Item 7. Management’s Discussion and Analysis
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 contain forward-looking statements that involve risks and uncertainties. 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 heading “Cautionary Notes Regarding Forward-looking Statements.”
Overview
In early 2018, the Company transitioned its operating platform from being primarily focused on the development and sale of residential homes to our current fee-based services model focused on commercial and mixed-use real estate primarily in the greater Washington, D.C. region. We are a developer, operator, and asset manager of mixed-use and transit-oriented development properties in the greater Washington, D.C. metropolitan area where we primarily focus on select high-growth urban and transitioning “sub-urban” markets. We also provide additional fee-based real estate services, including corporate planning, capital markets, brokerage, title insurance, design, and environmental consulting and remediation services, to properties in the Company’s managed portfolio and to other clients in the U.S. Mid-Atlantic Region.
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is contained in Note 2 in the accompanying 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 (“VIEs”), revenue recognition and the fair value of equity method investments. 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.
Goodwill impairment
We test our goodwill for impairment on an annual basis, and more frequently when an event occurs, or circumstances indicate that the carrying value of the asset may not be recoverable. We believe the methodology that we use, including both a discounted cash flow model as well as a market multiple model, to review impairment of goodwill, which includes a significant amount of judgment and estimates, provides us with a reasonable basis to determine whether impairment has occurred.
Investments in real estate ventures at fair value
For investments in real estate ventures reported at fair value, we maintain an investment account that is increased or decreased each reporting period by the difference between the fair value of the investment and the carrying value as of the balance sheet date. These fair value adjustments are reflected as gains or losses on the Consolidated Statements of Operations. The fair value of these investments as of the balance sheet date is generally determined using a Discounted Cash Flow (“DCF”) analysis, income approach, or sales comparable approach, depending on the unique characteristics of the real estate venture.
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Revenue recognition
Revenues generated through real estate professional services such as asset and property management, administrative support, environmental design, engineering and remediation represent a series of daily performance obligations delivered over time due to the continuous transfer of control to our clients. For asset and property management, pricing is generally in the form of monthly management fees based on a cost-plus agreement, percentage of property-level cash receipts, square footage under management or some other variable metric recognized over time. For Real Estate Services, pricing is generally in the form of cost-plus contracts recognized over time.
Equity-based compensation
Compensation costs related to our equity-based compensation plans are recognized within our income statement or capitalized to real estate inventories reported in discontinued operations 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 which includes certain subjective assumptions. Expected volatilities are calculated based on our historical trading activities. We recognize forfeitures as they occur. 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 Company’s historical experience.
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. We provide a valuation allowance when we consider it “more likely than not” (greater than a 50% probability) that a deferred income tax asset will not be fully recovered. Adjustments to the valuation allowance are a component of the deferred income tax expense or benefit in the Consolidated Statement of Operations.
Results of Operations
Year ended December 31, 2020 compared to year ended December 31, 2019
Revenue – asset management
Revenue from asset management for the years ended December 31, 2020 and 2019 was $21.9 million and $19.6 million, respectively. The 11.8% year over year growth of $2.3 million in revenue was primarily due to increased headcount and other costs that are reimbursable from Comstock Development Services ("CDS") under the 2019 AMA and the other asset management agreements. The reimbursable costs are recognized as revenue in the period in which the related costs are incurred. The increased headcount and associated personnel costs are primarily attributable to the additional real estate assets being managed along with the additional management agreements year over year. Please see Note 2 - Summary of Significant Accounting Policies for more information on the additional management agreements.
Revenue – real estate services
Revenue from real estate services for the years ended December 31, 2020 and 2019 was $6.8 million and $5.7 million, respectively. The 19.1% increase of $1.1 million is primarily attributable to continued organic revenue growth within our Comstock Environmental business, partially offset by a decrease in closing financing transactions which generated incremental revenue of $0.6 million and $1.1 million during the years ended December 31, 2020 and 2019, respectively.
Direct costs – asset management
Direct costs – asset management for the years ended December 31, 2020 and 2019 was $18.4 million and $16.6 million, respectively. This 11.4% increase of $1.9 million was primarily related to increased personnel expense from headcount increases as well as from the continued growth of our asset management operations.
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Direct costs – real estate services
Direct costs – real estate services decreased by $0.5 million to $4.1 million during the year ended December 31, 2020, as compared to $4.6 million during the year ended December 31, 2019. The decrease is primarily due to the recognition of $419 thousand in direct costs related to the real estate services segment from the Paycheck Protection Program Loan ("PPP Loan") as a government grant. Please see Note 9 - CARES Act for more information on the PPP Loan and the Paycheck Protection Program ("PPP"). The grant was recognized during the covered period of the PPP Loan in the second quarter of 2020 as the related payroll costs were incurred, and the Company has complied with the forgiveness conditions attached to the PPP Loan.
General and administrative
General and administrative expenses for the year ended December 31, 2020 increased $1.5 million to $3.0 million, as compared to $1.5 million for the year ended December 31, 2019. The year-over-year increase is attributable to increases in employee headcount and general overhead increases associated with the increased headcount. General overhead costs include such items as software expense and non-capitalized computer expenses.
Sales and marketing
Sales and marketing expenses was $661.0 thousand and $383.0 thousand for the years ended December 31, 2020 and 2019, respectively. The increase is attributable to increased sales development programs launched by our Environmental business unit to grow the business. The increase in sale development costs has helped drive our 19.1%$1.1 million increase in real estate services revenue year over year.
Interest expense
For the years ended December 31, 2020 and 2019 non-capitalized interest expense was $379.0 thousand and $474.0 thousand, respectively. This was a decrease of 20.0%. The $95.0 thousand decrease was primarily related to the retiring of the Comstock Growth Fund loan in 2020 that carried a higher interest rate than the CDS Note, partially offset by the April 30, 2019 Master Transfer Agreement (“MTA”). Prior to the MTA certain interest expense was capitalized to homebuilding projects and expensed when the projects were sold. After the MTA this interest expense is no longer capitalized into homebuilding projects but expensed as incurred.
Income taxes
During the year ended December 31, 2020, the Company recognized an income tax expense related to continuing operations of $25.0 thousand. During the year ended December 31, 2019, the Company recognized an income tax expense related to continuing operations of $2.0 thousand. The de minimis income tax expense in both years is primarily attributable to state tax obligations which our federal and state NOLs cannot offset.
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Loss from discontinued operations
On April 30, 2019, the Company entered into the Master Transfer Agreement ("MTA") that sets forth certain transactions to complete the Company’s previously announced exit from the homebuilding and land development business in favor of a migration to an asset management model. Refer to Note 13 – Consolidation of Variable Interest Entities
for further discussion regarding the accounting related to discontinued operations. The operating results of the discontinued operations that are reflected on the Consolidated Statement of Operations within the net loss from discontinued operations are as follows:
Year Ended December 31, 2019
Revenues
Revenue—homebuilding
$ 14,919
Total revenue
14,919
Expenses
Cost of sales—homebuilding
14,901
Sales and marketing
270
General and administrative
21
Operating loss (273)
Income tax benefit (15)
Net loss from discontinued operations (258)
Net income attributable to non-controlling interests
313
Net loss attributable to Comstock Holding Companies, Inc. $ (571)
Liquidity and Capital Resources
We finance our Asset Management and Real Estate Services operations, capital expenditures, and business acquisitions with internally generated funds, borrowings from our credit facilities and long-term debt. Pursuant to the Master Transfer Agreement (the "MTA"), the Company transferred to CDS management of its Class A membership interests in Investors X, the entity owning the Company’s residual homebuilding operations in exchange for residual cash flows. The associated debt obligations were also transferred to CDS. See Note 8 in the accompanying consolidated financial statements for more details on our debt and credit facilities.
On March 19, 2020, the Company entered into a Revolving Capital Line of Credit Agreement (the “Loan Documents”) with CDS, pursuant to which the Company secured a $10.0 million capital line of credit (the “Revolver”). Under the terms of the Loan Documents, the Revolver provides for an initial variable interest rate of the WSJ Prime Rate plus 1.00% per annum on advances made under the Revolver, payable monthly in arrears. The five-year term facility allows for interim draws that carry a maturity date of 12 months from the initial date of the disbursement unless a longer initial term is agreed to by CDS. On March 27, 2020 the Company borrowed $5.5 million under the Revolver. The $5.5 million borrowing has a maturity date of April 30, 2023. On April 10, 2020, the capital provided to the Company by the Revolver was utilized to retire all of the Company’s 10% corporate indebtedness maturing in 2020 owed to Comstock Growth Fund, L.C.
On April 20, 2020, the Company was granted the PPP Loan in the aggregate amount of $1.95 million pursuant to the PPP under the CARES Act, which was enacted March 27, 2020. Under the terms of the PPP, PPP loans and accrued interest are forgivable after twenty-four weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the forgiveness period.
As of December 31, 2020, the Company had used the entire loan proceeds to fund its payroll and rent expenses. As a result, the Company believes that it has met the PPP eligibility criteria for forgiveness and has concluded that the loan represents, in substance, a government grant that is expected to be forgiven. As such, in accordance with IAS 20 “Accounting for Government Grants and Disclosure of Government Assistance”, the Company has recognized the entire loan amount as a reduction to the associated expenses as at December 31, 2020.
The Company does not anticipate taking any action that would cause any portion of the PPP Loan to be ineligible for forgiveness. However, to the extent that any amount is deemed unforgivable, such amount is payable over 2 to 5 years at an interest rate of 1%, with a deferral of payments for the first 6 months.
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Cash Flow
Net cash provided by operating activities was $3.4 million for the year ended December 31, 2020. The $3.4 million net cash provided by operations in 2020 was primarily due to $2.1 million of net income generated during the year. Net cash provided by operating activities was $8.4 million for the year ended December 31, 2019. The $8.4 million net cash provided by operations in 2019 was primarily due to $7.8 million in cash provided by discontinued operations.
Net cash used in investing activities was $1.7 million for the year ended December 31, 2020. This was primarily attributable to the purchase of fixed assets for the new headquarters lease. Net cash used in investing activities attributable to continuing operations was immaterial for the years ended December 31, 2019.
Net cash used in financing activities was $1.6 million for the year ended December 31, 2020. This was primarily attributable to the retirement of debt partially offset by proceeds under the Revolver of $5.5 million. Net cash used in financing activities was immaterial for the year ended December 31, 2019 . Net cash used in financing activities from discontinued operations was $6.0 million primarily as a result of note payoff related to each lot or unit sale in the Investors X communities.
Share Repurchase Program
In November 2014, our board of directors approved a new share repurchase program authorizing the Company to repurchase up to 429,000 shares of our Class A common stock in one or more open market or privately negotiated transactions. We made no share repurchases under our share repurchase program in 2020 or 2019.
Trends and Uncertainties
In December 2019, a novel strain of coronavirus (“COVID-19”) surfaced in Wuhan, China. Through March 2021, the spread of this virus has caused business disruption primarily in the travel, leisure and hospitality industries and with respect to companies that have significant operations or supply chains in China. The spread of COVID-19 has also caused significant volatility in U.S. and international debt and equity markets, which can negatively impact consumer confidence. There is significant uncertainty around the breadth and duration of business disruptions related to COVID-19, as well as its impact on the U.S. economy and consumer confidence. The extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain it or treat its impact. While we have not seen a significant impact on our business resulting from COVID-19 to date, if the virus continues to cause significant negative impacts to economic conditions or consumer confidence, our results of operations and financial condition could be adversely impacted.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
Reference is made to the Consolidated Financial Statements, the notes thereto, and the report thereon, commencing on page F-1 of this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.