Comstock Holding Companies, Inc. 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K. All references to “2022” and “2021” are referring to the twelve-month period ended December 31 for each of those respective fiscal years. This section of this Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. The following discussion may contain forward-looking statements that reflect our plans and expectations. Our actual results could differ materially from those anticipated by these forward-looking statements due to the factors discussed elsewhere in this Annual Report on Form 10-K. 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. Overview Comstock is a leading real estate asset manager and developer of mixed-use and transit-oriented properties in the Washington, D.C. region. 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. and beyond. 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. area: 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 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 9 Table of Contents 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 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 remains uncertain, we believe that our business model is well-positioned to withstand any future potential negative impacts from the pandemic. Outlook 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. 10 Table of Contents Results of Operations The following tables set forth consolidated statement of operations data for the periods presented (in thousands): Year Ended December 31, 2022 2021 Revenue $ 39,313 $ 31,093 Operating costs and expenses: Cost of revenue 29,371 24,649 Selling, general, and administrative 1,784 1,285 Depreciation and amortization 206 94 Total operating costs and expenses 31,361 26,028 Income (loss) from operations 7,952 5,065 Other income (expense): Interest expense (222) (235) Gain (loss) on real estate ventures 121 (14) Other income 2 6 Income (loss) from continuing operations before income tax 7,853 4,822 Provision for (benefit from) income tax 125 (11,217) Net income (loss) from continuing operations 7,728 16,039 Net income (loss) from discontinued operations, net of tax (381) (2,430) Net income (loss) $ 7,347 $ 13,609 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 Revenue The following table summarizes revenue by line of business (in thousands): Year Ended December 31, 2022 2021 Change 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 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 $8.2 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. 11 Table of Contents Operating costs and expenses The following table summarizes operating costs and expenses (in thousands): Year Ended December 31, Change 2022 2021 $ % Cost of revenue $ 29,371 $ 24,649 $ 4,722 19.2 % Selling, general, and administrative 1,784 1,285 499 38.8 % Depreciation and amortization 206 94 112 119.1 % Total operating costs and expenses $ 31,361 $ 26,028 $ 5,333 20.5 % Operating costs and expenses increased 20.5% in 2022. 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) The following table summarizes other income (expense) (in thousands): Year Ended December 31, Change 2022 2021 $ % Interest expense $ (222) $ (235) $ 13 (5.5) % 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) 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. Income taxes 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 To provide investors with additional information regarding our financial results, we prepare certain financial measures that are not calculated in accordance with generally accepted accounting principles in the United States (“GAAP”), specifically Adjusted EBITDA. We define Adjusted EBITDA as net income (loss) from continuing operations, excluding the impact of interest expense (net of interest income), income taxes, depreciation and amortization, stock-based compensation, and gain (loss) on equity method investments. We use Adjusted EBITDA to evaluate financial performance, analyze the underlying trends in our business and establish operational goals and forecasts that are used when allocating resources. We expect to compute Adjusted EBITDA consistently using the same methods each period. We believe Adjusted EBITDA is a useful measure because it permits investors to better understand changes over comparative periods by providing financial results that are unaffected by certain non-cash items that are not considered by management to be indicative of our operational performance. 12 Table of Contents While we believe that Adjusted EBITDA is useful to investors when evaluating our business, it is not prepared and presented in accordance with GAAP, and therefore should be considered supplemental in nature. Adjusted EBITDA should not be considered in isolation, or as a substitute, for other financial performance measures presented in accordance with GAAP. Adjusted EBITDA may differ from similarly titled measures presented by other companies. The following table presents a reconciliation of net income (loss) from continuing operations, the most directly comparable financial measure as measured in accordance with GAAP, to Adjusted EBITDA (in thousands): Year Ended December 31, 2022 2021 Net income (loss) from continuing operations $ 7,728 $ 16,039 Interest expense 222 235 Income taxes 125 (11,217) Depreciation and amortization 206 94 Stock-based compensation 834 633 (Gain) loss on real estate ventures (121) 14 Adjusted EBITDA $ 8,994 $ 5,798 Seasonality and Quarterly Fluctuations None. Liquidity and Capital Resources Liquidity is defined as the current amount of readily available cash and the ability to generate adequate amounts of cash to meet the current needs for cash. We assess our liquidity in terms of our cash and cash equivalents on hand and the ability to generate cash to fund our operating activities. Our principal sources of liquidity as of December 31, 2022 were our cash and cash equivalents of $11.7 million and our $10.0 million of available borrowings on our Credit Facility. Significant factors which could affect future liquidity include the adequacy of available lines of credit, cash flows generated from operating activities, working capital management and investments. Our primary capital needs are for working capital obligations and other general corporate purposes, including investments and capital expenditures. Our primary sources of working capital are cash from operations and distributions from investments in real estate ventures. We have historically financed our operations with internally generated funds and borrowings from our credit facilities. 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. Cash Flows The following table summarizes our cash flows for the periods indicated (in thousands): Year Ended December 31, 2022 2021 Continuing operations Net cash provided by (used in) operating activities $ 8,397 $ 8,688 Net cash provided by (used in) investing activities (2,099) 1,276 Net cash provided by (used in) financing activities (10,068) (227) Total net increase (decrease) in cash - continuing operations (3,770) 9,737 Discontinued operations, net (331) (946) Net increase (decrease) in cash and cash equivalents $ (4,101) $ 8,791 13 Table of Contents Operating Activities 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 (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 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 From time to time, we may have off-balance-sheet unconsolidated investments in real estate ventures and other unconsolidated arrangements with varying structures. For a full discussion of our current investments in real estate ventures, see Note 5 in the Notes to Consolidated Financial Statements. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with GAAP. Accounting policies, methods and estimates are an integral part of the preparation of consolidated financial statements in accordance with U.S. GAAP and, in part, are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the consolidated financial statements and because of the possibility that future events affecting them may differ from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements, areas that are particularly significant include: • Investments in real estate ventures • Revenue - Incentive Fees • Income taxes 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 14 Table of Contents 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 Income taxes are accounted for under the asset and liability method. 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. The 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 income tax provision or benefit in our consolidated statements of operations. 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. . Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not applicable. 15 Table of Contents