Comstock Holding Companies, Inc. annual report, FY2017

Business context and reporting period

Comstock Holding Companies, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017; it was signed April 20, 2018. The company was then primarily a mid-Atlantic real estate developer and homebuilder. In 2018, it set out to shift toward asset management and real estate services and wind down on-balance-sheet production homebuilding. Accordingly, 2017 results largely reflect the legacy homebuilding business, not the new operating model.

Financial performance and liquidity

Amounts below are in millions, except per-share data and where noted.

• Homebuilding revenue was $43.399 million; other revenue was $2.031 million, primarily including the acquired environmental-services business. Homebuilding gross margin was 6.5%, versus 6.0% in 2016.
• Operating loss narrowed year over year. The company attributed the homebuilding margin improvement mainly to the mix of units settled and lower overhead as a percentage of revenue in certain communities.
• Operating cash flow improved to positive $5.064 million, principally because of $4.778 million released from real estate inventories as projects settled. Investing cash flow was negative $0.834 million; financing cash flow was negative $8.185 million. Cash declined by $3.955 million during 2017.
• At December 31, total assets were $51.158 million, liabilities $48.548 million, and total equity $2.610 million. Restricted cash was $1.141 million.
• Total notes payable, net of discounts and financing charges, were $39.393 million, compared with $43.704 million a year earlier. The debt schedule showed $33.510 million due in 2018. The company also disclosed $14.893 million of affiliate notes payable, primarily sourced from entities owned by the CEO.

Material changes versus the prior comparable period

• Total revenue increased about 9%, while homebuilding settlements fell to 89 units from 94. Net new orders declined to 74 from 104, and year-end backlog fell to 20 units worth $13.918 million from 35 units worth $16.670 million.
• Buyer cancellations increased to approximately 16% of orders from 7% in 2016. Average settlement price increased to $488,000 from $433,000; management attributed revenue and price movements primarily to the mix of units settled.
• Operating cash flow swung from negative $11.816 million to positive $5.064 million, largely reflecting the reversal from inventory investment in 2016 to inventory releases in 2017.
• Impairment charges and recovery, net, were $0.526 million in 2017 versus $1.703 million in 2016. The company separately reported write-offs of $0.5 million and $2.4 million, respectively, for project-related costs.
• The company acquired environmental-services business Monridge Environmental for a stated purchase price of $2.291 million, including $1.702 million of goodwill. Other revenue rose to $2.031 million from $0.884 million, while other cost of sales also increased substantially.

Outlook, risks, contingencies and unusual items

• Strategic transition and related-party agreement: On March 30, 2018, the company’s CAM subsidiary entered a master asset management agreement, effective January 2, 2018, with CDS, an entity wholly owned by CEO Christopher Clemente. The fee includes dedicated personnel expenses, public-company costs, and a fixed annual payment of $1 million. CAM received a $2.5 million deposit to be credited against the fee. The initial term runs through December 31, 2022. The agreement is a key part of the planned transition, but creates significant client concentration and related-party dependence.
• Liquidity and debt refinancing: Management said it expected available cash, private-placement proceeds, project settlements, and successful lender extensions to support operations for the next 12 months, but gave no assurance. As of April 20, 2018, it reported that lender obligations had been extended or repaid through that date and that it was pursuing longer-term modifications. Some 2018 maturities remained a material risk; debt agreements include covenants and cross-default provisions. A secured credit line had a covenant waiver for minimum EBITDA and liquidity at year-end 2017.
• Controls: Management concluded that disclosure controls and internal control over financial reporting were ineffective at December 31, 2017 because of a material weakness involving insufficient accounting and finance resources, inadequate documentation and review, and lack of segregation of duties. Planned remediation included hiring experienced accounting staff, added training, and stronger review procedures. The auditor audited the financial statements but was not engaged to audit internal controls.
• Other risks: The filing highlights real estate market and interest-rate exposure, access to financing, construction costs and labor availability, regulation, project impairments, homebuyer financing and cancellations, competition, and dependence on a limited number of management-services clients. Most operations and homebuilding exposure are concentrated in the Washington, D.C. region.
• Contingencies and tax items: No material legal proceedings were reported. At year-end, letters of credit were $1.1 million and performance and payment bonds were $4.0 million; none had been drawn. The company reported about $144 million of federal and state net operating losses, with deferred tax assets substantially fully reserved. The 2017 tax law change reduced the federal corporate rate and led to an approximately $20 million decrease in deferred tax assets, substantially offset by the valuation allowance.
• Q4 snapshot: Fourth-quarter 2017 revenue was $10.827 million and net loss was $2.378 million; loss attributable to common stockholders was $3.255 million, or $0.98 per share. The filing provides no formal forward revenue, earnings, or margin guidance.

Important facts for investors to verify

1. Whether the CEO-owned client agreement generates the stated fees on schedule, how the $2.5 million deposit is applied, and what termination or renewal terms could affect revenue.
2. Whether remaining debt maturities were extended or repaid on acceptable terms, and whether cash, settlements, and financing are sufficient to meet obligations and sustain operations.
3. Whether the company remediates the material weakness and establishes reliable controls and financial-reporting processes.
4. Whether the new asset-management and real-estate-services platforms can replace homebuilding revenue, diversify clients, and produce sustainable margins and cash flow.
5. Whether order cancellations, backlog, project inventory values, and remaining homebuilding assets develop as expected during the wind-down.