CB Richard Ellis Group, Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods. Amounts below are in U.S. dollars. Financial statements are unaudited.
Business context and reporting period
CBRE provides commercial real estate services, including brokerage, property and facilities management, mortgage origination and servicing, investment management, and development. It reports five segments: Americas, EMEA, Asia Pacific, Global Investment Management, and Development Services. Management said transaction activity rebounded from depressed 2009 levels as economic and credit conditions improved, though commercial real estate recovery remained uneven. Results are seasonal, with activity and earnings historically stronger in the second half, particularly the fourth quarter.
Key financial metrics
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $1,266.2 million | $1,023.2 million | $3,464.0 million | $2,869.3 million |
| Operating income | $130.6 million | $57.0 million | $273.4 million | $101.4 million |
| Net income (loss) attributable to CBRE | $57.0 million | $12.4 million | $105.2 million | $(30.9) million |
| Diluted earnings (loss) per share | $0.18 | $0.04 | $0.33 | $(0.11) |
| EBITDA, as reported by the company | $169.9 million | $98.1 million | $406.5 million | $205.0 million |
Revenue increased 23.8% in Q3 and 20.7% year to date. Operating margin improved to 10.3% from 5.6% in Q3 and to 7.9% from 3.5% year to date. Cost of services fell to 58.1% of revenue in Q3 from 59.3%; operating, administrative and other expenses declined to 29.6% from 33.0%. Management attributed improved margins primarily to higher revenue and a greater share of transaction revenue. EBITDA is a non-GAAP measure and is not a substitute for net income or free cash flow.
Cash flow: Operating activities provided $324.9 million in the first nine months of 2010, versus $53.5 million in 2009. Investing activities used $20.9 million, compared with $97.9 million used; financing activities used $273.0 million, versus $202.2 million provided. Cash increased $27.1 million to $768.7 million. Operating cash flow benefited from improved results, working-capital movements and tax refunds; investing cash flow benefited from real estate dispositions and asset-sale proceeds.
Balance sheet and liquidity at September 30, 2010: Total assets were $5.075 billion; total liabilities were $4.118 billion; equity was $957.0 million. Current assets of $2.178 billion exceeded current liabilities of $1.610 billion. Cash and cash equivalents were $768.7 million, with an additional $51.5 million of restricted cash. Short-term borrowings were $280.0 million, including $260.1 million of warehouse-line borrowing; current maturities of long-term debt were $108.2 million. Long-term debt was $1.798 billion, including $1.360 billion of senior secured term loans and $437.4 million of 11.625% subordinated notes. Real estate notes payable totaled $679.6 million, of which only $3.5 million was recourse to CBRE beyond the property-owning entities.
CBRE reported covenant coverage of 6.57x versus a 2.00x minimum and net leverage of 1.27x versus a 4.25x maximum, as defined in its credit agreement. The company stated that operating cash flow and its revolving facility should meet anticipated needs for at least the next 12 months.
Material changes versus the prior comparable period
- Q3 revenue growth was led by worldwide sales, up 62.8%, leasing, up 27.2%, and outsourcing, up 7.0%. Year-to-date sales rose 59.2%, leasing 26.6%, and outsourcing 7.8%.
- All three geographic service segments recorded higher Q3 revenue: Americas rose 25.7%, EMEA 12.2%, and Asia Pacific 27.2%. For the first nine months, revenue increased 19.5%, 18.5%, and 32.6%, respectively.
- Q3 Global Investment Management revenue rose 50.6%, partly because new accounting rules required consolidation of certain property entities. Excluding that accounting change, management said Q3 revenue rose $7.3 million, mainly on higher acquisition and asset-management fees. Assets under management were $35.7 billion, up 3% from year-end 2009.
- Development Services remained loss-making at the operating level, but its Q3 operating loss narrowed to $3.7 million from $19.1 million. Year-to-date revenue declined 8.0%, while the operating loss narrowed to $14.2 million from $44.3 million, reflecting lower impairment charges and cost reductions.
- Lower impairment charges and a shift to equity income from unconsolidated subsidiaries supported the improvement. Equity income was $3.7 million in Q3 and $11.3 million year to date, versus losses of $6.3 million and $18.3 million. Q3 discontinued-operations income was $7.8 million, and year-to-date income was $15.0 million, mostly from asset-disposition gains.
- Interest expense fell 8.0% in Q3 but rose 9.9% year to date, primarily because of the 11.625% notes issued in 2009 and consolidation-related interest, partly offset by lower credit-agreement interest. The prior-year nine-month period also included a $29.3 million financing-cost write-off.
Outlook, management commentary, risks and unusual items
- Management described property values as under pressure but stabilizing, and occupancy and rental rates as bottoming out. It cautioned that European improvement slowed in the second half of 2010 and that recovery depends on sustained economic growth, employment gains, accessible credit and restored business confidence.
- No specific revenue or earnings guidance is provided. Management expected a full-year 2010 effective tax rate of approximately 36%–38%, up to $60 million of net capital expenditures for 2010, and about $5 million of 2010 integration costs. It expected total 2010 pension contributions of $3.5 million; $2.5 million had been contributed by September 30.
- After quarter-end, CBRE issued $350 million of 6.625% senior notes due 2020 and repaid approximately $357.4 million of term A loans using the proceeds and cash. Management also described plans to refinance remaining credit-agreement debt, including intended use of cash and proposed new secured facilities; these plans were not yet completed as described in the filing.
- Adoption of ASU 2009-17 effective January 1, 2010 brought certain variable-interest entities into consolidation. At September 30, these entities included $245.4 million of real estate and $222.7 million of nonrecourse mortgage debt; their reported losses were attributable to non-controlling interests. Their creditors have no recourse to CBRE’s assets outside the entities.
- Real estate market weakness, credit availability, client spending and collections, foreign currency fluctuations, leverage and refinancing, covenant compliance, investment performance, impairments, and seasonal earnings variability are material risks. A 10% increase in rates on variable-rate debt excluding real estate notes was estimated to reduce nine-month pretax income and operating cash flow by $6.7 million; the estimated additional cost for real estate notes was $2.9 million.
- The filing reports pending or threatened ordinary-course lawsuits and Foreign Corrupt Practices Act investigations, including an investigation referenced in an October 5, 2010 Form 8-K. Management said it did not expect resulting liability to materially affect the company, but outcomes remain uncertain. CBRE also disclosed development guarantees, $11.7 million of guarantees primarily for unconsolidated subsidiaries, and $29.0 million of letters of credit.
- CBRE had $20.3 million of future Global Investment Management co-investment commitments and $27.2 million of additional capital commitments to Development Services unconsolidated subsidiaries. Fannie Mae loss-sharing arrangements covered loans with $1.7 billion of unpaid principal; CBRE Capital Markets’ potential exposure is subject to the program terms and reserves.
Important facts for investors to verify
- Whether the rebound in sales and leasing activity persisted, and how much reported growth reflects underlying activity versus currency translation and the new VIE consolidation.
- Whether planned refinancing was completed on expected terms, and the resulting debt maturities, interest expense, collateral and covenant headroom.
- Cash conversion and working-capital trends, including receivables, tax refunds, bonus accruals and the contribution of real estate and servicing-rights disposals to cash flow.
- The sustainability of improved margins and the extent to which earnings depend on seasonal fourth-quarter activity, discontinued-operation gains and other property dispositions.
- Potential additional real estate or investment impairments, FCPA or other legal developments, and cash calls or losses under guarantees, co-investments, development commitments and Fannie Mae loan arrangements.