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CHCI > SEC Filings for CHCI > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for COMSTOCK HOLDING COMPANIES, INC.

Form 10-K for COMSTOCK HOLDING COMPANIES, INC.


31-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Please see "Cautionary Notes Regarding Forward-looking Statements" for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including, but not limited to, those discussed below and elsewhere in this Annual Report on Form 10-K, particularly under the headings "Risk Factors" and "Cautionary Notes Regarding Forward-looking Statements."

Overview

The underlying trends in U.S. housing point toward an ongoing multi-year recovery supported by favorable demographics, an improving economy, mortgage interest rates near historic lows, and limited supplies of new and existing home inventories. Our results in 2013 showed significant improvement in the majority of our key operating metrics compared to 2012, driven by the introduction of new home inventory and development activities, as compared to the fully developed, available for sale legacy inventories settled in 2012. Sales trends in the first six months of 2013 were stronger than the last six months of the year. During the first half of 2013, the homebuilding market experienced favorable sales and pricing trends compared to 2012, driven by historically low mortgage interest rates and rising costs in the rental market which contributed to higher levels of housing affordability in the Washington, D.C. market. Sales trends in the second half of 2013 were strong compared to 2012, though negatively impacted by increasing mortgage interest rates, higher home prices and buyer uncertainty. The housing market also continues to face challenges from tight mortgage underwriting standards. While we have benefited from generally improved market conditions, we continue to face gross margin pressure due to increasing land acquisition, land development and home construction costs.

Home closings, revenues, average selling price, gross margin, overhead leverage, and net income from continuing operations all improved in 2013 compared to 2012. Our settlements for the year ended December 31, 2013 totaled 107 units, compared to 45 units in 2012, which represents an increase of 138%. Our consolidated homebuilding revenues for the year ended December 31, 2013 totaled $53.8 million, an increase of 363% from $11.6 million in 2012. Our net new orders increased by 147% in 2013 compared to 2012. An increase in the number of active communities with units available for sale contributed to the increase in net new orders as compared to 2012. The higher active community count resulted from our more disciplined land investment strategy and capital raising initiatives. We intend to continue to calibrate sales pace in each community to improve our gross margins and maximize returns on invested capital. We expect that this approach will continue to result in an expansion in our net new order volume in 2014, as compared to 2013. While we believe higher mortgage interest rates are inevitable and may have a moderating effect on demand and pricing, we believe this impact will be outweighed in the long-term by other factors driving increased sales volume as overall new home sales in the Washington, D.C. market remain low compared with historical levels.

The significant improvements reported for 2013, coupled with our successful capital raising initiatives, allowed us to continue to enhance our financial position. Unrestricted cash at December 31, 2013 totaled $11.9 million, an increase of $8.4 million from $3.5 million at December 31, 2012. Our improved financial position provided us additional flexibility to increase our pipeline and reduce our secured loan-to-inventory ratio to 57% at December 31, 2013, as compared to 70% at December 31, 2012.

In the short-term, we will continue to focus on maximizing our operating margins to enhance our balance sheet, despite the possibility of rising house cost pressures from increasing material prices and labor shortages, by using our existing land assets more effectively, allocating capital more effectively, and aggressively controlling unsold "spec" inventory. We believe we have positioned ourselves to deliver improved long-term returns. In planning for the longer term, we continue to maintain confidence that we are likely in the early stages of a broad, sustainable recovery in the U.S. new home market. While the U.S. macroeconomic environment continues to face challenges, we are continuing to pursue strategic land positions that meet our underwriting requirements in well-positioned locations and believe that sustained execution of our strategy will allow us to continue to improve our financial position and improve our returns on invested capital over the housing cycle.

Recent Developments

Comstock Maxwell Square, L.C.

On September 30, 2013, the Company, through its subsidiary Comstock Maxwell Square, L.C. the borrower, closed on its forty-five unit townhome condominium project located in downtown Frederick, Maryland (the "Townes at Maxwell Square"). In connection with the closing of the Townes at Maxwell Square, the borrower entered into a loan agreement and related documents with EagleBank pursuant to which the borrower secured (i) a $2.1 million acquisition and development loan, (ii) a $3.4 million revolving construction loan and (iii) a $51 letter of credit facility (collectively, the "Eagle Maxwell Loans") to finance the development of the Townes at Maxwell Square. The Eagle Maxwell Loans provide for a variable interest rate of LIBOR plus 3%, subject to a minimum floor of 4.75%. The Eagle Maxwell Loans have a maturity date of 24 months, subject to meeting a minimum sales and settlement schedule on a quarterly basis. There is no prepayment penalty associated with the Eagle Maxwell Loans, which are secured by a first deed of trust on the Townes at Maxwell Square and fully guaranteed by the Company.


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Comstock Investors VIII, L.C.

In December 2013, Comstock Investors VIII, L.C. ("Comstock VIII"), a subsidiary of the Company, entered into subscription agreements with certain accredited investors (the "Comstock VIII Class B Members"), pursuant to which the Comstock VIII Class B Members purchased membership interests in Comstock VIII for an aggregate amount of $4.0 million (the "Comstock VIII Private Placement"). In connection with the Comstock VIII Private Placement, the Company issued 102 warrants for the purchase of shares of the Company's Class A common stock to the non-affiliated accredited investors, who participated in the Comstock VIII Private Placement, having an aggregate fair value of $132. The Comstock VIII Class B Members included unrelated third-party accredited investors along with members of the Company's board of directors and the Company's Chief Operating Officer and the Chief Financial Officer. The Comstock VIII Class B Members are entitled to a cumulative, preferred return of 20% per annum, compounded annually on their capital account balances. The Company has the right to repurchase the interests of the Comstock VIII Class B Members at any time, provided that
(i) all of the Comstock VIII Class B Members' interests are acquired, (ii) the purchase is made in cash and (iii) the purchase price equals the Comstock VIII Class B Members' capital accounts plus an amount necessary to cause the preferred return to equal a cumulative cash on cash return equal to 20% per annum. The Comstock VIII Private Placement provides capital related to the current and planned construction of the following projects: The Townes at HallCrest in Sterling, Virginia, consisting of 42 townhomes and the Townes at Maxwell Square in Frederick, Maryland consisting of 45 townhome condominium units (collectively, the "Investor VIII Projects"). Proceeds of the Comstock VIII Private Placement are to be utilized (A) to provide capital needed to complete the Investor VIII Projects in conjunction with project financing for the Investor VIII Projects, (B) to reimburse the Company for prior expenditures incurred on behalf of the Investor VIII Projects, and (C) for general corporate purposes of the Company. No distributions were paid to the Comstock VIII Class B Members in 2013.

Comstock Hall Road, L.C.

On December 30, 2013, the Company, through its subsidiary Comstock Hall Road, L.C., the borrower, entered into a loan agreement and related documents with Cardinal Bank pursuant to which the borrower secured a $3.7 million acquisition and development loan, a $3.5 million revolving construction loan and a $2.0 million letter of credit facility (collectively, the "Hall Cardinal Loan") to finance the development of the Townes at Hallcrest project located in Loudoun County, Virginia (the "Townes at Hallcrest"). The Hall Cardinal Loan provides for an initial variable interest rate of prime plus 0.5%, subject to an interest rate floor of 4.5%, payable monthly to the extent not offset by a $250 interest reserve initially set aside for the benefit of the borrower. The Hall Cardinal Loan has a maturity date of 24 months, so long as the borrower obtains three sales and settlements within the 12 month period following the closing of the Hall Cardinal Loan. There is no prepayment penalty associated with the Hall Cardinal Loan, which is secured by a first deed of trust on the Townes at Hallcrest. The Loan is fully guaranteed by the Company and by a limited guaranty from Messrs. Christopher Clemente and Gregory Benson, the Chief Executive Officer and Chief Operating Officer of the Company, respectively. Messrs. Clemente and Benson have initially agreed not to charge a credit enhancement fee for the Hall Cardinal Loan as permitted by that certain Credit Enhancement and Indemnification Agreement previously entered into by and among the Company and Messrs. Clemente and Benson.

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, "Disclosures about Offsetting Assets and Liabilities," which requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. In January 2013, this guidance was amended by ASU 2013-01, "Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities," which limits the scope of ASU 2011-11 to certain derivatives, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions. The guidance is effective for fiscal years beginning on or after January 1, 2013 and interim periods within those annual periods. The adoption of this guidance, which is related to disclosure only, did not have a material impact on our disclosures in the notes to the consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a similar Tax Loss, or a Tax Credit Carryforward Exists". ASU 2013-11 which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward with certain defined exceptions. ASU 2013-11 is intended to end inconsistent practices regarding the presentation of a unrecognized tax benefits when a net operating loss (NOL), a similar tax loss or a tax credit carryforward is available to reduce the taxable income or tax payable that would result from the disallowance of a tax position. We adopted this guidance during fiscal year 2013. The adoption of ASU 2013-11 did not have a material impact on our consolidated financial statements.


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In April 2013, the FASB issued ASU 2013-04, "Liabilities", ("ASU 2013-04"). ASU 2013-04 provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. ASU 2013-04 will be effective for our fiscal year beginning January 1, 2014 and subsequent interim periods. The adoption of ASU 2013-04 is not expected to have a material effect on our consolidated financial statements.

Other accounting pronouncements issued or effective during the year ended December 31, 2013 are not applicable to us and are not anticipated to have an effect on our consolidated financial statements.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States ("GAAP"), which require us to make certain estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates, including those related to the consolidation of variable interest entities, revenue recognition, impairment of real estate inventories, warranty reserve and our environmental liability exposure. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates.

A summary of significant accounting policies is provided in Note 2 in the accompanying consolidated financial statements. The following section is a summary of certain aspects of those accounting policies that require the most difficult, subjective or complex judgments and estimates.

Real estate inventories

Real estate inventories include land, land development costs, construction and other costs. Real estate held for development and use is stated at cost, or when circumstances or events indicate that the real estate is impaired, at estimated fair value. Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Land, land development and indirect land development costs are accumulated by specific project and allocated to various units within that project using specific identification and allocation based upon the relative sales value method. Direct construction costs are assigned to units based on specific identification, when practical, or based upon the relative sales value method. Construction costs primarily include direct construction costs and capitalized field overhead. Other costs are comprised of fees, capitalized interest and real estate taxes. Costs incurred to sell real estate are capitalized to the extent they are reasonably expected to be recovered from the sale of the project and are tangible assets or services performed to obtain regulatory approval of sales. Other selling costs are expensed as incurred.

For assets held for development and use, a write-down to estimated fair value is recorded when the net carrying value of the property exceeds its estimated undiscounted future cash flows. Estimated fair value is based on comparable sales of real estate in the normal course of business under existing and anticipated market conditions. These evaluations are made on a property-by-property basis whenever events or changes in circumstances indicate that the net book value may not be recoverable.

If the project is considered held for sale, it is valued at the lower of cost or fair value less estimated selling costs. The evaluation takes into consideration the current status of the property, various restrictions, carrying costs, costs of disposition and any other circumstances that may affect fair value including management's plans for the property. As of December 31, 2012, the Company classified its Eclipse and Penderbrook projects as held for sale and accordingly, carried the projects at fair value less costs to sell as determined by discounted cash flow models, by reference to comparable market transactions, or relevant purchase offers. Discounted cash flow models are dependent upon several subjective factors, including estimated average sales prices, estimated sales pace, and the selection of an appropriate discount rate. The estimates of sales prices, sales pace and discount rates used by the Company were based on the best information available at the time the estimates were made. The Company did not have any development projects considered to be held for sale at December 31, 2013.


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Warranty reserve

Warranty reserves for units settled are established to cover potential costs for materials and labor with regard to warranty-type claims expected to arise during the typical one-year warranty period provided by the Company or within the two-year statutorily mandated structural warranty period for condominiums. Because the Company typically 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. This reserve is an estimate and actual warranty costs could vary from these estimates.

Revenue recognition

We recognize revenues and related profits or losses from the sale of residential properties and units, finished lots and land sales when closing has occurred, full payment has been received, title and possession of the property has transferred to the buyer and we have no significant continuing involvement in the property. Other revenues include revenue from land sales, rental revenue from leased multi-family units, which is recognized ratably over the terms of the respective leases, and revenue earned from management and administrative support services provided to related parties, which is recognized as the services are provided.

Equity-based compensation

Compensation costs related to our equity-based compensation plans are recognized within our income statement, or capitalized to real estate inventories for awards issued to employees that are involved in production. The costs recognized are based on the grant-date fair value. Compensation costs for share-based grants are recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant).

The fair value of each option award is calculated on the date of grant using the Black-Scholes option pricing model and certain subjective assumptions. Expected volatilities are calculated based on our historical trading activities. We estimate forfeitures using a weighted average historical forfeiture rate. Our estimates of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from their estimate. The risk-free rate for the periods is based on the U.S. Treasury rates in effect at the time of grant. The expected term of options is based on the simplified method which assumes that the option will be exercised midway between the vesting date and the contractual term of the option. The Company is able to use the simplified method as the options qualify as "plain vanilla" options as defined by ASC 718 - Stock Compensation.

Income taxes

Income taxes are accounted for under the asset and liability method in accordance with ASC 740, "Accounting for Income Taxes". Deferred tax assets and liabilities are recognized for 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 of a change in tax rates on the deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

Use of estimates

The preparation of the financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates are utilized in the valuation of real estate inventories, valuation of deferred tax assets, valuation of equity-based compensation, capitalization of costs, consolidation of variable interest entities and warranty reserves.


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Results of Operations

Year ended December 31, 2013 compared to year ended December 31, 2012

Orders, backlog and cancellations

                                           Twelve Months Ended December 31,
                                              2013                  2012
       Gross new orders                              147                    57
       Cancellations                                  21                     6
       Net new orders                                126                    51
       Gross new order revenue           $        70,283       $        18,894
       Cancellation revenue              $         9,554       $         2,465
       Net new order revenue             $        60,728       $        16,429
       Average gross new order price     $           478       $           332
       Settlements                                   107                    45
       Settlement revenue-homebuilding   $        53,806       $        11,633
       Average settlement price          $           503       $           259
       Backlog units                                  28                     9
       Backlog revenue                   $        12,343       $         5,421
       Average backlog price             $           441       $           602

Revenue - homebuilding

The number of units delivered for the year ended December 31, 2013 increased by 62 to 107 as compared to 45 units for the year ended December 31, 2012. Average revenue per unit delivered increased by approximately $244 to $503 for the year ended December 31, 2013 as compared to $259 for the year ended December 31, 2012. Revenue from homebuilding increased by $42.2 million to $53.8 million for the year ended December 31, 2013 as compared to $11.6 million for the year ended December 31, 2012. For the year ended December 31, 2013, the Company settled 107 units (33 units at The Hampshires, 53 units at Eastgate, 2 units at Penderbrook and 19 units at Eclipse), as compared to 45 units (37 units at Penderbrook and 8 units at Eclipse) for the year ended December 31, 2012. In addition, our homebuilding gross margin percentage for the year ended December 31, 2013 increased by 6.0% to 22.7%, as compared to 16.7% for the year ended December 31, 2012. The increase noted in revenue, average sales price and margins was a result of the increase in the number of homes settled, mix of units settled and the Company exiting impaired legacy projects. Excluding the impact of the release of the warranty reserve discussed in Note 2 in the accompanying consolidated financial statements, gross margin percentage was 21.9% for the year ended December 31, 2013.

Revenue - other

Revenue - other decreased approximately $1.9 million to $0.8 million during the year ended December 31, 2013, as compared to $2.7 million for the year ended December 31, 2012. The decrease primarily relates to revenue from rental operations, as the number of rental units at Penderbrook and Eclipse continued to decline until all units were sold in the second quarter of 2013. The completion of several of the general contracting projects in 2012 also contributed to the decline.

We consider revenue to be from homebuilding when there is a structure built or being built on the lot when delivered. Sales of lots occur, and are included in other revenues, when we sell raw land or finished home sites in advance of any home construction.

Cost of sales - homebuilding

Cost of sales - homebuilding for the year ended December 31, 2013 increased by $31.9 million, to $41.6 million as compared to $9.7 million for the year ended December 31, 2012. The number of units settled and mix of homes settled during the year ended December 31, 2013 accounted for the increase in cost of sales.

Cost of sales - other

Cost of sales - other decreased approximately $2.7 million to $0.8 million during the year ended December 31, 2013 as compared to $3.5 million for the year ended December 31, 2012. As a result of the continued absorption and sale of the condominium units at Penderbrook and Eclipse, the decline in the number of units used in rental operations resulted in a significant decrease in cost of sales - other. Additionally, the completion of several general contracting projects in 2012 also contributed to the decline.

Impairment charges and write-offs

We evaluate all of our projects to the extent of the existence of any impairment indicators requiring evaluation to determine if recorded carrying amounts were recoverable by evaluating discount rates, sales prices, absorption and our analysis of the best approach to marketing our projects for sale. Based on this evaluation, we recorded an impairment charge of $2.4 million during the year ended December 31, 2012, to properly record our for sale project at fair market value less costs to sell based on the then current bulk sale strategy consistent with the provisions of ASC 360.


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Due to a change to an individual unit retail sale model from our previous bulk sale disposition strategy, we reversed a previously recorded impairment charge of $0.7 million during the year ended December 31, 2013. Additionally, during 2013, we wrote-off $1.1 million in due diligence and entitlement pursuit costs related to the BLVD Newell project, which was controlled under a land purchase option contract. The write-off occurred in December 2013 due to the Company's unsuccessful attempt to obtain entitlement approvals. See real estate inventories in Note 4 in the accompanying consolidated financial statements for further discussion and the basis for determining the impairment charges, reversals and write-offs.

Sales and marketing expenses

Sales and marketing expenses for the year ended December 31, 2013 increased by $1.4 million to $2.0 million, as compared to $0.6 million for the year ended December 31, 2012. The increase in sales and marketing expenses over the prior year period is directly attributable to increases in active developments and marketing efforts, which resulted in an increase in homes ordered and delivered.

General and administrative expenses

General and administrative expenses for the year ended December 31, 2013 decreased by $1.3 million to $6.7 million, as compared to $8.0 million for the year ended December 31, 2012. The decrease in general and administrative expenses over the prior year is attributable to increased utilization of operations employees which increased capitalization to specific projects as a . . .

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