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 March 31, 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
Suite 510 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

 

As of May 16, 2005,  8,889,151 shares of the Class A common stock, par value $.01 per share and 2,733,500 shares of the Class B 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		1
ITEM 1. FINANCIAL STATEMENTS:		1
Consolidated Balance Sheets (unaudited) - March 31, 2005 and December 31, 2004		3
Consolidated Statements of Operations (unaudited) - Three Months Ended March 31, 2005 and 2004		4
Consolidated Statements of Cash Flows (unaudited) - Three Months Ended March 31, 2005 and 2004		5
Notes to Consolidated Financial Statements		6
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	15
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	20
ITEM 4.	CONTROLS AND PROCEDURES	20
PART II – OTHER INFORMATION		20
ITEM 1. LEGAL PROCEEDINGS		20
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		21
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		21
ITEM 5. OTHER INFORMATION		21
ITEM 6. EXHIBITS		21
SIGNATURES		22

 

2

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)

 

		March 31, 2005			December 31, 2004
ASSETS
Cash and cash equivalents		$	37,337		$	67,559
Restricted cash		10,620			7,500
Receivables		74			239
Due from related parties		1,603			1,447
Real estate held for development and sale		211,210			104,326
Inventory not owned - variable interest entities		33,640			118,558
Property, plant and equipment		496			488
Investment in real estate partnerships		1,029			1,029
Deferred income tax		1,009			821
Other assets		2,195			2,540
TOTAL ASSETS		$	299,213		$	304,507
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable and accrued liabilities		$	34,826		$	35,532
Income taxes payable		2,462			290
Due to related parties		149			148
Obligations related to inventory not owned		33,215			114,333
Notes payable		142,806			65,684
Notes payable—related parties		9,142			10,944
Distribution payable		9,677			12,655
TOTAL LIABILITIES		232,277			239,586
Commitments and contingencies (Note 11)
Minority interest		366			2,695
SHAREHOLDERS’ EQUITY
Class A common stock, $0.01 par value, 77,266,500 shares authorized, 9,160,837 issued and outstanding		92			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		75,535			75,510
Unearned compensation		(3,804		)	(4,314		)
Retained earnings (accumulated deficit)		(5,280		)	(9,089		)
TOTAL SHAREHOLDERS’ EQUITY		66,570			62,226
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)		$	299,213		$	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 STATEMENT OF OPERATIONS

(Amounts in thousands, except share data)

 

		Three Months Ended March 31,
		2005			2004
					Predecessor
Revenues
Sale of real estate—homes		$	28,465		$	15,136
Other revenue		264			2,745
Total revenue		28,729			17,881
Expenses
Cost of sales of real estate		17,591			10,313
Cost of sales of other		11			2,148
Selling, general and administrative		5,052			2,431
Operating income		6,075			2,989
Other (income) expense, net		(36		)	63
Income before minority interest and equity in earnings of real estate partnerships		6,111			2,926
Minority interest		1			848
Income before equity in earnings of real estate partnerships		6,110			2,078
Equity in earnings of real estate partnerships		30			28
Total pre tax income		6,140			2,106
Income taxes		2,331			—
Net income		$	3,809		$	2,106
Basic earnings per share		0.33			0.30
Basic weighted average shares outstanding		11,621			7,067
Diluted earnings per share		0.32			0.30
Diluted weighted average shares outstanding		11,769			7,067

 

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

 

4

 

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS

(Amounts in thousands, except share data)

 

		Three Months Ended
		2005			2004
					Predecessor
Cash flows from operating activities:
Net income		$	3,809		$	2,106
Adjustment to reconcile net income to net cash provided by operating activities
Depreciation		39			27
Loss on disposal of assets		8			—
Minority interest		1			848
Equity in earnings of real estate partnerships		(30		)	(28		)
Amortization of stock compensation		535			—
Deferred income tax		(188		)	—
Changes in operating assets and liabilities:
Restricted cash		(3,120		)	—
Receivables		165			1,234
Due from related parties		(156		)	(400		)
Real estate held for development and sale		(106,884		)	(3,560		)
Other assets		4,145			(151		)
Accounts payable and accrued liabilities		(706		)	2,194
Income tax payable		2,172			—
Due to related parties		1			5
Net cash (used in) provided by operating activities		(100,209		)	2,275
Cash flows from investing activities:
Purchase of property, plant, and equipment		(55		)	(130		)
Distributions from Investments in real estate partnerships		30			30
Net cash (used in) provided by investing activities		(25		)	(100		)
Cash flows from financing activities:
Proceeds from notes payable		93,458			12,033
Proceeds from related party notes payable		200			8
Payments on notes payable		(16,336		)	(12,077		)
Payments on related party notes payable		(2,002		)	—
Contribution from minority shareholders		79			—
Payments of distribution payable		(2,978		)	—
Distributions paid to minority shareholders		(2,409		)	(600		)
Net cash provided by (used in) financing activities		70,012			(636		)
Net (decrease) increase in cash and cash equivalents		(30,222		)	1,539
Cash and cash equivalents, beginning of period		67,559			17,160
Cash and cash equivalents, end of period		$	37,337		$	18,699

 

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

 

5

 

COMSTOCK HOMEBUILDING COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except share data)

 

1.              ORGANIZATION AND BASIS OF PRESENTATION

 

Comstock Companies, Inc. (the “Company”) was incorporated on May 24, 2004 as a Delaware corporation. On June 30, 2004, the Company changed its name to Comstock Homebuilding Companies, Inc.

 

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 and 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 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 stock holders are entitled to one vote for each share held while Class B stock holders 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.

 

Our common stock is traded on the NASDAQ National market under the symbol “CHCI”. We have no public trading history prior to December 14, 2004.

 

The consolidated financial statements and notes of the Company as of March 31, 2005 and for the three months ended March 31, 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 months ended March 31, 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.

 

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.

 

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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:

 

		March 31,				December 31,
		2005				2004
Land and land development costs		$		78,051		$		65,545
Cost of construction (including capitalized interest and real estate taxes)		133,159				38,781
		$	211,210			$	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 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

 

7

 

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 three months ended March 31, 2005 the Company acquired three entities which were previously consolidated under FIN 46-R at December 31, 2004. The effect of the consolidation at March 31, 2005 was the inclusion of $33,640 in “Inventory not owned—variable interest entities” with a corresponding inclusion of $33,215 (net of land deposits paid of $425) 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 months ending March 31, 2005 and 2004:

 

		Three Months Ended March 31,
		2005			2004
Balance at beginning of period		$	916		$	541
Additions		156			167
Releases and/or charges incurred		(118		)	(37		)
Balance at end of period		$	954		$	671

 

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.

 

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

 

		Three Months Ended March 31,
		2005			2004
Total interest incurred		$	2,551		$	1,031
Beginning interest capitalized		$	4,524		$	1,428
Plus: Interest incurred on notes payable		2,103			680
Plus: Interest incurred on related party notes payable		81			345
Less: Interest expensed as a component of cost of sales		(721		)	(250		)
Ending interest capitalized		$	5,987		$	2,203

 

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6.              EARNINGS PER SHARE

 

The following weighted average shares and share equivalents are used to calculate basic and diluted EPS for the three months ended March 31, 2005 and 2004:

 

		Three Months Ended March 31,
		2005			2004
Basic earnings per share
Net income		$	3,809		$	2,106
Basic weighted-average shares outstanding		11,621			7,067
Per share amounts		$	0.33		$	0.30
Diluted earnings per share
Net income		$	3,809		$	2,106
Basic weighted-average shares outstanding		11,621			7,067
Stock options and restricted stock grants		148			—
Diluted weighted-average shares outstanding		11,769			7,067
Per share amounts		$	0.32		$	0.30

 

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 year and three months ended December 31, 2004 and March 31, 2005, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying combined consolidated financial statements.

 

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.              DEBT

 

In February 2005, the Company completed a purchase of a 424 unit Condominium conversion project located in Fairfax, Virginia. To finance this transaction, the Company entered into a promissory note agreement relating to $67,000 of indebtedness bearing interest at a rate equal to the greater of: (i) 5.50% or (ii) 3.50% + the three month LIBOR rate. At March 31, 2005, the Company was advanced a total of $58,426.

 

In March 2005, as a result of purchasing three real estate projects known as Countryside, Barrington, and Blake, the Company entered into promissory note agreements relating to an aggregate of $29,282 of indebtedness bearing a weighted average interest rate of approximately 5.42% to finance the purchases and future development needs. At March 31, 2005, the Company was advanced a total of $18,678.

 

9

 

9.              INCOME TAX

 

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

 

Income tax provision consists of the following as of March 31, 2005:

 

Current:
Federal		2,021
State		405
		2,426
Deferred:
Federal		(85	)
State		(10	)
		(95	)
Total income tax expense		(2,331	)

 

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 March 31, 2005 were as follows:

 

		March 31, 2005
Deferred tax assets:
Inventory		2,093
Warranty		307
Deferred rent		13
Accrued expenses		96
Stock-based compensation		196
		2,705
Less — valuation allowance		(1,484	)
Net deferred tax assets		1,221
Deferred tax liabilities:
Depreciation and amortization		(212	)
Net deferred tax liabilities		(212	)
Net deferred tax assets		1,009

 

The Company has adequately provided for contingencies related to income taxes in accordance with SFAS No. 5.  At March 31, 2005, the Company recorded a $93 income tax reserve which is included in other accrued expenses 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 determined that a valuation allowance of approximately $1,484 as of March 31, 2005 related to a deferred tax asset of approximately $1,484 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, regulations and interpretations and established these reserves based on past experience and judgments about potential actions by taxing jurisdictions.

 

10

 

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

 

On December 14, 2004, the Company adopted the 2004 Long-Term Incentive Compensation 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. 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 Jan 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 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 supercedes 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.  In accordance with the provisions of SFAS No. 123(R) and SFAS No. 148, $0 and $535 was recorded for total stock-based compensation expense for the three months ended March 31, 2004 and 2005 respectively.  Of this amount $55 was related to stock option grants and $480 was related to restricted stock grants.

 

On March 31, 2005, the following amounts were available for issuance under the Plan:

 

Shares Available for issuance at December 31, 2004		1,168
Adjustments:
Restricted Stock Grants – Issued		—
Restricted Stock Grants – Forfeited		2
Shares Available for issuance at March 31, 2005		1,170

 

11.       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.

 

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 March 31, 2005, the Company has outstanding $8,804 in letters of credit and $9,165 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 March 31, 2005 approximate:

 

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Year Ended:			Amount
2005			$	483
2006			629
2007			642
2008			667
2009			547
2010			10
Thereafter			—
Total			$	2,978

 

Operating lease rental expense aggregated $138 and $89, respectively, for the three months ended March 31, 2005 and 2004.

 

12.       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 is due on June 15, 2006. As of March 31, 2005 and December 31, 2004, the amount owed to TCG Fund I amounted to approximately $3.3 million. Accrued interest on this note totaled $106 at both March 31, 2005 and December 31, 2004.

 

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 a affiliate 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 March 31, 2005 and December 31, 2004 the Company owed $2.5 and $2.4 million, respectively, under this promissory agreement. Accrued interest on this note totaled $25 and $49 at March 31, 2005 and December 31, 2004, respectively.

 

In April 2002 and January 2004, the Predecessor entered into lease agreements for 7,703 and 8,797 square feet, respectively, for its corporate headquarters at 11465 Sunset Hills Road, Reston, Virginia from Comstock Partners, L.C., an affiliate 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 months ended March 31, 2004, total payments made under this lease agreement were $64.  On September 30, 2004 the lease agreements were canceled and replaced with new leases for a total of 20,609 square feet with Comstock Asset Management, L.C., an entity owned by Christopher Clemente.  For the three months ended March 31, 2005, total payments made under this lease agreement was $135.

 

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 $3.4 million and $322 to this construction company during the three months ended March 31, 2005 and 2004, respectively.

 

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In April 2004, the Predecessor entered into an additional three year $5,000 promissory note agreement, with an entity controlled by Scott Kasprowicz, bearing interest at a rate of 12%. Under the terms of the note, the Predecessor was advanced $2,500 in April 2004 and additional $2,500 in June 2004.  As of March 31, 2005 and December 31, 2004 the amount owed to Scott Kasprowicz was $2,500. Accrued interest for the three months ended March 31, 2005 and 2004 totaled $49 and $0, respectively.

 

At March 31, 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 by Christopher Clemente, Gregory Benson, Bruce Labovitz, Lawrence Golub and James Keena (executive officers and/or shareholders of the Company).  At December 31, 2004 accrued interest 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, respectively, 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 shareholders interests referenced above for a approximate purchase price of $136.  In April 2005 the Company paid the $300 loan 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. During the three months ended March 31, 2005 and 2004, the Predecessor paid $105 and $112, 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 ended March 31, 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.

 

During the three months ended March 31, 2005 and 2004, the Predecessor received revenue of approximately $0 and $737, respectively, by providing administrative and sales support to Comstock Service Corp., Inc., a related party owned by Christopher Clemente, Gregory Benson, James Keena and Lawrence Golub.

 

For the three months ended March 31, 2005 and 2004, the Predecessor received revenue of approximately $215 and $371, respectively, by providing administrative and sales support to other related parties in which Christopher Clemente, Gregory Benson, Jim Keena, Lawrence Golub and Christopher Clemente’s father-in-law, Dwight Schar, are shareholders.

 

In October 2004, the Predecessor entered into an agreement with Comstock Asset Management Inc. to provide management services for a fee of $20 a month.  For the three months ended March 31, 2005 the Company recorded $60 in revenue. At March 31, 2005 and December 31, 2004 the Predecessor recorded a receivable for $0 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 this agreement.

 

During the three months ended March 31, 2005 and 2004, the Company provided bookkeeping services to related party entities at no charge.

 

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In August 2004, the Predecessor entered into a $2,400 promissory note agreement with Belmont Models I, L.C., an affiliate managed by Investors Management. The note bears an interest rate of 12%, which is payable monthly and matures in July 2005.  In March 2004, 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.  For the three months ended March 31, 2005 and year ended December 31, 2004 the Predecessor owed $473 and $2,400, respectively. Accrued interest on this note totaled $23, $0 and $49, respectively, as of three months ended March 31, 2005 and 2004 and year ended December 31, 2004.

 

During three months ended March 31, 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.

 

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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 and high-rise condominium development 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.

 

For the three month period ended March 31, as indicated below, the approximate average order prices for our market rate homes (which excludes county government mandated affordable housing program units sold at a discount) were as follows:

 

		Three Months Ended March 31,
		2005			2004
Townhouse		$	400,700		$	324,400
Single Family		616,400			419,300
Condominium		414,900			369,000

 

At March 31, 2005, we either owned or controlled under option agreements over 4,000 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 March 31, 2005:

 

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		As of March 31, 2005
Project		Status (1)		Estimated Units at Completion		Units Settled		Backlog (2)		Lots Owned Unsold		Lots under Option Agreement Unsold		Average Sales Price
Virginia
Blooms Mill TH 20°		Active		91		89		—		2		—		$	272,202
Blooms Mill TH 22°		Active		113		29		39		45		—		$	406,657
Blooms Mill Carriage		Active		91		33		40		18		—		$	439,745
Blooms Mill Singles		Active		35		33		—		2		—		$	486,785
Commons on Potomac Sq		Active		192		—		20		172		—		$	232,260
Commons on Williams Sq		Active		180		—		62		118		—		$	346,585
Countryside		Active		102		—		—		102		—		n/a
The Eclipse on Center Park		Active		465		—		355		110		—		$	390,379
Penderbrook		Active		424		—		—		424		—		n/a
River Club at Belmont Bay 5		Active		84		27		41		16		—		$	448,719
Woodlands at Round Hill		Active		65		1		16		48		—		$	705,781
Wescott Ridge - ADUs (3)		Active		37		34		3		—		—		$	76,920
Total VA Active				1,879		246		576		1,057		—		$	380,603
Total VA Active Weighted Avg (4)														$	243,801
Aldie Singles		Development		15		—		—		—		15		n/a
Barrington Park		Development		134		—		—		—		134		n/a
Blakes Crossing		Development		130		—		—		—		130		n/a
Brandy Station		Development		350		—		—		—		350		n/a
Loudoun Station Condominiums		Development		484		—		—		—		484		n/a
River Club at Belmont Bay 8&9		Development		600		—		—		—		600		n/a
Total VA Development				1,713		—		—		—		1,713
Total Virginia				3,592		246		576		1,057		1,713
Maryland
Emerald Farm		Active		84		40		23		21		—		$	423,594
Total Maryland				84		40		23		21		—
North Carolina
Allyn’s Landing		Active		117		11		2		104		—		$	222,824
Beckett Crossing		Active		115		101		8		6		—		$	311,994
Delta Rdge II Townhomes		Active		41		40		—		1		—		$	174,256
Kelton at Preston		Active		56		22		4		30		—		$	304,356
Wakefield Plantation		Active		57		27		2		28		—		$	458,538
Total North Carolina Active				386		201		16		169		—		$	294,394
Total North Carolina Active Weighted Average (4)														$	290,868
Holland Road		Development		90		—		—		—		90		n/a
Total North Carolina Development				90		—		—		—		90
Total North Carolina				476		201		16		169		90
TOTAL ACTIVE				2,349		487		615		1,247		—
TOTAL DEVELOPMENT				1,803		—		—		—		1,803
TOTAL				4,152		487		615		1,247		1,803
Joint Ventures
North Shore Condominiums		Active		196		—		5		191		—		$	294,422
North Shore Townhomes		Active		163		20		1		142		—		$	236,152
Total Joint Ventures				359		20		6		333		—
GRAND TOTAL				4,511		507		621		1,580		1,803

Key—for purposes of this chart:

(1)    "Active" communities are open for sales. "Development" communities are in the development process and have not yet opened for sales.

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

(3)    "ADUs" are affordable dwelling units.

(4)    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. S (estimated homes at completion x average sales price) ÷ S estimated homes at completion).

 

Results of Operations

 

Three months ended March 31, 2005 compared to three months ended March 31, 2004

 

Orders and Backlog

 

New orders for the three months ended March 31, 2005 increased $56.2 million, or 119.2%, to $103.3 million on 246 homes as compared to $47.1 million on 132 homes for the three months ended March 31, 2004. This increase in new orders was primarily attributable to an increase in saleable inventory resulting from the opening of new projects including the Commons at Williams Square (47 sales), the Woodlands at Round Hill (12 sales), the Commons on Potomac Square (20 sales) and the Eclipse at Potomac Yard (74 sales).

 

The average sale price per new order for the three months ended March 31, 2005 increased by $63,000 to $420,000 as compared to $357,000 for the three months ended March 31, 2004. This change was attributable to both

 

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a shift in product mix that included a significant number of higher-priced condominium sales derived from the opening at our Eclipse at Potomac Yard project, the opening of our new large-lot single family home community at the Woodlands at Round Hill and general price appreciation in the Washington, DC area, especially in the townhouse market where we took new orders for 61 townhouses at an average price of $451,000. On average, the sale price of townhouses increased $76,300 to $400,700 for the three months ended March 31, 2005 as compared to $324,400 for the three months ended March 31, 2004. On average, the sale price of our single-family homes increased by approximately $197,100 during the three months ended March 31, 2005 to $616,400 from $419,300 for the three months ended March 31, 2004. The average sale price of our condominiums increased by $45,900 to $414,900 for the three months ended March 31, 2005 as compared to $369,000 for the three months ended March 31, 2004.

 

Our backlog at March 31, 2005 increased $184.8 million, or 291.1%, to $248.3 million on 615 homes as compared to our backlog at March 31, 2004 of $63.5 million on 93 homes. This increase in backlog is primarily attributable to sales at the Eclipse project in Arlington, Virginia which represented approximately $138.6 million of the backlog at March 31, 2005.  In addition, backlog increased due to delays the Company experienced in obtaining building permits as a result of the adoption of new building code standards.  The delays in permitting caused delays in home starts which delayed the release of sold units from backlog.   In addition, as a result of our acquisition of Comstock Service on December 17, 2004, our Raleigh operation, which had not previously been included in our reported backlog, represented backlog of $5.8 million at March 31, 2005.

 

Revenues.

 

The number of homes delivered for the three months ended March 31, 2005 increased by 69.6% to 78 from 46 homes for the three months ended March 31, 2004. Average per settlement revenue increased by approximately $36,000 to $365,000 for the three months ended March 31, 2005 as compared to $329,000 for the three months ended March 31, 2004. Home building revenues increased by $13.4 million, or 88.1%, to $28.5 million for the three months ended March 31, 2005 as compared to $15.1 million for the three months ended March 31, 2004. Total revenue increased $10.8 million to $28.7 million for the three months ended March 31, 2005 as compared to $17.9 million in the three months ended March 31, 2004. The increase in deliveries and revenue for the three months ended March 31, 2005 is in large part attributable to the completion of the first mid-rise condominium building at River Club at Belmont Bay 5 (16 settlements), the continued development at projects such as Blooms Mill (18 settlements) and the delivery of the final mid-rise buildings at Wescott Ridge (27 settlements). Total revenue increases were in part offset by a $2.5 million reduction in other revenue for the three months ended March 31, 2005 as compared to the three months ended March 31, 2004.  This reduction is the result of our consolidation with Comstock Service which eliminated inter-company administrative and production other revenue.

 

Cost of sales and selling, general and administrative expenses.

 

Cost of sales for the three months ended March 31, 2005 increased $5.1 million, or 41.3%, to $17.6 million, or 61.3% of revenue, as compared to $12.5 million, or 69.7% of revenue, for the three months ended March 31, 2004. The increase in cost of goods sold during the three months ended March 31, 2005 as compared to the three months ended March 31, 2004 is directly attributable to the increase in deliveries. The increase of 8.4 percentage points in cost of goods sold as a percentage of revenue is primarily attributable to low cost of sales as a percentage of revenue at Blooms Mill and Wescott Ridge where we were able to reduce our estimated costs to complete for development and thereby lower development allocations on the units which settled at there projects during the three months ended March 31, 2005.  Gross margin at Blooms Mill for the three months ended March 31, 2005 was 40.9% and the gross margin at Wescott Ridge for the three months ended March 31, 2005 was 50.2%.  In addition, our consolidation with Comstock Service eliminated inter-company other revenue which represented lower gross margins than those generated from homebuilding. This elimination helped increase overall gross margins.

 

Selling, general and administrative costs for the three months ended March 31, 2005 increased $2.6 million or 107.8% to $5.0 million as compared to $2.4 million for the three months ended March 31, 2004. This increase was the result of additional staffing costs ($500,000) accounting and legal expenses ($400,850) board fees and stock compensation ($400,000), insurance costs ($200,000), consulting fees ($200,000) promotion ($100,000) and other miscellaneous expenses associated with our growth in staffing and land acquisition efforts ($400,850). In addition, our consolidation with Comstock Service increased our selling, general and administrative

 

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expenses by $400,000.  Selling, general and administrative expenses represented 17.6% of total revenue for the three months ended March 31, 2005 as compared to 13.6% for the three months ended March 31, 2004.

 

Operating income

 

Operating income for the three months ended March 31, 2005 increased $3.1 million to $6.1 million, as compared to $2.9 million for the three months ended March 31, 2004. Operating margin for the three months ended March 31, 2005 was 21.1% as compared with 16.7% for the three months ended March 31, 2004. The 4.4 percentage point increase in operating margin is primarily attributable to the 8.4 percentage point increase in gross margin which outpaced the 4.5 percentage point increase in selling, general and administrative expenses as a percentage of total revenue.

 

Other (income) expense, net

 

Other (income) expense, net increased by $0.1 million to a net income of $36 for the three months ended March 31, 2005 as compared to net expense of $63 for the three months ended March 31, 2004. The increase in other (income) expense net is primarily attributable to interest earned on the Company’s cash balances generated as a result of the proceeds from the Company’s  initial public offering.

 

Income before minority interest

 

Our income before minority interest increased by $3.2 million, or 108.9%, to $6.1 million for the three months ended March 31, 2005 as compared to $2.9 million for the three months ended March 31, 2004. Net margin before minority interest as a percentage of revenues increased by 4.9 percentage points to 21.3% for the three months ended March 31, 2005, as compared to 16.4% for the three months ended March 31, 2004. The increase in net income before minority interests was a result of the increase in operating income ($3.0 million) and a reduction in other (income) expenses, net of $0.2 million.

 

Minority interest

 

Minority interest expense decreased by $0.8 million, or 100.0%, to $1,000 for the three months ended March 31, 2005 as compared to $0.8 million for the three months ended March 31, 2004. This decrease is the result of our repurchase or redeemption the minority interest in four of our limited liability company subsidiaries including Comstock Investors V, L.C., Comstock Investors VI, L.C., Comstock Potomac Yard, L.C. and Comstock North Carolina, L.L.C.

 

Income taxes

 

On December 17, 2004, the Company reorganized from a group of S corporations to a C corporation. As a result, income tax expense increased $2.3 million for the three months ended March 31, 2005 as compared to no income tax expense for the three months ended March 31, 2004.  The Company’s combined effective tax rate both current and deferred provisions for this period was 38.0%.

 

Liquidity and Capital Resources

 

We require capital to post deposits on new deals, to purchase and develop land, to construct homes, to fund related carrying costs and overhead and to fund various advertising and marketing programs to facilitate sales. These expenditures include engineering, entitlement, architecture, site preparation, roads, water and sewer lines, impact fees and earthwork, as well as the construction costs of the homes and amenities. Our sources of capital include, and we anticipate will continue to include, funds derived from various secured and unsecured borrowings, operations which include the sale of constructed homes and finished lots, and the sale of equity securities. Our currently owned and controlled inventory of home sites will require substantial capital to develop and construct.

 

In production home building, it is common for builders such as us to employ revolving credit facilities whereby the maximum funding available under the facility exceeds the maximum outstanding balance allowed at any given time. Our overall borrowing capacity may be constrained by loan covenants which limit the ratio of our total liabilities to our total equity. This revolving debt will typically provide for funding of an amount up to a pre-determined percentage of the cost of each asset funded. The balance of the funding for that asset is provided for

 

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