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Item 7. Management’s Discussion and Analysis

2023-03-29 compared with 2022-03-31 · 84 added, 82 removed, 110 unchanged (60% of the section changed)

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We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.

We are a leading developer and manager of mixed-use and transit-oriented properties in the Washington, D.C.

metropolitan area.

As a vertically integrated and multi-faceted asset management and real estate services company, we have designed, developed, constructed, acquired, and managed thousands of residential units and millions of square feet of commercial and mixed-use properties in since 1985.

We provide a broad range of asset management and real estate services to our customers and partners, composed primarily of private and institutional owners, investors in commercial, residential, and mixed-use real estate, and various governmental bodies seeking to leverage the potential of public-private partnerships.

We have broad real estate development and management capabilities that enable us to generate fees for services provided in connection with the real estate assets we manage.

Our experienced team provides a full range of services related to acquisition, development, and operations of real estate assets.

Our revenue includes fees generated from asset management and real estate services that we provide to properties in our managed portfolio.

In addition, we invest capital both on our own account and on behalf of clients and institutional investors seeking above average risk-adjusted returns.

These strategic real estate investments tend to focus on office, retail, residential and mixed-use properties in which we generally retain an economic interest while also providing property management and other real estate services.

The services we provide pursuant to the asset management agreements covering our managed portfolio vary by property and client.

Substantially all the properties included in our managed portfolio are covered by long-term, full-service asset management agreements encompassing all aspects of design, development, construction, and operations management relating to the subject properties.

Anchoring our asset management services platform is a long-term full service asset management agreement with an affiliated company owned by the Comstock’s Chief Executive Officer, Christopher Clemente (the “2019 AMA”).

The 2019 AMA encompasses the majority of the properties we currently manage, including two of the largest transit-oriented, mixed-use developments in the Washington, D.C.

metropolitan area:

Reston Station and Loudoun Station, which along with other development properties under the 2019 AMA constitute our “Anchor Portfolio”.

As of December 31, 2021, our managed portfolio comprised 34 operating assets, including 14 commercial assets totaling approximately 2.2 million square feet, 6 multifamily assets totaling 1,636 units, and 14 commercial garages with over 11,000 parking spaces.

Additionally, we have:

(i) one commercial asset currently under-construction and scheduled for delivery in 2022 totaling approximately 250,000 square feet that is 100.0% pre-leased;

and (ii) 18 development pipeline assets consisting of approximately 2.0 million square feet of additional planned commercial development, approximately 1,900 multifamily units and 2 hotel assets that will include 460 keys.

Comstock is a leading real estate asset manager and developer of mixed-use and transit-oriented properties in the Washington, D.C.

Since 1985, we have acquired, developed, operated, and sold millions of square feet of residential, commercial, and mixed-use properties.

We benefit from our market-leading position in Northern Virginia's Dulles Corridor, one of the nation’s fastest growing real estate markets that is undergoing an urban transformation thanks to the recently completed construction of a Metro commuter rail connecting Dulles International Airport and the surrounding areas to Washington, D.C.

Our fee-based, asset-light, and substantially debt-free business model allows us to mitigate many of the risks that are typically associated with real estate development.

We provide a broad suite of asset management, property management, development and construction management, and other real estate services to our asset-owning clients, composed primarily of institutional real estate investors, high net worth family offices, and governmental bodies with surplus real estate holdings.

Our primary focus is the continued growth of our managed portfolio;

however, the fundamental strength of our balance sheet permits us to also explore strategic investment opportunities, typically in the form of a minority capital co-investment in select stabilized assets that complement our existing portfolio.

Our asset management services platform is anchored by a long-term full-service asset management agreement with a Comstock affiliate (the "2022 AMA" - see below for additional details) that extends through 2035 and covers most of the properties we currently manage, including two of the largest transit-oriented, mixed-use developments in the Washington, D.C.

Reston Station and Loudoun Station.

As a vertically integrated real estate services company, we self-perform all property management activity through three wholly owned operational subsidiaries:

CHCI Commercial Management, LC (“CHCI Commercial”);

CHCI Residential Management, LC (“CHCI Residential”);

and ParkX Management, LC (“ParkX”).

All 41 properties included in our managed portfolio have entered into property management agreements with our operational subsidiaries that provide for market-rate fees related to our services, including 10 commercial parking garages owned by unaffiliated parties and managed by ParkX.

We aspire to be among the most admired real estate asset managers, operators, and developers by creating extraordinary places, providing exceptional experiences, and generating excellent results for all stakeholders.

Our commitment to this mission drives our ability to expand our managed portfolio of assets, grow revenue, and deliver value to our shareholders.

Recent Developments

CES Divestiture

On June 16, 2021, we made the strategic decision to pursue the sale of the operations of Comstock Environmental Services, LLC ("CES"), a subsidiary of Comstock, based on the continued growth and future prospects of the asset management business.

Accordingly, we have reflected CES as a discontinued operation in our consolidated statements of operations for all periods presented, and have also designated CES assets and liabilities as held for sale in our consolidated balance sheets.

Unless otherwise noted, all amounts and disclosures relate to our continuing operations.

For additional information, see Note 3 in the Notes to Consolidated Financial Statements.

On March 31, 2022, we completed the sale of CES to August Mack Environmental, Inc.

("August Mack") for approximately $1.4 million of total consideration, composed of $1.0 million in cash and $0.4 million held in escrow that is subject to net working capital and other adjustments, as set forth in the executed Asset Purchase Agreement with August Mack.

On March 31, 2022, we completed the sale of Comstock Environmental Services, LLC ("CES"), a wholly owned subsidiary, to August Mack Environmental, Inc.

("August Mack").

This strategic divestiture was based on the continued growth and future prospects of our asset management business.

Accordingly, we have reflected CES as a discontinued operation in our consolidated financial statements for all periods presented, and unless otherwise noted, all amounts and disclosures relate solely to our continuing operations.

(See Note 3 in the Notes to Consolidated Financial Statements for additional information)

Series C Preferred Stock Redemption and 2022 Asset Management Agreement

On June 13, 2022, we completed two separate significant transactions to further deleverage our balance sheet and enhance our long-term revenue outlook and growth potential.

The first one with CP Real Estate Services, LC (“CPRES”), an entity owned by Christopher Clemente, Comstock’s Chief Executive Officer, redeemed all outstanding Series C preferred stock at a significant discount to carrying value.

Secondly, we executed a new asset management agreement with Comstock Partners, LC ("CP"), an entity controlled by Mr.

Clemente and wholly owned by Mr.

Clemente and certain family members, which covers our Anchor Portfolio of assets (the "2022 AMA").

The 2022 AMA increased the base fees we collect, expanded the services that qualify for additional supplemental fees, extended the term through 2035, and most notably introduced a mark-to-market incentive fee based

on the imputed profit of Anchor Portfolio assets, generally as each is stabilized and as further specified in the agreement.

(See Notes 10 and 14 in the Notes to Consolidated Financial Statements for additional information)

COVID-19 Update

The COVID-19 pandemic 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.

The extent to which the COVID-19 pandemic affects our financial results will depend on future developments, which are highly uncertain and cannot be predicted.

While we have not experienced a significant impact on our business resulting from COVID-19 to date, future developments may have a negative impact on our results of operations and financial condition.

We continue to monitor the ongoing impact of the COVID-19 pandemic, including the effects of recent notable variants of the virus.

The impact of the COVID-19 pandemic has caused uncertainty and business disruptions to both the real estate market in the greater Washington, D.C.

region and the U.S.

economy as a whole.

While we have not experienced a significant impact on our business resulting from COVID-19 to date, the extent to which it will impact our financial results will depend on future developments, which cannot be predicted.

We continue to monitor the ongoing impact of the COVID-19 pandemic, including the potential effects of notable variants of the COVID-19 virus.

The health and safety of our employees, customers, and the communities in which we operate remains our top priority.

Although the long-term impact of the COVID-19 pandemic on the commercial real estate market in the greater Washington, D.C.

area remains uncertain, we believe that our Anchor Portfolio is well positioned to withstand any future potential negative impacts of the COVID-19 pandemic.

Our management team is committed to executing on the Company's goal to provide exceptional experiences to those we do business with while maximizing shareholder value.

We believe that we are properly staffed for current market conditions and the foreseeable future and that our Company has the ability to manage risk and pursue opportunities for additional growth as market conditions warrant.

Our real estate development and management operations are primarily focused on the greater Washington, D.C.

area, where we believe our 30-plus years of experience provides us the best opportunity to continue leveraging our significant experience acquiring, developing, and managing high quality real estate assets and capitalizing on positive growth trends.

Although the long-term impact of the COVID-19 pandemic remains uncertain, we believe that our business model is well-positioned to withstand any future potential negative impacts from the pandemic.

Our management team is committed to executing on the Company's mission to create extraordinary places for people to live, work, and play.

We believe that we are properly staffed for current market conditions and have the ability to manage risk while pursuing opportunities for additional growth as opportunities arise.

Our real estate asset and property management operations are primarily focused on the greater Washington, D.C.

area, where we have operated, developed, and acquired high-quality assets for nearly 40 years, providing us with the leverage needed to capitalize on the region's numerous positive growth trends.

Results of Operations

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Interest expense (222) (235)

Gain (loss) on equity method investments (14) (160)

Gain (loss) on real estate ventures 121 (14)

Other income 2 6

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Net income (loss) $ 7,347 $ 13,609

Comparison of the Years Ended December 31, 2021 and December 31, 2020

Impact of Series C preferred stock redemption 2,046 —

Net income (loss) attributable to common stockholders $ 9,393 $ 13,609

Comparison of the Years Ended December 31, 2022 and 2021

The following table summarizes revenue by line of business (in thousands):

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2022 2021 Change

Net Sales % Net Sales % $ %

Amount % Amount % $ %

Asset management $ 26,680 67.9 % $ 22,539 72.5 % $ 4,141 18.4 %

Property management 9,398 23.9 % 6,939 22.3 % 2,459 35.4 %

Parking 1,615 5.2 % 1,020 4.5 % 595 58.3 %

Parking management 3,235 8.2 % 1,615 5.2 % 1,620 100.3 %

Total revenue $ 39,313 100.0 % $ 31,093 100.0 % $ 8,220 26.4 %

Revenue increased 26.4% in 2022.

The $8.6 million comparative increase was primarily due to a $3.0 million increase in base asset management fees, driven partially by the $1.4 million impact of the PPP Loan we received in 2020 that reduced the prior year reimbursable cost base.

In addition, in 2021 there was a $2.6 million increase in loan origination fees earned and a $1.4 million increase in revenue stemming from reimbursed payroll costs.

The increases in property management and parking revenue stem from seven additional managed commercial and residential properties and parking facilities in 2021.

The $8.2 million comparative increase was primarily driven by a $3.9 million increase in incentive fees, which were earned pursuant to the terms of the 2022 AMA.

Also contributing to the increase was the growth and improved performance of our managed portfolio, which included additional properties in 2022 and produced $2.2 million of additional asset management fees, $0.6 million of additional property management fees, a $1.3 million increase in recorded leasing fees, and a $2.8 million increase in reimbursable staffing charges.

These increases were partially offset by a $3.1 million decrease in loan origination fees, primarily related to the 2021 refinancing of the Reston Station office portfolio.

Operating costs and expenses

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Operating costs and expenses increased 20.5% in 2022.

The $6.2 million comparative increase was primarily due a $3.9 million increase in payroll costs, driven partially by the $1.5 million impact of the PPP Loan received in 2020 that reduced the prior year balance.

Also contributing to the increase was a $0.9 million increase in co-broker fees incurred in 2021 due to increased capital markets activity, as well as a $0.5 million increase in rent expense due to a rate increase at our corporate headquarters location.

The $5.3 million comparative increase was primarily due to a $5.4 million increase in personnel expenses stemming from increased headcount and employee compensation increases (including bonus expense), partially offset by a $0.9 million decrease in co-broker expenses stemming from the 2021 Reston Station refinancing transaction.

Other income (expense)

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Interest expense $ (222) $ (235) $ 13 (5.5) %

Gain (loss) on equity method investments (14) (160) 146 (91.3) %

Gain (loss) on real estate ventures 121 (14) 135 N/M

Other income 2 6 (4) (66.7) %

Total other income (expense) $ (99) $ (243) $ 144 (59.3) %

Other income (expense) decreased 50.2% in 2021.

The $0.2 million comparative decrease was primarily due to a $0.1 million decrease in interest expense as a result of replacing a higher interest rate loan with a lower interest credit facility, as well as $0.1 million net decrease in losses on equity method investments.

Benefit from income taxes was $11.2 million in 2021, compared to an immaterial expense in 2020.

The significant benefit in 2021 was primarily due to the partial $11.3 million release of a deferred tax asset valuation allowance in the second quarter.

This recognized tax benefit was derived from our ability to consistently deliver positive net income from continuing operations over the past 3 years and our expectation that current operations will continue to generate future taxable income.

Other income (expense) changed by $0.1 million in 2022, primarily driven by primarily driven by higher mark-to-market valuations of the fixed-rate debt associated with our equity method investments in the current period, as well as gains on the performance of our title insurance joint venture with Superior Title Services, Inc., driven by higher volume as compared to the prior period.

Provision for from income tax was $0.1 million in 2022, compared to a tax benefit of $11.2 million in 2021.

The significant benefit in 2021 was primarily due to the partial $11.3 million release of a deferred tax asset valuation allowance, which was derived from our ability to consistently deliver positive net income from continuing operations and our expectation that we will continue to generate future taxable income.

As of December 31, 2022, we had $131.7 million of net operating loss (“NOL") carryforwards.

Non-GAAP Financial Measures

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Net income (loss) from continuing operations $ 7,728 $ 16,039

Interest expense, net 235 344

Interest expense 222 235

Income taxes 125 (11,217)

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Stock-based compensation 834 633

Gain (loss) on equity method investments 14 160

(Gain) loss on real estate ventures (121) 14

Adjusted EBITDA $ 8,994 $ 5,798

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We have historically financed our operations with internally generated funds and borrowings from our credit facilities.

For further information on our debt and credit facilities, see Note 7 in the Notes to Consolidated Financial Statements.

For additional information, see Note 7 in the Notes to Consolidated Financial Statements.

We believe we currently have adequate liquidity and availability of capital to fund our present operations and meet our commitments on our existing debt.

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 2021 or 2020, and as of December 31, 2021 there are 404,000 shares of our Class A common stock that remain available for repurchase.

The following table summarizes our cash flows for the periods indicated (in thousands):

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Operating Activities

Net cash provided by operating activities increased by $5.1 million in 2021, primarily driven by a $2.8 million incremental cash inflow stemming from changes to our net working capital, including decreased accounts receivable and increased accrued personnel costs.

In addition, there was a $2.3 million increase in net income from continuing operations after adjustments for non-cash items that contributed to the comparative increase.

Net cash provided by operating activities decreased by $0.3 million in 2022, primarily driven by a $3.6 million incremental cash outflow stemming from changes to our net working capital, including increased accounts receivable, partially offset by a $3.3 million increase in net income from continuing operations after adjustments for non-cash items that contributed to the comparative increase.

Investing Activities

Net cash provided by investing activities decreased by $0.4 million in 2021, primarily driven by our $2.0 million real estate investment in BLVD Forty Four, partially offset by a $1.7 million increase in distributions from investments in real estate ventures.

Net cash provided by (used in) investing activities decreased by $3.4 million in 2022, primarily driven by primarily driven by a $3.3 million decrease in distributions from real estate investments, a $0.4 million increase in fixed and intangible asset purchases, and a $0.7 million decrease in investments in real estate ventures, partially offset by $1.0 million in proceeds received from the CES divestiture.

Financing Activities

Net cash used in financing activities decreased by $0.1 million in 2021, primarily driven by a $0.2 million decrease in net loan activity, partially offset by a $0.1 million increase in tax payments related to the net share settlement of equity awards.

Net cash used in financing activities increased by $9.8 million in 2022, primarily driven a $4.0 million cash payment made in connection with the early redemption of our Series C preferred stock and a $5.5 million payment made to satisfy the outstanding balance of our credit facility.

Off-Balance Sheet Arrangements

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While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements, areas that are particularly significant include:

• Goodwill impairment

• Investments in real estate ventures at fair value

• Investments in real estate ventures

• Revenue - Incentive Fees

• Income taxes

Goodwill impairment

On an annual basis as of October 1, and at interim periods when circumstances require, we test the recoverability of our goodwill and intangible assets and review for indicators of impairment.

Examples of such indicators include a significant change in the business climate, increased competition, loss of key personnel, significant or unusual changes in market capitalization, negative or declining cash flows, or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.

We perform impairment assessments at the reporting unit level, which is defined as an operating segment or one level below an operating segment, also known as a component.

Given that our goodwill balance on our consolidated balance sheets relates entirely to our Comstock Environmental Services ("CES") line of business, we perform our assessments on that single reporting unit.

To test for the recoverability of goodwill, we first perform a qualitative assessment based on economic, industry and company-specific factors the reporting unit to determine whether the existence of events and circumstances indicates that it is more likely than not that the goodwill is impaired.

Based on the results of the qualitative assessment, two additional steps in the impairment assessment may be required.

The first step would require a comparison of the reporting unit’s fair value to the respective carrying value.

If the carrying value exceeds the fair value, a second step is performed to measure the amount of impairment loss on a relative fair value basis, if any.

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.

As part of our annual goodwill assessment, we determined that there were potential indicators of impairment based on facts and circumstances that have arisen surrounding the divestiture of CES (see " Recent Developments" section above).

Upon performing the quantitative two-step impairment test, we determined that the carrying value of CES significantly exceeded its current fair value, which was estimated using Level 1 inputs.

As a result, we recorded a $1.4 million impairment loss in the fourth quarter 2021 to fully write off the remaining goodwill balance.

This impairment loss, along with the $0.3 million goodwill impairment loss recorded in our fiscal second quarter, resulted in a cumulative $1.7 million goodwill impairment charge in 2021 that is reflected in net income (loss) from discontinued operations in our consolidated statements of operations.

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 contributions, distributions, and the difference between the fair value of the investment and the carrying value as of the balance sheet date.

Investments in real estate ventures

For investments in real estate ventures that we have elected to report at fair value, we maintain an investment account that is increased or decreased each reporting period by contributions, distributions, and 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 in our consolidated statements of operations.

The fair value of these investments as of the balance sheet date is generally determined using a discounted cash flow analysis, income approach, or sales-comparable approach, depending on the unique characteristics of the real estate venture.

In addition, we perform a two-step analysis to determine if our investments in real estate ventures qualify as a variable interest entity (“VIE”) and need to be consolidated.

We first analyze if the entity lacks sufficient equity to finance its activities without additional subordinated financial support or if the equity holders, as a group, lack the characteristics of a controlling financial interest in order to determine VIE qualification.

If an entity is determined to be a VIE, we then analyze if it is the primary beneficiary to determine if the entity needs to be included in its consolidated financial results.

The primary beneficiary has both (i) the power to direct the activities that most significantly impact the VIE’s economic performance, and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the entity.

We consider a variety of factors in identifying the entity that holds the power to direct matters that most significantly impact the VIE’s economic performance, including evaluating the nature of relationships and activities of the parties involved and, where necessary, determining which party within a related-party group is most closely associated with the VIE and would therefore be considered the primary beneficiary.

We determine primary beneficiary status of a VIE at the time of investment and perform ongoing

reassessments to evaluate whether changes in the entity’s capital structure or changes in the nature of its involvement with the entity result in a change to the VIE designation or a change to its consolidation conclusion.

We have minority voting and economic interests in our investments in real estate ventures and do not control the activities that most significantly impact the economic performance.

We have determined we are not the primary beneficiary for any of our investments in real estate ventures and therefore do not include them in our consolidated balance sheets as of December 31, 2022 and 2021.

Revenue - Incentive Fees

Pursuant to the 2022 AMA, we are entitled to earn incentive compensation fees revenue ("Incentive Fees") on certain managed real estate assets if defined triggering events, which are differentiated based on the classification of the assets, are achieved.

(See Note 14 for additional information).

Incentive Fees are calculated as a percentage of the imputed profit that would be realized upon the hypothetical sale or recapitalization of the asset (or assets) for which triggering event criteria were met.

The calculation of imputed profit is based on a fair market value assessment that includes highly variable financial inputs and must also consider macro-economic and environmental factors that may affect fair market value.

Due to the subjective and potentially volatile nature of this variable consideration, we only recognize revenue on Incentive Fees for each managed asset when 1) any material uncertainties associated with the valuation of real estate assets that drive Incentive Fees are substantially resolved and 2) it is probable that a significant reversal in the amount of related cumulative Incentive Fee revenue recognized will not occur.

As a result, we have only recognized Incentive Fees at or near each asset's respective triggering event (as detailed in the 2022 AMA) when imputed profit could be reasonably calculated and relied upon to not materially change.

For the year ended December 31, 2022, we recognized revenue from Incentive Fees of $3.9 million, stemming from an operating asset triggering event on October 1, 2022 that is the first in series of annual operating asset triggering events that are scheduled each October 1 through 2024.

Income taxes are accounted for under the asset and liability method.

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Adjustments to the valuation allowance are a component of the income tax provision or benefit in our consolidated statements of operations.

In June 2021, based on our recent financial performance and current forecasts of future operating results, we determined that it was more likely than not that a portion of the deferred tax assets related to our net operating loss ("NOL") carryforwards would be utilized in future periods.

As a result, we recorded an $11.3 million income tax benefit in the second quarter of 2021 that represented a partial release of our valuation allowance.

For the years ended December 31, 2022 and 2021, we recorded net decreases to our deferred tax valuation allowance of $1.4 million and $13.0 million, respectively.

Quantitative and Qualitative Disclosures About Market Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis