Comstock Holding Companies, Inc. - Quarter Report: 2005 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

Quarterly Report Pursuant To Section 13 or 15(d) of
the Securities Exchange Act of 1934

 

For the Quarter Ended September 30, 2005

 

Commission File Number 1-32375

 

 

Comstock Homebuilding Companies, Inc.
(Exact Name of Registrant as Specified in Its Charter)

 

Delaware		20-1164345
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
11465 Sunset Hills Road 5th Floor Reston, Virginia 20190 (703) 883-1700
(Address including zip code, and telephone number, including area code, of principal executive offices)

 

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   ý

NO   o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

YES   o

NO   ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o  Yes   ý  No

 

As of November 10, 2005, 11,257,531 shares of the Class A common stock, par value $.01 per share, of the Registrant were outstanding.

 

 

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

 

PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets (unaudited) - September 30, 2005 and December 31, 2004
Consolidated Statements of Operations (unaudited) - Three and Nine Months Ended September 30, 2005 and 2004
Consolidated Statements of Cash Flows (unaudited) - Three and Nine Months Ended September 30, 2005 and 2004
Notes to Consolidated Financial Statements
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4.		CONTROLS AND PROCEDURES
PART II – OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5.	OTHER INFORMATION
ITEM 6.	EXHIBITS
SIGNATURES

 

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COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)

 

		September 30, 2005			December 31, 2004
ASSETS
Cash and cash equivalents		$	64,129		$	67,559
Restricted cash		13,147			7,500
Receivables		7,327			239
Due from related parties		3,318			1,447
Real estate held for development and sale		259,994			104,326
Inventory not owned - variable interest entities		68,250			118,558
Property, plant and equipment		521			488
Investment in real estate partnerships		(53		)	1,029
Deferred income tax		1,243			821
Other assets		6,130			2,540
TOTAL ASSETS		$	424,006		$	304,507
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable and accrued liabilities		$	59,089		$	35,532
Income taxes payable		3,946			290
Due to related parties		40			148
Obligations related to inventory not owned		63,850			114,333
Notes payable		155,004			65,684
Notes payable–related parties		3,263			10,944
Distribution payable		3,205			12,655
TOTAL LIABILITIES		288,397			239,586
Commitments and contingencies (Note 12)
Minority interest		387			2,695
SHAREHOLDERS’ EQUITY
Class A common stock, $0.01 par value, 77,266,500 shares authorized, 11,538,609 and 9,160,608 issued and outstanding		115			92
Class B common stock, $0.01 par value, 2,733,500 shares authorized, 2,733,500 issued and outstanding		27			27
Additional paid-in capital		128,958			75,510
Unearned Compensation		(3,146		)	(4,314		)
Retained earnings (accumulated deficit)		9,268			(9,089		)
TOTAL SHAREHOLDERS’ EQUITY		135,222			62,226
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)		$	424,006		$	304,507

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except share data)

 

		Three Months Ended Sept 30,						Nine Months Ended Sept 30,
		2005			2004			2005			2004
					Predecessor						Predecessor
Revenues
Sale of real estate—Homes		$	72,409		$	23,395		$	140,473		$	67,649
Other revenue		6,028			2,437			6,604			7,165
Total revenue		78,437			25,832			147,077			74,814
Expenses
Cost of sales of real estate		50,838			13,897			98,087			44,665
Cost of sales of other		3,118			1,773			3,138			5,419
Selling, general and administrative		6,562			2,636			17,222			9,546
Operating income		17,919			7,526			28,630			15,184
Other (income) expense, net		(463		)	241			(653		)	301
Income before minority interest and equity in earnings of real estate partnerships		18,382			7,285			29,283			14,883
Minority interest		6			1,812			14			4,360
Income before equity in earnings of real estate partnerships		18,376			5,473			29,269			10,523
Equity in earnings of real estate partnerships		48			35			82			93
Total pre tax income		18,424			5,508			29,351			10,616
Income taxes		6,941			—			10,993			—
Net income		$	11,483		$	5,508		$	18,358		$	10,616
Basic earnings per share		0.82			0.78			1.47			1.50
Basic weighted average shares outstanding		13,987			7,067			12,491			7,067
Diluted earnings per share		0.81			0.78			1.45			1.50
Diluted weighted average shares outstanding		14,168			7,067			12,653			7,067

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands, except share data)

 

		Nine Months Ended September 30,
		2005			2004
					Predecessor
Cash flows from operating activities:
Net income		$	18,358		$	10,616
Adjustment to reconcile net income to net cash provided by operating activities
Depreciation		125			75
Loss on disposal of assets		9			—
Minority interest		14			4,360
Equity in earnings of real estate partnerships		(82		)	(93		)
Distributions from investment in real estate partnerships		164			90
Amortization of stock compensation		1,749			—
Deferred income tax		(422		)	—
Changes in operating assets and liabilities:
Restricted cash		(5,647		)	—
Receivables		(7,088		)	1,070
Due from related parties		(1,871		)	(2,057		)
Real estate held for development and sale		(155,668		)	(10,487		)
Other assets		(3,765		)	(2,935		)
Accounts payable and accrued liabilities		23,555			5,126
Income tax payable		3,656			—
Due to related parties		(108		)	(24		)
Net cash (used in) provided by operating activities		(127,021		)	5,741
Cash flows from investing activities:
Purchase of property, plant, and equipment		(167		)	(187		)
Distributions of capital from investments in real estate partnerships		1,000			—
Net cash provided by (used in) investing activities		833			(187		)
Cash flows from financing activities:
Proceeds from notes payable		182,666			47,825
Proceeds from related party notes payable		444			8,988
Payments on notes payable		(93,346		)	(47,900		)
Payments on related party notes payable		(8,125		)	(144		)
Contribution from minority shareholders		87			—
Payment of distribution payable		(9,450		)	—
Distributions paid to minority shareholders		(2,409		)	(11,901		)
Distributions paid to shareholders		—			(4,233		)
Proceeds from shares issued under employee stock purchase plan		81			—
Net proceeds from follow on offering		52,810			—
Net cash provided by (used in) financing activities		122,758			(7,365		)
Net (decrease) in cash and cash equivalents		(3,430		)	(1,811		)
Cash and cash equivalents, beginning of period		67,559			17,160
Cash and cash equivalents, end of period		$	64,129		$	15,349

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share data)

 

1.              ORGANIZATION AND BASIS OF PRESENTATION

 

Comstock Homebuilding Companies, Inc. (the “Company”) was incorporated on May 24, 2004 as a Delaware corporation.

 

On December 17, 2004, as a result of completing its initial public offering (“IPO”) of its Class A Common Stock, the Company acquired 100% of the outstanding capital stock of Comstock Holding Company, Inc. and subsidiaries (“Comstock Holdings”) by merger, which followed a consolidation that took place immediately prior to the closing of the IPO (the “Consolidation”). The Consolidation was effected through the mergers of Sunset Investment Corp., Inc. and subsidiaries, Comstock Homes, Inc. and subsidiaries and Comstock Service Corp., Inc. and subsidiaries (“Comstock Service”) with and into Comstock Holdings. Pursuant to the terms of the merger agreement, shares of Comstock Holdings were canceled and replaced by 4,333 and 2,734 shares of Class A and B Common Stock of the Company, respectively. Both Class A and B Common Stock shares bear the same economic rights. However, for voting purposes, Class A stockholders are entitled to one vote for each share held while Class B stockholders are entitled to fifteen votes for each share held.

 

As a result of the IPO, the Company sold 3,960 Class A Common Shares at $16.00 per share, raising proceeds, net of the underwriting discount, of approximately $56.0 million. On December 28, 2004, pursuant to the underwriters’ exercise of their over-allotment option, the Company sold an additional 594 shares resulting in additional proceeds, net of underwriting discount, of approximately $8.8 million.

 

On June 22, 2005 the Company completed a follow on offering in which 2,360 shares of Class A Common stock were sold to the public at a price of $23.90 per share.  The offering resulted in total proceeds to the Company, net of underwriting discounts, of approximately $53.4 million.

 

Our common stock is traded on the NASDAQ National Market under the symbol “CHCI”. We have no public trading history prior to December 17, 2004.

 

The consolidated financial statements and notes of the Company as of September 30, 2005 and for the three and nine months ended September 30, 2005 and 2004 have been prepared by management without audit, pursuant to rules and regulations of the Securities and Exchange Commission and should be read in conjunction with the December 31, 2004 audited financial statements contained in the Company’s Annual Report on Form 10-K for the year then ended. In the opinion of management, all normal, recurring adjustments necessary for the fair presentation of such financial information have been included. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. Certain amounts in the prior year’s financial statements have been reclassified to conform to the current year’s presentation with no effect on previously reported net income or stockholders’ equity.

 

The Company historically has experienced and expects to continue to experience variability in quarterly results. The consolidated statement of operations for the three and nine months ended September 30, 2005 is not necessarily indicative of the results to be expected for the full year.

 

For purposes of identification and description, we are referred to as the “Predecessor” for the period prior to the IPO, the Company for the period subsequent to the IPO, and “we,” “us,” and “our” for both periods.

 

The Company develops, builds and markets single-family homes, townhouses and condominiums in the Washington D.C. and Raleigh, North Carolina metropolitan markets. The Company also provides certain management and administrative support services to certain related parties.

 

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2.              REAL ESTATE HELD FOR DEVELOPMENT AND SALE

 

Real estate held for development and sale includes land, land development costs, interest and other construction costs and is stated at cost or, when circumstances or events indicate that the real estate held for development or sale is impaired, at estimated fair value.

 

Land, land development and indirect land development costs are accumulated by specific area and allocated to various lots or housing units using specific identification and allocation based upon the relative sales value, unit or area methods. Direct construction costs are assigned to housing units based on specific identification. Construction costs primarily include direct construction costs and capitalized field overhead. Other costs are comprised of prepaid local government fees and capitalized interest and real estate taxes. Selling costs are expensed as incurred.

 

Estimated fair value is based on comparable sales of real estate in the normal course of business under existing and anticipated market conditions. The evaluation takes into consideration the current status of the property, various restrictions, carrying costs, costs of disposition and any other circumstances which may affect fair value including management’s plans for the property. Due to the large acreage of certain land holdings, disposition in the normal course of business is expected to extend over a number of years. A write-down to estimated fair value is recorded when the carrying value of the property exceeds its estimated fair value. These evaluations are made on a property-by-property basis. The Company assesses the impairment of real estate assets whenever events or changes in circumstances indicate that the net book value may not be recoverable.

 

Real estate held for development and sale consists of the following:

 

		September 30,			December 31,
		2005			2004
Land and land development costs		$	133,378		$	65,545
Cost of construction (including capitalized interest and real estate taxes)		126,616			38,781
		$	259,994		$	104,326

 

3.              CONSOLIDATION OF VARIABLE INTEREST ENTITIES

 

The Company typically acquires land for development at market prices from various entities under fixed price purchase agreements. The purchase agreements require deposits that may be forfeited if the Company fails to perform under the agreements. The deposits required under the purchase agreements are in the form of cash or letters of credit in varying amounts. The Company may, at its option, choose for any reason and at any time not to perform under these purchase agreements by delivering notice of its intent not to acquire the land under contract. The Company’s sole legal obligation and economic loss for failure to perform under these purchase agreements is typically limited to the amount of the deposit pursuant to the liquidated damages provision contained within the purchase agreement. As a result, none of the creditors of any of the entities with which the Company enters into forward fixed price purchase agreements have recourse to the general credit of the Company. The Company also does not share in an allocation of either the profit earned or loss incurred by any of these entities with which the Company enters fixed price purchase agreements.

 

The Company has concluded that whenever it options land or lots from an entity and pays a significant non-refundable deposit as described above, a variable interest entity is created under the provisions of FIN 46-R. This is because the Company has been deemed to have provided subordinated financial support, which refers to variable interest that will absorb some or all of an entity’s expected theoretical losses if they occur. The Company, therefore, examines the entities with which the Company enters into fixed price purchase agreements for possible consolidation by the Company under FIN 46-R. This requires the Company to compute expected losses and expected residual returns based on the probability of future cash flows as outlined in FIN 46-R. This calculation

 

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requires substantial management judgments and estimates. In addition, because the Company does not have any contractual or ownership interests in the entities with which it contracts to buy the land, the Company does not have the ability to compel these development entities to provide financial or other data to assist the Company in the performance of the primary beneficiary evaluation.

 

The Company has evaluated all of its fixed price purchase agreements and has determined that it is the primary beneficiary of some of those entities. As a result, at December 31, 2004, the Company has consolidated five entities in the accompanying consolidated balance sheet. The effect of the consolidation at December 31, 2004 was the inclusion of $118,558 in “Inventory not owned—variable interest entities” with a corresponding inclusion of $114,333 (net of land deposits paid of $4,225) to “Obligations related to inventory not owned.” During the nine months ended September 30, 2005, the Company consolidated three entities in the accompanying consolidated balance sheet.  The effect of the consolidation at September 30, 2005 was the inclusion of $68,250 in “Inventory not owned—variable interest entities” with a corresponding inclusion of $63,850 (net of land deposits paid of $4,400) to “Obligations related to inventory not owned.”  Creditors, if any, of these variable interest entities have no recourse against the Company.

 

4.              WARRANTY RESERVE

 

Warranty reserves for houses sold are established to cover potential costs for materials and labor with regard to warranty-type claims expected to arise during the one-year warranty period provided by the Company or within the five-year statutorily mandated structural warranty period. Since the Company subcontracts its homebuilding work, subcontractors are required to provide the Company with an indemnity and a certificate of insurance prior to receiving payments for their work. Claims relating to workmanship and materials are generally the primary responsibility of the subcontractors and product manufacturers. The warranty reserve is established at the time of closing, and is calculated based upon historical warranty cost experience and current business factors. Variables used in the calculation of the reserve, as well as the adequacy of the reserve based on the number of homes still under warranty, are reviewed on a periodic basis. Warranty claims are directly charged to the reserve as they arise. The following table is a summary of warranty reserve activity which is included in accounts payable and accrued liabilities for the three and nine months ending September 30, 2005 and 2004:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
Balance at beginning of period		$	945		$	751		$	916		$	541
Additions		291			138			600			556
Releases and/or charges incurred		(155		)	(56		)	(435		)	(264		)
Balance at end of period		$	1,081		$	833		$	1,081		$	833

 

5.              CAPITALIZED INTEREST AND REAL ESTATE TAXES

 

Interest and real estate taxes incurred relating to the development of lots and parcels are capitalized to real estate held for development and sale during the active development period, which generally commences when borrowings are used to acquire real estate assets and ends when the properties are substantially complete. Interest is capitalized based on the interest rate applicable to specific borrowings or the weighted average of the rates applicable to other borrowings during the period. Interest and real estate taxes capitalized to real estate held for development and sale are expensed as a component of cost of sales as related units are sold.

 

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The following table is a summary of interest incurred and capitalized:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
Total interest incurred		$	3,062		$	1,070		$	8,824		$	3,008
Beginning interest capitalized		8,009			$	2,796		4,524			$	1,428
Plus: Interest incurred on notes payable		3,001			738			8,097			1,950
Plus: Interest incurred on related party notes payable		20			275			289			1,046
Less: Interest expensed as a component of cost of sales		(1,646		)	(352		)	(3,526		)	(967		)
Ending interest capitalized		$	9,384		$	3,457		$	9,384		$	3,457

 

6.              EARNINGS PER SHARE

 

The following weighted average shares and share equivalents are used to calculate basic and diluted earnings per share for the three and nine months ended September 30, 2005 and 2004:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
Basic earnings per share
Net Income		$	11,483		$	5,508		$	18,358		$	10,616
Basic weighted-average shares outstanding		13,987			7,067			12,491			7,067
Per share amounts		$	0.82		$	0.78		$	1.47		$	1.50
Dilutive earnings per share
Net income		$	11,483		$	5,508		$	18,357		$	10,616
Basic weighted-average shares outstanding		13,987			7,067			12,491			7,067
Stock options and restricted stock grants		181			—			162			—
Dilutive weighted-average shares outstanding		14,168			7,067			12,653			7,067
Per share amounts		$	0.81		$	0.78		$	1.45		$	1.50

 

Shares issued to the owners of the Predecessor in exchange for their interests in connection with the Consolidation have been reflected in weighted average shares as of the beginning of the earliest period presented.

 

Comprehensive income

 

For the three and nine months ended September 30, 2005 and 2004, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying combined consolidated financial statements.

 

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7.              MINORITY INTERESTS

 

During March 2005, the Company purchased certain noncontrolling minority interests in its consolidated subsidiaries for a total purchase price of $2,242.  Because the underlying book value of the minority interests was $2,360, the Company allocated $118 as a reduction in the subsidiary’s real estate held for development and sale accounts.

 

8.              INVESTMENT IN REAL ESTATE PARTNERSHIPS

 

Prior to the Company’s acquisition of Comstock Service as discussed in Note 1, Comstock Service in 2001 had invested $41 in North Shore Investors, LLC (“North Shore”) for a 50% ownership interest. North Shore was formed to acquire and develop residential lots and construct single family and townhouse units. In 2002, as a result of recognizing its share of net losses incurred by North Shore, Comstock Service reduced its investment in North Shore, to $0.

 

Since the inception to September 30, 2005, North Shore has incurred losses of approximately $2,135.  On June 28, 2005 the Company received a capital call from North Shore in the amount of $719 so that North Shore may comply with certain debt repayments.  Because the Company may be obligated to provide future financial support to cover certain debt repayments, the Company, during the three and nine months ended September 30, 2005 recorded its share of losses incurred by North Shore in the accompanying financial statements in the amount of $27 and $53, respectively.

 

During the third quarter of 2005, the Company, as manager of an affiliated entity, exercised its option rights to purchase the project acquisition, development and construction loan made for the benefit of North Shore. The Company finalized the purchase of the loans on or about September 8, 2005, issued a notice of default under the acquisition and development loan at maturity on September 30, 2005 and subsequently filed suit for collection of the loans against one of the individual guarantors under the loan on or about October 21, 2005.

 

As of September 30, 2005 the Company carried the following amounts in its financial statements related to North Shore:

 

Investment in real estate partnerships		$	(53	)
Due from affiliates		$	1,491
Development and construction loan receivable		$	1,741

 

In addition the Company may be obligated in certain circumstances to provide additional capital to cover certain debt repayments to North Shore in the amount of $2 million. As of November 8, 2005 the Company has not paid its share of the capital call and is exploring alternatives with all parties involved to reorganize or restructure the partnership in order to maximize potential returns.  The Company has evaluated the carrying value of its investment in and receivables from North Shore. At this time the Company does not believe an impairment reserve is warranted. However, it is possible this may change in future periods.  In addition, based on results of negotiations, the Company may, in the future be required to consolidate the North Shore entity.

 

9.              DEBT

 

In September 2005, the Company completed a purchase of a 316 unit condominium conversion project located in Leesburg, Virginia.  To finance this transaction, the Company entered into a promissory note agreement relating to $47,725 of indebtedness bearing interest at a rate of 1.9% + the one month LIBOR rate (3.86% at September 30, 2005).  At September 30, 2005, the Company owed a total of $35,905 under this note.

 

10.       INCOME TAX

 

Prior to December 17, 2004, the Predecessor had elected to be treated as an S corporation under Subchapter S of the

 

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Internal Revenue Code and therefore was not subject to income taxes. Taxable income or loss was passed through and reported by the individual shareholders. Subsequent to the Consolidation, the Company was reorganized as a C corporation under which income taxes are accounted for under the asset and liability method in accordance with SFAS 109 “Accounting for Income Taxes.” Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

The Company’s income tax provision consists of the following as of September 30, 2005:

 

Current:
Federal		9,557
State		1,813
		11,370
Deferred:
Federal		318
State		59
		(377	)
Total income tax expense		10,993

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of the Company’s deferred tax assets and liabilities at September 30, 2005 were as follows:

 

		September 30, 2005
Deferred Tax Assets:
Inventory		1,507
Warranty		363
Deferred rent		19
Accrued expenses		109
Stock-based compensation		534
		2,532
Less — valuation allowance		(1,112	)
Net deferred tax assets		1,420
Deferred tax liabilities:
Depreciation and amortization		(177	)
Net deferred tax liabilities		(177	)
Net deferred tax assets		1,243

 

The Company has adequately provided for contingencies related to income taxes in accordance with SFAS No. 5.  At September 30, 2005, the Company recorded a $514 income tax reserve, which is on the balance sheet.  This tax reserve relates predominately to a potential dispute by taxing authorities over tax benefits resulting from additional income tax basis in certain residential housing development projects.  The Company has also established a valuation allowance of approximately $1,112 as of September 30, 2005 related to a deferred tax asset of approximately $1,112 resulting from additional tax basis in residential real estate development projects.  In analyzing the need for the provision of tax contingency reserves and the valuation allowance, management reviewed applicable statutes, rules,

 

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regulations and interpretations and established these reserves based on past experience and judgments about potential actions by taxing jurisdictions.

 

11.       RESTRICTED STOCK, STOCK OPTIONS, AND OTHER STOCK PLANS

 

On December 13, 2004, the Company adopted the 2004 Long-Term Incentive Compensation Plan (the “Plan”), which provides for the issuance of stock options, stock appreciation rights, or SARs, restricted stock, deferred stock, dividend equivalents, bonus stock and awards in lieu of cash compensation, other stock-based awards and performance awards. The Plan provided for an initial authorization of 1,550 shares of Class A Common stock for issuance thereunder, plus an additional annual authorization effective January 1, 2006 equal to the lesser of (i) 3% of the Class A Common Stock outstanding on the date of determination, (ii) 500,000 shares or (iii) such lesser amount as may be determined by the Company’s Board of Directors.

 

Effective January 1, 2004, the Company adopted SFAS No. 123R (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements over the vesting period based on their fair values at the date of grant.

 

On July 6, 2005 the Company issued 106,849 options to the certain officers and employees. The options were issued at an exercise price of $23.90 per share and vest in increments of 25% on December 31, 2006, June 30, 2007, December 31, 2007, and June 30, 2008.

 

The following table sets forth information about the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model and the weighted-average assumptions used for such grants:

 

Weighted-average fair value of options granted		$	7.61
Dividend yields		N/A
Expected volatility		44.6		%
Risk-free interest rates		3.6
Expected lives		2.5 Years

 

In accordance with the provisions of SFAS No. 123(R) and SFAS No. 148, $663 and $0 was recorded for total stock-based compensation expense for the three months ended September 30, 2005 and 2004, respectively, and $1,749 and $0 respectively for the nine months ended September 30, 2005 and 2004.  Of this amount $143 and $254 was related to stock option grants for the three and nine months ended September 30, 2005 and the remainder was related to restricted stock grants.

 

On September 30, 2005 the following amounts were available for issuance:

 

Shares Available for issuance at December 31, 2004		1,168
Adjustments:
Restricted Stock Grants – Issued		(16	)
Options – Issued		(107	)
Restricted Stock Grants – Forfeited		4
Shares Available for issuance at September 30, 2005		1,049

 

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12.       COMMITMENTS AND CONTINGENCIES

 

Litigation

 

In the normal course of its business, the Company and/or its subsidiaries are named as defendants in certain legal actions arising from its normal business activities. Management believes that none of the litigation matters in which the Company or any subsidiary is involved would have a material adverse effect on the consolidated financial condition or operations of the Company.  Additional disclosures involving legal proceedings are discussed in Part II, Item I in this Form 10-Q.

 

Letters of credit and performance bonds

 

The Company has commitments as a result of contracts entered into with certain third parties to meet certain performance criteria as outlined in such contracts. The Company is required to issue letters of credit and performance bonds to these third parties as a way of ensuring that such commitments entered into are met by the Company. At September 30, 2005, the Company has outstanding $5,069 in letters of credit and $13,597 in performance and payment bonds to these third parties. No amounts have been drawn against these letters of credit and performance bonds.

 

Operating leases

 

The Company leases office space under non-cancelable operating leases. Minimum annual lease payments under these leases at September 30, 2005 approximate:

 

Year Ended: Amount
2005		$	249
2006		837
2007		858
2008		892
2009		721
2010		10
Thereafter		—

 

Operating lease rental expense aggregated $492 and $269, respectively, for nine months ended September 30, 2005 and 2004.

 

13.       RELATED PARTY TRANSACTIONS

 

In June 2002, the Predecessor entered into a promissory note agreement with TCG Fund I, LC to fund development projects. TCG Fund I, LC, is a related party in which the Company has an equity investment. The promissory note agreement allows for the Company to borrow up to $4 million. The note bears interest at 12% per annum and was paid in full during June 2005.

 

In September 2004, the Predecessor entered into a promissory note agreement with TCG Fund II, LC to fund development projects. TCG Fund II, LC is an entity which the company manages as a non-member. The promissory note agreement allows the Company to borrow up to $10 million. The note bears interest at 12% per annum and is due on September 7, 2007. As of September 30, 2005 and December 31, 2004 the Company owed $2.6 and

 

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$2.4 million, respectively, under this promissory agreement. Accrued interest payable on this note totaled $26 and $49 at September 30, 2005 and December 31, 2004, respectively.

 

In April 2002 and January 2004, the Predecessor entered into lease agreements for approximately 7.7 and 8.8 square feet, respectively, for its corporate headquarters at 11465 Sunset Hills Road, Reston, Virginia from Comstock Partners, L.C., an affiliate of our predecessor in which executive officers of the Company Christopher Clemente, Gregory Benson, and others are principals. Christopher Clemente owns a 45% interest, Gregory Benson owns a 5% interest, an entity which is owned or controlled by Christopher Clemente’s father-in-law, Dwight Schar, owns a 45% interest, and an unrelated third party owns a 5% interest in Comstock Partners. For the three and nine months ended September 30, 2004, total payments made under this lease agreement were $90 and $231, respectively.  On September 30, 2004 the lease agreements were canceled and replaced with new leases for a total of 20.6 square feet with Comstock Asset Management, L.C., an entity owned by Christopher Clemente.  On August 1, 2005 the lease agreement was amended for an additional 8.4 square feet. For the three months and nine months ended September 30, 2005, total payments made under this lease agreement were $131 and $408, respectively.

 

In May 2003, the Predecessor hired a construction company, in which Christopher Clemente’s brother, Louis Clemente, serves as the President and is a significant shareholder, to provide construction services and act as a general contractor at one of the Company’s developments.  The Company paid $7.8 million and $3.6 million to this construction company during the nine months ended September 30, 2005 and 2004, respectively.

 

At September 30, 2005 and December 31, 2004, the Company had an outstanding note receivable from Investors Management, LLC of $0 and $163 respectively, which accrues interest at a rate of 10% per annum. Investors Management, LLC is a related party, which is owned partially by Christopher Clemente, Gregory Benson and Bruce Labovitz (executive officers and/or shareholders of the Company).  At December 31, 2004 accrued interest receivable on this note totaled $5. During February 2005 the Company received payment in full on this note.

 

Christopher Clemente’s mother-in-law, Janice Schar, and Gary Martin each invested $100 as minority shareholders in one of our subsidiaries, and Judah and Deborah Labovitz, the parents of Bruce Labovitz, loaned approximately $300 to another of our subsidiaries.  During the first quarter 2005, the Company repurchased the minority interests of Janice Schar and Gary Martin for an approximate purchase price of $136.  In April 2005, the Company paid the $300 loan to Judah and Deborah Labovitz in full.

 

During 2003, the Predecessor entered into agreements with I-Connect, L.C., a company in which Investors Management, LLC holds a 25% interest, for information technology consulting services and the right to use certain customized enterprise software developed with input from the Company. The intellectual property rights associated with the software solution that was developed by I-Connect along with any improvements made thereto by the Company remained the property of I-Connect. For the three months ended September 30, 2005 and 2004, the Company paid $101 and $87, respectively, to I-Connect.  During the nine months ended September 30, 2005 and 2004, the Company paid $361 and $326, respectively, to I-Connect.  Also, in March 2003, the Predecessor entered into a space sharing agreement with I-Connect, L.C. to occupy and use 3,342 square feet of office space subleased by I-Connect, L.C. from a third party in Reston, Virginia. The Predecessor paid $0 and $4, respectively, under this agreement for the three months and nine months September 30, 2005 and 2004. On June 24, 2003, the I-Connect, L.C. sublease was assigned to Comstock Partners, L.C. (as landlord). The space sharing agreement with I-Connect ended on September 30, 2004.

 

For three months ended September 30, 2005 and 2004, the Predecessor received revenue of approximately $0 and $909, respectively, by providing administrative and sales support to Comstock Service Corp., Inc., a related party owned by Christopher Clemente and Gregory Benson. During the nine months ended September 30, 2005 and 2004, the Company received revenue of approximately $0 and $3 million, respectively.

 

For the three months ended September 30, 2005 and 2004, the Predecessor received revenue of approximately $94 and $350, respectively, by providing administrative and sales support to other related parties in which Christopher Clemente, Gregory Benson, and Christopher Clemente’s father-in-law, Dwight Schar, are shareholders.  For the nine months ended September 30, 2005 and 2004, the Predecessor received revenue of approximately $465 and $1,060, respectively.

 

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In October 2004, the Predecessor entered into an agreement with Comstock Asset Management Inc., in which the Company would provide management services for a fee of $20 a month.  For the three months and nine months ended September 30, 2005 the Company recorded $60 and $180, respectively, in revenue. At September 30, 2005 and December 31, 2004 the Predecessor recorded a receivable for $20 and $60, respectively, from this entity. In addition, the Company in November 2004, entered into an agreement with Comstock Asset Management to sell certain retail condominium units at Potomac Yard for a total purchase price of $14,500. In connection with this sale, the Company received a deposit of $8,000 upon execution of the agreement.

 

During the nine months ended September 30, 2005 and 2004, the Company provided bookkeeping services to certain related party entities at no charge.

 

In August 2004, the Predecessor entered into a $2,400 promissory note agreement with Belmont Models I, L.C., an entity managed by Investors Management. The note bears an interest rate of 12%, which is payable monthly and matured July 2005.  In March 2005, the Company sold four condominium units to Belmont Models I, L.C. under a sale and leaseback arrangement. The four condominium units were delivered for a total purchase price of $2,000 and leased back at a rate of $20 per month.  The Company expects the lease to continue for a period of twenty-four months.  As a result of the deliveries, the promissory note was reduced by the total purchase price.  At September 30, 2005 and December 31, 2004 the Company owed $663 and $2,400, respectively. Accrued interest payable on this note totaled $7 and $49, respectively, at September 30, 2005 and December 31, 2004.

 

During nine months ended September 30, 2005 and 2004 the Predecessor entered into sales contracts to sell homes to certain employees of the Company.  The Company, in order to attract, retain, and motivate employees maintains a home ownership benefit program.  Under the home ownership benefits, an employee receives certain cost benefits provided by us when purchasing a home or having one built by us.  Sales of homes to employees for investment purposes are conducted at market prices.

 

In September 2005, Comstock Foundation, Inc., an affiliate, was created. Comstock Foundation is a not-for-profit organization organized exclusively for charitable purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code. The affairs of Comstock Foundation shall be managed by a five person board of directors with Christopher Clemente, Gregory Benson, Bruce Labovitz and Tracy Schar (employee of the Company and spouse of Christopher Clemente) being four of the five.  The Company will also provide bookkeeping services to the affiliate.

 

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COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

ITEM 2.                                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS

 

The following discussion of our financial condition and results of operations should be read in conjunction with the accompanying unaudited consolidated interim financial statements and the notes thereto appearing elsewhere in the this report and our audited consolidated and combined financial statements and the notes thereto for the year ended December 31, 2004, appearing in our Annual Report on Form 10-K for the year then ended (the “2004 Form 10-K”).

 

This report includes forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by the use of words such as “anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” “will,” “should,” “seeks” or other similar expressions. Forward-looking statements are based largely on our expectations and involve inherent risks and uncertainties, many of which are beyond our control. You should not place undue reliance on any forward-looking statement, which speaks only as of the date made. Some factors which may affect the accuracy of the forward-looking statements apply generally to the real estate industry, while other factors apply directly to us. Any number of important factors which could cause actual results to differ materially from those in the forward-looking statements include, without limitation: general economic and market conditions, including interest rate levels; our ability to service our substantial debt; inherent risks in investment in real estate; our ability to compete in the Washington, D.C. and Raleigh, North Carolina real estate and home building markets; regulatory actions; fluctuations in operating results; our anticipated growth strategies; shortages and increased costs of labor or building materials; the availability and cost of land in desirable areas; natural disasters; our ability to raise debt and equity capital and grow our operations on a profitable basis; and our continuing relationships with affiliates. Additional information concerning these and other important risk and uncertainties can be found under the heading “Risk Factors” in the 2004 Form 10-K. Our actual results could differ materially from these projected or suggested by the forward-looking statements.

 

Overview

 

We engage in the business of residential land development, production home building, high-rise condominium development, condominium conversion and land sales in the greater Washington, D.C. and Raleigh, North Carolina markets. Our business was started in 1985 by Christopher Clemente, our Chief Executive Officer, as a residential land developer and home builder focused on the luxury home market in the northern Virginia suburbs of Washington, D.C. In 1992, we repositioned ourselves as a production home builder focused on moderately priced homes in areas where we could more readily purchase finished building lots through option contracts. In 1997, we entered the Raleigh, North Carolina market.

 

The following table summarizes certain information related to new orders, settlements, and backlog for the three and nine month periods ended September 30, 2005 and 2004:

 

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		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
New orders		117			287			523			490
New order revenues		$	34,423		$	97,484		$	197,760		$	170,644
Average new order price		$	294		$	340		$	378		$	348
Settlements		202			74			403			208
Settlement revenue		$	72,409		$	23,395		$	140,473		$	67,649
Average settlement price		$	358		$	316		$	349		$	325
Backlog		$	231,833		$	135,442		$	231,833		$	135,442

 

At September 30, 2005, we either owned or controlled under option agreements or non-binding letters of intent over 4,802 building lots including non-consolidating joint ventures in which we are the manager.  We currently have communities under development in Arlington, Fairfax, Loudoun, Culpepper and Prince William counties in Virginia. In Maryland we are currently active in Frederick County. In North Carolina we have active communities in Raleigh and Wake counties. The following chart summarizes certain information for our current and planned communities as of September 30, 2005:

 

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		As of September 30, 2005
Project		Status (1)		Estimated Units at Completion		Units Settled		Backlog(2)		Lots Owned Unsold		Lots under Option Agreement Unsold		Average Sales Price
Virginia
Barrington Park		Active		148		—		—		148		—		n/a
Commons at Bellemeade		Active		316		—		—		316		—		n/a
Blooms Mill TH 22’		Active		113		70		12		31		—		$	422,419
Blooms Mill Carriage		Active		91		57		23		11		—		$	451,473
Commons on Potomac Sq		Active		192		—		20		172		—		$	232,260
Commons on Williams Sq		Active		180		20		58		102		—		$	360,339
Countryside		Active		102		23		13		66		—		$	287,904
The Eclipse on Center Park		Active		465		—		371		94		—		$	397,682
Penderbrook Square		Active		424		143		12		269		—		$	251,598
River Club at Belmont Bay 5		Active		84		54		19		11		—		$	459,479
Woodlands at Round Hill		Active		65		23		21		21		—		$	735,214
Total VA Active and Completed				2,180		390		549		1,241		—		$	399,818
Total VA Active and Completed Weighted Avg(3)														$	352,927
Aldie Singles		Development		15		—		—		—		15		n/a
Blakes Crossing		Development		130		—		—		130		—		n/a
Brandy Station		Development		350		—		—		—		350		n/a
Carter Lake		Development		258		—		—		—		258		n/a
Lake Pelham		Development		185		—		—		—		185		n/a
Loudoun Station Condominiums		Development		484		—		—		—		484		n/a
Beacon Park at Belmont Bay 8&9		Development		600		—		—		—		600		n/a
Total VA Development				2,022		—		—		130		1,892
Total Virginia				4,202		390		549		1,371		1,892
Maryland
Emerald Farm		Active		84		58		9		17		—		$	437,721
Total Maryland				84		58		9		17		—
North Carolina
Allyn’s Landing		Active		117		12		—		105		—		$	208,911
Beckett Crossing		Active		115		111		3		1		—		$	313,914
Delta Rdge II Townhomes		Active		41		40		—		1		—		$	174,256
Kelton at Preston		Active		56		28		1		27		—		$	306,968
Wakefield Plantation		Active		57		29		5		23		—		$	474,379
Total North Carolina Active				386		220		9		157		—		$	295,685
Total North Carolina Active Weighted Average(3)														$	289,940
Holland Road		Development		90		—		—		—		90		n/a
Total North Carolina Development				90		—		—		—		90
Total North Carolina				476		220		9		157		90
TOTAL ACTIVE AND COMPLETED				2,650		668		567		1,415		—
TOTAL DEVELOPMENT				2,112		—		—		130		1,982
TOTAL				4,762		668		567		1,545		1,982
Joint Ventures
North Shore Condominiums		Active		196		—		7		189		—		$	286,361
North Shore Townhomes		Active		163		33		7		123		—		$	239,107
Total Joint Ventures				359		33		14		312		—
GRAND TOTAL				5,121		701		581		1,857		1,982

 

(1)               “Active” communities are open for sales. “Development” communities are in the development process and have not yet opened for sales.  “Completed” communities have settled all units during the three months ended September 30, 2005.

(2)               “Backlog” means we have an executed order with a buyer, inclusive of lot sales, but the settlement has not yet taken place.

(3)               Weighted average is calculated as total estimated homes at completion for projects with average sales prices multiplied by Average sales price divided by total of estimated homes at completion (i.e.: å (estimated homes at completion ´ average sales price)¸ å estimated homes at completion).

 

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