========================================================================= SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 [_] 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 - 12231 --------------------- CB RICHARD ELLIS SERVICES, INC. (Exact name of registrant as specified in its charter) Delaware 52-1616016 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 200 North Sepulveda Boulevard El Segundo, California 90245-4380 (Address of principal executive offices) (Zip Code) (310) 563 - 8600 Not Applicable (Registrant's telephone (Former name, former address and formal number, including area code) fiscal year if changed since last report) --------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 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 [X] No [_]. Number of shares of common stock outstanding at October 29, 1999 was 20,684,495. 1 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES FORM 10-Q September 30, 1999 TABLE OF CONTENTS PART I - FINANCIAL INFORMATION PAGE ---- Item 1. Consolidated Condensed Financial Statements Consolidated Balance Sheets as of September 30, 1999 (Unaudited) and December 31, 1998...........................3 Unaudited Consolidated Statements of Operations for the three months ended September 30, 1999 and 1998 and for the nine months ended September 30, 1999 and 1998............................4 Unaudited Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 1999 and 1998................................................................................5 Notes to Consolidated Condensed Financial Statements.............................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................12 Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................................22 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................................................................................23 Signatures.................................................................................................................24 2 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share data) September 30, December 31, 1999 1998 ------------- ------------ (Unaudited) A S S E T S ----------- Current Assets: Cash and cash equivalents............................................................ $ 25,122 $ 19,551 Receivables, less allowance of $13,273 and $13,348 for doubtful accounts at September 30, 1999 and December 31, 1998......................................... 143,448 131,512 Deferred taxes....................................................................... 2,886 3,529 Prepaid expenses..................................................................... 9,215 13,459 Other assets......................................................................... 17,048 8,353 --------- --------- Total current assets................................................................ 197,719 176,404 Property and equipment, net........................................................... 62,808 58,366 Goodwill, net of accumulated amortization of $38,118 and $25,060 at September 30, 1999 and December 31, 1998............................................. 445,244 445,124 Other intangible assets, net of accumulated amortization of $273,931 and $268,497 at September 30, 1999 and December 31, 1998.......................................... 57,821 63,913 Prepaid pension expenses.............................................................. 27,287 28,241 Deferred taxes........................................................................ 21,693 23,100 Investment in and advances to unconsolidated subsidiaries............................. 37,322 31,633 Other assets, net..................................................................... 21,265 30,111 --------- --------- Total assets........................................................................ $ 871,159 $ 856,892 ========= ========= L I A B I L I T I E S A N D S T O C K H O L D E R S' E Q U I T Y -------------------------------------------------------------------- Current Liabilities: Compensation and employee benefits................................................... $ 89,326 $ 66,245 Accounts payable and accrued expenses................................................ 66,633 105,027 Reserve for bonus and profit sharing................................................. 24,542 39,270 Current maturities of long-term debt................................................. 3,846 12,343 Current portion of capital lease obligations......................................... 1,644 2,862 --------- --------- Total current liabilities........................................................... 185,991 225,747 Long-term debt: Senior term loans.................................................................... 231,502 183,502 Senior subordinated notes, less unamortized discount of $1,946 and $2,099 at September 30, 1999 and December 31, 1998............................................ 173,054 172,901 Other long-term debt................................................................. 8,671 17,288 --------- --------- Total long-term debt................................................................ 413,227 373,691 Other long-term liabilities........................................................... 71,467 60,737 --------- --------- Total liabilities................................................................... 670,685 660,175 Minority interest..................................................................... 4,150 5,875 Commitments and contingencies Stockholders' Equity: Preferred stock, $0.01 par value; 8,000,000 shares authorized; no shares issued or outstanding Common stock, $0.01 par value; 100,000,000 shares authorized; 20,686,995 and 20,636,134 shares issued and outstanding at September 30, 1999 and December 31, 1998.................................................................. 213 211 Additional paid-in capital........................................................... 355,030 349,796 Notes receivable from sale of stock.................................................. (8,087) (5,654) Accumulated deficit.................................................................. (139,516) (145,767) Accumulated other comprehensive income (loss)........................................ (639) 1,139 Treasury stock at cost, 626,900 and 488,900 shares at September 30, 1999 and December 31, 1998................................................................... (10,677) (8,883) --------- --------- Total stockholders' equity.......................................................... 196,324 190,842 --------- --------- Total liabilities and stockholders' equity.......................................... $ 871,159 $ 856,892 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. 3 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share and per share data) Three Months Ended Nine Months Ended September 30, September 30, ------------------------- -------------------------- 1999 1998 1999 1998 ----------- ----------- ----------- ------------ Revenue: Leases................................................ $ 111,430 $ 97,763 $ 295,957 $ 252,654 Sales................................................. 106,695 93,770 268,704 253,463 Property and facilities management fees............... 26,689 23,838 80,516 58,814 Consulting and referral fees.......................... 18,612 19,515 54,044 41,340 Appraisal fees........................................ 15,018 13,983 45,334 31,661 Loan origination and servicing fees................... 10,247 11,750 26,682 27,625 Realty advisor fees................................... 7,854 7,348 20,723 23,755 Other................................................. 10,473 5,836 25,426 14,902 ----------- ----------- ----------- ----------- Total revenue......................................... 307,018 273,803 817,386 704,214 Costs and Expenses: Commissions, fees and other incentives................ 137,709 119,959 351,317 315,271 Operating, administrative and other................... 139,262 117,909 394,404 309,700 Merger-related and other nonrecurring charges......... - - - 16,585 Depreciation and amortization......................... 10,001 9,337 29,963 22,086 ----------- ----------- ----------- ----------- Operating income......................................... 20,046 26,598 41,702 40,572 Interest income.......................................... 791 703 1,861 1,968 Interest expense......................................... 10,294 9,628 29,670 21,359 ----------- ----------- ----------- ----------- Income before provision for income tax................... 10,543 17,673 13,893 21,181 Provision for income tax................................. 5,895 7,534 7,642 10,257 ----------- ----------- ----------- ----------- Net income............................................... $ 4,648 $ 10,139 $ 6,251 $ 10,924 =========== =========== =========== =========== Deemed dividend on preferred stock....................... $ - $ - $ - $ 32,273 ----------- ----------- ----------- ----------- Earnings (loss) applicable to common stockholders........ $ 4,648 $ 10,139 $ 6,251 $ (21,349) =========== =========== =========== =========== Basic earnings (loss) per share.......................... $ 0.22 $ 0.49 $ 0.30 $ (1.07) =========== =========== =========== =========== Weighted average shares outstanding for basic earnings (loss) per share........................................ 21,098,757 20,692,573 21,021,512 19,917,773 =========== =========== =========== =========== Diluted earnings (loss) per share........................ $ 0.22 $ 0.48 $ 0.30 $ (1.07) =========== =========== =========== =========== Weighted average shares outstanding for diluted earnings (loss) per share............................... 21,162,334 21,101,324 21,103,139 19,917,773 =========== =========== =========== =========== The accompanying notes are an integral part of these consolidated financial statements. 4 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Dollars in thousands) Nine Months Ended September 30, --------------------- 1999 1998 -------- --------- Cash flows from operating activities: Net income.......................................................................... $ 6,251 $ 10,924 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization excluding deferred financing costs................... 29,963 22,086 Deferred compensation.............................................................. 13,691 11,375 Deferred taxes..................................................................... 1,334 5,706 Loss on disposition of property.................................................... 1,902 83 Increase in receivables............................................................. (13,436) (15,605) Decrease in compensation and employee benefits payable.............................. (10,200) (22,637) (Decrease) increase in accounts payable and accrued expenses........................ (14,691) 10,945 Net change in other operating assets and liabilities................................ (12,105) 4,209 -------- --------- Net cash provided by operating activities........................................ 2,709 27,086 -------- --------- Cash flows from investing activities: Purchases of property and equipment................................................. (19,213) (18,040) Proceeds from sale of inventoried property.......................................... 7,355 - Increase in intangible assets and goodwill.......................................... (3,364) (14,603) Acquisition of businesses including net assets acquired, intangibles and goodwill....................................................................... (10,353) (159,822) Decrease (increase) in investments in/advances to unconsolidated subsidiaries....... 4,605 (8,461) Other investing activities, net..................................................... (252) 1,130 -------- --------- Net cash used in investing activities............................................ (21,222) (199,796) -------- --------- Cash flows from financing activities: Proceeds from senior term loans..................................................... 146,000 268,000 Repayment of senior term loans...................................................... (98,000) (208,000) Proceeds from senior subordinated notes............................................. - 172,804 Repayment of inventoried property loan.............................................. (7,093) (377) Repayment of other loans............................................................ (10,388) (7,753) Payment of dividends payable........................................................ - (5,000) Repurchase of preferred stock....................................................... - (72,418) Repurchase of common stock.......................................................... (1,794) - Repayment of capital leases......................................................... (1,037) (1,354) Other financing activities, net..................................................... (3,079) 2,908 -------- --------- Net cash provided by financing activities........................................ 24,609 148,810 -------- --------- Net increase (decrease) in cash and cash equivalents.................................. 6,096 (23,900) Cash and cash equivalents, at beginning of period..................................... 19,551 47,181 Effect of exchange rate changes on cash............................................... (525) 156 -------- --------- Cash and cash equivalents, at end of period........................................... $ 25,122 $ 23,437 ======== ========= Supplemental disclosure of cash flow information: Cash paid (received) during the period for: Interest (none capitalized)........................................................ $ 25,302 $ 13,522 Income taxes....................................................................... $ 9,957 $ (435) The accompanying notes are an integral part of these consolidated financial statements. 5 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. Organization and Acquisitions Organization. CB Richard Ellis Services, Inc. ("CB Richard Ellis") or (the "Company") is a holding company that conducts its operations primarily through its subsidiaries CB Richard Ellis, Inc., CB Commercial Limited (the United Kingdom holding company, formerly known as REI Limited ("REI") for the various Richard Ellis companies operating outside the United Kingdom and the United States), L.J. Melody & Company ("L.J. Melody"), CB Richard Ellis Investors, L.L.C. and CB Hillier Parker Limited ("HP"), the United Kingdom holding company for operations within the United Kingdom. On November 25, 1996, CB Richard Ellis completed an initial public offering (the "Offering") of 4,347,000 shares of common stock, par value $.01 per share. The net proceeds from the Offering of $79.5 million were used to repay a portion of CB Richard Ellis' then outstanding senior secured indebtedness and senior subordinated indebtedness. Nature of Operations. The Company provides a full range of real estate services to commercial real estate tenants, owners and investors through approximately 250 offices worldwide including but not limited to the United States, Argentina, Australia, Brazil, Belgium, Canada, France, Germany, Hong Kong, India, Italy, the Netherlands, New Zealand, People's Republic of China, Portugal, Singapore, Spain, Switzerland, Taiwan and the United Kingdom. In July 1999, the Company undertook a reorganization that will streamline operations and result in a change in its segment reporting from four to three segments. The Company's services under this new segmentation include (i) brokerage services whereby the Company facilitates the sale and lease of properties, transaction management and advisory services, investment property transactions, including acquisitions and sales on behalf of investors ("Transaction Management"); (ii) capital market activities, including mortgage banking, brokerage and servicing, investment management and advisory services, real estate market research and valuation and appraisal services ("Financial Services"); and (iii) facilities management services to corporate real estate users, and property management and related services ("Management Services"). The Company's diverse client base includes local, national and multinational corporations, financial institutions, pension funds and other tax exempt entities, local, state and national government entities, and individuals. A significant portion of the Company's revenue is seasonal. Historically, this seasonality has caused the Company's revenue, operating income and net income to be lower in the first two calendar quarters and higher in the third and fourth calendar quarters of each year. In addition, the Company's operations are directly affected by actual and perceived trends in various national and economic conditions, including interest rates, the availability of credit to finance commercial real estate transactions and the impact of tax laws. To date, the Company does not believe that general inflation has had a material impact upon its operations. Revenues, commissions and other variable costs related to revenues are primarily affected by real estate market supply and demand rather than general inflation. Acquisitions. Refer to the Company's financial statements included in the Annual Report on Form 10-K for the year ended December 31, 1998 for a discussion of the Company's acquisitions prior to 1999. In 1999 the Company's only acquisition has been the acquisition of Eberhardt company by L.J. Melody in September 1999 for $6.0 million. The assets and liabilities of certain acquired companies, along with the related goodwill, intangibles and indebtedness, are reflected in the accompanying consolidated financial statements as of September 30, 1999. The results of operations of the acquired companies are included in the consolidated results from the dates they were acquired. The unaudited pro forma results of operations of the Company for the nine months ended September 30, 1998, assuming the REI acquisition, which constituted the Company's only material acquisition year to date, had occurred on January 1, 1998, would have been as follows (amounts in thousands, except per share data): Revenue...................................... $720,528 Net income................................... 1,953 Net loss applicable to common stockholders... (30,320) Loss per share Basic...................................... (1.48) Diluted.................................... (1.48) 6 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued) (Unaudited) Net loss applicable to common stockholders includes a deemed dividend of $32.3 million on the repurchase of the Company's preferred stock. The pro forma results do not necessarily represent results which would have occurred if the acquisitions had taken place on the date assumed above, nor are they indicative of the results of future combined operations. The amounts are based upon certain assumptions and estimates, and do not reflect any benefit from economies which might be achieved from combined operations. Further, REI historical results for the first three months of 1998 include certain nonrecurring adjustments. 2. Impairment of Long-Lived Assets The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, in March 1995. In accordance with SFAS No. 121, long-lived assets and certain intangibles held and used by the Company will be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Further, the Company periodically evaluates the recoverability of the carrying amount of goodwill and other intangible assets in accordance with SFAS No. 121. In this assessment, the Company considers macro market conditions and trends in the Company's relative market position, its capital structure, lender relationships and the estimated undiscounted future cash flows associated with these assets. If any of the significant assumptions inherent in this assessment materially change due to market, economic and/or other factors, the recoverability is assessed based on the revised assumptions and resultant undiscounted cash flows. If such analysis indicates impairment, it would be recorded in the period such changes occur based on the fair value of the goodwill and other intangible assets. 3. Other Current Assets In September 1999, the Company sold its Los Angeles headquarters building at a minimal loss. Other current assets include $7.7 million in receivables from the sale. 4. Goodwill and Other Intangible Assets Goodwill at September 30, 1999 consisted of $426.1 million related to the 1995 through 1999 acquisitions which is being amortized over an estimated useful life of 30 years and $19.1 million related to the Company's original acquisition in 1989 which is being amortized over an estimated useful life of 40 years. Other intangible assets at September 30, 1999 included approximately $7.2 million of deferred financing costs and $50.6 million of intangibles other than goodwill stemming from the 1995 through 1999 acquisitions. 5. Employee Benefit Plans In 1994 the Company implemented the Deferred Compensation Plan ("DCP"). Under the DCP, a select group of management and highly compensated employees can defer the payment of all or a portion of their compensation (including any bonus). The DCP permits participating employees to make an irrevocable election at the beginning of each year to receive amounts deferred at a future date either in cash, which is an unsecured long-term liability of the Company, or in newly issued shares of common stock of the Company which elections are recorded as additions to Stockholders' Equity. Effective May 1, 1999, the Company revised the DCP to add insurance products which function like mutual funds as an investment alternative and to fund the Company's obligation for deferrals invested in such insurance products. The Company received proceeds of approximately $1.6 million related to additional insurance products. For the nine months ended September 30, 1999, approximately $13.2 million and $1.1 million were deferred in cash (including interest) and stock, respectively. The accumulated deferrals at September 30, 1999, were approximately $30.1 million in cash (including interest and capital appreciation) and $11.1 million in stock for a total of $41.2 million, all of which was charged to expense in the period of deferral. 7 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued) (Unaudited) The Company, through the HP acquisition, maintains a contributory defined benefit pension plan ("DBP") to provide retirement benefits to former HP employees participating in the plan. The Company's funding policy for DBP is to make the minimum annual contributions required by applicable regulations. Reference is made to Note 6 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 for further discussion. At September 30, 1999, DBP plan assets exceeded DBP plan liabilities by approximately $27.3 million and the net prepaid pension asset is reflected in the accompanying balance sheet. 6. Debt In May 1998, the Company amended its revolving credit facility with a group of banks to provide up to $400.0 million for five years, subject to mandatory reductions of $40.0 million, $80.0 million and $80.0 million on December 31, 1999, 2000 and 2001, respectively. The amount outstanding under this facility was $215.0 million at September 30, 1999 which is included in the accompanying balance sheet. Interest rate alternatives include Bank of America's reference rate plus 1.00% and LIBOR plus 2.00%. The weighted average rate on the amounts outstanding at September 30, 1999 was 7.68%. The revolving credit facility contains numerous restrictive covenants that, among other things, limit the Company's ability to incur or repay other indebtedness, make advances or loans to subsidiaries and other entities, make capital expenditures, incur liens, enter into mergers or effect other fundamental corporate transactions, sell its assets, or declare dividends. In addition, the Company is required to meet certain ratios relating to its adjusted net worth, level of indebtedness, fixed charges and interest coverage. The Company and the banks recently executed an amendment to the revolving credit facility reducing the facility to $350.0 million, eliminating the mandatory reduction on December 31, 1999, and revising some of the covenants. In May 1998, the Company sold $175.0 million of 8.875% Senior Subordinated Notes ("Subordinated Notes") due on June 1, 2006. The Subordinated Notes are redeemable in whole or in part after June 1, 2002 at 104.438% of par on that date and at declining prices thereafter. On or before June 1, 2001, up to 35.0% of the issued amount may be redeemed at 108.875% of par plus accrued interest solely with the proceeds from an equity offering. The amount included in the accompanying balance sheet for the Subordinated Notes less unamortized discount was $173.1 million at September 30, 1999. 7. Income Taxes The provisions for income taxes for the nine month periods ended September 30, 1999 and 1998 were computed in accordance with Interpretation No. 18 of APB opinion No. 28 on reporting taxes for interim periods and were based on projections of total year pre-tax income. In accordance with APB opinion No. 23, no U.S. taxes have been provided on earnings of foreign subsidiaries because it is the intent of the Company to permanently re-invest the unremitted earnings of foreign subsidiaries. Reference is made to Note 10 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 for a discussion of the Company's deferred taxes including net operating loss carryforwards. 8. Commitments and Contingencies In December 1996, GMH Associates, Inc. ("GMH") filed a lawsuit against Prudential Realty Group ("Prudential") and the Company in Superior Court of Pennsylvania, Franklin County, alleging various contractual and tort claims against Prudential, the seller of a large office complex, and the Company, its agent in the sale, contending that Prudential breached its agreement to sell the property to GMH, breached its duty to negotiate in good faith, conspired with the Company to conceal from GMH that Prudential was negotiating to sell the property to another purchaser and that Prudential and the Company misrepresented that there were no other negotiations for the sale of the property. Following a non-jury trial, the court rendered a decision in favor of GMH and against Prudential and the Company, awarding GMH $20.3 million in compensatory damages, against Prudential and the Company jointly and severally, and $10.0 million in punitive damages, allocating the punitive damage award $7.0 million as against Prudential and $3.0 million as against 8 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued) (Unaudited) the Company. Following the denial of motions by Prudential and the Company for a new trial, a judgment was entered on December 3, 1998. Prudential and the Company have filed an appeal of the judgment. The Company believes that it has adequate insurance coverage for the compensatory portion of the judgment and adequate reserves for the punitive portion, as well as potential indemnity claims against Prudential for the entire judgment. In August 1993, a former commissioned sales person of the Company filed a lawsuit against the Company in the Superior Court of New Jersey, Bergen County, alleging gender discrimination and wrongful termination by the Company. On November 20, 1996, a jury returned a verdict against the Company, awarding $6.5 million in general and punitive damages to the plaintiff. Subsequently, the trial court awarded the plaintiff $638,000 in attorneys' fees and costs. Following denial by the trial court of the Company's motions for new trial, reversal of the verdict and reduction of damages, the Company filed an appeal of the verdict and requested a reduction of damages. On March 9, 1999 the appellate court ruled in the Company's favor, reversed the trial court decision and ordered a new trial. In June of 1999, the Supreme Court of New Jersey agreed to review the Appellate Court's decision and a hearing for this purpose has been set for November 30, 1999. Based on available reserves, cash and anticipated cash flows, the Company believes that the ultimate outcome will not have an impact on the Company's ability to carry on its operations. The Company is a party to a number of pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. Based on available cash and anticipated cash flows, the Company believes that the ultimate outcome will not have an impact on the Company's ability to carry on its operations. Management believes that any liability to the Company that may result from disposition of these lawsuits will not have a material effect on the consolidated financial position or results of operations of the Company. 9. Stockholders' Equity The translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate for the period. The cumulative gains or losses resulting from translations are included in stockholders' equity. 10. Comprehensive Income Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting of Comprehensive Income. Comprehensive income is a measure of all changes in equity of the Company that result from recognized transactions and other economic events of the period excluding investments in or distributions from the Company. All components of comprehensive income are reported under the provisions of SFAS No. 130. For the nine months ended September 30, 1999, total comprehensive income was $4.5 million which includes foreign currency translation loss of $1.8 million. For the nine months ended September 30, 1998, total comprehensive income was $13.7 million which includes foreign currency translation income of $2.8 million. 11. Per Share Information Basic and diluted earnings (loss) per share was computed by dividing net income (loss), less preferred dividend requirements as applicable, by the weighted average number of common shares outstanding during each period. When the Company has a net loss applicable to common stockholders for a particular reporting period, the stock options and warrants outstanding are excluded from the computation of diluted loss per share as they are anti-dilutive. 9 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued) (Unaudited) The following is a calculation of basic and diluted earnings (loss) per share (in thousands, except share and per share data): Three Months Ended September 30, --------------------------------------------------------------------- 1999 1998 ------------------------------------------- ----------------------- Per-Share Per-Share Income Shares Amount Income Shares Amount ------ ---------- --------- --------- ---------- ---------- Basic earnings per share Net income.......................................... $4,648 21,098,757 $0.22 $ 10,139 20,692,573 $ 0.49 ====== ========== ===== ======== ========== ========= Diluted earnings per share Net income.......................................... $4,648 21,098,757 $ 10,139 20,692,573 Diluted effect of exercise of options outstanding... 63,577 408,751 ------ ---------- -------- ---------- Earnings applicable to common stockholders.......... $4,648 21,162,334 $0.22 $ 10,139 21,101,324 $ 0.48 ====== ========== ===== ======== ========== ========= Nine Months Ended September 30, ---------------------------------------------------------------------- 1999 1998 -------------------------------- ---------------------------------- Per-Share Income Per-Share Income Shares Amount (Loss) Shares Amount ------ ---------- --------- -------- ---------- --------- Basic earnings (loss) per share Net income.......................................... $6,251 $ 10,924 Deemed dividend on preferred stock repurchase....... - (32,273) ------ -------- Earnings (loss) applicable to common stockholders... $6,251 21,021,512 $0.30 $(21,349) 19,917,773 $(1.07) ====== ========== ===== ======== ========== ========= Diluted earnings (loss) per share Earnings (loss) applicable to common stockholders... $6,251 21,021,512 $(21,349) 19,917,773 Diluted effect of exercise of options outstanding... 81,627 - ------ ---------- -------- ---------- Earnings (loss) applicable to common stockholders... $6,251 21,103,139 $0.30 $(21,349) 19,917,773 $(1.07) ====== ========== ===== ======== ========== ========= The following items were not included in the computation of diluted earnings (loss) per share because their effect was anti-dilutive for the quarters ended September 30: Three Months Ended September 30, Nine Months Ended September 30, ---------------------------------- ----------------------------------- 1999 1998 1999 1998 --------------- ---------------- ---------------- ---------------- Stock options Outstanding......... 2,081,032 1,574,676 1,955,355 2,993,477 Price ranges........ $ 16.38-$36.75 $ 31.00-$38.50 $ 18.04-$36.75 $ 0.38-$38.50 Expiration ranges... 6/8/04-5/31/09 4/21/07-7/22/08 4/15/06-5/31/09 4/18/99-7/22/08 Stock warrants Outstanding......... 599,967 599,967 599,967 599,967 Price............... $ 30.00 $ 30.00 $ 30.00 $ 30.00 Expiration.......... 8/28/04 8/28/04 8/28/04 8/28/04 12. Reclassification Certain reclassifications, which do not have any effect on net income, have been made to certain prior period financial statements to conform to the September 1999 presentation. 10 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (continued) (Unaudited) 13. Industry Segments In July 1999, the Company announced that it changed its segment reporting from four segments to three segments. Prior periods were restated to conform to the new segmentation. The three segments are Transaction Management, Management Services and Financial Services. The factors for determining the reportable segments were based on the type of service and client. Each business segment requires and is responsible for executing a unique marketing and business strategy. Transaction Management consists of commercial property sales and leasing services, transaction management and advisory services, investment property services (acquisitions and sales on behalf of investors). Management Services consists of facilities and property management and related services. Financial Services consists of mortgage loan origination and servicing through L.J. Melody, investment management and advisory services through CB Richard Ellis Investors, L.L.C., capital markets activities, valuation and appraisal services and real estate market research. The following tables summarize the revenue, cost and expenses, and operating income by operating segment for the periods ended September 30, 1999 and 1998. Three Months Ended Nine Months Ended September 30, September 30, -------------------- --------------------- 1999 1998 1999 1998 --------- -------- --------- --------- Revenue (1) Transaction Management.......................... $225,244 $197,507 $582,568 $520,679 Financial Services.............................. 42,947 42,289 122,699 99,168 Management Services............................. 38,827 34,007 112,119 84,367 -------- -------- -------- -------- $307,018 $273,803 $817,386 $704,214 ======== ======== ======== ======== Operating income (loss) Transaction Management.......................... $ 25,192 $ 22,927 $ 45,582 $ 53,619 Financial Services.............................. (3,157) 1,365 (1,933) 685 Management Services............................. (1,989) 2,306 (1,947) 2,853 Merger-related and other nonrecurring charges... - - - (16,585) -------- -------- -------- -------- 20,046 26,598 41,702 40,572 Interest income.................................. 791 703 1,861 1,968 Interest expense................................. 10,294 9,628 29,670 21,359 -------- -------- -------- -------- Income before provision for income tax........... $ 10,543 $ 17,673 $ 13,893 $ 21,181 ======== ======== ======== ======== Geographic Information Revenue United States................................... $237,954 $226,869 $633,591 $ 629,410 All other countries............................. 69,064 46,934 183,795 74,804 -------- -------- -------- --------- $307,018 $273,803 $817,386 $ 704,214 ======== ======== ======== ========= (1) Certain revenue types disclosed on the income statement may not be derived directly from amounts shown in this table. 11 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction - CB Richard Ellis Services, Inc. through its direct and indirect subsidiaries (collectively the "Company") provides real estate services through approximately 250 offices worldwide including but not limited to the United States, Argentina, Australia, Brazil, Belgium, Canada, France, Germany, Hong Kong, India, Italy, the Netherlands, New Zealand, People's Republic of China, Portugal, Singapore, Spain, Switzerland, Taiwan, and the United Kingdom. Over the course of the last five years the Company, in recognition of a rapidly changing structural and economic environment, has changed from being almost exclusively a traditional U.S. real estate broker to being a diversified global real estate services firm. The Company's brokerage business, commercial property sales and leasing, transaction management and advisory services, investment property transactions, including acquisitions and sales on behalf of investors ("Transaction Management") is one of the largest such businesses in the United States. As part of its strategic emphasis in developing a worldwide business, the Company has, since the beginning of 1995, completed multiple acquisitions, an $87.0 million public offering of common stock and a $175.0 million offering of senior subordinated notes. The Company is continually assessing acquisition opportunities as part of its growth strategy. Because of the substantial non- cash and non-tax deductible goodwill and intangible amortization charges incurred by the Company in connection with acquisitions subject to purchase accounting and because of interest expense associated with acquisition financing, past acquisitions have and future acquisitions may adversely affect net income. In addition, during the first six months following an acquisition, the Company believes there are generally significant one-time costs relating to integrating information technology, accounting and management services and rationalizing personnel levels (a portion of which the Company intends to reflect as a statement of operations charge or as part of the purchase price at the time of the acquisition as appropriate). Management's strategy is to pursue acquisitions that are expected to be accretive to income before interest expense and provision for amortization of goodwill and intangibles, if any, and to operating cash flows (excluding the costs of integration). Revenue from Transaction Management, which constitutes a substantial majority of the Company's revenue, is subject to economic cycles. However, the Company's significant size, geographic coverage, number of transactions and large continuing client base tend to minimize the impact of economic cycles on annual revenue and create what the Company believes is equivalent to a recurring stream of revenue. Approximately 52.0% of the costs and expenses associated with Transaction Management are directly correlated to revenue while approximately 20.0% of the costs and expenses of Management Services and Financial Services, are directly correlated to revenue. A significant portion of the Company's revenue is seasonal. Historically, this seasonality has caused the Company's revenue, operating income and net income to be lower in the first two calendar quarters and higher in the third and fourth calendar quarters of each year. In addition, the Company's operations are directly affected by actual and perceived trends in various national and economic conditions, including interest rates, the availability of credit to finance commercial real estate transactions and the impact of tax laws. To date, the Company does not believe that general inflation has had a material impact upon its operations. Revenues, commissions and other variable costs related to revenues are primarily affected by real estate market supply and demand rather than general inflation. 12 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) Results of Operations - Since 1992, the Company's results have benefitted from its ability to take advantage of a significant and ongoing recovery in U.S. commercial real estate markets and the generally rising occupancy and rental levels, and, as a result, property values as well as from significant expansion into international markets. Beginning in late 1998, some signs indicated that this recovery had reached a plateau in North America although management does not believe that this is the case. Since brokerage fees are typically based upon a percentage of transaction value, and property management fees are typically based upon a percentage of total rent collections, recent occupancy and rental rate increases at the property level have generated an increase in brokerage and property management fees to the Company. The following unaudited table sets forth items derived from the Company's Consolidated Statements of Operations for each of the periods presented in dollars and as a percentage of revenue. Three Months ended September 30, Nine Months Ended September 30, ------------------------------------- -------------------------------------- 1999 1998 1999 1998 ----------------- ----------------- ---------------- ------------------ (Dollars in thousands) Revenue: Leases........................... $111,430 36.3% $ 97,763 35.7% $295,957 36.2% $252,654 35.9% Sales............................ 106,695 34.7 93,770 34.3 268,704 32.9 253,463 36.0 Property and facilities management fees................. 26,689 8.7 23,838 8.7 80,516 9.9 58,814 8.3 Consulting and referral fees..... 18,612 6.1 19,515 7.1 54,044 6.6 41,340 5.9 Appraisal fees................... 15,018 4.9 13,983 5.1 45,334 5.5 31,661 4.5 Loan origination and servicing fees............................ 10,247 3.3 11,750 4.3 26,682 3.3 27,625 3.9 Realty advisor fees.............. 7,854 2.6 7,348 2.7 20,723 2.5 23,755 3.4 Other............................ 10,473 3.4 5,836 2.1 25,426 3.1 14,902 2.1 -------- ----- -------- ----- -------- ----- -------- ----- Total revenue.................... 307,018 100.0% 273,803 100.0% 817,386 100.0% 704,214 100.0% Costs and expenses: Commissions, fees and other incentives...................... 137,709 44.8 119,959 43.8 351,317 42.9 315,271 44.8 Operating, administrative and other....................... 139,262 45.4 117,909 43.1 394,404 48.3 309,700 44.0 Merger-related and other nonrecurring charges............ - - - - - - 16,585 2.3 Depreciation and amortization.... 10,001 3.3 9,337 3.4 29,963 3.7 22,086 3.1 -------- ----- -------- ----- -------- ----- -------- ----- Operating income.................. 20,046 6.5 26,598 9.7 41,702 5.1 40,572 5.8 Interest income................... 791 0.3 703 0.3 1,861 0.2 1,968 0.3 Interest expense.................. 10,294 3.4 9,628 3.5 29,670 3.6 21,359 3.0 -------- ----- -------- ----- -------- ----- -------- ----- Income before provision for income tax....................... 10,543 3.4 17,673 6.5 13,893 1.7 21,181 3.1 Provision for income tax.......... 5,895 1.9 7,534 2.8 7,642 0.9 10,257 1.5 -------- ----- -------- ----- -------- ----- -------- ----- Net income........................ $ 4,648 1.5% $ 10,139 3.7% $ 6,251 0.8% $ 10,924 1.6% ======== ===== ======== ===== ======== ===== ======== ===== EBITDA excluding merger-related and other nonrecurring charges... $ 30,047 9.8% $ 35,935 13.1% $ 71,665 8.8% $ 79,243 11.3% ======== ===== ======== ===== ======== ===== ======== ===== Three Months Ended September 30, 1999 Compared to Three Months Ended September 30, 1998 The Company reported a consolidated net income of $4.6 million, or $0.22 diluted earnings per share for the three months ended September 30, 1999 on revenues of $307.0 million compared to a consolidated net income of $10.1 million, or $0.48 diluted earnings per share on revenues of $273.8 million for the three months ended September 30, 1998. To improve operating results the Company implemented a reduction in force program geared primarily towards managers which on a full year basis is expected to reduce expenses by $14.0 million (approximately $4 million in 1999). The quarter result includes proceeds from an insurance policy of $1.6 million and a charge of approximately $1.1 million from the recently announced restructuring. 13 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) Revenues on a consolidated basis were $307.0 million, an increase of $33.2 million or 12.1% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. The overall increase reflected the continued improvement of the real estate market, although at a slower pace. The improved market resulted in higher property values, higher rental rates and increased activity, which translated into increases in brokerage sales and lease transactions, and investment properties transactions closed for the three months ended September 30, 1999. The Company continued to benefit from its global market presence by leveraging the ability to deliver comprehensive real estate services into new businesses. However, revenues for the third quarter continue to be affected by the liquidity problems which began in September of 1998 in the global capital markets in general and the Commercial Mortgage-Backed Securities ("CMBS") market in particular. Commissions, fees and other incentives on a consolidated basis were $137.7 million, an increase of $17.8 million or 14.8% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. The increase in these costs is attributable to the increase in revenue since most of the Company's sales professionals are compensated based on revenue. As a percentage of revenue, commissions, fees and other incentives were 44.8% for the three months ended September 30, 1999, compared to 43.8% for the three months ended September 30, 1998. Operating, administrative and other on a consolidated basis was $139.3 million, an increase of $21.4 million or 18.1% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. As a percentage of revenue, operating, administrative and other were 45.4% for the three months ended September 30, 1999 compared to 43.1% for the three months ended September 30, 1998. The increase in amount and percentage is primarily due to an overall increase in overhead expenses and the sale of the Company's headquarters building at a minimal loss. Consolidated interest income was $0.8 million, an increase of $0.1 million or 12.5% for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. Consolidated interest expense was $10.3 million, an increase of $0.7 million or 6.9% for the three months ended September 30, 1999, as compared to the three months ended September 30, 1998. The increase primarily resulted from the renewal of certain senior term loans at a higher borrowing rate. Provision for income tax on a consolidated basis was $5.9 million for the three months ended September 30, 1999, as compared to the provision for income tax of $7.5 million for the three months ended September 30, 1998. The decrease is primarily due to the decrease in income before provision for income tax. The effective tax rate increased in 1999, primarily as a result of additional nonamortizable goodwill from recent acquisitions. In early 1998 the Company repurchased its outstanding preferred stock which triggered a limitation on the annual amount of net operating loss ("NOL") it can use to offset future U.S. taxable income. This limitation does not affect the way taxes are reported for financial reporting purposes, but it will affect the timing of the actual amount of taxes paid on an annual basis. EBITDA was $30.0 million for the three months ended September 30, 1999, as compared to $35.9 million for the three months ended September 30, 1998. EBITDA effectively removes the impact of certain non-cash and nonrecurring charges on income such as depreciation and the amortization of intangible assets relating to acquisitions, merger-related and other nonrecurring charges, extraordinary items, and income taxes. Management believes that the presentation of EBITDA will enhance a reader's understanding of the Company's operating performance and ability to service debt as it provides a measure of cash (subject to the payment of interest and income taxes) generated that can be used by the Company to service its debt and other required or discretionary purposes. Net cash that will be available to the Company for discretionary purposes represents remaining cash after debt service and other cash requirements, such as capital expenditures, are deducted from EBITDA. EBITDA should not be considered as an alternative to (i) operating income determined in accordance with GAAP or (ii) operating cash flow determined in accordance with GAAP. Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30, 1998 The Company reported a consolidated net income of $6.3 million, or $0.30 diluted earnings per share for the nine months ended September 30, 1999 on revenues of $817.4 million compared to a consolidated net income of $10.9 million on revenues of $704.2 million for the nine months ended September 30, 1998. The net loss applicable to common stockholders, including the deemed dividend resulting from the accounting treatment of the preferred stock repurchase, was $21.3 million, or $1.07 diluted loss per share for the nine months ended September 30, 1998. Revenues on a consolidated basis were $817.4 million, an increase of $113.2 million or 16.1% for the nine months 14 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) ended September 30, 1999, compared to the nine months ended September 30, 1998. The overall increase reflected the full contribution from REI and HP and various other 1998 acquisitions, and the continued improvement of the real estate market. The improved market resulted in higher property values, higher rental rates and increased activity, which translated into increases in brokerage sales and lease transactions, closed for the nine months ended September 30, 1999. The Company continued to benefit from its global market presence by leveraging the ability to deliver comprehensive real estate services into new businesses. However, revenues year to date continue to be affected by the liquidity problems which began in September of 1998 in the global capital markets in general and the CMBS market in particular. Commissions, fees and other incentives on a consolidated basis were $351.3 million, an increase of $36.0 million or 11.4% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998. The increase in these costs is attributable to the increase in revenue since most of the Company's sales professionals are compensated based on revenue. Operating, administrative and other on a consolidated basis was $394.4 million, an increase of $84.7 million or 27.4% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998. The increase in amount is primarily due to the acquisitions of REI and HP, which have higher fixed operating expenses. Consolidated interest income was $1.9 million, a decrease of $0.1 million or 5.4% for the nine months ended September 30, 1999, as compared to the nine months ended September 30, 1998. Consolidated interest expense was $29.7 million, an increase of $8.3 million or 38.9% for the nine months ended September 30, 1999, as compared to the nine months ended September 30, 1998. The increase primarily resulted from the renewal of certain senior term loans at a higher borrowing rate. Provision for income tax on a consolidated basis was $7.6 million for the nine months ended September 30, 1999, as compared to the provision for income tax of $10.3 million for the nine months ended September 30, 1998. The decrease is primarily due to the decrease in income before provision for income tax. The effective tax rate increased in 1999, primarily as a result of additional nonamortizable goodwill from recent acquisitions. In early 1998 the Company repurchased its outstanding preferred stock which triggered a limitation on the annual amount of NOL it can use to offset future U.S. taxable income. This limitation does not affect the way taxes are reported for financial reporting purposes, but it will affect the timing of the actual amount of taxes paid on an annual basis. EBITDA was $71.7 million for the nine months ended September 30, 1999, as compared to $79.2 million for the nine months ended September 30, 1998. EBITDA effectively removes the impact of certain non-cash and nonrecurring charges on income such as depreciation and the amortization of intangible assets relating to acquisitions, merger-related and other nonrecurring charges, extraordinary items, and income taxes. Management believes that the presentation of EBITDA will enhance a reader's understanding of the Company's operating performance and ability to service debt as it provides a measure of cash (subject to the payment of interest and income taxes) generated that can be used by the Company to service its debt and other required or discretionary purposes. Net cash that will be available to the Company for discretionary purposes represents remaining cash after debt service and other cash requirements, such as capital expenditures, are deducted from EBITDA. EBITDA should not be considered as an alternative to (i) operating income determined in accordance with GAAP or (ii) operating cash flow determined in accordance with GAAP. 15 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) Segment Operations The Company provides integrated real estate services through three global business segments. The three segments are Transaction Management, Management Services and Financial Services. The factors for determining the reportable segments were based on the type of service and client. Each business segment requires and is responsible for executing a unique marketing and business strategy. Transaction Management consists of commercial property sales and leasing services, transaction management and advisory services, investment property services (acquisitions and sales on behalf of investors). Management Services consists of facilities and property management and related services. Financial Services consists of mortgage loan origination and servicing through L.J. Melody, investment management and advisory services through CB Richard Ellis Investors, L.L.C., capital markets activities, valuation and appraisal services and real estate market research. The following tables summarize the revenue, cost and expenses, and operating income by operating segment for the three months ended September 30, 1999 and 1998 and the nine months ended September 30, 1999 and 1998. Three Months Ended September 30, Nine Months Ended September 30, ------------------------------------------- ------------------------------------- 1999 1998 1999 1998 -------------------- ------------------- ----------------- ---------------- (Dollars in thousands) Transaction Management Revenue: Leases................................... $105,893 47.0% $ 93,433 47.3% $280,866 48.2% $240,584 46.2% Sales.................................... 103,890 46.1 91,107 46.1 261,510 44.9 246,780 47.4 Other consulting and referral fees (1)... 15,461 6.9 12,967 6.6 40,192 6.9 33,315 6.4 -------- ------- -------- ------- -------- ----- -------- ----- Total revenue............................ $225,244 100.0% $197,507 100.0% $582,568 100.0% $520,679 100.0% Costs and expenses: Commissions, fees and other incentives... 119,717 53.2 105,041 53.2 305,206 52.4 278,497 53.5 Operating, administrative and other...... 75,509 33.5 65,558 33.2 218,165 37.5 179,604 34.5 Depreciation and amortization............ 4,826 2.1 3,981 2.0 13,615 2.3 8,959 1.7 -------- ------- -------- ------- -------- ----- -------- ----- Operating income (2)...................... $ 25,192 11.2% $ 22,927 11.6% $ 45,582 7.8% $ 53,619 10.3% ======== ======= ======== ======= ======== ===== ======== ===== EBITDA.................................... $ 30,018 13.3% $ 26,908 13.6% $ 59,197 10.1% $ 62,578 12.0% ======== ======= ======== ======= ======== ===== ======== ===== Financial Services Revenue: Appraisal fees........................... $ 14,730 34.3% $ 14,389 34.0% $ 44,129 36.0% $ 31,911 32.2% Loan origination and servicing fees...... 10,247 23.9 11,750 27.8 26,680 21.7 27,625 27.8 Realty advisor fees...................... 7,338 17.1 7,496 17.7 19,765 16.1 23,281 23.5 Other (1)................................ 10,632 24.7 8,654 20.5 32,125 26.2 16,351 16.5 -------- ------- -------- ------- -------- ----- -------- ----- Total revenue............................ $ 42,947 100.0% $ 42,289 100.0% $122,699 100.0% $ 99,168 100.0% Costs and expenses: Commissions, fees and other incentives... 14,858 34.6 12,437 29.4 36,966 30.1 28,140 28.4 Operating, administrative and other...... 28,442 66.2 25,407 60.1 78,406 63.9 62,844 63.4 Depreciation and amortization............ 2,804 6.5 3,080 7.3 9,260 7.6 7,499 7.5 -------- ------- -------- ------- -------- ----- -------- ----- Operating income (loss) (2)............... $ (3,157) (7.3)% $ 1,365 3.2% $ (1,933) (1.6)% $ 685 0.7% ======== ======= ======== ======= ======== ===== ======== ===== EBITDA.................................... $ (353) (0.8)% $ 4,445 10.5% $ 7,327 6.0% $ 8,184 8.2% ======== ======= ======== ======= ======== ===== ======== ===== Management Services Revenue: Property management fees................. $ 19,706 50.7% $ 20,054 59.0% $ 60,712 54.2% $ 46,085 54.6% Facilities management fees............... 5,961 15.4 3,857 11.3 16,725 14.9 11,497 13.6 Leases................................... 5,364 13.8 4,165 12.3 14,809 13.2 11,837 14.0 Sales.................................... 1,547 4.0 1,205 3.5 3,727 3.3 3,909 4.7 Other (1)................................ 6,249 16.1 4,726 13.9 16,146 14.4 11,039 13.1 -------- ------- -------- ------- -------- ----- -------- ----- Total revenue............................ $ 38,827 100.0% $ 34,007 100.0% $112,119 100.0% $ 84,367 100.0% Costs and expenses: Commissions, fees and other incentives... 3,134 8.1 2,481 7.3 9,145 8.1 8,634 10.2 Operating, administrative and other...... 35,311 90.9 26,944 79.2 97,833 87.3 67,252 79.7 Depreciation and amortization............ 2,371 6.1 2,276 6.7 7,088 6.3 5,628 6.7 -------- ------- -------- ------- -------- ----- -------- ----- Operating income (loss) (2)............... $ (1,989) (5.1)% $ 2,306 6.8% $ (1,947) (1.7)% $ 2,853 3.4% ======== ======= ======== ======= ======== ===== ======== ===== EBITDA.................................... $ 382 1.0% $ 4,582 13.5% $ 5,141 4.6% $ 8,481 10.1% ======== ======= ======== ======= ======== ===== ======== ===== Merger-related and other nonrecurring charges...................... $ - $ - $ - $ 16,585 ======== ======= ======== ======== Total operating income..................... $ 20,046 $26,598 $ 41,702 $ 40,572 ======== ======= ======== ======== Total EBITDA excluding merger-related and other nonrecurring charges................ $ 30,047 $35,935 $ 71,665 $ 79,243 ======== ======= ======== ======== - --------- (1) Revenue is allocated by material line of business specific to each segment. "Other" includes types of revenue that have not been broken out separately due to their immaterial balances. (2) Segment operating income excludes merger-related and other nonrecurring charges. 16 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) Three Months Ended September 30, 1999 Compared to the Three Months Ended September 30, 1998 Transaction Management Revenue increased by $27.7 million or 14.0% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998, due primarily to the continued improvement of the real estate market. The improved market resulted in higher property values, higher rental rates and increased activity, which translated into increases in brokerage sales and lease transactions and investment properties transactions, closed for the three months ended September 30, 1999. Commissions, fees and other incentives increased by $14.7 million or 14.0% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. As a percentage of revenue, commissions, fees and other incentives were 53.2% for the three months ended September 30, 1999 and 1998. The increase in amount is due to increased revenues, which resulted in higher commission eligibility levels, and, thus, higher commission. Operating, administrative, and other increased by $10.0 million or 15.2% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. The increase in the amount is a result of additional overhead expenses. Depreciation and amortization increased by $0.8 million or 21.2% for the three months ended September 30, 1999 as compared to the three months ended September 30, 1998. Financial Services Revenue increased by $0.7 million or 1.6% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. Commissions, fees and other incentives increased by $2.4 million or 19.5% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. As a percentage of revenue, commissions, fees and other incentives were 34.6% for the three months ended September 30, 1999 compared to 29.4% for the three months ended September 30, 1998. The increase in amount and percentage of revenue is primarily due to higher commission eligibility levels outside the U.S. Operating, administrative, and other increased by $3.0 million or 11.9% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998. Depreciation and amortization decreased by $0.3 million or 9.0% for the three months ended September 30, 1999, as compared to the three months ended September 30, 1998. Management Services Revenue increased by $4.8 million or 14.2% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998, primarily due to growth in the facilities management business. Commissions, fees and other incentives increased by $0.7 million or 26.3% for the three months ended September 30, 1999 compared to the three months ended September 30, 1998, primarily due to increased revenues. As a percentage of revenue, commissions, fees and other incentives were 8.1% for the three months ended September 30, 1999 compared to 7.3% for the three months ended September 30, 1998. Operating, administrative and other increased by $8.4 million or 31.1% for the three months ended September 30, 1999, compared to the three months ended September 30, 1998, primarily related to increased overhead expenses. As a percentage of revenue, operating, administrative and other were 90.9% for the three months ended September 30, 1999 compared to 79.2% for the three months ended September 30, 1998. The increase in operating, administrative and other as a percentage of revenue is primarily due to the building of the facilities management infrastructure in response to the revenue growth. Depreciation and amortization increased by $0.1 million or 4.2% for the three months ended September 30, 1999, as compared to the three months ended September 30, 1998. Nine Months Ended September 30, 1999 Compared to the Nine Months Ended September 30, 1998 Transaction Management Revenue increased by $61.9 million or 11.9% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998, due to the full contribution of REI and HP and various other 1998 acquisitions, and the continued improvement of the real estate market. Commissions, fees and other incentives increased by $26.7 million or 9.6% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998, primarily due to increased revenues, which resulted in higher commission eligibility levels, and, thus, higher commissions. Operating, administrative, and other increased by $38.6 million or 21.5% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998. The increase in the amount is primarily due to the inclusion of REI and HP and various other 1998 acquisitions. Depreciation and amortization increased by $4.7 million or 52.0% for the nine months ended September 30, 1999, as compared to the nine months ended September 17 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) 30, 1998, primarily as a result of additional investments in hardware and software to support the increase in new business. Financial Services Revenue increased by $23.5 million or 23.7% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998. The increase in revenue is primarily due to the appraisal and valuation services which includes the full contribution from REI and HP and various other 1998 acquisitions. Commissions, fees and other incentives increased by $8.8 million or 31.4% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998. The increase is primarily a result of the revenue increase and the resulting higher commission eligibility levels from the REI and HP contribution. Operating, administrative, and other increased by $15.6 million or 24.8% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998, primarily as a result of increased overhead expenses and the integration of REI and HP and various other 1998 acquisitions. Depreciation and amortization increased by $1.8 million or 23.5% for the nine months ended September 30, 1999, as compared to the nine months ended September 30, 1998, primarily related to the additional investment in hardware and software to support the increase in new business and the acquisitions of REI and HP and various other 1998 acquisitions. Management Services Revenue increased by $27.8 million or 32.9% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998, primarily due to growth in the property and facilities management businesses and the full contribution from REI and HP and various other 1998 acquisitions. Commissions, fees and other incentives increased by $0.5 million or 5.9% for the nine months ended September 30, 1999 compared to the nine months ended September 30, 1998. Operating, administrative, and other increased $30.6 million or 45.5% for the nine months ended September 30, 1999, compared to the nine months ended September 30, 1998, primarily related to the acquisitions of REI and HP, which have higher fixed operating expenses, and increases in overhead expenses. Depreciation and amortization increased by $1.5 million or 25.9% for the nine months ended September 30, 1999, as compared to the nine months ended September 30, 1998, primarily related to the acquisitions of REI and HP and various other 1998 acquisitions. Liquidity and Capital Resources The Company has historically financed its operations and non-acquisition related capital expenditures primarily with internally generated funds and borrowings under a revolving credit facility. In order to fund certain working capital requirements, the Company had additional net borrowings of $48.0 million under the revolving credit facility, during the nine months ended September 30, 1999. The Company's EBITDA was $71.7 million and $79.2 million for the nine months ended September 30, 1999 and 1998, respectively. The decrease in EBITDA reflects the continuing liquidity problems in the global capital markets as discussed in Results of Operations and a possible slowdown in the volume of transactions. Net cash provided by operating activities was $2.7 million for the nine months ended September 30, 1999, compared to $27.1 million for the nine months ended September 30, 1998. The change is primarily due to changes in components of operating assets and liabilities, including the additional insurance products and sale of properties, the increase in compensation costs accrued in 1999 due to timing, and the decrease in the merger-related and other nonrecurring costs accrued in 1998. Net cash used in investing activities was $21.2 million for the nine months ended September 30, 1999, compared to $199.8 million for the nine months ended September 30, 1998. The change is primarily due to a lower level of acquisition of businesses, the sale of the inventoried property, and the absence in 1999 of the supplemental purchase price payments included in 1998 in connection with a 1995 acquisition. Net cash provided by financing activities was $24.6 million for the nine months ended September 30, 1999, compared to $148.8 million used in financing activities for the nine months ended September 30, 1998. The decrease primarily results from increases in repayments of the inventoried property loan, other loans and lower 1999 net borrowings from the revolving credit facility. In May 1998, the Company amended its revolving credit facility with a group of banks to provide up to $400.0 18 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) million for five years, subject to mandatory reductions of $40.0 million, $80.0 million and $80.0 million on December 31, 1999, 2000 and 2001, respectively. The amount outstanding under this facility was $215.0 million at September 30, 1999 which is included in the accompanying balance sheet. Interest rate alternatives include Bank of America's reference rate plus 1.00% and LIBOR plus 2.00%. The weighted average rate on amounts outstanding at September 30, 1999 was 7.68%. The revolving credit facility contains numerous restrictive covenants that, among other things, limit the Company's ability to incur or repay other indebtedness, make advances or loans to subsidiaries and other entities, make capital expenditures, incur liens, enter into mergers or effect other fundamental corporate transactions, sell its assets, or declare dividends. In addition, the Company is required to meet certain ratios relating to its adjusted net worth, level of indebtedness, fixed charges and interest coverage. The Company and the banks recently executed an amendment to the revolving credit facility reducing the facility to $350.0 million, eliminating the mandatory reduction on December 31, 1999, and revising some of the covenants. The Company expects to have capital expenditures ranging from $25.0 million to $30.0 million in 1999. The Company expects to use net cash provided by operating activities for the next several years primarily to fund capital expenditures for computer related purchases, acquisitions, including earnout payments, and to make required principal payments under the Company's outstanding indebtedness. The Company believes that it can satisfy its non- acquisition obligations as well as working capital requirements from internally generated cash flow, borrowings under the amended revolving credit facility or any replacement credit facilities. Material future acquisitions, if any, that require cash will require new sources of capital such as an expansion of the amended revolving credit facility and raising money by issuing additional debt or equity. The Company anticipates that its existing sources of liquidity, including cash flow from operations, will be sufficient to meet the Company's anticipated non-acquisition cash requirements for the foreseeable future and in any event for at least the next twelve months. On September 1, 1999, the Company announced that its Board of Directors authorized a repurchase program under which it would purchase up to $5.0 million of its common stock. The purchases would be made from time to time either in the open market or through privately negotiated transactions. To date, the Company purchased 138,000 shares of common stock for approximately $1.8 million. Year 2000 Issues Update As fully discussed in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, the Company is replacing and upgrading all of its affected hardware and software to ensure continued operations beyond December 31, 1999. Although, there can be no assurances, the Company believes that its proprietary accounting systems, information technology and embedded systems will be Y2K compliant by the end of 1999. To date, the Company estimates that it has spent approximately $11.0 million for the Y2K issue. The Company does not track the cost and time that its own internal employees spend on the Y2K project. Except as noted above, management's assessment of the status of the Year 2000 project and its contingency plans remain unchanged from that described in the Company's 1998 Annual Report on Form 10-K. Even though the Company has completed an assessment of risk with respect to third-party suppliers and clients, the Company cannot conclusively determine that such risk could have a material adverse impact on the Company's result of operations, liquidity or financial condition. The risks include, but are not limited to, temporary failure of one or more infrastructure services provided by third-party suppliers such as bank and payroll transaction processes, utilities and transportation services; loss of real-time processing capability by the Company's internal information systems; and interruption of commerce with customers or suppliers that experience Y2K-related failures within their businesses. The Company's plans to address the Year 2000 issues are based on management's current estimates and are subject to the aforementioned uncertainties that could cause the actual results to differ materially from these plans. Euro Conversion Disclosure The Company does not expect the introduction of the Euro to have a significant impact on its market or the manner in which it conducts business, and believes the related impact on the Company's financials is not material. Approximately six percent of the Company's 1998 business was transacted in the participating member countries. The 19 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) Company is currently using the legacy currencies to conduct business in these member countries. The Company is in the process of replacing or upgrading the affected hardware and software to allow for dual-currency reporting during the transition period, and issues related but not limited to converting amounts and rounding. The Company anticipates these system upgrades will be fully functional prior to the end of the transition period. Litigation In December 1996, GMH Associates, Inc. ("GMH") filed a lawsuit against Prudential Realty Group ("Prudential") and the Company in Superior Court of Pennsylvania, Franklin County, alleging various contractual and tort claims against Prudential, the seller of a large office complex, and the Company, its agent in the sale, contending that Prudential breached its agreement to sell the property to GMH, breached its duty to negotiate in good faith, conspired with the Company to conceal from GMH that Prudential was negotiating to sell the property to another purchaser and that Prudential and the Company misrepresented that there were no other negotiations for the sale of the property. Following a non-jury trial, the court rendered a decision in favor of GMH and against Prudential and the Company, awarding GMH $20.3 million in compensatory damages, against Prudential and the Company jointly and severally, and $10.0 million in punitive damages, allocating the punitive damage award $7.0 million as against Prudential and $3.0 million as against the Company. Following the denial of motions by Prudential and the Company for a new trial, a judgment was entered on December 3, 1998. Prudential and the Company have filed an appeal of the judgment. The Company believes that it has adequate insurance coverage for the compensatory portion of the judgment and adequate reserves for the punitive portion, as well as potential indemnity claims from Prudential for the entire judgment. In August 1993, a former commissioned sales person of the Company filed a lawsuit against the Company in the Superior Court of New Jersey, Bergen County, alleging gender discrimination and wrongful termination by the Company. On November 20, 1996, a jury returned a verdict against the Company, awarding $6.5 million in general and punitive damages to the plaintiff. Subsequently, the trial court awarded the plaintiff $638,000 in attorneys' fees and costs. Following denial by the trial court of the Company's motions for new trial, reversal of the verdict and reduction of damages, the Company filed an appeal of the verdict and requested a reduction of damages. On March 9, 1999 the appellate court ruled in the Company's favor, reversed the trial court decision and ordered a new trial. In June of 1999, the Supreme Court of New Jersey agreed to review the Appellate Court's decision and a hearing for this purpose has been set for November 30, 1999. Based on available reserves, cash and anticipated cash flows, the Company believes that the ultimate outcome will not have an impact on the Company's ability to carry on its operations. The Company is a party to a number of pending or threatened lawsuits arising out of, or incident to, its ordinary course of business. Based on available cash and anticipated cash flows, the Company believes that the ultimate outcome will not have an impact on the Company's ability to carry on its operations. Management believes that any liability to the Company that may result from disposition of these lawsuits will not have a material effect on the consolidated financial position or results of operations of the Company. Net Operating Losses The Company had U.S. federal income tax NOLs of approximately $70.8 million as of December 31, 1998, corresponding to $24.8 million of the Company's $53.3 million in net deferred tax assets before valuation allowance. The ability of the Company to utilize NOLs was limited in 1998 and will be in subsequent years as a result of the Company's 1996 public offering, the 1997 Koll acquisition and the 1998 repurchase of preferred stock which cumulatively caused a more than 50.0% change of ownership within a three year period. As a result of the limitation, the Company will be able to use approximately $26.0 million of its NOL in 1999 and in each subsequent year. The amount of NOLs is, in any event, subject to uncertainty until the statute of limitations lapses after their utilization to offset taxable income. Segment Reporting In July 1999, the Company announced that it changed its segment reporting from four segments to three segments. Prior periods have been restated to conform to the new segmentation. 20 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) New Accounting Pronouncements The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information during the six months ended December 31, 1998. SFAS 131 requires the use of the "management approach" for segment reporting, which is based on the way the chief operating decision maker organizes segments within a company for making operating decisions and assessing performance. The adoption of this statement did not have a material impact on the Company's financial statements. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, which deferred the effective date of SFAS No. 133 for one year. SFAS No. 137 is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company has not yet quantified the impacts of adopting SFAS No. 133 on its financial statements and has not determined the timing of or method of its adoption of SFAS No. 133. Based on derivative instruments outstanding, SFAS No. 133 is not anticipated to have a significant impact on earnings or other components of comprehensive income. In 1999, the Company adopted Statement of Position ("SOP") 98-5, Reporting on the Costs of Start-up Activities. SOP 98-5, which requires costs of start-up activities and organization costs to be expensed as incurred. The adoption of this statement did not have a material impact on the Company's financial statements. 21 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES (continued) ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's exposure to market risk consists of foreign currency exchange rate fluctuations related to international operations and changes in interest rates on debt obligations. Approximately 20.0% of the Company's business is transacted in local currencies of foreign countries. The Company attempts to manage its exposure primarily by balancing monetary assets and liabilities, and maintaining cash positions only at levels necessary for operating purposes. While the Company's international results of operations as measured in dollars are subject to foreign exchange rate fluctuations, the related risk is not considered material. The Company routinely monitors its transaction exposure to currency rate changes, and enters into currency forward and option contracts to limit such exposure, as appropriate. Gains and losses on contracts are deferred until the transaction being hedged is finalized. At September 30, 1999, the Company had no outstanding contracts. The Company does not engage in any speculative activities. The Company manages its interest expense by using a combination of fixed and variable rate debt. The Company utilizes sensitivity analyses to assess the potential effect of its variable rate debt. If interest rates were to increase by 70 basis points (approximately 10.0% of the Company's weighted-average variable rate at September 30, 1999) the net impact would not result in a material change in the Company's interest expense or the fair value of the Company's debt obligation. REGARDING OUTLOOK AND OTHER FORWARD-LOOKING DATA Portions of the Quarterly Report, including Management's Discussion and Analysis, contain forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the Company's actual results and performance in future periods to be materially different from any future results or performance suggested in forward-looking statements in this release. Such forward-looking statements speak only as of the date of this report and the Company expressly disclaims any obligation to update or revise any forward-looking statements found herein to reflect any changes in Company expectations or results or any change in events. Factors that could cause results to differ materially include, but are not limited to: commercial real estate vacancy levels; employment conditions and their effect on vacancy rates; property values; rental rates; any general economic recession domestically or internationally; and general conditions of financial liquidity for real estate transactions. 22 CB RICHARD ELLIS SERVICES, INC. AND SUBSIDIARIES PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 Financial Data Schedule (filed only with the SEC) (b) Report on Form 8-K The registrant filed a Current Report on Form 8-K dated November 12, 1999 concerning the Company's press release announcing the results of operations for the three and nine months ended September 30, 1999 23 SIGNATURES Pursuant to the requirements of 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. CB RICHARD ELLIS SERVICES, INC. Date: November 12, 1999 /s/ Ronald J. Platisha -------------------------------- Ronald J. Platisha Executive Vice President, Financial Operations 24 EXHIBIT INDEX Exhibit Number Description of Exhibit ------- ------------------------------------------------------ 27 Financial Data Schedule (filed only with the SEC) 25