Comstock Holding Companies, Inc. - Quarter Report: 2006 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

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

For the quarterly period ended June 30, 2006

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

For the transition period from                      to                     

Commission File Number 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 þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer o Accelerated filer þ Non-accelerated filer o 

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

As of August 8, 2006, 13,396,534 shares of the Class A common stock, par value $.01 per share, and 2,733,500 shares of Class B common stock, par value $0.01, of the Registrant were outstanding.

 

 

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX

		Page
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets (unaudited) - June 30, 2006 and December 31, 2005
Consolidated Statements of Operations (unaudited) - Three and Six Months Ended June 30, 2006 and 2005
Consolidated Statements of Cash Flows (unaudited) - Six Months Ended June 30, 2006 and 2005
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 1A. RISK FACTORS
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

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)

		June 30, 2006				December 31, 2005
ASSETS
Cash and cash equivalents		$	22,739			$	42,167
Restricted cash			13,157				10,800
Receivables			2,528				6,365
Note receivable			—				1,250
Due from related parties			3,381				2,899
Real estate held for development and sale			476,534				263,802
Inventory not owned — variable interest entities			50,490				89,890
Property, plant and equipment			1,814				605
Investment in real estate partnerships			(88	)			(35	)
Deferred income tax			—				2,545
Other assets			12,033				11,031
TOTAL ASSETS		$	582,588			$	431,319
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable and accrued liabilities		$	50,810			$	59,131
Due to related parties			39				40
Obligations related to inventory not owned			48,206				83,015
Notes payable			286,525				142,994
Junior subordinated debt			30,000				—
Notes payable—related parties			663				663
Deferred income tax			8,430				—
TOTAL LIABILITIES			424,673				285,843
Commitments and contingencies (Note 14)
Minority interest			402				400
SHAREHOLDERS’ EQUITY
Class A common stock, $0.01 par value, 77,266,500 shares authorized, 14,120,222 and 11,532,442 issued and outstanding			141				115
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			146,620				126,461
Treasury Stock, at cost (258,400 Class A Common Stock)			(1,865	)			—
Retained earnings			12,590				18,473
TOTAL SHAREHOLDERS’ EQUITY			157,513				145,076
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	582,588			$	431,319

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

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share data)

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Revenues
Sale of real estate—Homes		$	50,351			$	39,599			$	86,716			$	68,064
Other revenue			346				312				576				576
Total revenue			50,697				39,911				87,292				68,640
Expenses
Cost of sales of real estate			41,295				29,658				68,456				47,249
Cost of sales of other			21				9				30				20
Impairments and write-offs			12,914				0				12,914				0
Selling, general and administrative			8,429				5,608				16,076				10,660
Operating (loss) income			(11,962	)			4,636				(10,184	)			10,711
Other (income) expense, net			(355	)			(154	)			(587	)			(190	)
(Loss) income before minority interest and equity in earnings of real estate partnerships			(11,607	)			4,790				(9,597	)			10,901
Minority interest			12				7				5				8
(Loss) income before equity in earnings of real estate partnerships			(11,619	)			4,783				(9,602	)			10,893
Equity in earnings of real estate partnerships			(26	)			4				(53	)			34
Total pre tax (loss) income			(11,645	)			4,787				(9,655	)			10,927
Income tax (benefit) provision			(4,522	)			1,721				(3,771	)			4,052
Net (loss) income		$	(7,123	)		$	3,066			$	(5,884	)		$	6,875
Basic earnings per share		$	(0.47	)		$	0.26			$	(0.41	)		$	0.59
Basic weighted average shares outstanding			15,034				11,831				14,511				11,727
Diluted earnings per share		$	(0.47	)		$	0.26			$	(0.41	)		$	0.58
Diluted weighted average shares outstanding			15,034				11,993				14,511				11,882

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

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, except share data)

		Six Months Ended June 30,
		2006				2005
Cash flows from operating activities:
Net (loss) income		$	(5,884	)		$	6,875
Adjustment to reconcile net (loss) income to net cash used in operating activities
Amortization and depreciation			259				81
Write-down of land, deposits and pre-acquisition costs			12,914				—
Loss on disposal of assets			—				9
Minority interest			5				8
Equity in losses (earnings) of real estate partnerships			53				(34	)
Amortization of stock compensation			1,546				1,086
Deferred income taxes			(4,769	)			(328	)
Changes in operating assets and liabilities:
Restricted Cash			(2,357	)			(5,836	)
Receivables			5,620				(5,073	)
Due from related parties			(482	)			(203	)
Real estate held for development and sale			(108,416	)			(109,493	)
Other assets			4,457				3,249
Accounts payable and accrued liabilities			(21,581	)			9,120
Income tax payable			—				863
Due to related parties			(1	)			(71	)
Net cash used in operating activities			(118,636	)			(99,747	)
Cash flows from investing activities:
Purchase of property, plant, and equipment			(1,236	)			(121	)
Distributions of capital from investments in real estate partnerships			—				60
Business acquisitions, net of cash acquired			(15,491	)			—
Net cash used in investing activities			(16,727	)			(61	)
Cash flows from financing activities:
Proceeds from notes payable			160,798				116,276
Proceeds from junior subordinated debt			30,000				—
Proceeds from related party notes payable			—				444
Payments on notes payable			(91,635	)			(50,156	)
Payments on related party notes payable			—				(8,125	)
Contribution from minority shareholders			—				79
Distributions paid to minority shareholders			(3	)			(2,409	)
Distributions paid to shareholders			—				(6,309	)
Proceeds from shares issued under employee stock purchase plan			78				36
Purchase of treasury stock			(1,864	)			—
Net proceeds from equity offerings			18,561				52,810
Net cash provided by financing activities			115,935				102,646
Net (decrease) increase in cash and cash equivalents			(19,428	)			2,838
Cash and cash equivalents, beginning of period			42,167				67,559
Cash and cash equivalents, end of period		$	22,739			$	70,397

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

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.

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 June 30, 2006 and for the three and six months ended June 30, 2006 and 2005 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, 2005 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.

The Company historically has experienced and expects to continue to experience variability in quarterly results. The consolidated statement of operations for the three and six months ended June 30, 2006 is not necessarily indicative of the results to be expected for the full year.

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., Raleigh, North Carolina, Charlotte, North Carolina, Myrtle Beach, South Carolina and Atlanta, Georgia markets. Our business was founded in 1985 by Christopher Clemente, our Chairman and Chief Executive Officer, as a residential land developer and home builder focused on land development and semi-custom homebuilding in the northern Virginia suburbs of Washington, D.C. In 1992, we repositioned ourselves as a finished-lot-option 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. In the late 1990s we began entitling and developing land once again and in the early 2000s we became active in development and construction of mixed-use and urban in-fill projects in the greater Washington, DC area. In all of our markets we focus on middle-market products for first time, early move-up and first move-down home buyers. In January 2006, we completed the acquisition of Parker Chandler Homes, Inc. and expanded into the Atlanta, Georgia, Charlotte, North Carolina and Myrtle Beach, South Carolina area. In May 2006, we completed the acquisition of Capitol Homes, Inc. which expanded our existing presence in Raleigh, North Carolina.

For purposes of identification and description, we are referred to as the “Predecessor” for the period prior to the IPO in December 2004, the Company for the period subsequent to the IPO, and “we,” “us,” and “our” for both periods.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the FASB issued FASB Interpretation No. 48, “An Interpretation of FASB Statement No. 109,” (“FIN 48”) which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 reflects the benefit recognition approach, where a tax benefit is recognized when it is “more likely than not” to be sustained based on the technical merits of the position.

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is evaluating the impact of FIN 48 on its consolidated financial statements.

On June 29, 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-05, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-05”). The scope of EITF 04-05 is limited to limited partnerships or similar entities (such as limited liability companies that have governing provisions that are the functional equivalent of a limited partnership) that are not variable interest entities under FIN 46 and provides a new framework for addressing when a general partner in a limited partnership, or managing member in the case of a limited liability company, controls the entity. Under EITF 04-05, we may be required to consolidate certain investments, that are not variable interest entities, in which we hold a general partner or managing member interest. EITF 04-05 is effective after June 29, 2005 for new entities formed after such date and for existing entities for which the agreements are subsequently modified and is effective for our fiscal year beginning January 1, 2006 for all other entities. The adoption of EITF 04-05 did not have any impact on our financial statements.

3. 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 project and allocated to various lots or housing units within that project 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.

During the second quarter of 2006, the Company experienced continued significant slowdown in demand for homes at several of its projects. This slowdown in demand resulted in lower overall sales volume, reduction in selling prices, increases in concessions being offered to customers and extensions of estimated project completion dates. As a result, the Company evaluated each of its projects to determine if recorded carrying amounts were recoverable. This evaluation resulted in an aggregate impairment charge of $9,500 at seven projects throughout the Company’s markets. The impairment charge was calculated using a discounted cash flow analysis model, which is dependent on several subjective factors, including the selection of an appropriate discount rate, estimated average selling prices and estimated sales and absorption rates. The estimates used by the Company are based on the best available information available at the time the estimates are made. Adverse changes to these estimates in future periods could result in additional material impairment amounts to be recorded.

In addition to the impairment charges, as a result of current market conditions, the Company wrote-off approximately $3.4 million related to deposits on option contacts, value assigned to option contracts and related feasibility costs.

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

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

		June 30,				December 31,
		2006				2005
Land and land development costs		$	250,436			$	119,530
Cost of construction (including capitalized interest and real estate taxes)			226,098				144,272
		$	476,534			$	263,802

4. 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, Consolidation of Variable Interest Entities. 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 losses 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 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, 2005, the Company has consolidated five entities in the accompanying consolidated balance sheets. The effect of the consolidation at December 31, 2005 was the inclusion of $89,890 in “Inventory not owned—variable interest entities” with a corresponding inclusion of $83,015 (net of land deposits paid of $6,875) to “Obligations related to inventory not owned.” At June 30, 2006, the Company consolidated seven entities in the accompanying consolidated balance sheet. The effect of the consolidation at June 30, 2006 was the inclusion of $50,490 in “Inventory not owned—variable interest entities” with a corresponding inclusion of $48,206 (net of land deposits paid of $2,284) to “Obligations related to inventory not owned.” Creditors, if any, of these variable interest entities have no recourse against the Company.

5. WARRANTY RESERVE

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

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. Because 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 six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Balance at beginning of period		$	1,310			$	954			$	1,206			$	916
Additions			514				153				814				309
Releases and/or charges incurred			(267	)			(162	)			(463	)			(280	)
Balance at end of period		$	1,557			$	945			$	1,557			$	945

6. 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.

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

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Total interest incurred		$	6,844			$	3,254			$	11,612			$	5,767
Beginning interest capitalized			15,562			$	5,987				11,590			$	4,524
Plus: Interest incurred on notes payable			6,824				2,993				11,572				5,096
Plus: Interest incurred on related party notes payable			20				188				40				269
Less: Interest expensed as a component of cost of sales			(1,567	)			(1,159	)			(2,363	)			(1,880	)
Ending interest capitalized		$	20,839			$	8,009			$	20,839			$	8,009

7. EARNINGS PER SHARE

The following weighted average shares and share equivalents, using the treasury stock method, are used to calculate basic and diluted earnings per share for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Basic earnings per share
Net (loss) income		$	(7,123	)		$	3,066			$	(5,884	)		$	6,875
Basic weighted-average shares outstanding			15,034				11,831				14,511				11,727

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

		Three Months Ended June 30,								Six Months Ended June 30,
		2006				2005				2006				2005
Per share amounts		$	(0.47	)		$	0.26			$	(0.41	)		$	0.59
Dilutive earnings per share
Net income		$	(7,123	)		$	3,066			$	(5,884	)		$	6,875
Basic weighted-average shares outstanding			15,034				11,831				14,511				11,727
Stock options and restricted stock grants			—				162				—				155
Dilutive weighted-average shares outstanding			15,034				11,993				14,511				11,882
Per share amounts		$	(0.47	)		$	0.26			$	(0.41	)		$	0.58

During the three and six months ended June 30, 2006, 92,279 and 92,209 shares where excluded from the diluted shares outstanding because inclusion would be anti-dilutive.

Comprehensive income

     For the three and six months ended June 30, 2006 and 2005, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying combined consolidated financial statements.

8. INVESTMENT IN REAL ESTATE PARTNERSHIPS

Prior to the Company’s acquisition of Comstock Service in December of 2004, 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. The Company, as part of the acquisition of Comstock Service, recorded this investment in North Shore at $0.

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, is recording its share of losses incurred by North Shore in the accompanying financial statements in the amount of $(26), for the three months ended June 30, 2006 and 2005, respectively. The Company’s share of losses were $(53) and $(26) for the six months ended June 30, 2006 and 2005, 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 and issued a notice of default under the acquisition and development loan at maturity on September 30, 2005. The Company then filed suit for collection of the loans against one of the individual guarantors under the loan on or about October 21, 2005 and initiated foreclosure proceedings on or about November 18, 2005. On or about December 22, 2005, the individual guarantor subject to the earlier suit filed a countersuit against two of the officers of the Company who were also individual guarantors under the acquisition and development loan. The Company has agreed to indemnify these officers. The Company, as manager of an affiliated entity, set and held a foreclosure sale on March 24, 2006 in which it was the highest bidder. However, transfer of title to the property has been delayed pending judicial resolution of a suit filed on March 24, 2006 by the non-affiliated 50% owner of North Shore. On June 30, 2006, the Company, on its own behalf and on behalf of affiliates, filed an additional lawsuit expanding the number of party defendants, demanding equitable relief and demanding $33,000 in damages. As of June 30, 2006, the Company carried the following amounts in its financial statements related to North Shore:

Investment in real estate partnerships		$	(88	)
Development and construction loan receivable		$	3,235

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

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. ACQUISITIONS

On January 19, 2006, the Company acquired all of the issued and outstanding capital stock of Parker Chandler Homes, Inc., a homebuilder in the Atlanta, Georgia metropolitan market, for a cash purchase price of $10,400 (including transaction costs) and the assumption of $63,800 in liabilities. The results of Parker Chandler Homes are included in the accompanying financial statements from the period January 19, 2006 to June 30, 2006. The Company accounted for this transaction in accordance with SFAS No. 141. “Business Combinations” Approximately $700 of the purchase price was allocated to intangibles with a weighted average life of 4.6 years. The intangibles are related to the Parker Chandler trade name, employment and non-compete agreements entered into with certain selling shareholders. The remainder of the purchase price was allocated to real estate held for development and sale and land option agreements. There was no goodwill recorded.

On May 5, 2006, the Company acquired all of the issued and outstanding capital stock of Capitol Homes, Inc., a homebuilder in North Carolina, for a cash purchase price of $7,500 (including transaction costs) and the assumption of $20,600 in liabilities. The results of Capitol Homes are included in the accompanying financial statements from the period May 5, 2006 to June 30, 2006. The Company accounted for this transaction in accordance with SFAS No. 141. “Business Combinations” Approximately $251 of the purchase price was allocated to intangibles with a weighted average life of 2.7 years. The intangibles are related to the Capitol Homes trade name, employment and non-compete agreements entered into with certain selling shareholders. The remainder of the purchase price was allocated to real estate held for development for sale and land option agreements. There was no goodwill recorded in connection with the initial purchase accounting. However, the Company may be obligated to pay an earn-out in the amount of $2,500 if certain profit margins are achieved over the course of a 3 year period. In the event, an earn-out amount becomes payable, it will be recorded as goodwill.

10. DEBT

On May 4, 2006, the Company closed on a privately placed 30-year, $30 million junior subordinated unsecured note offering with a five year fixed rate of 9.72% and a floating rate of Libor + 4.2% thereafter. Interest payments are due quarterly with principal due at the end of the 30 year term. The Company is required to maintain certain covenants which include the maintenance of minimum tangible net worth in the amount of $120,000, a leverage ratio not to exceed 3:1 and a fixed charge ratio not to be less than 2:1.

On May 26, 2006, the Company became a borrower pursuant to the Borrowing Base Revolving Credit Agreement between the Company and Wachovia Bank. Pursuant to the Borrowing Base Revolving Facility, the lender agreed to advance up to a maximum of $40 million at any given time under a senior secured revolving credit facility bearing interest equal to the 30 day LIBOR rate + 2.75%. The loan is secured by certain projects of the Company in North Carolina. As of June 30, 2006, the Company had drawn $11,600 under this facility. The Company is required to maintain certain covenants which include the maintenance of minimum tangible net worth in the amount of $125,000 increasing each year by 25% of income before taxes, EBITDA to debt service ratio equal to or greater than 2.5:1, a senior liabilities to tangible net worth ratio which is less than or equal to 2.5:1 and certain restrictions on the number of speculative homes the Company may have at any given time.

11. INCOME TAX

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

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

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.

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 June 30, 2006 and December 31, 2005 were as follows:

		June 30, 2006				December 31, 2005
Deferred tax assets:
Inventory (1)		$	—			$	2,245
Warranty			583				417
Deferred rent			40				27
Accrued expenses			64				73
Stock based compensation			1,363				790
			2,050				3,552
Less—valuation allowance			(569	)			(840	)
Net deferred tax assets			1,481				2,712
Deferred tax liabilities:
Inventory (1)		$	(9,756	)		$	—
Investment in affiliates			(8	)			(8	)
Depreciation and amortization			(147	)			(159	)
Net deferred tax liabilities			(9,911	)			(167	)
Net deferred tax (liabilities) assets		$	(8,430	)		$	2,545

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

Effective January 1, 2004, the Company adopted the fair value recognition provisions of SFAS No. 123(R). Prior to December 14, 2004 the Company did not sponsor any stock based plans. Accordingly, no stock based compensation was included for the year ended December 2003.

On December 14, 2004 the Company adopted the 2004 Long-Term Compensation Plan (the “Plan”). The Plan 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. Any shares issued under the Plan typically vest over service periods that range from one to five years. Stock options issued under the Plan expire ten years from the date they are granted.

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.

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)

The following equity awards were outstanding at June 30, 2006:

Stock options			213,993
Restricted stock grants			947,860
Total outstanding equity awards			1,161,853

On June 30, 2006 the following amounts were available for issuance under the plan:

Shares available for issuance at January 1, 2006			1,050,231
Adjustments:
Additional shares added to plan			337,757
Restricted stock grants — Issued			(690,160	)
Shares issued under employee stock purchase plan			(7,512	)
Restricted stock grants — Forfeitures			16,191
Shares available for issuance at June 30, 2006			706,507

At June 30, 2006 the Company had 213,993 options outstanding with a weighted average exercise price of $19.94. There was no stock option activity for the six months ended June 30, 2006 and there were no options which were fully vested as of June 30, 2006.

A summary of the Company’s restricted share activity is presented below:

						Weighted
						average
						fair value
						at date
		Shares				of grant
Restricted shares outstanding at December 31, 2005			273,891			$	16.46
Granted			690,160				11.84
Vested			—				—
Forfeited			(16,191	)			15.43
Restricted shares outstanding at June 30, 2006			947,860			$	13.11

As of June 30, 2006, there was $9,178 of total unrecognized compensation cost related to nonvested restricted stock issuances granted under the Plan. Of this cost, $6,178 is expected to be recognized over a weighted-average period of 3.75 years and $3,000 may vest over a 1.5 year period if certain performance and service conditions are met.

Total compensation expense for share based payment arrangements for the three months ended June 30, 2006 and 2005 was $1,006 and $561 respectively, of which $91 and $129 was capitalized to real estate held for development and sale. Total compensation expense for share based payment arrangements for the six months ended June 30, 2006 and 2005 was $1,542 and $1,097, respectively, of which $162 and $213 was capitalized to real estate held for development and sale.

The total deferred tax benefit related to stock compensation, recorded on the balance sheet as of June 30, 2006 and December 31, 2005 amounted to $1,363 and $790, respectively.

In accordance with SFAS 123(R), the Company is required to establish a deferred tax asset related to stock awards based on the fair value of the award at date of grant. At the time the award is vested, the realized tax benefit as a result of the fair value on date on grant will most likely be different as compared to the amount recorded on the financial statements, which will result excess tax benefits or unrealized tax benefits. SFAS 123(R) requires that excess tax benefits be recognized as an addition to capital surplus and that unrealized tax benefits be recognized as income tax expense unless there are excess tax benefits from previous equity awards to which it can be offset. Because the Company had no issuances of stock awards prior to adoption to SFAS 123(R), the Company does not have any eligible excess tax benefits that are available to offset future tax shortfalls.

The Company has approximately 143,764 stock grants which are expected to vest at December 31, 2006 with an average fair value at date of issuance of $16.08 per share. Based on the closing stock price of $5.67 at July 31,