and retain and
attract key individuals; and
• placing us at a competitive disadvantage compared to our competitors with less debt and
greater financial resources.
Our future cash flow may not be sufficient to meet our obligations and commitments. If we are
unable to generate sufficient cash flow from operations in the future to service our indebtedness
and to meet our other commitments, we will be required to adopt one or more alternatives, such as
refinancing or restructuring our indebtedness, selling material assets, operations or seeking to
raise additional debt or equity capital or terminating significant numbers of key associates. These
actions may not be effected on a timely basis or on satisfactory terms or at all, and these actions
may not enable us to continue to satisfy our capital requirements. As a result, we may not be able
to maintain or accelerate our growth, and any failure to do so could adversely affect our ability
to generate revenue and control our expenses, which could adversely affect our business, financial
condition and results of operations.
Significant fluctuations in our revenues and net income may make it difficult for us to
achieve steady earnings growth on a quarterly or an annual basis, which may make the comparison
between periods difficult and may cause the price of our Class A common stock to decline.
We have experienced and continue to experience significant fluctuations in revenues and net
income as a result of many factors, including the timing of transactions, the commencement and
termination of contracts, revenue mix and the timing of additional selling, general and
administrative expenses to support new business activities. We provide many of our services without
written contracts or pursuant to contracts that are terminable at will.
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Consequently, many of our
clients can terminate or significantly reduce their relationships with us on very short notice for
any reason.
We plan our capital and operating expenditures based on our expectations of future revenues
and, if revenues are below expectations in any given quarter or year, we may be unable to adjust
capital or operating expenditures in a timely manner to compensate for any unexpected revenue
shortfall, which could have an immediate material adverse effect on our business, financial
condition and results of operation.
Our results of operation vary significantly among quarters during each calendar year, which
makes comparisons of our quarterly results difficult.
A significant portion of our revenue is seasonal. Historically, this seasonality has caused
our revenue, operating income, net income and cash flows from operating activities to be lower in
the first six months of the year and higher in the second half of the year. This variance among
periods during each calendar year makes comparison between such periods difficult, and it also
makes the comparison of the same periods during different calendar years difficult as well.
Employee misconduct, which is difficult to detect and deter, could harm us by impairing our
ability to attract and retain clients and subjecting us to significant legal liability and
reputational harm.
If our associates engage in misconduct, our business could be adversely affected. For example,
our business often requires that we deal with confidential matters of great significance to our
clients. It is not always possible to deter employee misconduct, and the precautions we take to
deter and prevent this activity may not be effective in all cases. If our associates were
improperly to use or disclose confidential information provided by our clients, we could be subject
to regulatory sanctions and suffer serious harm to our reputation, financial position and current
client relationships and significantly impair our ability to attract future clients, which could
adversely affect our business, financial condition and results of operation.
Compliance failures and changes in regulation could result in an increase in our compliance
costs or subject us to sanctions or litigation.
A number of our services are subject to regulation, including by the Securities and Exchange
Commission, National Association of Securities Dealers, Inc. (the “NASD”) and state real estate
commissions and securities regulators. Our failure to comply or have complied with applicable laws
or regulations could result in fines, suspensions of personnel or other sanctions, including
revocation of the registration of us or any of our subsidiaries as a commercial real estate broker
or broker-dealer. Even if a sanction imposed against us or our personnel is small in monetary
amount, the adverse publicity arising from the imposition of sanctions against us by regulators
could harm our reputation and cause us to lose existing clients or significantly impair our ability
to gain new clients. Our broker-dealer operations are subject to periodic examination by the
Securities and Exchange Commission and the NASD. Because the Reorganization Transactions resulted
in HFF, Inc. acquiring a greater than 25% equity interest in HFF Securities, a registered
broker-dealer, HFF Securities filed an application with the NASD for approval of the change of
control that was deemed to result from such transactions. As a result, HFF Securities complied with
the NASD requirements to provide advance notice of, and apply for approval of, the deemed change of
control and was permitted under the rules of the NASD to complete the Reorganization Transactions.
However, in connection with the application for a change of control, the NASD may identify
deficiencies in the procedures and practices of HFF Securities and may require HFF Securities to
take remedial action. The NASD may also identify significant violations of law, rules or
regulations, resulting in formal disciplinary action and the imposition of sanctions, including
potentially the revocation of HFF Securities’ registration as a broker-dealer. We cannot predict
the outcome of any such examinations or processes, and any negative regulatory action may have a
significant and material adverse affect on our company. In addition, it is possible that the
regulatory scrutiny of, and litigation in connection with, conflicts of interest will make our
clients less willing to enter into transactions in which such a conflict may occur, and will
adversely affect our businesses as well as significantly impair our ability to gain new clients,
which could adversely affect our business, financial condition and results of operation.
In addition, we may be adversely affected as a result of new or revised legislation or
regulations adopted by the Securities and Exchange Commission, other United States or state or
local governmental regulatory authorities or self-regulatory organizations that supervise the
financial and commercial real estate markets.
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Risks Related to Our Organizational Structure
Our only material asset is our units in the Operating Partnerships, and we are accordingly
dependent upon distributions from the Operating Partnerships to pay our expenses, taxes and
dividends (if and when declared by our board of directors).
HFF, Inc. is a holding company and has no material assets other than its ownership of
partnership units in the Operating Partnerships. HFF, Inc. has no independent means of generating
revenue. We intend to cause the Operating Partnerships to make distributions to its partners in an
amount sufficient to cover all expenses, applicable taxes payable and dividends, if any, declared
by our board of directors. To the extent that HFF, Inc. needs funds, and the Operating Partnerships
are restricted from making such distributions under applicable law or regulation or under any
present or future debt covenants, or are otherwise unable to provide such funds, it could
materially adversely affect our business, liquidity, financial condition and results of operation.
We will be required to pay HFF Holdings for most of the benefits relating to any additional
tax depreciation or amortization deductions we may claim as a result of the tax basis step-up we
receive, subsequent sales of our common stock and related transactions with HFF Holdings.
As
part of the Reorganization Transactions, approximately 45% of the
partnership units in each of the Operating Partnerships (including
partnership units in the Operating Partnerships held by Holliday GP) held by Holdings Sub, a wholly-owned subsidiary of HFF Holdings, were sold to
HoldCo LLC, our wholly-owned subsidiary, for cash raised in the initial public offering. In the
future, partnership units in HFF LP and HFF Securities held by HFF Holdings may be exchanged by HFF
Holdings for shares of our Class A common stock. The initial sale and subsequent exchanges are
expected to result in increases in the tax basis of the assets of HFF LP and HFF Securities that
would be allocated to HFF, Inc. These increases in tax basis would likely reduce the amount of tax
that we would otherwise be required to pay in the future depending on the amount, character and
timing of our taxable income, but there can be no assurances that such treatment will continue in
the future.
HFF, Inc. entered into a tax receivable agreement with HFF Holdings that provides for the
payment by HFF, Inc. to HFF Holdings of 85% of the amount of cash savings, if any, in U.S. federal,
state and local income tax that we actually realize as a result of these increases in tax basis and
as a result of certain other tax benefits arising from our entering into the tax receivable
agreement and making payments under that agreement. For purposes of the tax receivable agreement,
cash savings in income tax will be computed by comparing our actual income tax liability to the
amount of such taxes that we would have been required to pay had there been no increase to the tax
basis of the assets of HFF LP and HFF Securities as a result of the initial sale and later
exchanges and had we not entered into the tax receivable agreement. The term of the tax receivable
agreement will continue until all such tax benefits have been utilized or expired, including the
tax benefits derived from future exchanges.
While the actual amount and timing of payments under the tax receivable agreement will depend
upon a number of factors, including the amount and timing of taxable income we generate in the
future, the value of our individual assets, the portion of our payments under the tax receivable
agreement constituting imputed interest and increases in the tax basis of our assets resulting in
payments to HFF Holdings, we expect that the payments that may be made to HFF Holdings will be
substantial. Future payments to HFF Holdings in respect of subsequent exchanges would be in
addition to these amounts and are expected to be substantial. The payments under the tax receivable
agreement are not conditioned upon HFF Holdings’ or its affiliates’ continued ownership of us. We
may need to incur debt to finance payments under the tax receivable agreement to the extent our
cash resources are insufficient to meet our obligations under the tax receivable agreement as a
result of timing discrepancies or otherwise.
In addition, although we are not aware of any issue that would cause the Internal Revenue
Service, or IRS, to challenge the tax basis increases or other benefits arising under the tax
receivable agreement, HFF Holdings will not reimburse us for any payments previously made if such
basis increases or other benefits were later not allowed. As a result, in such circumstances we
could make payments to HFF Holdings under the tax receivable agreement in excess of our actual cash
tax savings.
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If HFF, Inc. was deemed an “investment company” under the Investment Company Act of 1940 as a
result of its ownership of the Operating Partnerships, applicable restrictions could make it
impractical for us to continue our business as contemplated and could have a material adverse
effect on our business.
If HFF, Inc. were to cease participation in the management of the Operating Partnerships, its
interest in the Operating Partnerships could be deemed an “investment security” for purposes of the
Investment Company Act. Generally, a person is deemed to be an “investment company” if it owns
investment securities having a value exceeding 40% of the value of its total assets (exclusive of
U.S. government securities and cash items) on an unconsolidated basis, absent an applicable
exemption. HFF, Inc. has no material assets other than its equity interest in the Operating
Partnerships and Holliday GP. A determination that this interest was an investment security could
result in HFF, Inc. being an investment company under the Investment Company Act and becoming
subject to the registration and other requirements of the Investment Company Act. HFF, Inc. will
not be deemed an investment company because it will manage the Operating Partnerships through its
wholly owned subsidiary, Holliday GP. Holliday GP is the sole general partner of each of the
Operating Partnerships.
The 1940 Act and the rules thereunder contain detailed parameters for the organization and
operations of investment companies. Among other things, the 1940 Act and the rules thereunder limit
or prohibit transactions with affiliates, impose limitations on the issuance of debt and equity
securities, prohibit the issuance of stock options, and impose certain governance requirements. We
intend to conduct our operations so that HFF, Inc. will not be deemed to be an investment company
under the 1940 Act. However, if anything were to happen which would cause HFF,
Inc. to be deemed to be an investment company under the 1940 Act, we could, among other
things, be required to substantially change the manner in which we conduct our operations either to
avoid being required to register as an investment company or to register as an investment company.
If we were required to register as an investment company under the 1940 Act, we would be subject to
substantial regulation with respect to, among other things, our capital structure (including our
ability to use leverage), management, operations, ability to transact business with affiliated
persons as defined in the 1940 Act (including our subsidiaries), portfolio composition (including
restrictions with respect to diversification and industry concentrations) and ability to compensate
key employees. These restrictions and limitations could make it impractical for us to continue our
business as currently conducted, impair our agreements and arrangements and materially adversely
affect our business, financial condition and results of operations.
Risks Related to Our Class A Common Stock
Control by HFF Holdings of the voting power in HFF, Inc. may give rise to conflicts of
interests and may prevent new investors from influencing significant corporate decisions.
Our certificate of incorporation provides that the holders of our Class B common stock (other
than HFF, Inc. or any of its subsidiaries) will be entitled to a number of votes that is equal to
the total number of shares of Class A common stock for which the partnership units that HFF
Holdings holds in the Operating Partnerships are exchangeable.
HFF Holdings currently has approximately 55% of the voting power in HFF, Inc. As a result,
because HFF Holdings will have a majority of the voting power in HFF, Inc. and our certificate of
incorporation does not provide for cumulative voting, HFF Holdings has the ability to elect all of
the members of our board of directors and thereby to control our management and affairs, including
determinations with respect to acquisitions, dispositions, borrowings, issuances of common stock or
other securities, and the declaration and payment of dividends. In addition, HFF Holdings will be
able to determine the outcome of all matters requiring stockholder approval and will be able to
cause or prevent a change of control of our company or a change in the composition of our board of
directors and could preclude any unsolicited acquisition of our company. We cannot assure you that
the interests of HFF Holdings and its members will not conflict with your interests.
The concentration of ownership could deprive our Class A stockholders of an opportunity to
receive a premium for their shares as part of a sale of our company and might ultimately affect the
market price of our Class A common stock. As a result of the control exercised by HFF Holdings over
us, we cannot assure you that we would not have received more favorable terms from an unaffiliated
party in our agreements with HFF Holdings.
In addition, the HFF LP and HFF Securities Profit Participation Bonus Plans may only be
amended or terminated with the written approval of all of the limited partners and general partners
of each Operating Partnership. Accordingly, so long as HFF Holdings continues to hold any
partnership units in the Operating
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Partnerships, the consent of HFF Holdings will required to amend
or terminate these plans. This could prevent our board of directors or management from amending or
terminating these plans.
Transformation into a public company may increase our costs and disrupt the regular operations
of our business.
Our business has historically operated as a privately-owned company, and we expect to incur
significant additional legal, accounting, reporting and other expenses as a result of having
publicly traded common stock. We will also incur costs which we have not previously incurred,
including, but not limited to, costs and expenses for directors fees, increased directors and
officers insurance, investor relations fees, expenses for compliance with the Sarbanes-Oxley Act
and new rules implemented by the Securities and Exchange Commission and the New York Stock
Exchange, and various other costs of a public company. On an annual basis, we estimate that we will
incur costs of more than $3 million per year as a result of becoming a publicly-traded company.
Since we have not operated as a public company before, there can be no assurance that this estimate
is accurate and our actual costs may be significantly higher.
We also anticipate that we will incur costs associated with recently adopted corporate
governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as amended,
as well as rules implemented by the SEC and the NYSE. We expect these rules and regulations to
increase our legal and financial compliance costs and make some management and corporate governance
activities more time-consuming and costly. These rules and regulations may make it more difficult
and more expensive for us to obtain director and officer liability insurance
and we may be required to accept reduced policy limits and coverage or incur substantially
higher costs to obtain the same or similar coverage, and therefore could have an adverse impact on
our ability to recruit and bring on a qualified independent board. We cannot predict or estimate
the amount of additional costs we may incur as a result of these requirements or the timing of such
costs.
The individuals who now constitute our management have never had responsibility for managing a
publicly-traded company, and we may experience difficulty attracting and retaining qualified
individuals to serve on our board of directors or as executive officers. The additional demands
associated with being a public company may disrupt regular operations of our business by diverting
attention of some of our most active senior transaction professionals away from revenue producing
activities to management and administrative oversight, adversely affecting our ability to attract
and complete business opportunities with clients and increasing difficulty in retaining transaction
professionals and managing and growing our businesses, the occurrence of any of which could harm
our business, financial condition and results of operations.
Our internal controls over financial reporting may not be effective and our independent
registered public accounting firm may not be able to certify as to their effectiveness, which could
have a significant and adverse effect on our business and reputation.
We will evaluate our internal controls over financial reporting in order to allow management
to report on, and our independent registered public accounting firm to attest to, our internal
controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002, as
amended, and rules and regulations of the SEC thereunder, which we refer to as “Section 404.” The
process of documenting and testing our internal control procedures in order to satisfy the
requirements of Section 404 requires annual management assessments of the effectiveness of our
internal controls over financial reporting and a report by our independent registered public
accounting firm addressing these assessments. During the course of our testing, we may identify
deficiencies which we may not be able to remediate in time to meet the deadline imposed by the
Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition, if we fail to
achieve and maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we may not be able to ensure that we can conclude on an
ongoing basis that we have effective internal controls over financial reporting in accordance with
Section 404. We cannot be certain as to the timing of completion of our evaluation, testing and any
remediation actions or the impact of the same on our operations. If we are not able to implement
the requirements of Section 404 in a timely manner or with adequate compliance, our independent
registered public accounting firm may not be able to certify as to the effectiveness of our
internal control over financial reporting and we may be subject to sanctions or investigation by
regulatory authorities, such as the SEC. As a result, there could be a negative reaction in the
financial markets due to a loss of confidence in the reliability of our financial statements. In
addition, we may be required to incur costs in improving our internal control system and the hiring
of additional personnel. Any such action could harm our reputation and cause us to lose existing
clients or fail to gain new clients and otherwise
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negatively affect our results of operations.
While our management has not identified any material weaknesses in our internal controls over
financial reporting at December 31, 2006, management has identified significant deficiencies
involving, among other things, the documentation of and adherence to certain accounting policy and
financial reporting matters and management and governance of information systems, which could have
an adverse effect on our business, financial condition or results of operations if not remediated
timely.
If securities analysts do not publish research or reports about our business or if they
downgrade our company or our sector, the price of our Class A common stock could decline.
The trading market for our Class A common stock will depend in part on the research and
reports that industry or financial analysts publish about us or our business. We do not control
these analysts. Furthermore, if one or more of the analysts who do cover us downgrades our company
or our industry, or the stock of any of our competitors, the price of our Class A common stock
could decline. If one or more of these analysts ceases coverage of our company, we could lose
visibility in the market, which in turn could cause the price of our Class A common stock to
decline.
Our share price may decline due to the large number of shares eligible for future sale and for
exchange.
The market price of our Class A common stock could decline as a result of sales of a large
number of shares of Class A common stock in the market after the offering or the perception that
such sales could occur. These sales, or the possibility that these sales may occur, also might make
it more difficult for us to sell equity securities in the future at a time and at a price that we
deem appropriate.
We have agreed with the underwriters not to dispose of or hedge any of our Class A common
stock or securities convertible into or exchangeable for shares of our Class A common stock,
subject to specified exceptions, until 180 days after the date of the prospectus used in connection
with our initial public offering, except with the prior written consent of the underwriters.
Subject to these agreements, we may issue and sell in the future additional shares of Class A
common stock.
In addition, HFF Holdings owns 20,355,000 partnership units in each of the Operating
Partnerships. Our amended and restated certificate of incorporation will allow the exchange of
partnership units in the Operating Partnerships (other than those held by us) for shares of our
Class A common stock on the basis of two partnership units (one in each Operating Partnership) for
one share of Class A common stock, subject to customary conversion rate adjustments for stock
splits, stock dividends and reclassifications. HFF Holdings has agreed with the underwriters not to
dispose of or hedge any of our Class A common stock or securities convertible into or exchangeable
for shares of our Class A common stock (including partnership units in the Operating Partnerships),
subject to specified exceptions, until 180 days after the date of the prospectus used in connection
with our initial public offering,, except with the prior written consent of the underwriters. After
the expiration of the 180-day lock-up period, the shares of Class A common stock issuable upon
exchange of the partnership units in the Operating Partnerships will be eligible for resale from
time to time, subject to certain contractual and Securities Act restrictions. Pursuant to
contractual provisions and subject to certain exceptions, HFF Holdings will be restricted from
exchanging partnership units for Class A common stock for two years. After two years, HFF Holdings
will have the right to exchange 25% of its partnership units, with an additional 25% becoming
available for exchange each year thereafter. However, these contractual provisions may be waived,
amended or terminated by the members of Holdings LLC following consultation with our Board of
Directors.
HFF Holdings has entered into a registration rights agreement with us. Under that agreement,
after the expiration of the 180-day lock-up period, HFF Holdings will have the ability to cause us
to register the shares of our Class A common stock it could acquire upon exchange of its
partnership units in the Operating Partnerships.
The market price of our Class A common stock may be volatile, which could cause the value of
your investment to decline or subject us to litigation.
Our stock price will be affected by a number of factors, including quarterly and annual
variations in our results and those of our competitors; changes to the competitive landscape;
estimates and projections by the investment community; the arrival or departure of key personnel,
especially the retirement or departure of key senior transaction professionals and management,
including members of HFF Holdings; the introduction of new services by us or our competitors; and
acquisitions, strategic alliances or joint ventures involving us or our competitors. Securities
markets worldwide experience significant price and volume fluctuations. This market volatility, as
well as general global and domestic economic, market or political conditions, could reduce the
market price of our Class A common
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stock. In addition, our operating results could be below the
expectations of public market analysts and investors, and in response, the market price of our
Class A common stock could decrease significantly. You may be unable to resell your shares of our
Class A common stock at or above the initial public offering price.
When the market price of a company’s common stock drops significantly, stockholders sometimes
institute securities class action lawsuits against the company. A securities class action lawsuit
against us could cause us to incur substantial costs and could divert the time and attention of our
management and other resources from our business.
Anti-takeover provisions in our charter documents and Delaware law could delay or prevent a
change in control.
Our certificate of incorporation and by-laws may delay or prevent a merger or acquisition that
a stockholder may consider favorable by permitting our board of directors to issue one or more
series of preferred stock, requiring advance notice for stockholder proposals and nominations,
providing for a classified board of directors, providing for super-majority votes of stockholders
for the amendment of the bylaws and certificate of incorporation, and placing limitations on
convening stockholder meetings and not permitting written consents of stockholders. In addition, we
are subject to provisions of the Delaware General Corporation Law that restrict certain business
combinations with interested stockholders. These provisions may also discourage acquisition
proposals or delay or prevent a change in control, which could harm our stock price.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices are located in leased office space at One Oxford Centre, 301
Grant Street, Suite 600, Pittsburgh, Pennsylvania. We also lease or sublease space for our offices
at Boston, Massachusetts; Hartford, Connecticut; Westport, Connecticut; New York, New York; Florham
Park, New Jersey; Washington, D.C.; Miami, Florida; Atlanta, Georgia; Indianapolis, Indiana;
Chicago, Illinois; Houston, Texas; Dallas, Texas; San Diego, California; Orange County, California;
Los Angeles, California; San Francisco, California and Portland, Oregon. We do not own any real
property. We believe that our existing facilities will be sufficient for the conduct of our
business during the next fiscal year.
Item 3. Legal Proceedings
We are party to various litigation matters, in most cases involving ordinary course and
routine claims incidental to our business. We cannot estimate with certainty our ultimate legal
and financial liability with respect to any pending matters. However, we believe, based on our
examination of such pending matters, that our ultimate liability for these matters will not have a
material adverse effect on our business or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our security holders during the fourth quarter of 2006.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.
Market Information
Our Class A common stock, par value $0.01 per share, trades on the New York Stock Exchange
(“NYSE”) under the symbol “HF.” In connection with our initial public offering, our Class A common
stock was priced for initial sale on January 30, 2007. There was no established public trading
market for our common stock prior to that date. On March 9, 2007 the closing sales price, as
reported by the NYSE was $17.59.
Holders
On
March 9, 2007, we had 1 stockholder of record of our common stock.
Dividends
We currently do not intend to pay cash dividends on our Class A common stock. If we do declare
a dividend at some point in the future, the Class B common stock will not be entitled to dividend
rights. The declaration and payment of any future dividends will be at the sole discretion of our
board of directors.
HFF, Inc. is a holding company and has no material assets other than its ownership of
partnership units in the Operating Partnerships. If we declare a dividend at some point in the
future, we intend to cause the Operating Partnerships to make distributions to HFF, Inc. in an
amount sufficient to cover any such dividends. If the Operating Partnerships make such
distributions, HFF Holdings will be entitled to ratably receive equivalent distributions on its
partnership units in the Operating Partnerships.
Initial Public Offering Use of Proceeds
We completed an initial public offering of our Class A common stock, par value $.01 per share,
on February 5, 2007 and the sale of additional shares pursuant to the underwriters’ over-allotment
option on February 22, 2007. In the offering, we sold 16,445,000 shares of Class A common stock
for an aggregate gross offering price of $296.0 million. These shares were registered for sale
under the Securities Act of 1933, as amended, pursuant to our Registration Statement on Form S-1
(File number 333-138579) which was declared effective by the Securities and Exchange Commission on
January 30, 2007. Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated acted as joint
book-running managers.
Net proceeds to us, after deducting underwriting discounts and commissions and offering
expenses, totaled approximately $271.6 million. Aggregate underwriting discounts and commissions
totaled approximately $20.7 million and aggregate offering expenses totaled approximately $3.7
million.
We used the net offering proceeds to us of $271.6 million to purchase from HFF Holdings all of
the shares of Holliday GP and the partnership units representing approximately 45% of each of the
Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday
GP). HFF Holdings used approximately $56.3 million its proceeds to repay all outstanding
indebtedness under HFF LP’s credit agreement. Accordingly, we did not retain any of the proceeds
from this offering.
Performance Graph
In connection with our initial public offering, our Class A common stock was priced for
initial sale on January 30, 2007. There was no established public trading market for our common
stock prior to that date.
Recent Sales of Unregistered Securities
On November 2, 2006, we issued 1 share of our common stock, par value $0.01 per share, to an
officer of the Company for $1.00. The issuance of such share of common stock was not registered
under the Securities Act,
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because the share was offered and sold in a transaction exempt from
registration under Section 4(2) of the Securities Act.
Issuer Purchases of Equity Securities.
On February 5, 2007, in connection with the closing of our initial public offering of Class A
common stock, we purchased the 1 share of common stock, par value $0.01 per share, held by an
officer of the Company (discussed above) for $1.00.
Item 6. Selected Financial Data
The following tables present our selected combined financial data, which reflects the
financial position and results of operations as if Holliday GP, the Operating Partnerships and HFF,
Inc., were combined for all periods presented. The selected historical combined financial data as
of and for the years ended December 31, 2006, 2005, and 2004 have been derived from our audited
combined financial statements included elsewhere in this Annual Report on Form 10-K, which have
been audited by Ernst & Young LLP, our independent registered public accounting firm. The selected
historical combined financial data for the period from June 16, 2003 through December 31, 2003 was
also derived from our audited consolidated financial statements, which have been audited by Ernst &
Young LLP, our independent registered public accounting firm, but are not otherwise included in
this Annual report on form 10-K. We derived the selected historical combined financial data set
forth below as of December 31, 2003, and 2002, and for the period from January 1, 2003 through June
15, 2003 and for the year ended December 31, 2002 from our unaudited combined financial information
not included elsewhere in this Annual Report on Form 10-K. Our historical results are not
necessarily indicative of future performance or results of operations. You should read the combined
historical financial data together with our combined financial statements and related notes
included in Item 8 of this Annual Report on Form 10-K and with Item 7—Management’s Discussion and
Analysis of Financial Condition and Results of Operations and the combined financial statements and
the related notes thereto and other financial data included elsewhere in this Annual Report on Form
10-K.
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| Successor | Predecessor (a) | ||||||||||||||||||||||||
| For the Year Ended | Year Ended | ||||||||||||||||||||||||
| December 31, | 6/16/03 - | 1/1/03 - | December 31, | ||||||||||||||||||||||
| 2006 | 2005 | 2004 | 12/31/03 | 6/15/03 | 2002 | ||||||||||||||||||||
| (unaudited) | (unaudited) | ||||||||||||||||||||||||
| (in thousands) | (in thousands) | ||||||||||||||||||||||||
Statement of Income Data: |
|||||||||||||||||||||||||
Total revenue |
$ | 229,697 | $ | 205,848 | $ | 143,691 | $ | 72,474 | $ | 36,725 | $ | 84,661 | |||||||||||||
Operating expenses |
174,903 | 157,619 | 113,961 | 58,579 | 32,461 | 78,658 | |||||||||||||||||||
Operating income |
54,794 | 48,229 | 29,730 | 13,895 | 4,264 | 6,003 | |||||||||||||||||||
Interest and other income |
632 | 274 | 67 | 63 | — | — | |||||||||||||||||||
Interest expense |
( 3,541 | ) | ( 80 | ) | ( 86 | ) | (38 | ) | — | — | |||||||||||||||
Income before income taxes |
51,885 | 48,423 | 29,711 | 13,920 | 4,264 | 6,003 | |||||||||||||||||||
Income taxes (b) |
332 | 288 | 296 | — | — | — | |||||||||||||||||||
Net income |
$ | 51,553 | $ | 48,135 | $ | 29,415 | $ | 13,920 | $ | 4,264 | $ | 6,003 | |||||||||||||
Balance Sheet Data: |
|||||||||||||||||||||||||
Total assets |
$ | 154,302 | $ | 38,630 | $ | 23,940 | $ | 34,361 | $ | 44,430 | |||||||||||||||
Long term debt, excluding current
portion |
$ | 91 | $ | 150 | $ | 193 | $ | 243 | $ | — | |||||||||||||||
Total liabilities |
$ | 198,620 | $ | 29,521 | $ | 11,568 | $ | 10,205 | $ | 11,749 | |||||||||||||||
| (a) | The financial information for the period from January 1, 2002 through June 15, 2003, is derived from unaudited financial information and general ledger reports provided by HFF LP’s parent company at that time. Prior to June 15, 2003, HFF LP was an indirect wholly-owned subsidiary of Lend Lease, an Australian company with a June 30 fiscal year. The acquisition of HFF LP on June 16, 2003 by HFF Holdings created a new basis of accounting and, accordingly, the financial information for the periods through December 31, 2003 are not comparable to recent periods and comparisons of those periods to recent periods may not be accurate indicators of our relative financial performance. | |
| (b) | We have historically operated as two limited liability companies (HFF Holdings and Holdings Sub), a corporation (Holliday GP) and two limited partnerships (HFF LP and HFF Securities), which two partnerships we refer to as the Operating Partnerships. As a result, our income has been subject to limited U.S. federal income taxes and our income and expenses have been passed through and reported on the individual tax returns of the members of HFF Holdings. Income taxes shown on the Company’s combined statements of income reflect federal income taxes of the corporation and business and corporate income taxes in various jurisdictions. Following the offering, the Company will be subject to additional entity-level taxes that will be reflected in our consolidated financial statements. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Key Financial Measures and Indicators – Costs and Expenses – Income Tax Expense.” |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Selected Financial Data and
our audited financial statements and the accompanying notes thereto included elsewhere herein. The
following discussion is based on the combined results of Holliday GP, the Operating Partnerships
and HFF, Inc. In addition to historical information, the following discussion also contains
forward-looking statements that include risks and uncertainties. Our actual results may differ
materially from those anticipated in these forward-looking statements as a result of certain
factors, including those factors set forth under Item 1A—Risk Factors of this Annual Report on Form
10-K.
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Overview
Our Business
We are a leading provider of commercial real estate and capital markets services to the U.S.
commercial real estate industry based on transaction volume and are one of the largest private
full-service commercial real estate financial intermediaries in the country. We operate out of 18
offices nationwide with more than 130 transaction professionals and approximately 270 support
associates. In 2006, we advised on approximately $36.4 billion of completed commercial real estate
transactions, approximately a 14.5% increase compared to the
approximately $31.8 billion of
completed transactions we advised on in 2005.
Substantially
all of our revenues are in the form of capital markets service 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 create a stable and
diversified revenue stream. Furthermore, we believe our business mix, operational expertise and the
leveragability of our platform have enabled us to achieve profit margins that are among the highest
of our public company peers. Our revenues and net income were $229.7 million and $51.6 million,
respectively, for the year ended December 31, 2006, compared to $205.8 million and $48.1 million,
respectively, for the year ended December 31, 2005.
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 and even a regional economic downturn could adversely affect our business. A general decline in acquisition and disposition activity can lead to a reduction in fees and commission 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 as well as a significant reduction in our loan servicing activities, due to increased delinquencies and lack of additional loans that we would have otherwise added to our loan servicing portfolio, all of which would have an adverse effect on our business. | ||
| • | 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 superior performance of other asset classes when compared with continued good 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. | ||
| • | 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. |
Other factors that may adversely affect our business are discussed under the heading
“Forward-Looking Statements” and under the caption “Risk Factors” in this Annual Report on Form
10-K.
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Key Financial Measures and Indicators
Revenues
Substantially
all of our revenues are derived from capital markets services. These capital
markets services revenues are in the form of fees collected from our clients, usually negotiated on a
transaction-by-transaction basis, which includes origination fees, investment sales fees earned for
brokering sales of commercial real estate, loan servicing fees and note sale and note sales
advisory and other production fees. We also earn interest on mortgage notes receivable. For the
year ended December 31, 2006, we had total revenues of approximately $229.7 million, of which
approximately 98% were attributable to capital markets services revenue, 0.6% were attributable to
interest on mortgage notes receivable and 1.4% were attributable to other revenue sources. For the
year ended December 31, 2005, our total revenues equaled approximately $205.8 million, of which
approximately 99% were generated by our capital markets services, 0.2% were attributable to
interest on mortgage notes receivable and 0.8% were attributable to other revenue sources.
Total Revenues:
Capital markets services revenues. We earn our capital markets services revenue through the
following activities and sources:
| • | Origination fees. Our origination fees are earned through the placement of debt, equity and structured financing. Debt placements represent the majority of our business, with approximately $22.1 billion of debt transaction volume in 2006. Fees earned by HFF Securities for discretionary and non-discretionary equity capital raises and other investment banking services are also included with capital markets services revenue in our consolidated statements of income. We recognize origination revenues at the closing of the applicable financing and funding of capital, when such fees are generally collected. | ||
| • | Investment sales fees. We earn investment sales fees by acting as a broker for commercial real estate owners seeking to sell a property(ies) or an interest in a property(ies). We recognize investment sales revenues at the close and funding of the sale, when such fees are generally collected. | ||
| • | Loan servicing fees. We generate loan servicing fees through the provision of collection, remittance, recordkeeping, reporting and other related loan servicing functions, activities and services. We also earn fees through escrow balances maintained as a result of required reserve accounts and tax and insurance escrows for the loans we service. We recognize loan servicing revenues at the time services are rendered, provided the loans are current and the debt service payments are actually made by the borrowers. We recognize the other fees related to escrows and other activities at the time the fees are paid. | ||
| • | Note sale, note sales advisory and other production fees. We generate note sale, note sales advisory and other production fees through assisting our clients in their efforts to sell all or portions of commercial real estate debt notes. We recognize note sale, note sales advisory and other production revenues at the close and funding of the capital to consummate sale, when such fees are generally collected. |
Interest on mortgage notes receivable. We recognize interest income on the accrual basis
during the approximately one month holding period based on the contract interest rate in the loan
that is to be purchased by Freddie Mac, provided that the debt service is paid by the borrower.
Other. Our other revenues include expense reimbursements from clients related to out of
pocket costs incurred, which reimbursements are considered revenue for accounting purposes.
A substantial portion of our transactions are success based, with a small percentage including
retainer fees (such retainer fees typically being included in a success-based fee upon the closing
of a transaction). Transactions that are terminated before completion will sometimes generate
breakage fees, which are usually calculated as a set amount or a percentage (which varies by deal
size and amount of work done at the time of breakage) of the fee we would
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have received had the
transaction closed. The amount and timing of all of the fees paid vary by the type of transaction
and are generally negotiated on a transaction-by-transaction basis.
Costs and Expenses
The largest components of our expenses are our operating expenses, which consist of cost of
services, personnel expenses not directly attributable to providing services to our clients,
occupancy expenses, travel and entertainment expenses, supplies, research and printing expenses and
other expenses. For the year ended December 31, 2006, our total operating expenses were
approximately $174.9 million. In addition, we incur non-operating expenses relating to interest
expense and income tax expense.
Operating Expenses:
Cost of Services. The largest portion of our expenses is cost of services. We consider
personnel expenses directly attributable to providing services to our clients and certain purchased
services to be directly attributable to the generation of our capital markets services revenue, and
classify these expenses as cost of services in the combined statements of income. Personnel
expenses include employee-related compensation and benefits. Most of our transaction professionals
are paid commissions; however, there are some transaction professionals who are initially paid a
salary with commissions credited against the salary. Analysts, who support transaction
professionals in executing transactions, are paid a salary plus a discretionary bonus, which is
usually calculated as a percentage of an analyst bonus pool or as direct bonuses for each
transaction, depending on the policy of each regional office. All other employees receive a
combination of salary and an incentive bonus based on performance, job function, individual office
policy/profitability, and overall corporate profitability.
Personnel. Personnel expenses include employee-related compensation and benefits that are not
directly attributable to providing services to our clients. In addition, personnel expense includes
profit participation bonuses in which offices or lines of business that generate profit margins of
14.5% or more are entitled to additional bonuses of 15% of net income from the office. The
allocation of the profit participation and how it is shared within the office are determined by the
office head with a review by the managing member of HFF Holdings. In 2006, total profit
participation bonuses paid were approximately 14% of operating profit before the profit
participation bonus.
Occupancy. Occupancy expenses include rental expenses and other expenses related to our 18
offices nationwide.
Travel and entertainment. Travel and entertainment expenses include travel and other
entertainment expenses incurred in conducting our business activities.
Supplies, research and printing. Supplies, research and printing expenses represent expenses
related to office supplies, market and other research (including expenses relating to our
proprietary database) and printing.
Other. The balance of our operating expenses include costs for insurance, professional fees,
depreciation and amortization, interest on our warehouse line of credit and other operating
expenses. We refer to all of these expenses below as “Other” expenses.
As a result of our initial public offering, we are no longer a privately-owned company and our
costs for such items as insurance, accounting and legal advice will increase substantially relative
to our historical costs for such services. We will also incur costs which we have not previously
incurred for directors fees, increased directors and officers insurance, investor relations fees,
expenses for compliance with the Sarbanes-Oxley Act and new rules implemented by the Securities and
Exchange Commission and the New York Stock Exchange, and various other costs of a public company.
On an annual basis, we estimate that we will incur costs of more than $3 million per year as a
result of becoming a publicly-traded company. Since we have not operated as a public company
before, there can be no guarantee that this estimate is accurate and our actual costs may be
significantly higher. In addition, we expect to incur substantial one-time costs in meeting the
legal and regulatory requirements of a public company, including Section 404 of the Sarbanes-Oxley
Act.
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Interest and Other Income:
Interest and other income consist primarily of interest earned from the investment of our cash
and cash equivalents and short-term investments.
Interest Expense:
Interest expense represents the interest on our outstanding debt instruments, including
indebtedness outstanding under our credit agreement.
Income Tax Expense:
We have historically operated as two limited liability companies (HFF Holdings and Holdings
Sub), a corporation (Holliday GP) and two limited partnerships (HFF LP and HFF Securities, which
two partnerships we refer to collectively as the Operating Partnerships). As a result, our income
has been subject to limited U.S. federal corporate income taxes (allocable to Holliday GP), and the
remainder of our income and expenses have been passed through and reported on the individual tax
returns of the members of HFF Holdings. Income taxes shown on our combined statements of income are
attributable to taxes incurred at the state and local level.
Following our initial public offering, the Operating Partnerships have and will continue to
operate in the U.S. as partnerships for U.S. federal income tax purposes. In addition, however,
HFF, Inc. is subject to additional entity-level taxes that will be reflected in our consolidated
financial statements.
In accordance with the partnership agreements, we intend to cause the Operating Partnerships
to make cash distributions to the holders of partnership units of the Operating Partnerships for
purposes of funding their tax obligations in respect of the income of the Operating Partnerships
that is allocated to them. Generally, these tax distributions will be computed based on our
estimate of the net taxable income of the Operating Partnerships allocable to such holder of
partnership units multiplied by an assumed tax rate equal to the highest effective marginal
combined U.S. federal, state and local income tax rate prescribed for an individual or corporate
resident of New York, New York (taking into account the nondeductibility of certain expenses and
the character of our income). If we had effected the Reorganization Transactions on January 1,
2006, this assumed tax rate for 2006 would have been approximately 46%.
Minority Interest:
On a historical basis, we have not reflected any minority interest in our financial results.
Following this offering, however, we will record significant minority interest relating to the
ownership interest of HFF Holdings in the Operating Partnerships. HoldCo LLC, a wholly-owned
subsidiary of HFF, Inc., will own the sole general partner of the Operating Partnerships.
Accordingly, although HFF, Inc. will have a minority economic interest in the Operating
Partnerships, it will have a majority voting interest and control the management of the Operating
Partnerships. The limited partners in the Operating Partnerships do not have kick-out rights or
other substantive participating rights. As a result, HFF, Inc. will consolidate the Operating
Partnerships and record a minority interest for the economic interest in the Operating Partnerships
indirectly held by HFF Holdings.
Results of Operations
Following is a discussion of our results of operation for the years ended December 31, 2006,
2005 and 2004. The tables included in the period comparisons below provide summaries of our
results of operations. The period-to-period comparisons of financial results are not necessarily
indicative of future results.
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Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
| For the Year | ||||||||||||||||||||||||
| Ended | ||||||||||||||||||||||||
| December 31, | ||||||||||||||||||||||||
| 2006 | 2005 | Total | Total | |||||||||||||||||||||
| % of | % of | Dollar | Percentage | |||||||||||||||||||||
| Dollars | Revenue | Dollars | Revenue | Change | Change | |||||||||||||||||||
| (dollars in thousands, unless percentages) | ||||||||||||||||||||||||
Revenues |
||||||||||||||||||||||||
Capital markets services revenue |
$ | 225,242 | $ | 203,457 | $ | 21,785 | ||||||||||||||||||
Interest on mortgage notes receivable |
1,354 | 412 | 942 | |||||||||||||||||||||
Other |
3,101 | 1,979 | 1,122 | |||||||||||||||||||||
Total revenues |
229,697 | 100 | % | 205,848 | 100 | % | 23,849 | 11.6 | % | |||||||||||||||
Operating expenses |
||||||||||||||||||||||||
Cost of services |
130,708 | 56.9 | % | 119,106 | 57.9 | % | 11,602 | 9.7 | % | |||||||||||||||
Personnel |
13,471 | 5.9 | % | 14,019 | 6.8 | % | (548 | ) | (3.9 | )% | ||||||||||||||
Occupancy |
6,319 | 2.8 | % | 5,357 | 2.6 | % | 962 | 18.0 | % | |||||||||||||||
Travel and entertainment |
5,789 | 2.5 | % | 5,067 | 2.5 | % | 722 | 14.2 | % | |||||||||||||||
Supplies, research and printing |
6,463 | 2.8 | % | 5,089 | 2.5 | % | 1,374 | 27.0 | % | |||||||||||||||
Other |
12,153 | 5.3 | % | 8,981 | 4.4 | % | 3,172 | 35.3 | % | |||||||||||||||
Total operating expenses |
174,903 | 76.2 | % | 157,619 | 76.7 | % | 17,284 | 11.0 | % | |||||||||||||||
Operating income |
54,794 | 23.8 | % | 48,229 | 23.3 | % | 6,565 | 13.6 | % | |||||||||||||||
Interest and other income |
632 | NM | 274 | NM | 358 | NM | ||||||||||||||||||
Interest expense |
(3,541 | ) | NM | (80 | ) | NM | (3,461 | ) | NM | |||||||||||||||
Income before taxes |
51,885 | 22.6 | % | 48,423 | 23.5 | % | 3,462 | 7.1 | % | |||||||||||||||
Income tax expense |
332 | NM | 288 | NM | 44 | NM | ||||||||||||||||||
Net income |
$ | 51,553 | 22.5 | % | $ | 48,135 | 23.4 | % | $ | 3,418 | 7.1 | % | ||||||||||||
| “NM” = Not Meaningful | ||
Revenues. Our total revenues were $229.7 million for the year ended December 31, 2006
compared to $205.8 million for the same period in 2005, an increase of $23.9 million, or 11.6%.
Revenues increased primarily as a result of increased production.
| • | The revenues we generated from capital markets services for the year ended December 31, 2006 increased $21.8 million, or 10.7%, to $225.2 million from $203.5 million for the same period in 2005. The increase is primarily attributable to increased production. | ||
| • | The revenues derived from interest on mortgage notes were $1.4 million for the year ended December 31, 2006 compared to $0.4 million for the same period in 2005, an increase of $1.0 million. Revenues increased primarily as a result of increased production of Freddie Mac loans. | ||
| • | The other revenues we earned were $3.1 million for the year ended December 31, 2006 compared to $2.0 million for the same period in 2005, an increase of $1.1 million, or 56.7%. Other revenues increased primarily as a result of expense reimbursements on a larger number of transactions with expense reimbursement compared to the number of transactions with expense reimbursement in 2005. |
Total Operating Expenses. Our total operating expenses were $174.9 million for the year ended
December 31, 2006 compared to $157.6 million for the same period in 2005, an increase of $17.3
million, or 11.0%. Expenses increased primarily due to commissions on increased production.
| • | The costs of services for the year ended December 31, 2006 increased $11.6 million, or 9.7%, to $130.7 million from $119.1 million for the same period in 2005. The increase is most significantly a result of commissions on increased capital markets services provided for clients. | ||
| • | Personnel expenses that are not directly attributable to providing services to our clients for the year ended December 31, 2006 decreased $0.5 million, or 3.9%, to $13.5 million from $14.0 million for the same period in 2005. The decrease is primarily related to a lower profit participation payout in 2006. |
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| • | Occupancy, travel and entertainment, and supplies, research and printing expenses for the year ended December 31, 2006 increased $3.1 million, or 19.7%, to $18.6 million compared to the same period in 2005. These increases are primarily due to increased business activity, and additional space occupied, higher rents and new office space. | ||
| • | Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $12.2 million in the year ended December 31, 2006, an increase of $3.2 million, or 35.3%, versus $9.0 million in the year ended December 31, 2005. This increase is primarily related to costs associated with increased Freddie Mac volume resulting in interest expense on our warehouse line and increased professional fees in relation to the contemplated reorganization transaction. |
Net Income. Our net income for the year ended December 31, 2006 was $51.6 million, an
increase of $3.5 million, or 7.1%, versus $48.1 million for the same fiscal period in 2005. We
attribute this increase to several factors, with the more significant cause being an increase of
operating income of $6.6 million. Other factors included:
| • | Interest and other income, partially offsetting the costs we incurred in these periods, increased $0.3 million, to $0.6 million versus $0.3 million earned in the year ended December 31, 2005. This increase is principally attributable to increased cash balances as a result of increased production. | ||
| • | The interest expense we incurred in the year ended December 31, 2006 totaled $3.5 million, an increase of $3.4 million from $0.1 million of similar expenses incurred in the year ended December 31, 2005. This increase resulted from the term loan of $60.0 million funded in March 2006. | ||
| • | Expenses from income tax were approximately $0.3 million for the years ended December 31, 2006 and 2005. |
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Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
| For the Year | ||||||||||||||||||||||||
| Ended | ||||||||||||||||||||||||
| December 31, | ||||||||||||||||||||||||
| 2005 | 2004 | Total | Total | |||||||||||||||||||||
| % of | % of | Dollar | Percentage | |||||||||||||||||||||
| Dollars | Revenue | Dollars | Revenue | Change | Change | |||||||||||||||||||
| (In thousands, unless percentages) | ||||||||||||||||||||||||
Revenues |
||||||||||||||||||||||||
Capital markets services revenue |
$ | 203,457 | $ | 142,192 | $ | 61,265 | ||||||||||||||||||
Interest on mortgage notes receivable |
412 | — | 412 | |||||||||||||||||||||
Other |
1,979 | 1,499 | 480 | |||||||||||||||||||||
Total revenues |
205,848 | 100 | % | 143,691 | 100 | % | 62,157 | 43.3 | % | |||||||||||||||
Operating expenses |
||||||||||||||||||||||||
Cost of services |
119,106 | 57.9 | % | 85,778 | 59.7 | % | 33,328 | 38.9 | % | |||||||||||||||
Personnel |
14,019 | 6.8 | % | 8,882 | 6.2 | % | 5,137 | 57.8 | % | |||||||||||||||
Occupancy |
5,357 | 2.6 | % | 5,047 | 3.5 | % | 310 | 6.1 | % | |||||||||||||||
Travel and entertainment |
5,067 | 2.5 | % | 3,617 | 2.5 | % | 1,450 | 40.1 | % | |||||||||||||||
Supplies, research and printing |
5,089 | 2.5 | % | 2,933 | 2.0 | % | 2,156 | 73.5 | % | |||||||||||||||
Other |
8,981 | 4.4 | % | 7,704 | 5.4 | % | 1,277 | 16.6 | % | |||||||||||||||
Total operating expenses |
157,619 | 76.7 | % | 113,961 | 79.3 | % | 43,658 | 38.3 | % | |||||||||||||||
Operating income |
48,229 | 23.3 | % | 29,730 | 20.7 | % | 18,499 | 62.2 | % | |||||||||||||||
Interest and other income |
274 | NM | 67 | NM | 207 | NM | ||||||||||||||||||
Interest expense |
(80 | ) | NM | (86 | ) | NM | 6 | NM | ||||||||||||||||
Income before taxes |
48,423 | 23.5 | % | 29,711 | 20.7 | % | 18,712 | 63.0 | % | |||||||||||||||
Income tax expense |
288 | NM | 296 | NM | (8 | ) | NM | |||||||||||||||||
Net income |
$ | 48,135 | 23.4 | % | $ | 29,415 | 20.5 | % | $ | 18,720 | 63.6 | % | ||||||||||||
| “NM” = Not Meaningful | ||
Total Revenues. Our total revenues were $205.8 million for the year ended December 31, 2005
compared to $143.7 million for 2004, an increase of $62.1 million, or 43.3%. Revenues increased
primarily as a result of increased business volume across all capital
markets services transaction
types.
| • | The revenues earned from our capital markets services for the year ended December 31, 2005 increased $61.3 million, or 43.1%, to $203.5 million from $142.2 million for the year ended December 31, 2004. The increase resulted from a number of factors, most significantly an increase in number of transactions as well as higher fees per transaction professional and an increase in the number of transaction professionals, a larger servicing portfolio and an increased focus on certain revenue sources that were not previously a main focus for the company including service fees from CMBS loans and expanding activity of HFF Securities. | ||
| • | The revenues derived from interest on mortgage notes receivable were $0.4 million for the year ended December 31, 2005. No such revenue was recorded in 2004. We earn interest on mortgage notes receivable in connection with our loan servicing business and our participation in Freddie Mac’s Program Plus Seller Servicer program. HFF LP qualified for this program in December 2004; accordingly, we did not begin earning revenue derived from this program until 2005. | ||
| • | Our other revenues increased $0.5 million to $2.0 million for the year ended December 31, 2005 compared with $1.5 million in 2004. Other revenues increased primarily as a result of expense reimbursements on a larger number of transactions. |
Total Operating Expenses. Our total operating expenses were $157.6 million for the year ended
December 31, 2005 compared to $114.0 million for the same period in 2004, an increase of $43.6
million, or 38.3%. Expenses increased primarily due to a $33.3 million increase in
employee-compensation related costs of services and certain purchased services directly
attributable to the generation of capital markets services revenue, a $5.1 million increase
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in personnel expenses, a $0.3 million increase in occupancy expenses, a $1.5 million increase
in travel and entertainment expenses and a $2.2 million increase in expenses related to supplies,
research and printing.
| • | Our cost of services for the year ended December 31, 2005 was $119.1 million, which represented a $33.3 million, or 38.9%, increase over $85.8 million in similar expenses incurred in 2004. We attribute this increase primarily to increased commissions we paid in 2005, which increase was directly attributable to our increased capital markets services revenue. | ||
| • | Personnel expenses for 2005 increased $5.1 million, or 57.8%, to $14.0 million from $8.9 million for the year ended December 31, 2004. The increase was primarily a result of an increase in the profit participation bonus that is calculated based on the net income of each office. | ||
| • | Our occupancy expenses were $5.4 million for 2005, which represented an increase of $0.3 million, or 6.1%, from $5.1 million in 2004. The primary reason for this increase was an increase in office space and operating leases to support our growth and expansion in several locations. Our travel and entertainment expenses increased $1.5 million, or 40.1%, to $5.1 million in 2005 from $3.6 million in 2004, while our supply, research and printing expenses increased $2.2, or 73.5% to $5.1 million for the year ended 2005 compared with $2.9 million in 2004. | ||
| • | Other expenses were $9.0 million in the year ended December 31, 2005, an increase of $1.3 million, or 16.6%, versus $7.7 million in 2004. This increase was most significantly attributable to an increase of our occupancy, depreciation and amortization expenses. |
Net Income. Our net income increased $18.7 million, or 63.6%, to $48.1 million for the year
ended December 31, 2005 versus $29.4 million in 2004. The primary reason underlying this increase
was a $18.5 million increase in operating income, which was principally driven by increased
business volume. Less significant factors included:
| • | Interest and other income increased $0.2 million to $0.3 million in the year ended 2005 compared with $0.1 million in 2004. This increase primarily arose as a consequence of higher cash balances resulting from increased net income. | ||
| • | Our interest expense incurred in each of 2005 and 2004 equaled $0.1 million. | ||
| • | Income tax expense incurred in each of 2005 and 2004 equaled $0.3 million. |
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Cash Flows
Our historical cash flows are primarily related to the timing of receipt of transaction fees,
the timing of distributions to members of HFF Holdings and payment of commissions and bonuses to
employees.
2006
Cash and cash equivalents decreased $5.5 million in the year ended December 31, 2006. Net cash
of $64.0 million was used in operating activities, primarily resulting from a $111.0 million
increase in mortgage notes receivable partially offset by $51.6 million from net income. Cash of
$2.6 million was used for investing in property and equipment. Financing activities provided $61.1
million of cash primarily due to a $111.0 million increase on our warehousing line of credit and
borrowings under our credit agreement of $60.0 million, which was partially offset by distributions
to HFF Holdings of $105.0 million.
2005
Cash and cash equivalents increased $0.1 million in the year ended December 31, 2005.
Operating activities provided $38.4 million, primarily resulting from $48.1 million in net income
partially offset by a $14.7 million increase in mortgage notes receivable. Cash of $1.5 million was
used to invest in property and equipment. Financing activities used $36.8 million of cash primarily
as a result of distributions to HFF Holdings of $51.4 million, which was partially offset by
borrowing in 2005 of $14.7 million under our warehouse line of credit.
2004
Cash and cash equivalents decreased $9.7 million in the twelve month period ended December 31,
2004. Cash of $33.4 million was provided by operating activities primarily due to $29.4 million
from net income. Investing activities used $1.6 million to purchase property and equipment. Net
cash used in financing activities was $41.5 million which was primarily related to distributions to
HFF Holdings of $41.2 million.
Liquidity and Capital Resources
Our current assets typically have consisted primarily of cash and accounts receivable in
relation to earned transaction fees. Our liabilities have typically consisted of accounts payable
and accrued compensation.
Cash distributions to HFF Holdings were generally made two times each year, although
approximately 75% to 90% of the anticipated total annual distribution was distributed to HFF
Holdings each January. Therefore, levels of cash on hand decrease significantly after the January
distribution of cash to HFF Holdings, and gradually increase until year end. As a result of the
offering, we will no longer make distributions as described above. Following the offering and in
accordance with the Operating Partnerships’ partnership agreements, we intend to cause the
Operating Partnerships to make distribution to its partners, including HFF, Inc., in an amount
sufficient to cover all applicable taxes payable by the members of HFF Holdings and by us and to
cover dividends, if any, declared by the board of directors.
Over the twelve month period ended December 31, 2006, we generated approximately $47.0 million
of cash from operations, excluding the funding of Freddie Mac loan closings discussed below. Our
short-term liquidity needs are typically related to compensation expenses and other operating
expenses such as occupancy, supplies, marketing, professional fees and travel and entertainment.
For the year ended December 31, 2006, we incurred approximately $174.9 million in total operating
expenses. The majority of our operating expenses are variable, highly correlated to our revenue
streams and dependent on the collection of transaction fees. During the year ended December 31,
2006, approximately 66% of our operating expenses were variable expenses. Our liquidity needs
related to our long term obligations are primarily related to our facility leases and long-term
debt obligations. In connection with our initial public offering, we paid off the entire balance of
our credit facility of $56.3 million and entered into a new credit facility that provides us with a
$40.0 million line of credit. We believe that cash flows from operating activities will be
sufficient to satisfy our long-term obligations. For the year ended December 31, 2006, we incurred
approximately $6.3 million in occupancy expenses and approximately $3.5 million in interest
expense.
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Our cash flow generated from operations historically has been sufficient to enable us to meet
our objectives. Assuming current conditions remain unchanged and our pipeline remains strong. We
believe that cash flows from operating activities should be sufficient for us to fund our current
obligations for the next 12 months and beyond. In addition, we maintain and intend to continue to
maintain lines of credit that can be utilized should the need arise. In the course of the past
several years, we have entered into financing arrangements designed to strengthen our liquidity.
Our current principal financing arrangements are described below.
On March 29, 2006, we entered into an $80.0 million credit agreement with Bank of America,
N.A. that matures on March 29, 2010, subject to our option to extend the maturity date an
additional 12 months upon the satisfaction of certain conditions set forth in the credit agreement.
The agreement consisted of a senior secured term loan facility in an aggregate amount of $60.0
million and a senior secured revolving credit facility in an aggregate amount of $20.0 million.
Borrowings under the credit agreement accrued interest at the applicable thirty-day London
Interbank Offered Rate, or LIBOR (5.33% at December 31, 2006), plus 250 basis points. We recognized
approximately $1 million of debt issuance cost and $3.5 million of interest expense for the twelve
months ended December 31, 2006. The proceeds from this term loan facility borrowings have been used
for distribution payments to the members of HFF Holdings and for working capital purposes. As a
result of the initial public offering, all amounts outstanding under this facility, including the
$20.0 million line of credit, became immediately due and payable upon the offering. A portion of
the proceeds received from HFF Holdings from the initial public offering was used to repay all outstanding borrowing under the
term loan facility and the revolving credit facility. We then entered into a new credit facility
with Bank of America, N.A. for a new $40 million line of credit that was put in place
contemporaneously with the consummation of the initial public offering. We believe that our
results from operations plus our new revolver of $40.0 million are sufficient to meet our working
capital needs.
In 2005, we entered into an uncommitted financing arrangement with Red Mortgage Capital, Inc.
to fund our Freddie Mac loan closings. Pursuant to this arrangement, Red Mortgage Capital funds
multifamily Freddie Mac loan closings on a transaction-by-transaction basis, with each loan being
separately collateralized by a loan and mortgage on a multifamily property that is ultimately
purchased by Freddie Mac. Red Mortgage Capital documents each funding with standard agreements,
including a Letter Agreement Regarding Participation Interest, a Participation and Servicing
Agreement and a Participation Certificate. Each of these documents generally remains unchanged from
transaction to transaction with the exception of the exhibit which outlines the specific terms of
the loan. As of December 31, 2006, we had outstanding borrowing of $125.7 million under this
arrangement and a corresponding amount of mortgage notes receivable. Borrowings under this
arrangement generally bear interest at the thirty day LIBOR rate plus 75 basis points, although
rates may be negotiated to a lower amount if the rate associated with the underlying Freddie Mac
loan does not cover the rate charged by Red Capital on the warehouse line of credit. Although we
intend to maintain this arrangement, we cannot guarantee that we will be able to do so. In the
event we are not able to secure a warehouse line of credit for our Freddie Mac loan closings, we
will cease originating Freddie Mac loans until we have an available warehouse line of credit. We
are also paid interest on our loan secured by a multifamily loan at the interest rate set forth in
the Freddie Mac note.
We regularly monitor our liquidity position, including cash levels, credit lines, interest and
payments on debt, capital expenditures and matters relating to liquidity and to compliance with
regulatory net capital requirements. We maintain a line of credit under our revolving credit
facility in excess of anticipated liquidity requirements. As of December 31, 2006, we had $20
million in undrawn line of credit available to us under our credit agreement with Bank of America,
N.A. This facility provides us with the ability to meet short-term cash flow needs resulting from
our various business activities. If this facility proves to be insufficient or unavailable to us,
we would seek additional financing in the credit or capital markets, although we may be
unsuccessful in obtaining such additional financing on acceptable terms or at all. In addition, we
entered into a tax receivable agreement with HFF Holdings that will provide for the payment by us
to HFF Holdings of 85% of the amount of cash savings, if any, in U.S. federal, state and local
income tax that we actually realize as a result of these increases in tax basis and as a result of
certain other tax benefits arising from our entering into the tax receivable agreement and making
payments under that agreement.
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Critical Accounting Policies; Use of Estimates
We prepare our financial statements in accordance with U.S. generally accepted accounting
principles. In applying many of these accounting principles, we need to make assumptions, estimates
and/or judgments that affect the reported amounts of assets, liabilities, revenues and expenses in
our consolidated financial statements. We base our estimates and judgments on historical experience
and other assumptions that we believe are reasonable under the circumstances. These assumptions,
estimates and/or judgments, however, are often subjective and they and our actual results may
change negatively based on changing circumstances or changes in our analyses. If actual amounts are
ultimately different from our estimates, the revisions are included in our results of operations
for the period in which the actual amounts become known. We believe the following critical
accounting policies could potentially produce materially different results if we were to change
underlying assumptions, estimates and/or judgments. See the notes to our consolidated financial
statements for a summary of our significant accounting policies.
Goodwill. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142,
“Goodwill and Other Intangible Assets,” we evaluate goodwill for potential impairment annually or
more frequently if circumstances indicate impairment may have occurred. In this process, we make
estimates and assumptions in order to determine the fair value of the Company. In determining the
fair value of the Company for purposes of evaluating goodwill for impairment, we utilize a
valuation multiple approach. In applying this approach, we use recent historical EBITDA amounts and
multiply by EBITDA multiples observed in transactions in the market. We utilize judgment in
determining which market transactions best represent our Company and the mix of our revenue
streams. We evaluate goodwill for impairment at the reporting unit level, which is the financial
statements of HFF LP. Based on HFF LP’s EBITDA levels as of December 31, 2006 and the results of
recent transactions in the market, HFF LP’s twelve-month rolling EBITDA could decrease by more than
$50 million before our estimated fair value of the Company would be lower than the book value of
the Company. Goodwill is considered impaired if the recorded book value of goodwill exceeds the
implied fair value of goodwill as determined under this valuation technique. We use our best
judgment and information available to us at the time to perform this review. Because our
assumptions and estimates are used in projecting future earnings as part of the valuation, actual
results could differ.
Intangible Assets. Our intangible assets primarily include servicing rights under agreements
with third party lenders and deferred financing costs. Servicing rights are recorded at the lower
of cost or market. Management makes certain judgments and estimates in determining the fair value
of servicing rights. These judgments and estimates include prepayment levels of the underlying
mortgages, the income margin expected to be realized by the Company and the discount rate. The
prepayment level is the most important factor affecting the value of the servicing rights.
Management estimates the prepayment levels of the underlying mortgages by analyzing recent
historical experience. Many of the commercial loans being serviced have financial penalties for
prepayment or early payoff before the stated maturity date. As a result, the Company has
consistently experienced a low level of loan runoff. The estimated value of the servicing rights is
impacted by changes in these assumptions. As of December 31, 2006, the fair value and net book
value of the servicing rights were $2.8 million and $2.4 million, respectively. A 10% and 20%
increase in the level of assumed prepayments would decrease the estimated fair value of the
servicing rights by 35% and 49%, respectively. A 10% and 20% decrease in the estimated net income
margin of the servicing business would decrease the estimated fair value of the servicing rights by
29% and 37%, respectively. A 10% and 20% increase in the discount rate would decrease the estimated
fair value of the servicing rights by 25% and 29%, respectively. The effect of a variation in each
of these assumptions on the estimated fair value of the servicing rights is calculated
independently without changing any other assumption. Servicing rights are amortized over their
estimated useful life using a method of amortization that reflects the pattern of economic benefit,
which results in an accelerated level of amortization over eight years. In accordance with
Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” we
evaluate amortizable intangible assets on an annual basis, or more frequently if circumstances so
indicate, for potential impairment.
Leases. The Company leases all of its facilities under operating lease agreements. These
lease agreements typically contain tenant improvement allowances and rent holidays. In instances
where one or more of these items are included in a lease agreement, the Company records these
allowances as a leasehold improvement asset, included in property and equipment, net in the
consolidated balance sheet, and a related deferred rent liability and amortizes these items on a
straight-line basis over the shorter of the term of the lease or useful life of the asset as
additional depreciation expense and a reduction to rent expense, respectively. Lease agreements
sometimes contain
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rent escalation clauses, which are recognized on a straight-line basis over the life of the
lease in accordance with SFAS No. 13, Accounting for Leases. Lease terms generally range from two
to ten years. Before entering into a lease, an analysis is performed to determine whether a lease
should be classified as a capital or an operating lease according to SFAS No. 13, as amended.
Certain Information Concerning Off-Balance Sheet Arrangements
We do not currently invest in any off-balance sheet vehicles that provide liquidity, capital
resources, market or credit risk support, or engage in any leasing activities that expose us to any
liability that is not reflected in our combined financial statements.
Contractual and Other Cash Obligations
The following table summarizes our contractual and other cash obligations at December 31, 2006:
| Payments due by period | ||||||||||||||||||||
| Less than | 1-3 | 3-5 | More than | |||||||||||||||||
| Total | 1 year | years | years | 5 years | ||||||||||||||||
Long-term debt |
$ | 56,250 | $ | 56,250 | $ | — | $ | — | $ | — | ||||||||||
Capital lease obligations |
234 | 143 | 86 | 5 | — | |||||||||||||||
Operating lease obligations |
28,662 | 4,754 | 8,746 | 6,749 | 8,413 | |||||||||||||||
Purchase obligations |
— | — | — | — | — | |||||||||||||||
Other long-term liabilities
reflected on the balance
sheet |
— | — | — | — | — | |||||||||||||||
Total contractual obligations |
$ | 85,146 | $ | 61,147 | $ | 8,832 | $ | 6,754 | $ | 8,413 | ||||||||||
Seasonality
Our capital markets services revenue are seasonal, which can affect an investor’s ability to
compare our financial condition and results of operation on a quarter-by-quarter basis.
Historically, this seasonality has caused our revenue, operating income, net income and cash flows
from operating activities to be lower in the first six months of the year and higher in the second
half of the year. The concentration of earnings and cash flows in the last six months of the year
is due to an industry-wide focus of clients to complete transactions towards the end of the
calendar year.
Effect of Inflation
Inflation will significantly affect our compensation costs, particularly those not directly
tied to our transaction professionals’ compensation, due to factors such as increased costs of
capital. The rise of inflation could also significantly and adversely affect certain of expenses,
such as debt service costs, information technology and occupancy costs. To the extent that
inflation results in rising interest rates and has other effects upon the commercial real estate
markets in which we operate and, to a lesser extent, the securities markets, it may affect our
financial position and results of operations by reducing the demand for commercial real estate and
related services which could have a material adverse effect on our financial condition. See “Risk
Factors — General Economic Conditions and Commercial Real Estate Market Conditions.”
Recent Accounting Pronouncements
SFAS 123(R). On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued
SFAS No. 123 (revised 2003), Share-Based Payment, or SFAS 123(R), which is a revision of SFAS No.
123, Accounting for Stock-Based Compensation. SFAS 123(R) supersedes Accounting Principles Board
(“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement
of Cash Flows. Generally, the
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approach in SFAS 123(R) is similar to the approach described in SFAS
123. However, SFAS 123(R) requires all
share-based payments to employees, including grants of employee stock options, to be
recognized in the consolidated statements of income based on their fair values. Pro forma
disclosure is no longer an option. We have operated as a series of partnerships and limited
liability companies and have not historically issued stock-based compensation awards. The Company
adopted SFAS 123(R) on January 1, 2006, using the modified prospective method. The impact of
adopting SFAS 123(R) will depend on the nature and level of share-based awards granted in the
future.
SFAS 154. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections,
or SFAS 154. SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB SFAS No. 3,
Reporting Accounting Charges in Interim Financial Statements. SFAS 154 requires that a voluntary
change in accounting principle be applied retrospectively with all prior period financial
statements presented on the new accounting principle, unless it is impracticable to do so. SFAS 154
also provides that a correction of errors in previously issued financial statements should be
termed a “restatement.” The new standard is effective for accounting changes and correction of
errors beginning July 1, 2005. The Company adopted SFAS 154 on January 1, 2006. The adoption of
SFAS 154 did not have a material effect on the Company’s consolidated financial condition or result
of operations.
SFAS 156. In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets — an amendment of FASB Statement No. 140,” or SFAS 156. SFAS No. 156 requires an entity to
recognize a servicing asset or servicing liability at fair value each time it undertakes an
obligation to service a financial asset by entering into a servicing contract, regardless of
whether explicit consideration is exchanged. The statement also permits a company to choose to
either subsequently measure servicing rights at fair value and to report changes in fair value in
earnings, or to retain the amortized method whereby servicing rights are recorded at the lower of
cost or fair value and are amortized over their expected life, including servicing contracts with
no recorded value. The provisions of SFAS 156 are effective for fiscal years beginning after
September 15, 2006. The Company plans to retain the amortization method upon adoption of FAS 156,
but will begin recognizing the fair value of servicing assets and liabilities on any new servicing
contracts involving no consideration acquired after January 1, 2007. The impact of adopting this
provision of FAS 156 will likely be material to the Company’s financial condition and results of
operations and will depend on the volume and timing of servicing received after January 1, 2007.
SFAS 157. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157
or Statement). The Statement was issued to define fair value, establish a framework for measuring
fair value in generally accepted accounting principles (GAAP), and to expand fair value disclosure
requirements. Prior to issuance of this Statement, different definitions of fair value existed
within GAAP, and there was limited guidance available on applying existing fair value definitions.
The Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. Prior to
adoption, we will evaluate the impact of adopting SFAS 157 on our consolidated financial
statements.
FIN 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies
the application of SFAS No. 109, Accounting for Income Taxes, by defining a criterion that an
individual tax position must meet for any part of the benefit of that position to be recognized in
an enterprise’s financial statements and also provides guidance on measurement, derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after December 15, 2006, but earlier adoption is
permitted. We will adopt FIN 48 for the first quarter ended March 31, 2007. We are currently
assessing the impact the adoption of FIN 48 will have on our financial position and results of
operations.
Recent Developments
In connection with our initial public offering, in February 2007, we entered into an amended
and restated credit agreement with Bank of America, N.A.. This credit agreement consists of a
revolving credit facility in the maximum principal amount of $40.0 million. Borrowings under the
credit agreement bear interest at (a) the applicable London Interbank Offered Rate, or LIBOR rate
(for interest periods of one, two, three, six or twelve months) plus (b) the applicable margin of
200 basis points, 175 basis points or 150 basis points (such margin is
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determined from time to time
in accordance with the credit agreement, based on our then applicable consolidated leverage ratio). We may also elect, subject to the terms of the credit agreement, to cause
borrowings to accrue interest at the Base Rate, which is equal to the greater of (i) the federal
funds rate plus 50 basis points or (ii) the prime rate, as determined pursuant to the credit
agreement, plus 150 basis points. As of March 9, 2007, we had no borrowings under our revolving
credit facility. The credit agreement matures on April 5, 2010, subject to our option to extend
the maturity date an additional twelve months upon the satisfaction of certain conditions set forth
in the credit agreement.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Due to the nature of our business and the manner in which we conduct our operations, in
particular that our financial instruments which are exposed to concentrations of credit risk
consist primarily of short-term cash investments, we believe we do not face any material interest
rate risk, foreign currency exchange rate risk, equity price risk or other market risk.
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Item 8. Financial Statements and Supplementary Data
| Page | ||||
HFF, Inc.: |
||||
| 38 | ||||
| 39 | ||||
| 40 | ||||
HFF, Inc., Combined: |
||||
| 45 | ||||
| 46 | ||||
| 47 | ||||
| 48 | ||||
| 49 | ||||
| 51 | ||||
HFF Holdings, LLC and Subsidiaries: |
||||
| 69 | ||||
| 70 | ||||
| 71 | ||||
| 72 | ||||
| 73 | ||||
| 75 | ||||
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Report of Independent Registered Public Accounting Firm
The Board of Directors and
Stockholders
HFF, Inc.
HFF, Inc.
We have audited the accompanying statement of financial condition of HFF, Inc. as of December
31, 2006. This statement of financial condition is the responsibility of the Company’s management.
Our responsibility is to express an opinion on this statement of financial condition based on our
audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of financial condition is free of material
misstatement. We were not engaged to perform an audit of the Company’s internal control over
financial reporting. Our audit included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but not for
the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
statement of financial condition,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall statement of financial condition presentation.
We believe that our audit of the statement of financial condition provides a
reasonable basis for our opinion.
In
our opinion, the statement of financial condition referred to above presents fairly, in all material
respects, the financial position of HFF, Inc. as of December 31, 2006, in conformity with
U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Pittsburgh, Pennsylvania
March 8, 2007
March 8, 2007
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HFF, Inc.
Statement of Financial Condition
As of December 31, 2006
As of December 31, 2006
Assets — Cash |
$ | 1 | ||
Stockholder’s Equity: |
||||
Class A Common Stock, par value $.01 per share, 1,000 shares authorized 1 share issued and outstanding |
$ | — | ||
Additional Paid in Capital |
1 | |||
Total Stockholder’s Equity |
$ | 1 | ||
See accompanying notes.
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HFF, Inc
Notes to Statement of Financial Condition
NOTES TO STATEMENT OF FINANCIAL CONDITION
1. Organization
HFF, Inc., a Delaware corporation, was formed in November 2006 in connection with a proposed
initial public offering of its Class A common stock (the “Offering”). HFF, Inc. has not engaged in
any business or other activities except in connection with its formation.
As a result of a reorganization into a holding company structure to be effected simultaneously with
the Offering, HFF, Inc. will become a holding company through a series of transactions pursuant to
a sale and purchase agreement. Upon consummation of the Offering and reorganization, HFF, Inc.’s
sole assets will be, through its wholly-owned subsidiary HFF Partnership Holdings LLC, a Delaware
limited liability company (“HoldCo LLC”), partnership interests in Holliday Fenoglio Fowler, L.P.,
a Texas limited partnership (“HFF LP”) and HFF Securities L.P., a Delaware limited partnership and
registered broker-dealer (“HFF Securities” and together with HFF LP, the “Operating Partnerships”)
and all of the shares of Holliday GP Corp., a Delaware corporation and the sole general partner of
each of the Operating Partnerships (“Holliday GP”).
As the controlling owner of Holliday GP, the sole general partner of the Operating Partnerships,
HFF, Inc. will operate and control all of the business and affairs of the Operating Partnerships
and continue to conduct the business now conducted by the Operating Partnerships, acting as a
financial intermediary and advisor in the commercial real estate industry, and engaging in debt,
private equity, and structured financing placements, as well as investment sales, note sales, and
loan servicing out of offices in 18 cities nationwide. The “Company,” as used in Note 4 below,
refers to HFF, Inc., the newly formed Delaware corporation and its consolidated subsidiaries, after
giving effect to the reorganization transactions.
HFF, Inc. will consolidate the financial results of the Operating Partnerships and the ownership
interest of HFF Holdings in the Operating Partnerships will be treated as a minority interest in
HFF, Inc.’s consolidated financial statements.
2. Summary of Significant Accounting Policies
Basis of Presentation
The statement of financial condition has been prepared in accordance with accounting principles
generally accepted in the United States. Separate statements of income, changes in stockholders’
equity and cash flows have not been presented in the financial statements because there have been
no activities of this entity.
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HFF, Inc.
Notes to Statement of Financial Position (continued)
3. Stockholders’ Equity
HFF, Inc. is authorized to issue 1,000 shares of Class A common stock, $.01 par value per share.
HFF, Inc. has issued one share of Class A common stock in exchange for $1.00.
4. Subsequent Events
On November 9, 2006, HFF, Inc. filed a registration statement on Form S-1 with the United States
Securities and Exchange Commission (the “SEC”) relating to a proposed underwritten initial public
offering of 14,300,000 shares of Class A common stock of HFF, Inc. On January 30, 2007, the SEC
declared the registration statement on Form S-1 effective and the Company priced 14,300,000 shares
for the initial public offering at a price of $18.00 per share. On January 31, 2007, the Company’s
common stock began trading on the New York Stock Exchange under the symbol “HF.”
On February 5, 2007, the Company closed its initial public offering of 14,300,000 shares of
common stock. Net proceeds from the sale of the stock were $235.7 million, net of $18.0 million of
underwriting commissions and $3.7 million of offering expenses. The proceeds of the public offering
were used to purchase from HFF Holdings all of the shares of Holliday GP and purchase from HFF
Holdings partnership units representing approximately 39% of each of the Operating Partnerships
(including partnership units in the Operating Partnerships held by Holliday GP). HFF Holdings used
approximately $56.3 million of its proceeds to repay all outstanding indebtedness under HFF LP’s
credit agreement. Accordingly the Company did not retain any of the proceeds from this offering.
On February 22, 2007, the underwriters exercised their option to purchase an additional 2,145,000
shares of Class A common stock (15% of original issuance) at $18.00 per share. Net proceeds of the
overallotment were $35.9 million, net of $2.7 million of underwriting commissions and other
expenses. These proceeds were used to purchase HFF Holdings partnership units representing
approximately 6.0% of each of the Operating Partnerships.
In addition to cash received for its sale of all of the shares of Holliday GP and approximately 45%
of partnership units of each of the Operating Partnerships (including partnership units in the
Operating Partnerships held by Holliday GP), HFF Holdings also received an exchange right that will
permit HFF Holdings to exchange interests in the Operating Partnerships for shares of (i) HFF,
Inc.’s Class A common stock (the “Exchange Right”) and (ii) rights under a tax receivable agreement
between HFF, Inc. and HFF Holdings (the “TRA”).
As a result of the offering, HFF Holdings beneficially owns 20,355,000 partnership units in each of
the Operating Partnerships. Pursuant to the terms of HFF, Inc.’s amended and restated certificate
of incorporation, HFF Holdings could from time to time exchange its partnership units
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HFF, Inc.
Notes to
Statement of Financial Position (continued)
in the Operating Partnerships for shares of the Company’s Class A common stock on the basis of
two partnership units, one of each Operating Partnership, for one share of Class A common stock,
subject to customary conversion rate adjustments for stock splits, stock dividends and
reclassifications. The following table reflects HFF Holdings’ right to
exchange its partnership units in the Operating Partnerships for shares of the Company’s Class A
common stock pursuant to contractual provisions in the HFF Holdings Operating Agreement. However,
these contractual provisions may be waived, amended or terminated by a vote of the members holding
65% of the interests of HFF Holdings following consultation with the board of directors.
| Percentage of HFF | ||||||||
| Number of | Holdings’ Partnership | |||||||
| Additional Shares | Units in the | |||||||
| of Class A Common | Operating | |||||||
| Stock Expected to | Partnerships | |||||||
| Become Available | Becoming Eligible | |||||||
| Anniversary of the Offering | for Exchange | for Exchange | ||||||
Second |
5,088,750 | 25 | % | |||||
Third |
5,088,750 | 25 | % | |||||
Fourth |
5,088,750 | 25 | % | |||||
Fifth |
5,088,750 | 25 | % | |||||
Total |
20,355,000 | 100 | % | |||||
HFF Holdings was issued one share of the Company’s Class B common stock. Class B common stock
has no economic rights but will entitle the holder to a number of votes that is equal to the total
number of shares of Class A common stock for which the partnership units that HFF Holdings holds in
the Operating Partnerships as of the relevant record date for the HFF, Inc. stockholder action are
exchangeable.
HFF LP and HFF Securities intend to have an election under Section 754 of the Internal Revenue Code
effective for 2007 and for each taxable year in which an exchange of partnership units for shares
occurs. The initial sale is expected to produce (and later exchanges may produce) increases to the
tax basis of the assets owned by HFF LP and HFF Securities at the time of the initial public
offering (and at the time of each exchange of partnership units). These anticipated increases in
tax basis would be allocated to the Company and would likely reduce the amount of tax that the
Company would otherwise be required to pay in the future. HFF, Inc. entered into a tax receivable
agreement with HFF Holdings that provides for the payment by HFF, Inc. to HFF Holdings of 85% of
the amount of cash savings, if any, in U.S. federal, state and local income tax that the Company
actually realizes as a result of these increases in tax basis and as a result of certain other tax
benefits arising from the Company entering into the tax receivable agreement and making payments
under that agreement. For purposes of the tax receivable agreement, cash savings in income tax will
be computed by comparing the Company’s actual income tax liability to the amount of such taxes that
it would have been required to pay had there been no increase to the tax basis of the assets of HFF
LP and HFF Securities as a result of the initial sale and later
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HFF, Inc.
Notes to
Statement of Financial Position (continued)
exchanges and had the Company not entered into the tax receivable agreement. The term of the
tax receivable agreement commences upon consummation of the offering and will continue until all
such tax benefits have been utilized or expired, including the tax benefits derived from future
exchanges. While the actual amount and timing of payments under the tax receivable agreement will
depend upon a number of factors, including the amount and timing of taxable income generated in the
future, the value of individual assets, the portion of the Company’s payments under the tax
receivable agreement constituting imputed interest and increases in the tax basis of the Company’s
assets resulting in payments to HFF Holdings, the Company expects that the payments that may be
made to HFF Holdings will be substantial. Assuming no material changes in the relevant tax law and
that the Company earns significant taxable income to realize the full tax benefit of the increased
amortization of its assets, the Company expects that future payments to HFF Holdings in respect of
the initial sale and the overallotment to aggregate approximately $127.0 million and range from
approximately $5.0 million to $14.0 million per year over the next 15 years. Future payments to HFF
Holdings in respect of subsequent exchanges would be in addition to these amounts and are expected
to be substantial. The payments under the tax receivable agreement are not conditioned upon HFF
Holdings’ or its affiliates’ continued ownership of the Company.
The Company will account for the income tax effects and corresponding tax receivable agreement
effects as a result of the initial purchase and the sale of units of the Operating Partnerships in
connection with the reorganization transactions and future exchanges of Operating Partnership units
for the Company’s Class A shares by recognizing an increase in its deferred tax asset for the
estimated income tax effects of the increase in the tax basis of the assets owned by the Operating
Partnerships, based on enacted tax rates at the date of the transaction, less any tax valuation
allowance the Company believes is required if the Company evaluates it is more likely than not
that it will realize the benefit represented by the deferred tax asset, and the Company will record
85% of the estimated amount of the increase in deferred tax assets, net of any valuation allowance,
as a liability to HFF Holdings under the tax receivable agreement and the remaining 15% of the
increase in deferred tax assets directly in additional paid-in capital in stockholders’ equity.
All of the effects of changes in any of the Company’s estimates after the date of any exchange will
be included in net income. Similarly, the effect of subsequent changes in the enacted tax rates
will be included in net income.
Prior to
the effective date of the offering, the sole Stockholder of HFF, Inc. and the Board of
Directors adopted the HFF, Inc., 2006 Omnibus Incentive Compensation Plan (the “Plan”). Upon the
effective date of the registration statement, grants were awarded under the Plan to certain
employees and the Board of Directors. The Plan imposes limits on the awards that may be made to
any individual during a calendar year. The number of shares available for awards under the terms
of the Plan is 3,500,000 (subject to stock splits, stock dividends and similar transactions).
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HFF, Inc.
Notes to
Statement of Financial Position (continued)
4. Subsequent Event (continued)
On February 5, 2007, HFF LP entered into an Amended and Restated Credit Agreement with Bank of
America, N.A. (Amended Credit Agreement). The Amended Credit Agreement is comprised of a $40.0
million revolving credit facility, which replaced The New Credit Agreement mentioned in note 5.
The Amended Credit Agreement matures on February 5, 2010 and may be extended for one year based on
certain conditions as defined in the agreement.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
HFF, Inc.
HFF, Inc.
We have
audited the accompanying combined balance sheets as of
December 31, 2006 and 2005, of HFF, Inc., Holliday GP Corp.,
Holliday Fenoglio Fowler, L.P. and HFF Securities L.P. (the Combined
Companies) and the related combined statements of income, stockholders’
equity/partners’ capital (deficiency), and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the
responsibility of the Combined Companies’
management. Our responsibility is to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. We
were not engaged to perform an audit of the Combined Companies’ internal control over financial reporting.
Our audits included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Combined Companies’ internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
As discussed in Note 1, the combined financial statements reflect the financial position and
results of operations and cash flows as if the Combined Companies were combined for all
periods presented.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the combined financial position at December 31, 2006 and 2005, of the Combined Companies and the combined results of their operations and their cash flows for each of the three
years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting
principles.
/s/ Ernst & Young LLP
Pittsburgh, Pennsylvania
March 8, 2007
March 8, 2007
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HFF, Inc.
Combined Balance Sheets
(Dollars In Thousands)
| December 31 | ||||||||
| 2006 | 2005 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 3,345 | $ | 8,836 | ||||
Restricted cash (Note 5) |
2,440 | 389 | ||||||
Accounts receivable |
2,508 | 921 | ||||||
Receivable
from affiliate (Note 12) |
3,003 | 468 | ||||||
Mortgage notes receivable (Note 6) |
125,700 | 14,700 | ||||||
Prepaid expenses and other current assets |
4,533 | 1,671 | ||||||
Total current assets |
141,529 | 26,985 | ||||||
Property and equipment, net (Note 3) |
5,040 | 4,276 | ||||||
Goodwill |
3,712 | 3,712 | ||||||
Intangible assets, net (Note 4) |
3,293 | 2,889 | ||||||
Other noncurrent assets |
728 | 768 | ||||||
| $ | 154,302 | $ | 38,630 | |||||
Liabilities and stockholders’ equity/partners’ capital: |
||||||||
Current liabilities: |
||||||||
Current portion of long-term debt (Note 5) |
$ | 56,393 | $ | 122 | ||||
Warehouse line of credit (Note 6) |
125,700 | 14,700 | ||||||
Accrued compensation and related taxes |
10,836 | 10,800 | ||||||
Accounts payable |
856 | 330 | ||||||
Other current liabilities |
2,162 | 905 | ||||||
Total current liabilities |
195,947 | 26,857 | ||||||
Deferred rent credit |
2,404 | 2,366 | ||||||
Other long-term liabilities |
178 | 148 | ||||||
Long-term debt, less current portion (Note 5) |
91 | 150 | ||||||
Total liabilities |
198,620 | 29,521 | ||||||
Stockholders’ equity/partners’ capital: |
||||||||
Class A common stock, par value $0.01 per share, 1,000
shares authorized, 1 share outstanding |
— | — | ||||||
Partners’ capital (deficiency) |
(44,318 | ) | 9,109 | |||||
Total stockholders’ equity/partners’ capital (deficiency) |
(44,318 | ) | 9,109 | |||||
| $ | 154,302 | $ | 38,630 | |||||
See accompanying notes.
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HFF, Inc.
Combined Statements of Income
(Dollars In Thousands)
| Years Ending December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Revenues |
||||||||||||
Capital markets services revenue |
$ | 225,242 | $ | 203,457 | $ | 142,192 | ||||||
Interest on mortgage notes receivable |
1,354 | 412 | — | |||||||||
Other |
3,101 | 1,979 | 1,499 | |||||||||
| 229,697 | 205,848 | 143,691 | ||||||||||
Expenses |
||||||||||||
Cost of services |
130,708 | 119,106 | 85,778 | |||||||||
Personnel |
13,471 | 14,019 | 8,882 | |||||||||
Occupancy |
6,319 | 5,357 | 5,047 | |||||||||
Travel and entertainment |
5,789 | 5,067 | 3,617 | |||||||||
Supplies, research, and printing |
6,463 | 5,089 | 2,933 | |||||||||
Insurance |
1,457 | 1,459 | 1,046 | |||||||||
Professional fees |
2,023 | 1,101 | 807 | |||||||||
Depreciation and amortization |
2,806 | 2,595 | 2,466 | |||||||||
Interest on warehouse line of credit |
1,375 | 409 | — | |||||||||
Other operating |
4,492 | 3,417 | 3,385 | |||||||||
| 174,903 | 157,619 | 113,961 | ||||||||||
Operating income |
54,794 | 48,229 | 29,730 | |||||||||
Interest and other income |
632 | 274 | 67 | |||||||||
Interest expense |
(3,541 | ) | (80 | ) | (86 | ) | ||||||
Income before taxes |
51,885 | 48,423 | 29,711 | |||||||||
Income tax expense |
332 | 288 | 296 | |||||||||
Net income |
$ | 51,553 | $ | 48,135 | $ | 29,415 | ||||||
See accompanying notes.
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HFF, Inc.
Combined Statements of Stockholders’ Equity/Partners’ Capital (Deficiency)
(Dollars In Thousands, except share data)
(Dollars In Thousands, except share data)
| Common Stock | Partners’ | |||||||||||||||
| Shares | Amount | Capital | Total | |||||||||||||
Stockholders’ equity/partners’ capital,
December 31, 2003 |
— | $ | — | $ | 24,156 | $ | 24,156 | |||||||||
Net income |
— | — | 29,415 | 29,415 | ||||||||||||
Distributions |
— | — | (41,199 | ) | (41,199 | ) | ||||||||||
Stockholders’ equity/partners’ capital,
December 31, 2004 |
— | — | 12,372 | 12,372 | ||||||||||||
Net income |
— | — | 48,135 | 48,135 | ||||||||||||
Distributions |
— | — | (51,398 | ) | (51,398 | ) | ||||||||||
Stockholders’ equity/partners’ capital,
December 31, 2005 |
— | — | 9,109 | 9,109 | ||||||||||||
Issuance of class A common stock |
1 | — | — | — | ||||||||||||
Net income |
— | — | 51,553 | 51,553 | ||||||||||||
Distributions |
— | — | (104,980 | ) | (104,980 | ) | ||||||||||
Stockholders’ equity/partners’ capital
(deficiency), December 31, 2006 |
1 | $ | — | $ | (44,318 | ) | $ | (44,318 | ) | |||||||
See accompanying notes.
48
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HFF, Inc.
Combined Statements of Cash Flows
(Dollars In Thousands)
(Dollars In Thousands)
| Year Ended December 31 | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Operating activities |
||||||||||||
Net income |
$ | 51,553 | $ | 48,135 | $ | 29,415 | ||||||
Adjustments to reconcile net income to net
cash provided by operating activities: |
||||||||||||
Depreciation and amortization: |
||||||||||||
Property and equipment |
1,728 | 1,611 | 1,352 | |||||||||
Intangibles |
1,078 | 984 | 1,114 | |||||||||
(Gain) loss on sale or
disposition of assets |
(507 | ) | (140 | ) | 28 | |||||||
Purchase of NASD license |
— | — | (100 | ) | ||||||||
Increase (decrease) in cash from
changes in: |
||||||||||||
Restricted cash |
(2,051 | ) | 392 | (244 | ) | |||||||
Accounts receivable |
(1,587 | ) | (721 | ) | 944 | |||||||
Receivable from affiliate |
(2,535 | ) | 567 | 160 | ||||||||
Mortgage notes receivable |
(111,000 | ) | (14,700 | ) | — | |||||||
Prepaid expenses and other
current assets |
(2,862 | ) | (569 | ) | (684 | ) | ||||||
Other noncurrent assets |
40 | (449 | ) | (230 | ) | |||||||
Accrued compensation and
related taxes |
36 | 2,935 | 985 | |||||||||
Accounts payable |
526 | 25 | 7 | |||||||||
Other accrued liabilities |
1,257 | 466 | (25 | ) | ||||||||
Other long-term liabilities |
290 | (162 | ) | 654 | ||||||||
Net cash (used) provided by operating activities |
(64,034 | ) | 38,374 | 33,376 | ||||||||
Investing activities |
||||||||||||
Purchases of property and equipment |
(2,624 | ) | (1,447 | ) | (1,646 | ) | ||||||
Net cash used in investing activities |
(2,624 | ) | (1,447 | ) | (1,646 | ) | ||||||
Financing activities |
||||||||||||
Net borrowings on warehouse line of credit |
111,000 | 14,700 | — | |||||||||
Borrowings on long-term debt |
60,000 | — | — | |||||||||
Payments on long-term debt |
(3,878 | ) | (86 | ) | (274 | ) | ||||||
Deferred financing costs |
(975 | ) | (14 | ) | — | |||||||
Partners’ distributions |
(104,980 | ) | (51,398 | ) | (41,199 | ) | ||||||
Net cash provided by (used) in financing
activities |
61,167 | (36,798 | ) | (41,473 | ) | |||||||
Net (decrease) increase in cash |
(5,491 | ) | 129 | (9,743 | ) | |||||||
Cash and cash equivalents, beginning of period |
8,836 | 8,707 | 18,450 | |||||||||
Cash and cash equivalents, end of period |
$ | 3,345 | $ | 8,836 | $ | 8,707 | ||||||
49
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HFF, Inc.
Combined Statements of Cash Flows — continued
(Dollars In Thousands)
Combined Statements of Cash Flows — continued
(Dollars In Thousands)
| Years Ended December 31 | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Supplemental disclosure of cash flow
information |
||||||||||||
Cash paid for income taxes |
$ | 362 | $ | 288 | $ | 296 | ||||||
Cash paid for interest |
$ | 4,442 | $ | 444 | $ | 86 | ||||||
Supplemental disclosure of non-cash financing
activities |
||||||||||||
Property acquired under capital leases |
$ | 90 | $ | 89 | $ | 28 | ||||||
See accompanying notes.
50
Table of Contents
HFF, Inc.
Notes to Combined Financial Statements
1. Organization
HFF, Inc., a Delaware corporation, was formed in November 2006 in connection with a proposed
initial public offering of its Class A common stock (the “Offering”). HFF, Inc. has not engaged
in any business or other activities except in connection with its formation.
As a result of the reorganization into a holding company structure in connection with the Offering,
HFF, Inc. became a holding company through a series of transactions pursuant to a sale and purchase
agreement. Pursuant to the Offering and reorganization, HFF, Inc.’s sole assets are through its
wholly-owned subsidiary HFF Partnership Holdings, LLC, a Delaware limited liability company,
partnership interests in Holliday Fenoglio Fowler, L.P. a Texas limited partnership (“HFF LP”) and
HFF Securities L.P., a Delaware limited partnership and registered broker-dealer (“HFF Securities”
and together with HFF LP, the “Operating Partnerships”) and all of the shares of Holliday GP Corp.,
a Delaware corporation and the sole general partner of each of the Operating Partnerships
(“Holliday GP”).
HFF, Inc., through its Operating Partnerships, is a financial intermediary and advisor in the
commercial real estate industry, and engages in debt, private equity, and structured financing
placements, as well as investment sales, note sales, and loan servicing in 18 major cities
nationwide.
HFF LP was acquired on June 16, 2003 and accounted for in accordance with Statement of Financial
Accounting Standards (SFAS) No, 141, Business Combinations (SFAS No. 141). The total purchase
price of $8.8 million was allocated to the assets acquired and liabilities assumed based on
estimated fair values at the date of acquisition.
During 2004, HFF LP and Holliday GP formed HFF Securities. HFF Securities is a broker-dealer that
performs private placements of securities by raising equity capital from institutional investors
for discretionary, commingled real estate funds to execute real estate acquisitions,
recapitalizations, developments, debt investments, and other real estate-related strategies. HFF
Securities may also provide other investment banking and advisory services on various project or
entity-level strategic assignments such as mergers and acquisitions, sales and divestitures,
recapitalizations and restructurings, privatizations, management buyouts, and arranging joint
ventures for specific real estate strategies.
The reorganization transaction is being treated, for financial reporting purposes, as a
reorganization of entities under common control. As such, these financial statements present the
combined financial position and results of operations as if HFF, Inc., Holliday GP and the
Operating Partnerships (collectively referred to as the Company) were combined for all periods
presented.
51
Table of Contents
HFF, Inc.
Notes to
Combined Financial Statements (continued)
1. Organization (continued)
Distributions
Distributions of distributable cash flow (as defined) are made upon approval of the Operating
Committee. Such distributions generally must be made to members first to the extent of unpaid
cumulative preferred returns (15% per year) on the initial capital contribution, and second in
proportion to their respective percentage interests.
2. Summary of Significant Accounting Policies
Combination
The combined financial statements reflect the financial position and results of operations as if
HFF, Inc., Holliday GP, HFF LP, and HFF Securities were combined for all periods presented. All
intercompany accounts have been eliminated.
Concentrations of Credit Risk
The Company’s financial instruments that are exposed to concentrations of credit risk consist
primarily of cash. The Company places its cash with financial institutions in amounts which at
times exceed the FDIC insurance limit. The Company has not experienced any losses in such accounts
and believes it is not exposed to any significant credit risk on cash.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and in bank accounts, and short-term investments
with original maturities of three months or less.
52
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HFF, Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Revenue Recognition
Capital markets services revenues consist of origination fees, investment sale fees, note sale
fees, placement fees, and servicing fees. Origination fees are earned for the placement of debt,
equity, or structured financing for real estate transactions. Investment sales and note sales fees
are earned for brokering sales of real estate and/or notes. Placement fees are earned by HFF
Securities for discretionary and nondiscretionary equity capital raises and other investment
banking services. These fees are negotiated between the Company and its clients, generally on a
case-by-case basis and are recognized and generally collected at the closing and the funding of the
transaction. The Company’s fee agreements do not include terms or conditions that require the
Company to perform any service or fulfill any obligation once the transaction closes and revenue is
recognized. Servicing fees are compensation for providing collection, remittance, recordkeeping,
reporting, and other services for either lenders or borrowers on mortgages placed with third-party
lenders. Servicing fees are recognized when cash is collected as these fees are contingent upon the
borrower making its payments on the loan.
Certain of the Company’s fee agreements provide for reimbursement of employee-related costs which
the Company recognizes as revenue. In accordance with EITF 00-14, Income Statement Characterization
of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, certain reimbursements received
from clients for out-of-pocket expenses are characterized as revenue in the statement of income
rather than as a reduction of expenses incurred. Since the Company is the primary obligor, has
supplied discretion, and bears the credit risk for such expenses, the Company records reimbursement
revenue for such out-of-pocket expenses. Reimbursement revenue is recognized when the fees for the
related transaction are collected at the closing of the transaction. Reimbursement revenue is
classified as other revenue in the combined statement of income.
Mortgage Notes Receivable
The Company is qualified with the Federal Home Loan Mortgage Corporation (Freddie Mac) as a Freddie
Mac Multifamily Program Plus® Seller/Servicer. Under this Program, the Company originates mortgages
based on commitments from Freddie Mac, and then sells the loans to Freddie Mac approximately one
month following the loan originations. The Company recognizes interest income on the accrual basis
during this holding period based on the contract interest rate in the loan that will be purchased
by Freddie Mac.
53
Table of Contents
HFF, Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
The loans are initially recorded and then subsequently sold to Freddie Mac at the Company’s cost.
The Company monitors the market value of these loans for declines in value from the origination
date to the sale date. Based on the Company’s evaluation, no valuation allowance for lower of cost
or market adjustments was necessary as of December 31, 2006 and 2005.
Freddie
Mac requires HFF LP to meet minimum net worth and liquid assets requirements and to comply
with certain other standards. Following the closing of the Credit Agreement in March 2006 and the
distribution of the proceeds to the members, HFF LP did not meet such minimum net worth requirement, therefore, HFF LP entered into a $2.0 million letter of credit backed by
$2.0 million in cash which is classified as Restricted Cash on the balance sheet as of December 31,
2006. In connection with the Company’s initial public offering, discussed in Note 13 below, and the resulting
payoff of the entire outstanding balance under the Credit Agreement in February 2007, HFF LP now meets Freddie
Mac’s minimum net worth requirement (see note 5).
Advertising
Costs associated with advertising are expensed as incurred. Advertising expense was $0.8 million,
$0.8 million and $0.6 million for the years ended December 31, 2006, 2005 and 2004, respectively.
These amounts are included in other operating expenses in the accompanying combined statements of
income.
Property and Equipment
Property and equipment are recorded at cost, except for those assets acquired on June 16, 2003,
which were recorded at their estimated fair values. Depreciation of furniture and computer
equipment is computed using accelerated methods over five to seven years. Depreciation of software
costs is computed using the straight-line method over three years. Leasehold improvements are
depreciated using the straight-line method over the shorter of the term of the lease or useful life
of the asset.
Expenditures for routine maintenance and repairs are charged to expense as incurred. Renewals and
betterments which substantially extend the useful life of an asset are capitalized.
Leases
The Company leases all of its facilities under operating lease agreements. These lease agreements
typically contain tenant improvement allowances and rent holidays. In instances where one or more
of these items are included in a lease agreement, the Company records these allowances as a
leasehold improvement asset, included in property and equipment, net in the
54
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HFF, Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
combined
balance sheets and a related deferred rent liability and amortizes these items on a
straight-line basis over the shorter of the term of the lease or useful life of the asset as
additional depreciation expense and a reduction to rent expense, respectively. Lease agreements
sometimes contain rent escalation clauses, which are recognized on a straight-line basis over the
life of the lease in accordance with SFAS No. 13, Accounting for Leases. Lease terms generally
range from two to ten years. Before entering into a lease, an analysis is performed to determine
whether a lease should be classified as a capital or an operating lease according to SFAS No. 13,
as amended.
Computer Software Costs
Certain costs related to the development or purchases of internal-use software are capitalized in
accordance with the American Institute of Certified Public Accountants (AICPA) Statement of
Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. Internal computer software costs that are incurred in the preliminary project stage
are expensed as incurred. Direct consulting costs as well as payroll and related costs, which are
incurred during the development stage of a project are capitalized and amortized using the
straight-line method over estimated useful lives of three years when placed into production.
Goodwill
Goodwill of $3.7 million represents the excess of the purchase price over the estimated fair value
of the acquired net assets of HFF on June 16, 2003 (see Note 1). In accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, the Company does not amortize goodwill, but evaluates
goodwill on an annual basis for potential impairment.
Prepaid Compensation Under Employment Agreements
The Company has employment agreements with certain employees whereby sign-up bonuses and incentive
compensation payments were made during 2004, 2005 and 2006. In most cases, the sign-up bonuses and
the incentive compensation are to be repaid to the Company upon voluntary termination by the
employee or termination by cause (as defined) by the Company prior to the termination of the
employment agreement. The total cost of the employment agreements is being amortized by the
straight-line method over the term of the agreements and is included in cost of services on the
accompanying combined statements of income.
55
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Producer Draws
As part of the Company’s overall compensation program, the Company offers a new producer draw
arrangement which generally lasts until such time as a producer’s pipeline of business is
sufficient to allow the producer to earn sustainable commissions. This program is intended to
provide the producer with a minimal amount of cash flow to allow adequate time for the producer to
develop business relationships. Similar to traditional salaries, the producer draws are paid
irrespective of the actual fees generated by the producer. Often these producer draws represent the
only form of compensation received by the producer. Furthermore, it is not the Company’s policy to
seek collection of unearned producer draws under this arrangement. As a result, the Company has
concluded that producer draws are economically equivalent to salaries paid and accordingly, charges
them to compensation as incurred. The producer is also entitled to earn a commission on closed
revenue transactions. Commissions are calculated as the commission that would have been earned by
the broker under one of the Company’s commission programs, less any amount previously paid to the
producer in the form of a draw.
Intangible Assets
Intangible assets include servicing rights under agreements with third-party lenders, costs
associated with obtaining a NASD license, and deferred financing costs.
Servicing rights were recorded at their estimated fair value of $5.4 million on June 16, 2003, and
are being amortized over the expected life of the mortgage servicing rights in proportion to the
estimated future net servicing income. Additionally, servicing rights are capitalized on loans
originated and sold to FHLMC with servicing retained based on an allocation of the carrying amount
of the loan and the servicing right in proportion to the relative fair values at the date of sale.
These servicing rights are recorded at the lower of cost or fair value and are being amortized over
their expected life. The determination of fair value of the servicing rights is determined using a
discounted cash flow model which considers various factors such as estimated prepayment speeds of
the underlying mortgages, the estimated life of the mortgages, the estimated cost to service the
loans, and the discount rate.
Deferred financing costs were deferred and are being amortized by the straight-line method over
four years, which approximates the effective interest method.
56
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
HFF Securities has recognized an intangible asset in the amount of $0.1 million for the costs of
obtaining a NASD license as a broker-dealer. The license is determined to have an indefinite useful
economic life and is, therefore, not being amortized.
The Company periodically evaluates the remaining useful lives and carrying values of the intangible
assets to determine whether events and circumstances indicate that a change in the useful life or
impairment in value may have occurred. Indicators of impairment monitored by management include a
decline in the level of serviced loans. No indicators of impairment were noted as a result of
management’s evaluation. This evaluation is performed at least annually.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Income Taxes
The Company has historically operated as two limited liability companies (HFF Holdings and Holdings
Sub), a corporation (Holliday GP) and two limited partnerships (HFF LP and HFF Securities). As a
result, income has been subject to limited U.S. federal income taxes and income and expenses have
been passed through and reported on the individual tax returns of the members of HFF Holdings.
Income taxes shown on the Company’s combined statements of income reflect federal income taxes of
the corporation and business and corporate income taxes in various jurisdictions. Following the
offering, the Company will be subject to additional entity-level taxes that will be reflected in
its combined financial statements.
Cost of Services
The Company considers personnel expenses directly attributable to providing services to its
clients, such as salaries, commission and bonuses to producers and analysts, and certain purchased
services to be directly attributable to the generation of capital markets services revenue and has
classified these expenses as costs of services in the combined statements of income.
57
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Segment Reporting
The Company operates in one reportable segment, the commercial real estate financial intermediary
segment and offers debt placement, investment sales, note sales, structured finance, equity
placement and investment banking services through its 18 offices. The results of each office have
been aggregated for segment reporting purposes as they have similar economic characteristics and
provide similar services to a similar class of customer.
Recent Accounting Pronouncements
SFAS 123(R). On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 123 (revised 2003), Share-Based Payment, or SFAS 123(R), which is a revision of SFAS No. 123,
Accounting for Stock-Based Compensation. SFAS 123(R) supersedes Accounting Principles Board (“APB”)
Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash
Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the combined statements of income based on their fair values.
Pro forma disclosure is no longer an option. We have operated as a series of partnerships and
limited liability companies and have not historically issued stock-based compensation awards. The
Company adopted SFAS 123(R) on January 1, 2006, using the modified prospective method. The impact
of adopting SFAS 123(R) will depend on the nature and level of share-based awards granted in the
future.
SFAS 154. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, or
SFAS 154. SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB SFAS No. 3, Reporting
Accounting Charges in Interim Financial Statements. SFAS 154 requires that a voluntary change in
accounting principle be applied retrospectively with all prior period financial statements
presented on the new accounting principle, unless it is impracticable to do so. SFAS 154 also
provides that a correction of errors in previously issued financial statements should be termed a
“restatement.” The new standard is effective for accounting changes and correction of errors
beginning July 1, 2005. The Company adopted SFAS 154 on January 1, 2006. The adoption of SFAS 154
did not have a material effect on the Company’s combined financial condition or result of
operations.
58
Table of Contents
HFF, Inc.
Notes to
Combined Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
SFAS 156. In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets — an amendment of FASB Statement No. 140,” or SFAS 156. SFAS No. 156 requires an entity to
recognize a servicing asset or servicing liability at fair value each time it undertakes an
obligation to service a financial asset by entering into a servicing contract, regardless of
whether explicit consideration is exchanged. The statement also permits a company to choose to
either subsequently measure servicing rights at fair value and to report changes in fair value in
earnings, or to retain the amortized method whereby servicing rights are recorded at the lower of
cost or fair value and are amortized over their expected life, including servicing contracts with
no recorded value. The provisions of SFAS 156 are effective for fiscal years beginning after
September 15, 2006. The Company plans to retain the amortization method upon adoption of FAS 156,
but will begin recognizing the fair value of servicing assets and liabilities on any new servicing
contracts involving no consideration acquired after January 1, 2007. The impact of adopting this
provision of FAS 156 will likely be material to the Company’s financial condition and results of
operations and will depend on the volume and timing of servicing received after January 1, 2007.
SFAS 157. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157 or
Statement). The Statement was issued to define fair value, establish a framework for measuring fair
value in generally accepted accounting principles (GAAP), and to expand fair value disclosure
requirements. Prior to issuance of this Statement, different definitions of fair value existed
within GAAP, and there was limited guidance available on applying existing fair value definitions.
The Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. Prior to
adoption, the Company will evaluate the impact of adopting SFAS 157 on its combined financial
statements.
FIN 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies
the application of SFAS No. 109, Accounting for Income Taxes, by defining a criterion that an
individual tax position must meet for any part of the benefit of that position to be recognized in
an enterprise’s financial statements and also provides guidance on measurement, derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after December 15, 2006, but earlier adoption is
permitted. The Company will adopt FIN 48 for the first quarter ended
March 31, 2007. The Company is currently
assessing the impact the adoption of FIN 48 will have on its financial position and results of
operations.
59
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
3. Property and Equipment
Property and equipment consist of the following (in thousands):
| December 31 | ||||||||
| 2006 | 2005 | |||||||
Furniture and equipment |
$ | 3,202 | $ | 2,199 | ||||
Computer equipment |
1,530 | 1,199 | ||||||
Capitalized software costs |
831 | 739 | ||||||
Leasehold improvements |
5,005 | 3,718 | ||||||
Subtotal |
10,568 | 7,855 | ||||||
Less accumulated depreciation and amortization |
(5,528 | ) | (3,579 | ) | ||||
| $ | 5,040 | $ | 4,276 | |||||
At December 31, 2006 and 2005, the Company has recorded office equipment, within furniture and
equipment, under capital leases of $0.5 million and $0.4 million, respectively, including
accumulated amortization of $0.3 million and $0.2 million, respectively, which is included within
depreciation and amortization expense on the accompanying combined statements of income. See Note 7
for discussion of the related capital lease obligations.
4. Intangible Assets
The Company’s intangible assets are summarized as follows (in thousands):
| December 31, 2006 | December 31, 2005 | |||||||||||||||||||||||
| Gross | Gross | |||||||||||||||||||||||
| Carrying | Accumulated | Net Book | Carrying | Accumulated | Net Book | |||||||||||||||||||
| Amount | Amortization | Value | Amount | Amortization | Value | |||||||||||||||||||
Amortizable intangible assets: |
||||||||||||||||||||||||
Mortgage servicing rights |
$ | 6,085 | $ | (3,695 | ) | $ | 2,390 | $ | 5,578 | $ | (2,803 | ) | $ | 2,775 | ||||||||||
Deferred financing costs |
988 | (185 | ) | 803 | 14 | — | 14 | |||||||||||||||||
Unamortizable intangible assets: |
||||||||||||||||||||||||
NASD license |
100 | — | 100 | 100 | — | 100 | ||||||||||||||||||
Total intangible assets |
$ | 7,173 | $ | (3,880 | ) | $ | 3,293 | $ | 5,692 | $ | (2,803 | ) | $ | 2,889 | ||||||||||
60
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
4. Intangible Assets (continued)
Amortization
expense related to intangible assets was $1.1 million,
$1.0 million, and $1.1 million
for the years ended December 31, 2006, 2005 and 2004, respectively.
Estimated amortization expense for the next five years is as follows (in thousands):
2007 |
$ | 1,008 | ||
2008 |
848 | |||
2009 |
676 | |||
2010 |
306 | |||
2011 |
74 |
The weighted-average life of these intangibles was five years at December 31, 2006.
5. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations consist of the following at December 31, 2006, and
2005 (in thousands):
| December 31 | ||||||||
| 2006 | 2005 | |||||||
Bank term note payable |
$ | 56,250 | $ | — | ||||
Capital lease obligations |
234 | 272 | ||||||
Total long-term debt and capital leases |
56,484 | 272 | ||||||
Less current maturities |
56,393 | 122 | ||||||
Long-term debt and capital leases |
$ | 91 | $ | 150 | ||||
61
Table of Contents
HFF,
Inc.
Notes to
Combined Financial Statements (continued)
5. Long-Term Debt and Capital Lease Obligations (continued)
(a) The Credit Agreement
In March 2006, HFF LP entered into a credit agreement (the Credit Agreement) with a financial
institution. The Credit Agreement was comprised of a $60.0 million term loan and a $20.0 million
revolving credit facility, which replaced the revolving credit agreement. HFF Holdings distributed
the $60.0 million proceeds from the term loan to the members generally based on their respective
ownership interests, and are reflected as distributions in the financial statements. The terms of
the Credit Agreement require quarterly payments of $1.25 million and annual payments equal to 22.5%
of adjusted annual net income. In connection with the Credit Agreement, each member signed a
revised operating agreement which requires each member to repay their portion of the remaining
outstanding balance of the loan in the event the member leaves the Company prior to the loan being
repaid in full. The Company is obligated under the Credit Agreement to remit all amounts collected
from withdrawing members to the financial institution for repayment of the loan.
The Credit Agreement expires in March 29, 2010, and may be extended for one year at the option of
the Company. Interest on outstanding balances is payable at the 30-day LIBOR rate (5.33% at
December 31, 2006) plus 2.50%. The Company has the option to convert revolving credit borrowings,
subject to certain restrictions, to Base Note Rates upon which interest is calculated at the
greater of the bank’s prime rate (8.25% at
December 31, 2006) plus 1.50% or the Federal Funds
Effective Rate (5.17% at December 31, 2006) plus 2.00%. The agreement also requires payment of a
commitment fee of .35% on the unused amount of credit. The Company did not borrow on this revolving
credit facility during the year ended December 31, 2006.
The Credit Agreement contains various restrictive covenants relating to financial ratios, permitted
investments, incurrence of indebtedness, distributions to members, and transactions with related
parties. Obligations outstanding under the revolving credit agreement are collateralized by the
ownership interests in HFF LP, Holliday GP, and HFF Securities. This Agreement was paid in full in
connection with the proceeds from the initial public offering discussed in Note 11 below.
(b) Letters of Credit and Capital Lease Obligation
The
Company has outstanding letters of credit of approximately
$2.3 million and $0.2 million at December 31, 2006 and 2005, respectively, with the same bank as the term note and
revolving credit arrangements, to comply with bonding requirements of certain state regulatory
agencies, as security for three leases and as collateral to meet Freddie Mac net worth
requirements. The Company segregated cash in a separate bank account to collateralize the letters
of credit. The letters of credit expire through 2007 but can be automatically extended for one year
except for the $2.0 million letter of credit with Freddie Mac,
which expired on February 28, 2007. Additionally, in connection with the Company’s initial public
offering and the resulting pay-off of the entire outstanding balance under the Credit Agreement in February 2007, HFF LP now meets
Freddie Mac’s minimum net worth requirement.
62
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
5. Long-Term Debt and Capital Lease Obligations (continued)
Capital lease obligations consist primarily of office equipment leases that expire at various dates
through May 2010 and bear interest at rates ranging from 3.65% to 6.19%. A summary of future
minimum lease payments under capital leases at December 31, 2006, is as follows (in thousands):
2007 |
$ | 143 | ||
2008 |
47 | |||
2009 |
39 | |||
2010 |
5 | |||
| $ | 234 | |||
6. Warehouse Line of Credit
In 2005, HFF LP obtained an uncommitted warehouse line of credit for the purpose of funding the
Freddie Mac mortgage loans that it originates. Each funding is separately approved on a
transaction-by-transaction basis and is collateralized by a loan and mortgage on a multifamily
property that is ultimately purchased by Freddie Mac. As of December 31, 2006, and 2005, HFF LP had
$125.7 million and $14.7 million, respectively, outstanding on the warehouse line of credit and a
corresponding amount of mortgage notes receivable. Interest on the warehouse line of credit is at
the 30-day LIBOR rate plus a spread (5.84% at December 31, 2006, and 5.40% at December 31, 2005)
and HFF LP is also paid interest on its loan secured by a multifamily loan at the rate in the
Freddie Mac note.
7. Lease Commitments
The Company leases various corporate offices, parking spaces, and office equipment under
noncancelable operating leases. These leases have initial terms of two to ten years. The majority
of the leases have termination clauses whereby the term may be reduced by two to seven years upon
prior notice and payment of a termination fee by the Company. Total rental expense charged to
operations was $4.6 million, $3.9 million, and $3.6 million for the years ended December 31, 2006,
2005 and 2004, respectively.
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
7. Lease Commitments (continued)
Future minimum rental payments for the next five years under operating leases with noncancelable
terms in excess of one year and without regard to early termination provisions are as follows (in
thousands):
2007 |
$ | 4,754 | ||
2008 |
4,802 | |||
2009 |
3,944 | |||
2010 |
3,615 | |||
2011 |
3,134 | |||
Thereafter |
8,413 | |||
| $ | 28,662 | |||
The Company subleases certain office space to subtenants which may be canceled at any time. The
rental income received from these subleases is included as a reduction of occupancy expenses in the
accompanying combined statements of income.
The Company also leases certain office equipment under capital leases that expire at various dates
through 2010. See Note 3 and Note 5 above for further description of the assets and related
obligations recorded under these capital leases at December 31, 2006 and 2005, respectively.
HFF Holdings is not an obligor, nor does it guarantee any of the Company’s leases.
8. Retirement Plan
The Company maintains a retirement savings plan for all eligible employees, in which employees may
make deferred salary contributions up to the maximum amount allowable by the IRS. After-tax
contributions may also be made up to 50% of compensation. The Company makes matching contributions
equal to 50% of the first 6% of both deferred and after-tax salary contributions, up to a maximum
of $5,000. The Company match was fully vested after two years of service during 2003 and 2004,
after one year of service in 2005, and after one month of service effective January 1, 2006. The
Company’s contributions charged to expense for the plan were $1.2 million, $0.9 million, and $0.7
million for the years ended December 31, 2006, 2005 and 2004, respectively.
64
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
9. Servicing
The Company services commercial real estate loans for investors. The servicing portfolio totaled
$18.0 billion, $14.9 billion, and $13.0 billion at December 31, 2006, December 31, 2005 and
December 31, 2004, respectively.
In connection with its servicing activities, the Company holds funds in escrow for the benefit of
mortgagors for hazard insurance, real estate taxes and other financing arrangements. At December
31, 2006, 2005 and 2004, the funds held in escrow totaled $104.4 million, $113.0 million and $107.0
million, respectively. These funds, and the offsetting liabilities, are not presented in the
Company’s financial statements as they do not represent the assets and liabilities of the Company.
Pursuant to the requirements of the various investors for which the Company services loans, the
Company maintains bank accounts, holding escrow funds, which have balances in excess of the FDIC
insurance limit. The fees earned on these escrow funds are reported in capital markets services
revenue in the combined statements of income.
10. Legal Proceedings
The Company is party to various litigation matters, in most cases involving ordinary course and
routine claims incidental to its business. The Company cannot estimate with certainty its ultimate
legal and financial liability with respect to any pending matters. In accordance SFAS 5,
Accounting for Contingencies, a reserve for estimated losses is recorded when the amount is
probable and can be reasonably estimated. However, the Company believes, based on examination of
such pending matters that its ultimate liability will not have a material adverse effect on its
business or financial condition.
11.
Concentrations
A
significant portion of the Company’s capital markets services
revenues is derived from transactions involving commercial real
estate located in specific geographic areas. During 2006,
approximately 10.8% and 21.1% of the Company’s capital markets
services revenues were derived from transactions involving commercial
real estate located in Florida and Texas, respectively. During 2005,
approximately 12.7% and 21.7% of the Company’s capital markets
services revenues were derived from transactions involving commercial
real estate located in California and Texas, respectively. As a
result, a significant portion of the Company’s business is
dependent on the economic conditions in general and the markets for
commercial real estate in these areas.
12. Related Party Transactions
The Company allocated expenses to two affiliates of approximately $0.55 million, $0.41 million and
$0.25 million during the years ending December 31, 2006, 2005 and 2004, respectively, for services
performed on behalf of the affiliates. The Company made payments on behalf of two affiliates of
approximately $0.8 million, $0.3 million and $5.7 million during the years ending December 31,
2006, 2005 and 2004, respectively. The Company received amounts from two affiliates of
approximately $1.1 million, $1.25 million and $6.1 million during the years ending December 31,
2006, 2005 and 2004, respectively. Also during 2006, the Company paid approximately $2.3 million
of costs in connection with the initial public offering on behalf of one of the affiliates. The
Company is due $3.0 million and $0.5 million from the two affiliates as of December 31, 2006 and
2005, respectively.
13. Subsequent Events
On November 9, 2006, HFF, Inc. filed a registration statement on Form S-1 with the United States
Securities and Exchange Commission (the “SEC”) relating to a proposed underwritten
65
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
initial public offering of 14,300,000 shares of Class A common stock of HFF, Inc.. On January 30,
2007, the SEC declared the registration statement on Form S-1 effective and the Company priced
14,300,000 shares for the initial public offering at a price of $18.00 per share. On January 31,
2007, the Company’s common stock began trading on the New York Stock Exchange under the symbol
“HF.”
On February 5, 2007, the Company closed its initial public offering of 14,300,000 shares of
common stock. Net proceeds from the sale of the stock were $235.7 million, net of $18.0 million of
underwriting commissions and $3.7 million of offering expenses. The proceeds of the public offering
were used to purchase from HFF Holdings all of the shares of Holliday GP and purchase from HFF
Holdings partnership units representing approximately 39% of each of the Operating Partnerships
(including partnership units in the Operating Partnerships held by Holliday GP). HFF Holdings used
approximately $56.3 million of its proceeds to repay all outstanding indebtedness under HFF LP’s
credit agreement. Accordingly the Company did not retain any of the proceeds from this offering.
On February 22, 2007, the underwriters exercised their option to purchase an additional 2,145,000
shares of Class A common stock (15% of original issuance) at $18.00 per share. Net proceeds of the
overallotment were $35.9 million, net of $2.7 million of underwriting commissions and other
expenses. These proceeds were used to purchase HFF Holdings partnership units representing
approximately 6.0% of each of the Operating Partnerships.
In addition to cash received for its sale of all of the shares of Holliday GP and approximately 45%
of partnership units of each of the Operating Partnerships (including partnership units in the
Operating Partnerships held by Holliday GP). HFF Holdings also received an exchange right that will
permit HFF Holdings to exchange interests in the Operating Partnerships for shares of (i) HFF,
Inc.’s Class A common stock (the “Exchange Right”) and (ii) rights under a tax receivable agreement
between HFF, Inc. and HFF Holdings (the “TRA”).
As a result of the offering, HFF Holdings beneficially owns 20,355,000 partnership units in each of
the Operating Partnerships. Pursuant to the terms of HFF, Inc.’s amended and restated certificate
of incorporation, HFF Holdings could from time to time exchange its partnership units in the
Operating Partnerships for shares of the Company’s Class A common stock on the basis of two
partnership units, one of each Operating Partnership, for one share of Class A common stock,
subject to customary conversion rate adjustments for stock splits, stock dividends and
reclassifications. The following table reflects HFF Holdings’ right to
exchange its partnership units in the Operating Partnerships for shares of the Company’s Class A
common stock pursuant to contractual provisions in the HFF Holdings Operating Agreement. However,
these contractual provisions may be waived, amended or terminated by a vote of the members holding
65% of the interests of HFF Holdings following consultation with the board of directors.
| Percentage of HFF | ||||||||
| Number of | Holdings’ | |||||||
| Additional Shares | Partnership | |||||||
| of Class A | Units in the | |||||||
| Common | Operating | |||||||
| Stock Expected to | Partnerships | |||||||
| Become Available | Becoming Eligible | |||||||
| Anniversary of the Offering | for Exchange | for Exchange | ||||||
Second |
5,088,750 | 25 | % | |||||
Third |
5,088,750 | 25 | % | |||||
Fourth |
5,088,750 | 25 | % | |||||
Fifth |
5,088,750 | 25 | % | |||||
Total |
20,355,000 | 100 | % | |||||
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
HFF Holdings was issued one share of the Company’s Class B common stock. Class B common stock has
no economic rights but will entitle the holder to a number of votes that is equal to the total
number of shares of Class A common stock for which the partnership units that HFF Holdings holds in
the Operating Partnerships as of the relevant record date for the HFF, Inc. stockholder action are
exchangeable.
HFF LP and HFF Securities intend to have an election under Section 754 of the Internal Revenue Code
effective for 2007 and for each taxable year in which an exchange of partnership units for shares
occurs. The initial sale is expected to produce (and later exchanges may produce) increases to the
tax basis of the assets owned by HFF LP and HFF Securities at the time of the initial public
offering (and at the time of each exchange of partnership units). These anticipated increases in
tax basis would be allocated to the Company and would likely reduce the amount of tax that the
Company would otherwise be required to pay in the future. HFF, Inc. entered into a tax receivable
agreement with HFF Holdings that provides for the payment by HFF, Inc. to HFF Holdings of 85% of
the amount of cash savings, if any, in U.S. federal, state and local income tax that the Company
actually realizes as a result of these increases in tax basis and as a result of certain other tax
benefits arising from the Company entering into the tax receivable agreement and making payments
under that agreement. For purposes of the tax receivable agreement, cash savings in income tax will
be computed by comparing the Company’s actual income tax liability to the amount of such taxes that
it would have been required to pay had there been no increase to the tax basis of the assets of HFF
LP and HFF Securities as a result of the initial sale and later exchanges and had the Company not
entered into the tax receivable agreement. The term of the tax receivable agreement commences upon
consummation of the offering and will continue until all such tax benefits have been utilized or
expired, including the tax benefits derived from future exchanges. While the actual amount and
timing of payments under the tax receivable agreement will depend upon a number of factors,
including the amount and timing of taxable income generated in the future, the value of individual
assets, the portion of the Company’s payments under the tax receivable agreement constituting
imputed interest and increases in the tax basis of the Company’s assets resulting in payments to
HFF Holdings, the Company expects that the payments that may be made to HFF Holdings will be
substantial. Assuming no material changes in the relevant tax law and that the Company earns
significant taxable income to realize the full tax benefit of the increased amortization of its
assets, the Company expects that future payments to HFF Holdings in respect of the initial sale and
the overallotment to aggregate approximately $127.0 million and range from approximately $5.0
million to $14.0 million per year over the next 15 years. Future payments to HFF Holdings in
respect of subsequent exchanges would be in addition to these amounts and are expected to be
substantial. The payments under the tax receivable agreement are not conditioned upon HFF Holdings’
or its affiliates’ continued ownership of the Company.
The Company will account for the income tax effects and corresponding tax receivable agreement
effects as a result of the initial purchase and the sale of units of the Operating Partnerships in
connection with the reorganization transactions and future exchanges of Operating Partnership units
for the Company’s Class A shares by recognizing an increase in its deferred tax asset for the
estimated income tax effects of the increase in the tax basis of the assets owned by the Operating
Partnerships, based on enacted tax rates at the date of the transaction, less any tax valuation
allowance the Company believes is required if the Company evaluates it is more likely than not
that it will realize the benefit represented by the deferred tax asset, and the Company will record
85% of the estimated amount of the increase in deferred tax assets, net of any valuation allowance,
as a liability to HFF Holdings under the tax receivable agreement and the remaining 15% of the
increase in deferred tax assets directly in additional paid-in capital in stockholders’ equity.
All of the effects of changes in any of the Company’s estimates after the date of any exchange will
be included in net income. Similarly, the effect of subsequent changes in the enacted tax rates
will be included in net income.
Prior to
the effective date of the offering, the sole Stockholder of HFF, Inc. and the Board of
Directors adopted the HFF, Inc., 2006 Omnibus Incentive Compensation Plan (the “Plan”). Upon the
effective date of the registration statement, grants were awarded under the Plan to certain
employees and the Board of Directors. The Plan imposes limits on the awards that may be made to
any individual during a calendar year. The number of shares available for awards under the terms
of the Plan is 3,500,000 (subject to stock splits, stock dividends and similar transactions).
67
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HFF,
Inc.
Notes to
Combined Financial Statements (continued)
On February 5, 2007, the Company entered into an Amended and Restated Credit Agreement with
Bank of America (Amended Credit Agreement). The Amended Credit Agreement is comprised of a $40.0
million revolving credit facility, which replaced The New Credit Agreement mentioned in note 5.
The Amended Credit Agreement matures on February 5, 2010 and may be extended for one year based on
certain conditions as defined in the agreement.
68
Table of Contents
Report of Independent Registered Public Accounting Firm
The Operating Committee and Members of
HFF Holdings, LLC
We have audited the accompanying consolidated balance sheets of HFF Holdings, LLC and subsidiaries
as of December 31, 2006 and 2005, and the related consolidated statements of income, members’
equity, and cash flows for each of the three years in the period ended December 31, 2006. These
financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. We
were not engaged to perform an audit of the Company’s internal control over financial reporting.
Our audits included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of HFF Holdings, LLC and subsidiaries at December 31,
2006 and 2005 and the consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
/s/ Ernst & Young LLP
Pittsburgh,
Pennsylvania
March 8, 2007
March 8, 2007
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HFF Holdings, LLC and Subsidiaries
Consolidated Balance Sheets
(Dollars in Thousands)
(Dollars in Thousands)
| 2006 | 2005 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 57,198 | $ | 59,595 | ||||
Restricted cash (Note 5) |
3,485 | 389 | ||||||
Accounts receivable |
2,508 | 921 | ||||||
Mortgage notes receivable (Note 6) |
125,700 | 14,700 | ||||||
Prepaid expenses and other current assets |
7,843 | 2,691 | ||||||
Total current assets |
196,734 | 78,296 | ||||||
Property and equipment, net (Note 3) |
5,040 | 4,276 | ||||||
Goodwill |
3,712 | 3,712 | ||||||
Intangible assets, net (Note 4) |
3,293 | 2,889 | ||||||
Other noncurrent assets |
728 | 768 | ||||||
| $ | 209,507 | $ | 89,941 | |||||
Liabilities and members’ equity |
||||||||
Current liabilities: |
||||||||
Current portion of long-term debt (Note 5) |
$ | 56,393 | $ | 122 | ||||
Warehouse line of credit (Note 6) |
125,700 | 14,700 | ||||||
Accrued compensation and related taxes |
10,836 | 10,800 | ||||||
Accounts payable |
868 | 330 | ||||||
Other current liabilities |
2,260 | 1,027 | ||||||
Total current liabilities |
196,057 | 26,979 | ||||||
Deferred rent credit |
2,404 | 2,366 | ||||||
Other long-term liabilities |
438 | 408 | ||||||
Long-term debt, less current portion (Note
5) |
91 | 150 | ||||||
Total liabilities |
198,990 | 29,903 | ||||||
Members’ equity (Note 1) |
10,517 | 60,038 | ||||||
| $ | 209,507 | $ | 89,941 | |||||
See accompanying notes.
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HFF Holdings, LLC and Subsidiaries
Consolidated Statements of Income
(Dollars In Thousands)
(Dollars In Thousands)
| Year Ended December 31 | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Revenues |
||||||||||||
Capital markets services revenue |
$ | 225,242 | $ | 203,457 | $ | 142,192 | ||||||
Interest on mortgage notes receivable |
1,354 | 412 | — | |||||||||
Other |
3,101 | 1,979 | 1,499 | |||||||||
| 229,697 | 205,848 | 143,691 | ||||||||||
Expenses |
||||||||||||
Cost of services |
130,708 | 119,106 | 85,778 | |||||||||
Personnel |
13,938 | 14,369 | 9,107 | |||||||||
Occupancy |
6,319 | 5,357 | 5,047 | |||||||||
Travel and entertainment |
5,789 | 5,067 | 3,617 | |||||||||
Supplies, research, and printing |
6,463 | 5,089 | 2,933 | |||||||||
Insurance |
3,126 | 2,470 | 1,500 | |||||||||
Professional fees |
3,030 | 1,201 | 871 | |||||||||
Depreciation and amortization |
2,806 | 2,735 | 2,506 | |||||||||
Interest on warehouse line of credit |
1,375 | 409 | — | |||||||||
Other operating |
4,474 | 3,483 | 3,441 | |||||||||
| 178,028 | 159,286 | 114,800 | ||||||||||
Operating income |
51,669 | 46,562 | 28,891 | |||||||||
Interest and other income |
2,339 | 1,267 | 317 | |||||||||
Interest expense |
(3,541 | ) | (271 | ) | (406 | ) | ||||||
Income before taxes |
50,467 | 47,558 | 28,802 | |||||||||
Income tax expense |
774 | 715 | 728 | |||||||||
Net income |
$ | 49,693 | $ | 46,843 | $ | 28,074 | ||||||
See accompanying notes.
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HFF Holdings, LLC and Subsidiaries
Consolidated Statements of Members’ Equity
(Dollars In Thousands)
(Dollars In Thousands)
| Retained | Receivable | Payable | ||||||||||||||||||
| Capital | Earnings | From Members | To Members | Total | ||||||||||||||||
Members’ equity,
December 31, 2003 |
$ | 7,000 | $ | 13,529 | $ | — | $ | — | $ | 20,529 | ||||||||||
Net income |
— | 28,074 | — | — | 28,074 | |||||||||||||||
Distributions |
— | (11,491 | ) | — | — | (11,491 | ) | |||||||||||||
Members’ equity,
December 31, 2004 |
7,000 | 30,112 | — | — | 37,112 | |||||||||||||||
Withdrawal of member |
(71 | ) | — | — | — | (71 | ) | |||||||||||||
Net income |
— | 46,843 | — | — | 46,843 | |||||||||||||||
Distributions |
— | (23,846 | ) | — | — | (23,846 | ) | |||||||||||||
Members’ equity,
December 31, 2005 |
6,929 | 53,109 | — | — | 60,038 | |||||||||||||||
Contributions |
71 | — | — | — | 71 | |||||||||||||||
Net income |
— | 49,693 | — | — | 49,693 | |||||||||||||||
Distributions |
— | (100,330 | ) | — | — | (100,330 | ) | |||||||||||||
Reset of equity (Note 1) |
— | — | (4,709 | ) | 5,754 | 1,045 | ||||||||||||||
Members’ equity,
December 31, 2006 |
$ | 7,000 | $ | 2,472 | $ | (4,709 | ) | $ | 5,754 | $ | 10,517 | |||||||||
See accompanying notes.
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HFF Holdings, LLC and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars In Thousands)
(Dollars In Thousands)
| Year Ended December 31 | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Operating activities |
||||||||||||
Net income |
$ | 49,693 | $ | 46,843 | $ | 28,074 | ||||||
Adjustments to reconcile net income to net
cash provided by operating activities: |
||||||||||||
Depreciation and amortization: |
||||||||||||
Property and equipment |
1,728 | 1,611 | 1,352 | |||||||||
Intangibles |
1,078 | 1,124 | 1,154 | |||||||||
(Gain) loss on sale or disposition of assets |
(507 | ) | (140 | ) | 28 | |||||||
Purchase of NASD license |
— | — | (100 | ) | ||||||||
Increase (decrease) in cash from changes in: |
||||||||||||
Restricted cash |
(3,096 | ) | 392 | (244 | ) | |||||||
Accounts receivable |
(1,587 | ) | (721 | ) | 944 | |||||||
Mortgage notes receivable |
(111,000 | ) | (14,700 | ) | — | |||||||
Prepaid expenses and other current assets |
(5,152 | ) | (1,138 | ) | (1,011 | ) | ||||||
Other noncurrent assets |
40 | (449 | ) | (230 | ) | |||||||
Accrued compensation and related taxes |
36 | 2,935 | 985 | |||||||||
Accounts payable |
538 | 25 | 9 | |||||||||
Other accrued liabilities |
1,233 | 553 | (5 | ) | ||||||||
Other long-term liabilities |
290 | 98 | 654 | |||||||||
Net cash (used) provided by operating
activities |
(66,706 | ) | 36,433 | 31,610 | ||||||||
Investing activities |
||||||||||||
Purchases of property and equipment |
(2,624 | ) | (1,447 | ) | (1,646 | ) | ||||||
Net cash used in investing activities |
(2,624 | ) | (1,447 | ) | (1,646 | ) | ||||||
Financing activities |
||||||||||||
Net borrowings on warehouse line of credit |
111,000 | 14,700 | — | |||||||||
Net borrowings on short-term debt |
— | — | (217 | ) | ||||||||
Borrowings on long-term debt |
60,000 | — | — | |||||||||
Payments on long-term debt |
(3,878 | ) | (7,461 | ) | (2,433 | ) | ||||||
Deferred financing costs |
(975 | ) | (14 | ) | — | |||||||
Members’ contributions (withdrawals) |
1,116 | (71 | ) | — | ||||||||
Members’ distributions |
(100,330 | ) | (23,846 | ) | (11,491 | ) | ||||||
Net cash provided by (used) in financing
activities |
66,933 | (16,692 | ) | (14,141 | ) | |||||||
Net (decrease) increase in cash |
(2,397 | ) | 18,294 | 15,823 | ||||||||
Cash and cash equivalents, beginning of period |
59,595 | 41,301 | 25,478 | |||||||||
Cash and cash equivalents, end of period |
$ | 57,198 | $ | 59,595 | $ | 41,301 | ||||||
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HFF Holdings, LLC and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
(Dollars In Thousands)
(Dollars In Thousands)
| Years Ended December 31 | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Supplemental disclosure of cash flow
information |
||||||||||||
Cash paid for income taxes |
$ | 771 | $ | 715 | $ | 728 | ||||||
Cash paid for interest |
$ | 4,442 | $ | 650 | $ | 405 | ||||||
Supplemental disclosure of noncash
financing
activities |
||||||||||||
Property acquired under capital leases |
$ | 90 | $ | 89 | $ | 28 | ||||||
See accompanying notes.
74
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements
1. Organization
HFF Holdings, LLC (HFF Holdings) was incorporated as a Delaware Limited Liability Company on June
16, 2003. HFF Holdings then formed HFF LP Acquisition LLC (Holdings Sub), Holliday GP Acquisition
LLC (HFF GP), and Holliday GP Corp. (Holliday GP) in connection with HFF Holdings’ acquisition of
Holliday Fenoglio Fowler, L.P. (HFF LP) from the prior owners. Upon such acquisition, Holdings Sub
became the sole limited partner of HFF LP, HFF GP became a general partner of HFF LP, and Holliday
GP became the managing general partner of HFF LP. HFF GP subsequently merged into Holliday GP; as a
result, Holliday GP became the sole general partner of HFF LP. The acquisition was financed
primarily with long-term borrowings and was accounted for in accordance with Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations (SFAS No. 141). The total purchase price
of $8.8 million (as adjusted from a base purchase price of $10.0 million for the difference between
estimated net assets and closing net assets and for other adjustments and costs of completing the
closing) was allocated to the assets acquired and liabilities assumed based on estimated fair
values at the date of acquisition.
During
2004, Holdings Sub and Holliday GP formed HFF Securities L.P. (HFF Securities). HFF
Securities is a broker-dealer that performs private placements of securities by raising equity
capital from institutional investors for discretionary, commingled real estate funds to execute
real estate acquisitions, recapitalizations, developments, debt investments, and other real
estate-related strategies. HFF Securities may also provide other investment banking and advisory
services on various project or entity-level strategic assignments such as mergers and acquisitions,
sales and divestitures, recapitalizations and restructurings, privatizations, management buyouts,
and arranging joint ventures for specific real estate strategies.
HFF Holdings, through its Operating Partnerships, HFF, LP and HFF Securities, is a financial
intermediary and advisor in the commercial real estate industry, and engages in debt, private
equity, and structured financing placements, as well as investment sales, note sales, and loan
servicing in 18 major cities nationwide.
These financial statements present the consolidated financial position of HFF Holdings and its
wholly owned subsidiaries (collectively referred to as Holdings Consol) as of December 31, 2006 and
2005 and the consolidated results of Holdings Consol for each of the three years in the period
ended December 31, 2006.
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Notes to Consolidated Financial Statements (continued)
1. Organization (continued)
Capital Contributions
At inception, HFF Holdings’ members made capital contributions of $7.0 million. In accordance with
the Operating Agreement, additional capital contributions may be required upon recommendation by
the Operating Committee and approval by 65% of the members.
Percentage interests of the members may be adjusted every three years upon recommendation by a
committee appointed by the members and then subsequently approved by 65% of the members. If the
recommended adjustments are approved, additional capital contributions will be required from
members whose percentage interests (or new members) are increased, and members whose interests are
decreased will be entitled to receive payments from HFF Holdings, based on a comparison of the fair
value of HFF Holdings immediately prior to and as of the reset date.
During 2006, the HFF Holdings reset the ownership percentages of existing members and admitted six
new members. The equity reset and addition of new members resulted in an increase or decrease in
ownership percentage for existing members. The purchase of additional ownership interests by the
new and existing members was funded by $9.8 million in cash and promissory notes receivable of $5.6
million from members to HFF Holdings. The cash received was paid to existing members based upon the
percentage dilution of their ownership. The notes receivable are payable to HFF Holdings in three
equal installments over a three year period (January 2007–2009) with full recourse secured by each
member’s interest in HFF Holdings and all amounts payable to the member by HFF Holdings. The
remaining amounts due to the members whose ownership interest was diluted by the reset are
contingent on the payment of cash by the new members under the notes. The note receivable of $4.6
million plus accrued interest of $0.1 million and the related payable of $5.6 million plus accrued
interest of $0.1 million due diluted members are reflected on Holdings Consol’s consolidated
financial statements as components of members’ equity under the provisions of Staff Accounting
Bulletin No. 40. In connection with the initial public offering of HFF, Inc., discussed in Note
12 below, the promissory notes receivable and the related payable were paid in full by the members with the proceeds
received from the offering.
The liability of HFF Holdings’ members is generally limited to their capital contributions.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Organization (continued)
Distributions
Distributions of distributable cash flow (as defined) are made upon approval of the Operating
Committee. Such distributions generally must be made to members first to the extent of unpaid
cumulative preferred returns (15% per year) on the initial capital contribution, and second in
proportion to their respective percentage interests.
Redemption
Withdrawing members may require HFF Holdings to redeem their interests for an amount equal to the
Redemption Price as defined in the Operating Agreement, except in cases such as termination for
cause or competing or solicitation as defined in the Operating Agreement. In the event a
withdrawing member subsequently competes or solicits as defined in the Operating Agreement, his
right to receipt of the redemption price is subject to reduction based on the time period within
which such activity occurs. Upon withdrawing, HFF Holdings is required to pay the withdrawing
member his initial capital contribution and redemption payments over five years starting one year
after the withdrawal date. The redemption payments are based on the Redemption Price determined by
the Operating Committee, as defined in the Operating Agreement, and are subject to available cash
flow, as defined in the Operating Agreement.
2. Summary of Significant Accounting Policies
Consolidation
The consolidated financial statements include the accounts of HFF Holdings and its wholly owned
subsidiaries, Holdings Sub, Holliday GP, HFF Securities, and HFF LP. All intercompany accounts have
been eliminated.
Concentrations of Credit Risk
Holdings Consol’s financial instruments that are exposed to concentrations of credit risk consist
primarily of cash. Holdings Consol places its cash with financial institutions in amounts which at
times exceed the FDIC insurance limit. Holdings Consol has not experienced any losses in such
accounts and believes it is not exposed to any significant credit risk on cash.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and in bank accounts, and short-term investments
with original maturities of three months or less.
Revenue Recognition
Capital markets services revenues consist of origination fees, investment sale fees, note sale
fees, placement fees, and servicing fees. Origination fees are earned for the placement of debt,
equity, or structured financing for real estate transactions. Investment sales and note sales fees
are earned for brokering sales of real estate and/or notes. Placement fees are earned by HFF
Securities for discretionary and nondiscretionary equity capital raises and other investment
banking services. These fees are negotiated between Holdings Consol and its clients, generally on a
case-by-case basis and are recognized and generally collected at the closing and the funding of the
transaction. Holdings Consol’s fee agreements do not include terms or conditions that require
Holdings Consol to perform any service or fulfill any obligation once the transaction closes and
revenue is recognized. Servicing fees are compensation for providing collection, remittance,
recordkeeping, reporting, and other services for either lenders or borrowers on mortgages placed
with third-party lenders. Servicing fees are recognized when cash is collected as these fees are
contingent upon the borrower making its payments on the loan.
Certain of Holdings Consol’s fee agreements provide for reimbursement of employee-related costs
which Holdings Consol recognizes as revenue. In accordance with EITF 00-14, Income Statement
Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred, certain
reimbursements received from clients for out-of-pocket expenses are characterized as revenue in the
statement of income rather than as a reduction of expenses incurred. Since Holdings Consol is the
primary obligor, has supplied discretion, and bears the credit risk for such expenses, Holdings
Consol records reimbursement revenue for such out-of-pocket expenses. Reimbursement revenue is
recognized when the fees for the related transaction are collected at the closing of the
transaction. Reimbursement revenue is classified as other revenue in the consolidated statement of
income.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Mortgage Notes Receivable
HFF LP is qualified with the Federal Home Loan Mortgage Corporation (Freddie Mac) as a Freddie Mac
Multifamily Program Plus® Seller/Servicer. Under this Program, HFF LP originates mortgages based on
commitments from Freddie Mac, and then sells the loans to Freddie Mac approximately one month
following the loan originations. HFF LP recognizes interest income on the accrual basis during this
holding period based on the contract interest rate in the loan that will be purchased by Freddie
Mac.
The loans are initially recorded and then subsequently sold to Freddie Mac at HFF LP’s cost.
Holdings Consol monitors the market value of these loans for declines in value from the origination
date to the sale date. Based on Holdings Consol’s evaluation, no valuation allowance for lower of
cost or market adjustments was necessary as of December 31, 2006 and 2005.
Freddie Mac requires HFF LP to meet minimum net worth and liquid assets requirements and to comply with
certain other standards. Following the closing of the Credit Agreement in March 2006 and the
distribution of the proceeds to the members, HFF LP did not meet such minimum net worth requirement; therefore, HFF LP entered into a $2.0 million letter of credit backed by
$2.0 million in cash which is classified as Restricted Cash on the balance sheet as of December 31,
2006. In connection with HFF Inc.’s initial public offering, discussed in Note 12 below, and the resulting payoff of the entire
outstanding balance under the New Credit Agreement in February 2007, HFF LP now meets Freddie Mac’s minimum net worth requirements (see note 5).
Advertising
Costs associated with advertising are expensed as incurred. Advertising expense was $0.8 million,
$0.8 million and $0.6 million for the years ended December 31, 2006, 2005 and 2004, respectively.
These amounts are included in other operating expenses in the accompanying consolidated statements
of income.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment are recorded at cost, except for those assets acquired on June 16, 2003,
which were recorded at their estimated fair values. Depreciation of furniture and computer
equipment is computed using accelerated methods over five to seven years. Depreciation of software
costs is computed using the straight-line method over three years. Leasehold improvements are
depreciated using the straight-line method over the shorter of the term of the lease or useful life
of the asset
Expenditures for routine maintenance and repairs are charged to expense as incurred. Renewals and
betterments which substantially extend the useful life of an asset are capitalized.
Leases
Holdings Consol leases all of its facilities under operating lease agreements. These lease
agreements typically contain tenant improvement allowances and rent holidays. In instances where
one or more of these items are included in a lease agreement, Holdings Consol records these
allowances as a leasehold improvement asset, included in property and equipment, net in the
consolidated balance sheets and a related deferred rent liability and amortizes these items on a
straight-line basis over the shorter of the term of the lease or useful life of the asset as
additional depreciation expense and a reduction to rent expense, respectively. Lease agreements
sometimes contain rent escalation clauses, which are recognized on a straight-line basis over the
life of the lease in accordance with SFAS No. 13, Accounting for Leases. Lease terms generally
range from two to ten years. Before entering into a lease, an analysis is performed to determine
whether a lease should be classified as a capital or an operating lease according to SFAS No. 13,
as amended.
Computer Software Costs
Certain costs related to the development or purchases of internal-use software are capitalized in
accordance with the American Institute of Certified Public Accountants (AICPA) Statement of
Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. Internal computer software costs that are incurred in the preliminary project stage
are expensed as incurred. Direct consulting costs as well as payroll and related costs, which are
incurred during the development stage of a project are capitalized and amortized using the
straight-line method over estimated useful lives of three years when placed into production.
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Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Goodwill
Goodwill of $3.7 million represents the excess of the purchase price over the estimated fair value
of the acquired net assets of HFF LP on June 16, 2003 (see Note 1). In accordance with SFAS No.
142, Goodwill and Other Intangible Assets, the Company does not amortize goodwill, but evaluates
goodwill on an annual basis for potential impairment.
Prepaid Compensation Under Employment Agreements
Holdings Consol has employment agreements with certain employees whereby sign-up bonuses and
incentive compensation payments were made during 2004, 2005 and 2006. In most cases, the sign-up
bonuses and the incentive compensation are to be repaid to Holdings Consol upon voluntary
termination by the employee or termination by cause (as defined) by Holdings Consol prior to the
termination of the employment agreement. The total cost of the employment agreements is being
amortized by the straight-line method over the term of the agreements and is included in cost of
services on the accompanying consolidated statements of income.
Producer Draws
As part of Holdings Consol’s overall compensation program, it offers a new producer draw
arrangement which generally lasts until such time as a producer’s pipeline of business is
sufficient to allow the producer to earn sustainable commissions. This program is intended to
provide the producer with a minimal amount of cash flow to allow adequate time for the producer to
develop business relationships. Similar to traditional salaries, the producer draws are paid
irrespective of the actual fees generated by the producer. Often these producer draws represent the
only form of compensation received by the producer. Furthermore, it is not Holdings Consol’s policy
to seek collection of unearned producer draws under this arrangement. As a result, Holdings Consol
has concluded that producer draws are economically equivalent to salaries paid and accordingly,
charges them to compensation as incurred. The producer is also entitled to earn a commission on
closed revenue transactions. Commissions are calculated as the commission that would have been
earned by the broker under one of Holdings Consol’s commission programs, less any amount previously
paid to the producer in the form of a draw.
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Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Intangible Assets
Intangible assets include servicing rights under agreements with third-party lenders, costs
associated with obtaining a NASD license, and deferred financing costs.
Servicing rights were recorded at their estimated fair value of $5.4 million on June 16, 2003, and
are being amortized over the expected life of the mortgage servicing rights in proportion to the
estimated future net servicing income. Additionally, servicing rights are capitalized on loans
originated and sold to FHLMC with servicing retained based on an allocation of the carrying amount
of the loan and the servicing right in proportion to the relative fair values at the date of sale.
These servicing rights are recorded at the lower of cost or fair value and are being amortized over
their expected life. The determination of fair value of the servicing rights is determined using a
discounted cash flow model which considers various factors such as estimated prepayment speeds of
the underlying mortgages, the estimated life of the mortgages, the estimated cost to service the
loans, and the discount rate.
Deferred financing costs were deferred and are being amortized by the straight-line method over
four years, which approximates the effective interest method.
HFF Securities has recognized an intangible asset in the amount of $0.1 million for the costs of
obtaining a NASD license as a broker-dealer. The license is determined to have an indefinite useful
economic life and is, therefore, not being amortized.
Holdings Consol periodically evaluates the remaining useful lives and carrying values of the
intangible assets to determine whether events and circumstances indicate that a change in the
useful life or impairment in value may have occurred. Indicators of impairment monitored by
management include a decline in the level of serviced loans. No indicators of impairment were noted
as a result of management’s evaluation. This evaluation is performed at least annually.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Income Taxes
Holdings Consol consists of two limited liability companies (HFF Holdings and Holdings Sub), a
corporation (Holliday GP), and two limited partnerships (HFF LP and HFF Securities). The limited
liability companies and the limited partnerships are not taxpaying entities for federal purposes
and their income and expenses are passed through and reported on the individual income tax returns
of the members of HFF Holdings. Income taxes shown on Holdings Consol’s consolidated statements of
income reflect federal income taxes of the corporation and business and corporate income taxes in
various jurisdictions. For tax purposes, HFF LP’s goodwill of $9.0 million is being amortized by
the straight-line method over 15 years.
Cost of Services
Holdings Consol considers personnel expenses directly attributable to providing services to its
clients, such as salaries, commission and bonuses to producers and analysts, and certain purchased
services to be directly attributable to the generation of capital markets services revenue and has
classified these expenses as costs of services in the consolidated statements of income.
Segment Reporting
Holdings Consol operates in one reportable segment, the commercial real estate financial
intermediary segment and offers debt placement, investment sales, note sales, structured finance,
equity placement and investment banking services through its 18 offices. The results of each office
have been aggregated for segment reporting purposes as they have similar economic characteristics
and provide similar services to a similar class of customer.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements
SFAS 123(R). On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 123 (revised 2003), Share-Based Payment, or SFAS 123(R), which is a revision of SFAS No. 123,
Accounting for Stock-Based Compensation. SFAS 123(R) supersedes Accounting Principles Board (“APB”)
Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash
Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123.
However, SFAS 123(R) requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the consolidated statements of income based on their fair
values. Pro forma disclosure is no longer an option. We have operated as a series of partnerships
and limited liability companies and have not historically issued stock-based compensation awards.
Holdings Consol adopted SFAS 123(R) on January 1, 2006, using the modified prospective method. The
impact of adopting SFAS 123(R) will depend on the nature and level of share-based awards granted in
the future.
SFAS 154. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, or
SFAS 154. SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB SFAS No. 3, Reporting
Accounting Charges in Interim Financial Statements. SFAS 154 requires that a voluntary change in
accounting principle be applied retrospectively with all prior period financial statements
presented on the new accounting principle, unless it is impracticable to do so. SFAS 154 also
provides that a correction of errors in previously issued financial statements should be termed a
“restatement.” The new standard is effective for accounting changes and correction of errors
beginning July 1, 2005. Holdings Consol adopted SFAS 154 on January 1, 2006. The adoption of SFAS
154 did not have a material effect on Holdings Consol’s consolidated financial condition or result
of operations.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
SFAS 156. In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets — an amendment of FASB Statement No. 140,” or SFAS 156. SFAS No. 156 requires an entity to
recognize a servicing asset or servicing liability at fair value each time it undertakes an
obligation to service a financial asset by entering into a servicing contract, regardless of
whether explicit consideration is exchanged. The statement also permits a company to choose to
either subsequently measure servicing rights at fair value and to report changes in fair value in
earnings, or to retain the amortized method whereby servicing rights are recorded at the lower of
cost or fair value and are amortized over their expected life, including servicing contracts with
no recorded value. The provisions of SFAS 156 are effective for fiscal years beginning after
September 15, 2006. Holdings Consol plans to retain the amortization method upon adoption of FAS
156, but will begin recognizing the fair value of servicing assets and liabilities on any new
servicing contracts involving no consideration acquired after January 1, 2007. The impact of
adopting this provision of FAS 156 will likely be material to Holdings Consol’s financial condition
and results of operations and will depend on the volume and timing of servicing received after
January 1, 2007.
SFAS 157. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157 or
Statement). The Statement was issued to define fair value, establish a framework for measuring fair
value in generally accepted accounting principles (GAAP), and to expand fair value disclosure
requirements. Prior to issuance of this Statement, different definitions of fair value existed
within GAAP, and there was limited guidance available on applying existing fair value definitions.
The Statement does not require any new fair value measurements. SFAS 157 is effective for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. Prior to
adoption, Holdings Consol will evaluate the impact of adopting SFAS 157 on its consolidated financial
statements.
FIN 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48). This interpretation clarifies
the application of SFAS No. 109, Accounting for Income Taxes, by defining a criterion that an
individual tax position must meet for any part of the benefit of that position to be recognized in
an enterprise’s financial statements and also provides guidance on measurement, derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after December 15, 2006, but earlier adoption is
permitted. Holdings Consol will adopt FIN 48 for the first quarter ended
March 31, 2007. Holdings Consol is currently
assessing the impact the adoption of FIN 48 will have on its financial position and results of
operations.
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Notes to Consolidated Financial Statements (continued)
3. Property and Equipment
Property and equipment consist of the following (in thousands):
| December 31 | ||||||||
| 2006 | 2005 | |||||||
Furniture and equipment |
$ | 3,202 | $ | 2,199 | ||||
Computer equipment |
1,530 | 1,199 | ||||||
Capitalized software costs |
831 | 739 | ||||||
Leasehold improvements |
5,005 | 3,718 | ||||||
Subtotal |
10,568 | 7,855 | ||||||
Less accumulated depreciation and amortization |
(5,528 | ) | (3,579 | ) | ||||
| $ | 5,040 | $ | 4,276 | |||||
At December 31, 2006 and 2005, Holdings Consol has recorded office equipment, within furniture and
equipment, under capital leases of $0.5 million and $0.4 million, respectively, including
accumulated amortization of $0.3 million and $0.2 million, respectively, which is included within
depreciation and amortization expense on the accompanying consolidated statements of income. See
Note 7 for discussion of the related capital lease obligations.
4. Intangible Assets
Holdings Consol’s intangible assets are summarized as follows (in thousands):
| December 31, 2006 | December 31, 2005 | |||||||||||||||||||||||
| Gross | Gross | |||||||||||||||||||||||
| Carrying | Accumulated | Net Book | Carrying | Accumulated | Net Book | |||||||||||||||||||
| Amount | Amortization | Value | Amount | Amortization | Value | |||||||||||||||||||
Amortizable intangible assets: |
||||||||||||||||||||||||
Mortgage servicing rights |
$ | 6,085 | $ | (3,695 | ) | $ | 2,390 | $ | 5,578 | $ | (2,803 | ) | $ | 2,775 | ||||||||||
Deferred financing costs |
988 | (185 | ) | 803 | 14 | — | 14 | |||||||||||||||||
Unamortizable intangible
assets: |
||||||||||||||||||||||||
NASD license |
100 | — | 100 | 100 | — | 100 | ||||||||||||||||||
Total intangible assets |
$ | 7,173 | $ | (3,880 | ) | $ | 3,293 | $ | 5,692 | $ | (2,803 | ) | $ | 2,889 | ||||||||||
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Notes to Consolidated Financial Statements (continued)
4. Intangible Assets (continued)
Amortization expense related to intangible assets was $1.1 million, $1.1 million, and $1.2 million
for the years ended December 31, 2006, 2005 and 2004, respectively.
Estimated amortization expense for the next five years is as follows (in thousands):
2007 |
$ | 1,008 | ||
2008 |
848 | |||
2009 |
676 | |||
2010 |
306 | |||
2011 |
74 |
The weighted-average life of these intangibles was five years at December 31, 2006.
5. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations consist of the following at December 31, 2006 and 2005
(in thousands):
| December 31 | ||||||||
| 2006 | 2005 | |||||||
Bank term note payable |
$ | 56,250 | $ | — | ||||
Capital lease obligations |
234 | 272 | ||||||
Total long-term debt and capital leases |
56,484 | 272 | ||||||
Less current maturities |
56,393 | 122 | ||||||
Long-term debt and capital leases |
$ | 91 | $ | 150 | ||||
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Notes to Consolidated Financial Statements (continued)
5. Long-Term Debt and Capital Lease Obligations (continued)
(a) The Credit Agreement
In connection with HFF Holdings’ acquisition of HFF LP from the prior owners, HFF Holdings entered
into a Credit Agreement (Credit Agreement) with a financial institution which was comprised of a
$10.0 million term loan and a revolving line of credit. The bank term note payable required
quarterly principal installments of $0.1 million by HFF Holdings. The bank term note payable at
December 31, 2004, was $7.4 million. In December 2005, this note was paid in full.
Interest on the note was payable at the applicable LIBOR rate plus 2.50%. The interest rate could
be converted to prime plus 1.50% at the option of HFF Holdings. In June 2005, HFF Holdings agreed
to a fixed rate of 6.12% through December 2005.
In 2005, borrowings under the revolving credit agreement were limited to $7.0 million. Interest on
outstanding balances was payable at the 30-day LIBOR rate (4.39% at December 31, 2005) plus 2.50%.
The agreement required payment of a commitment fee of 0.35% on the unused amount of credit. HFF LP
did not borrow on this revolving credit facility during 2005 and 2004.
The loan agreements for the term note and revolving credit arrangement contain various restrictive
covenants relating to financial ratios, permitted investments, incurrence of indebtedness,
distributions to members, and transactions with related parties. Obligations outstanding under the
revolving credit agreement are collateralized by the ownership interests in Holdings Sub, Holliday
GP, HFF Securities, and HFF LP.
(b) The New Credit Agreement
In March 2006, HFF LP entered into a new credit agreement (The New Credit Agreement) with a
financial institution. The New Credit Agreement was comprised of a $60.0 million term loan and a
$20.0 million revolving credit facility, which replaced the revolving credit agreement above. HFF
LP distributed the $60.0 million proceeds from the term loan to the members generally based on
their respective ownership interests, which are reflected as distributions in the consolidated
statements of members’ equity. The terms of the New Credit Agreement require quarterly
payments of $1.25 million and annual payments equal to 22.5% of adjusted annual net income. In
connection with The New Credit Agreement,
each member signed a revised operating agreement which requires each member to repay their portion
of the
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Long-Term Debt and Capital Lease Obligations (continued)
remaining outstanding balance of the loan in the event the member leaves the Company prior to the
loan being repaid in full. Holdings Consol is obligated under the New Credit Agreement to remit all
amounts collected from withdrawing members to the financial institution for repayment of the loan.
The New Credit Agreement expires in March 29, 2010, and may be extended for one year at the option
of HFF LP. Interest on outstanding balances is payable at the 30-day LIBOR rate (5.33% at December
31, 2006) plus 2.50%. HFF LP has the option to convert revolving credit borrowings, subject to
certain restrictions, to Base Note Rates upon which interest is calculated at the greater of the
bank’s prime rate (8.25% at December 31, 2006) plus 1.50% or the Federal Funds Effective Rate
(5.17% at December 31, 2006) plus 2.00% . The agreement also requires payment of a commitment fee
of .35% on the unused amount of credit. HFF LP did not borrow on this revolving credit facility
during the year ended December 31, 2006.
The New Credit Agreement contains various restrictive covenants relating to financial ratios,
permitted investments, incurrence of indebtedness, distributions to members, and transactions with
related parties. Obligations outstanding under the revolving credit agreement are collateralized by
the ownership interests in Holdings Sub, Holliday GP, and HFF
LP. This Agreement was paid in full from the
proceeds of the initial public offering discussed in Note 12 below.
(c) Letters of Credit and Capital Lease Obligation
Holdings Consol has outstanding letters of credit of approximately $2.3 million and $0.2 million at
December 31, 2006 and 2005, respectively, with the same bank as the term note and revolving credit
arrangements, to comply with bonding requirements of certain state regulatory agencies, as security
for three leases and as collateral to meet Freddie Mac net worth requirements. HFF LP segregated
cash in a separate bank account to collateralize the letters of credit. The letters of credit
expire through 2007 but can be automatically extended for one year except for the $2.0 million
letter of credit with Freddie Mac, which expired on February 28,
2007. Additionally, in connection with HFF Inc.’s initial public
offering and the resulting pay-off of the entire outstanding balance
under the New Credit Agreement in February 2007, HFF LP now meets
Freddie Mac’s minimum net worth requirement.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Long-Term Debt and Capital Lease Obligations (continued)
Capital lease obligations consist primarily of office equipment leases that expire at various dates
through May 2010 and bear interest at rates ranging from 3.65% to 6.19%. A summary of future
minimum lease payments under capital leases at December 31, 2006, is as follows (in thousands):
2007 |
$ | 143 | ||
2008 |
47 | |||
2009 |
39 | |||
2010 |
5 | |||
| $ | 234 | |||
6. Warehouse Line of Credit
In 2005, HFF LP obtained an uncommitted warehouse line of credit for the purpose of funding the
Freddie Mac mortgage loans that it originates. Each funding is separately approved on a
transaction-by-transaction basis and is collateralized by a loan and mortgage on a multifamily
property that is ultimately purchased by Freddie Mac. As of December 31, 2006, and 2005, HFF LP had
$125.7 million and $14.7 million, respectively, outstanding on the warehouse line of credit and a
corresponding amount of mortgage notes receivable. Interest on the warehouse line of credit is at
the 30-day LIBOR rate plus a spread (5.84% at December 31, 2006, and 5.40% at December 31, 2005)
and HFF LP is also paid interest on its loan secured by a multifamily loan at the rate in the
Freddie Mac note.
7. Lease Commitments
HFF LP leases various corporate offices, parking spaces, and office equipment under noncancelable
operating leases. These leases have initial terms of two to ten years. The majority of the leases
have termination clauses whereby the term may be reduced by two to seven years upon prior notice
and payment of a termination fee by HFF LP. Total rental expense charged to operations was $4.6
million, $3.9 million, and $3.6 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Lease Commitments (continued)
Future minimum rental payments for the next five years under operating leases with noncancelable
terms in excess of one year and without regard to early termination provisions are as follows (in
thousands):
2007 |
$ | 4,754 | ||
2008 |
4,802 | |||
2009 |
3,944 | |||
2010 |
3,615 | |||
2011 |
3,134 | |||
Thereafter |
8,413 | |||
| $ | 28,662 | |||
HFF LP subleases certain office space to subtenants which may be canceled at any time. The rental
income received from these subleases is included as a reduction of occupancy expenses in the
accompanying consolidated statements of income.
HFF LP also leases certain office equipment under capital leases that expire at various dates
through 2010. See Note 3 and Note 5 above for further description of the assets and related
obligations recorded under these capital leases at December 31, 2006 and 2005, respectively.
HFF Holdings is not an obligor, nor does it guarantee any of the HFF LP leases.
8. Retirement Plan
Holdings Consol maintains a retirement savings plan for all eligible employees, in which employees
may make deferred salary contributions up to the maximum amount allowable by the IRS. After-tax
contributions may also be made up to 50% of compensation. HFF LP makes matching contributions equal
to 50% of the first 6% of both deferred and after-tax salary contributions, up to a maximum of
$5,000. The Holdings Consol match was fully vested after two years of service during 2003 and 2004,
after one year of service in 2005, and after one month of service effective January 1, 2006.
Holdings Consol’s contributions charged to expense for the plan were $1.2 million, $0.9 million,
and $0.7 million for the years ended December 31, 2006, 2005 and 2004, respectively.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. Servicing
HFF LP services commercial real estate loans for investors. The servicing portfolio totaled $18.0
billion, $14.9 billion, and $13.0 billion at December 31, 2006, December 31, 2005 and December 31,
2004, respectively.
In connection with its servicing activities, the HFF LP holds funds in escrow for the benefit of
mortgagors for hazard insurance, real estate taxes and other financing arrangements. At December
31, 2006, 2005 and 2004, the funds held in escrow totaled $104.4 million, $113.0 million and $107.0
million, respectively. These funds, and the offsetting liabilities, are not presented in Holdings
Consol’s financial statements as they do not represent the assets and liabilities of Holdings
Consol. Pursuant to the requirements of the various investors for which HFF LP services loans, HFF
LP maintains bank accounts, holding escrow funds, which have balances in excess of the FDIC
insurance limit. The fees earned on these escrow funds are reported in capital markets services
revenue in the consolidated statements of income.
10. Legal Proceedings
Holdings Consol is party to various litigation matters, in most cases involving ordinary course and
routine claims incidental to its business. Holdings Consol cannot estimate with certainty its
ultimate legal and financial liability with respect to any pending matters. In accordance SFAS 5,
Accounting for Contingencies, a reserve for estimated losses is recorded when the amount is
probable and can be reasonably estimated. However, Holdings Consol believes, based on examination
of such pending matters that its ultimate liability will not have a material adverse effect on its
business or financial condition.
11.
Concentrations
A
significant portion of the Holdings Consol’s capital markets services
revenues is derived from transactions involving commercial real
estate located in specific geographic areas. During 2006,
approximately 10.8% and 21.1% of Holdings Consol’s capital markets
services revenues were derived from transactions involving commercial
real estate located in Florida and Texas, respectively. During 2005,
approximately 12.7% and 21.7% of the Holdings Consol’s capital markets
services revenues were derived from transactions involving commercial
real estate located in California and Texas, respectively. As a
result, a significant portion of Holdings Consol’s business is
dependent on the economic conditions in general and the markets for
commercial real estate in these areas.
12. Subsequent Events
On November 9, 2006, HFF, Inc., an affiliate formed for the purpose of completing an initial public
offering, filed a registration statement on Form S-1 with the United States Securities and Exchange
Commission (the “SEC”) relating to a proposed underwritten initial public offering of 14,300,000
shares of Class A common stock of HFF, Inc. On January 30, 2007, the SEC declared HFF, Inc.’s
registration statement on Form S-1 effective and 14,300,000 shares for the initial public offering
were priced at $18.00 per share. On January 31, 2007, HFF, Inc.’s common stock began trading on the
New York Stock Exchange under the symbol “HF.”
On February 5, 2007, HFF, Inc. closed the initial public offering of 14,300,000 shares of common
stock. Net proceeds from the sale of the stock were $235.7 million, net of $18.0 million of
underwriting commissions and $3.7 million of offering expenses. The proceeds of
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
the public offering were used to purchase from HFF Holdings all of the shares of Holliday GP and
purchase from HFF Holdings partnership units representing approximately 39% of each of the
Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday
GP). HFF Holdings used approximately $56.3 million of its proceeds to repay all outstanding
indebtedness under HFF LP’s credit agreement. Accordingly HFF, Inc. did not retain any of the
proceeds from this offering.
On February 22, 2007, the underwriters exercised their option to purchase an additional 2,145,000
shares of Class A common stock (15% of original issuance) at $18.00 per share. Total proceeds of
the overallotment were $38.6 million, net of $2.7 million of underwriting commissions and other
expenses. These proceeds were used to purchase HFF Holdings partnership units representing
approximately 6.0% of each of the Operating Partnerships.
In addition to cash received for its sale of all of the shares of Holliday GP and approximately 45%
of partnership units of each of the Operating Partnerships (including partnership units in the
Operating Partnerships held by Holliday GP) , HFF Holdings also received an exchange right that
will permit HFF Holdings to exchange interests in the Operating Partnerships for shares of HFF,
Inc.’s Class A common stock (the “Exchange Right”) and rights under a tax receivable agreement
between HFF, Inc. and HFF Holdings (the “TRA”).
As a result of the offering, HFF Holdings beneficially own 20,355,000 partnership units in each of
the Operating Partnerships. Pursuant to the terms of HFF, Inc.’s amended and restated certificate
of incorporation, HFF Holdings could from time to time exchange its partnership units in the
Operating Partnerships for shares of HFF, Inc.’s Class A common stock on the basis of two
partnership units, one of each Operating Partnership, for one share of Class A common stock,
subject to customary conversion rate adjustments for stock splits, stock dividends and
reclassifications. The following table reflects the exchangeability of HFF Holdings’ rights to
exchange its partnership units in the Operating Partnerships for shares of HFF, Inc.’s Class A
common stock, pursuant to contractual provisions in the HFF Holdings Operating Agreement. However,
these contractual provisions may be waived, amended or terminated by a vote of the members holding
65% of the interests of HFF Holdings following consultation with the board of directors.
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
| Percentage of HFF | ||||||||
| Number of | Holdings’ Partnership | |||||||
| Additional Shares | Units in the | |||||||
| of Class A Common | Operating | |||||||
| Stock Expected to | Partnerships | |||||||
| Become Available | Becoming Eligible | |||||||
| Anniversary of the Offering | for Exchange | for Exchange | ||||||
Second |
5,088,750 | 25 | % | |||||
Third |
5,088,750 | 25 | % | |||||
Fourth |
5,088,750 | 25 | % | |||||
Fifth |
5,088,750 | 25 | % | |||||
Total |
20,355,000 | 100 | % | |||||
HFF Holdings was issued one share of HFF, Inc.’s Class B common stock. Class B common stock has no
economic rights but will entitle the holder to a number of votes that is equal to the total number
of shares of Class A common stock for which the partnership units that HFF Holdings holds in the
Operating Partnerships as of the relevant record date for the HFF, Inc. stockholder action are
exchangeable.
HFF LP and HFF Securities intend to have an election under Section 754 of the Internal Revenue Code
effective for 2007 and for each taxable year in which an exchange of partnership units for shares
occurs. The initial sale is expected to produce (and later exchanges may produce) increases to the
tax basis of the assets owned by HFF LP and HFF Securities at the time of the initial public
offering (and at the time of each exchange of partnership units). These anticipated increases in
tax basis would be allocated to HFF, Inc. and would likely reduce the amount of tax that HFF, Inc.
would otherwise be required to pay in the future. HFF, Inc. entered into a tax receivable
agreement with HFF Holdings that provides for the payment by HFF, Inc. to HFF Holdings of 85% of
the amount of cash savings, if any, in U.S. federal, state and local income tax that HFF, Inc.
actually realizes as a result of these increases in tax basis and as a result of certain other tax
benefits arising from entering into the tax receivable agreement and making payments under that
agreement. For purposes of the tax receivable agreement, cash savings in income tax will be
computed by comparing HFF, Inc.’s actual income tax liability to the amount of such taxes that HFF,
Inc. would have been required to pay had there been no increase to the tax basis of the assets of
HFF LP and HFF
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HFF Holdings, LLC and Subsidiaries
Notes to Consolidated Financial Statements (continued)
Securities as a result of the initial sale and later exchanges and had HFF, Inc. not entered into
the tax receivable agreement. The term of the tax receivable agreement commences upon consummation
of the offering and will continue until all such tax benefits have been utilized or expired,
including the tax benefits derived from future exchanges. While the actual amount and timing of
payments under the tax receivable agreement will depend upon a number of factors, including the
amount and timing of taxable income HFF, Inc. generates in the future, the value of its individual
assets, the portion of its payments under the tax receivable agreement constituting imputed
interest and increases in the tax basis of its assets resulting in payments to HFF Holdings, HFF,
Inc. expects that the payments that may be made to HFF Holdings will be substantial. Assuming no
material changes in the relevant tax law and that HFF, Inc. earns significant taxable income to
realize the full tax benefit of the increased amortization of its assets, HFF, Inc. expects that
future payments to HFF Holdings in respect of the initial sale and the overallotment to aggregate
$127.0 million and range from approximately $5.0 million to $14.0 million per year over the next 15
years. Future payments to HFF Holdings in respect of subsequent exchanges would be in addition to
these amounts and are expected to be substantial. The payments under the tax receivable agreement
are not conditioned upon HFF Holdings’ or its affiliates’ continued ownership of HFF, Inc.
HFF, Inc. will account for the income tax effects and corresponding tax receivable agreement
effects as a result of the initial purchase and the sale of units of the Operating Partnerships in
connection with the reorganization transactions and future exchanges of Operating Partnership units
for HFF, Inc.’s Class A shares by recognizing an increase in its deferred tax asset for the
estimated income tax effects of the increase in the tax basis of the assets owned by the Operating
Partnerships, based on enacted tax rates at the date of the transaction, less any tax valuation
allowance it believes is required if HFF, Inc. evaluates it is more likely than not that it will
realize the benefit represented by the deferred tax asset, and HFF, Inc. will record 85% of the
estimated amount of the increase in deferred tax assets, net of any valuation allowance, as a
liability to HFF Holdings under the tax receivable agreement and the remaining 15% of the increase
in deferred tax assets directly in additional paid-in capital in stockholders’ equity.
All of the effects of changes in any of HFF, Inc;’s estimates after the date of any exchange
will be included in net income. Similarly, the effect of subsequent changes in the enacted tax
rates will be included in net income.
On February 5, 2007, HFF LP entered into an Amended and Restated Credit Agreement with a financial
institution (Amended Credit Agreement). The Amended Credit Agreement is comprised of a $40.0
million revolving credit facility, which replaced The New Credit Agreement mentioned in note 5.
The Amended Credit Agreement matures on February 5, 2010 and may be extended for one year based on
certain conditions as defined in the agreement.
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures.
The Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that the Company files or furnishes under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms, and that such information is accumulated and
communicated to the Company’s management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required financial disclosure.
Our Chief Executive Officer and Chief Financial Officer (our principal executive officer and
principal financial officer, respectively) have evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this Annual Report on Form 10-K.
Based on this evaluation, our principal executive officer and principal financial officer have
concluded that, as of December 31, 2006, our current disclosure controls and procedures are
effective to provide reasonable assurance that material information required to be included in our
periodic SEC reports is recorded, processed, summarized and reported within the time periods
specified in the SEC rules and forms.
The design of any system of control is based upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in achieving its stated
objectives under all future events, no matter how remote, or that the degree of compliance with the
policies or procedures may not deteriorate. Because of its inherent limitations, disclosure
controls and procedures may not prevent or detect all misstatements. Accordingly, even effective
disclosure controls and procedures can only provide reasonable assurance of achieving their control
objectives.
There have been no changes in our internal controls over financial reporting that occurred
during the three month period ended December 31, 2006 that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference from the Company’s
definitive proxy statement for use in connection with the 2007 Annual Meeting of Stockholders (the
“Proxy Statement”) to be filed within 120 days after the end of the Company’s fiscal year ended
December 31, 2006.
The Company has adopted a code of conduct that applies to its Chief Executive Officer and
Chief Financial Officer. This code of conduct is available on the Company’s Web site at
www.hfflp.com. If the Company makes any amendments to this code other than technical,
administrative or other non-substantive amendments, or grants any waivers, including implicit
waivers, from a provision of this code to the Company’s Chief Executive Officer or Chief Financial
Officer, the Company will disclose the nature of the amendment or waiver, its effective date and to
whom it applies in a Current Report on Form 8-K filed with the SEC.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from the Proxy
Statement.
Table of Contents
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The information required by this Item is incorporated herein by reference from the Proxy
Statement.
Item 13. Certain Relationships, Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference from the Proxy
Statement.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated herein by reference from the Proxy
Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Documents filed as part of this report:
(1) Financial Statements
The
Company’s combined financial statements listed below have been filed as part of this
report.
All schedules are omitted because they are not applicable or not required, or the information
appears in the Company’s combined financial statements or notes thereto.
(3) Exhibits
See Exhibit Index.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) or the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized on March 15, 2007.
| HFF, INC. |
||||
| By: | /s/ John H. Pelusi, Jr. | |||
| John H. Pelusi, Jr. | ||||
| Its: Chief Executive Officer | ||||
Table of Contents
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons in the capacities and on the dates indicated.
| Signature | Capacity | Date | ||||
By:
|
/s/
John H. Pelusi, Jr. |
Chief Executive Officer, Director and Executive Managing Director (Principal Executive Officer) | March 15, 2007 | |||
By:
|
/s/ Gregory R. Conley |
Chief Financial Officer (Principal Financial and Accounting Officer) | March 15, 2007 | |||
By:
|
/s/ John P. Fowler | Director | March 15, 2007 | |||
By:
|
/s/ Mark D. Gibson | Director | March 15, 2007 | |||
By:
|
/s/ John Z. Kukral | Director | March 15, 2007 | |||
By:
|
/s/ Deborah H. McAneny | Director | March 15, 2007 | |||
By:
|
/s/ George L. Miles, Jr. | Director | March 15, 2007 | |||
By:
|
/s/ Lenore M. Sullivan | Director | March 15, 2007 | |||
By:
|
/s/ Joe B. Thornton, Jr. | Director | March 15, 2007 | |||
By:
|
/s/ McHenry T. Tichenor, Jr. | Director | March 15, 2007 | |||
Table of Contents
Exhibit Index
| 2.1 | Sale and Merger Agreement, dated January 30, 2007 (incorporated by reference to Exhibit 10.5 to the Registrant’s Registration Statement on Form S-l (File No. 333-138579) (“Form S-l”) filed with the SEC on December 22, 2006) | |
| 3.1 | Amended and Restated Certificate of incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Form S-l filed with the SEC on December 22, 2006) | |
| 3.2 | Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to the Form S-1 filed with the SEC on December 22, 2006) | |
| 10.1 | Holliday Fenoglio Fowler, L.P. Partnership Agreement, dated February 5, 2007 | |
| 10.2 | HFF Securities L.P. Partnership Agreement, dated February 5, 2007 | |
| 10.3 | Tax Receivable Agreement, dated February 5, 2007 (incorporated by reference to Exhibit 10.3 to the Form S-1 filed with the SEC on December 22, 2006) | |
| 10.4 | Registration Rights Agreement, dated February 5, 2007 (incorporated by reference to Exhibit 10.4 to the Form S-1 filed with the SEC on December 22, 2006) | |
| 10.5 | HFF, Inc. 2006 Omnibus Incentive Compensation Plan, dated January 30, 2007 (incorporated by reference to Exhibit 10.9 to the Form S-l filed with the SEC on January 8, 2007) | |
| 10.6 | Holliday Fenoglio Fowler, L.P. Profit Participation Bonus Plan (incorporated by reference to Exhibit 10.10 to the Form S-1 filed with the SEC on January 8, 2007) | |
| 10.7 | HFF Securities, L.P. Profit Participation Bonus Plan (incorporated by reference to Exhibit 10.11 to the Form S-l filed with the SEC on January 8, 2007) | |
| 10.8 | Employment Agreement between the Registrant and John H. Pelusi, Jr., dated January 30, 2007 | |
| 10.9 | Employment Agreement between the Registrant and Gregory R. Conley, dated January 30, 2007 | |
| 10.10 | Employment Agreement between the Registrant and Nancy Goodson, dated January 30, 2007 | |
| 10.11 | Amended and Restated Credit Agreement dated January 5, 2007* | |
| 21.1 | Subsidiaries of the registrant. | |
| 23.1 | Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm | |
| 31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1 | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| * | The schedules and annexes to the exhibits attached to Exhibit 10.11 have been omitted. The Registrant hereby agrees to furnish supplementally a copy of any omitted schedule or annex to the exhibits attached thereto to the Securities and Exchange Commission upon its request. |