**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

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**FORM 10-Q**

 

**QuarterlyReport Pursuant To Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

 

**For the Quarter Ended September30, 2005**

 

**Commission File Number 1-32375**

 

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**ComstockHomebuilding Companies, Inc.******(Exact Name of Registrantas Specified in Its Charter)

 
| **Delaware**                                                                                              | ** ** | **20-1164345**                        |
|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of Incorporation or Organization)                                           |       | (I.R.S. Employer  Identification No.) |
|                                                                                                      |       |                                  |
| **11465  Sunset Hills Road  5th Floor Reston, Virginia 20190  (703) 883-1700**                            |
| (Address including zip  code, and telephone number, including area  code, of principal executive offices) |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 
| YES   ý |   | NO   o |
|-----------------------------|--------|-----------------------|

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 
| YES   o |   | NO   ý |
|------------------------|--------|----------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o  Yes   ý  No

 

As of November 10, 2005,11,257,531 shares of the Class A common stock, par value $.01 per share, of theRegistrant were outstanding.

 

 

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 
| **PART I – FINANCIAL INFORMATION**                                                                       |                                                                                        |
|---------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
|                                                                                                          |                                                                                        |
| ITEM 1. FINANCIAL  STATEMENTS:                                                                                |                                                                                        |
|                                                                                                          |                                                                                        |
| Consolidated Balance Sheets (unaudited) - September  30, 2005 and December 31, 2004                           |                                                                                        |
|                                                                                                          |                                                                                        |
| Consolidated  Statements of Operations (unaudited) - Three and Nine Months Ended September  30, 2005 and 2004 |                                                                                        |
|                                                                                                          |                                                                                        |
| Consolidated  Statements of Cash Flows (unaudited) - Three and Nine Months Ended September  30, 2005 and 2004 |                                                                                        |
|                                                                                                          |                                                                                        |
| Notes to  Consolidated Financial Statements                                                                   |                                                                                        |
|                                                                                                          |                                                                                        |   |
| ITEM 2.                                                                                                       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |
|                                                                                                          |                                                                                        |   |
| ITEM 3.                                                                                                       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |   |
|                                                                                                          |                                                                                        |   |
| ITEM 4.                                                                                                       | CONTROLS AND PROCEDURES                                                                     |   |
|                                                                                                          |                                                                                        |   |
| **PART II – OTHER  INFORMATION**                                                                         |                                                                                        |
|                                                                                                          |                                                                                        |   |
| ITEM 1.                                                                                                       | LEGAL PROCEEDINGS                                                                           |   |
|                                                                                                          |                                                                                        |   |
| ITEM 2.                                                                                                       | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                |   |
|                                                                                                          |                                                                                        |   |
| ITEM 3.                                                                                                       | DEFAULTS UPON SENIOR  SECURITIES                                                            |   |
|                                                                                                          |                                                                                        |   |
| ITEM 4.                                                                                                       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |   |
|                                                                                                          |                                                                                        |   |
| ITEM 5.                                                                                                       | OTHER INFORMATION                                                                           |   |
|                                                                                                          |                                                                                        |   |
| ITEM 6.                                                                                                       | EXHIBITS                                                                                    |   |
|                                                                                                          |                                                                                        |   |
| SIGNATURES                                                                                                    |                                                                                        |
|                                                                                                               |                                                                                             |  |  |

 

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**UNAUDITED CONSOLIDATED BALANCESHEETS**

**(Amounts in thousands, exceptshare data)**

 
| ** **                                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                                                   |       |                    |       |                   |       |
| ASSETS                                                                                                                 |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                              |       | $                       | 64,129     |                   | $          | 67,559 |   |
| Restricted cash                                                                                                        |       | 13,147                  |       | 7,500                  |       |
| Receivables                                                                                                            |       | 7,327                   |       | 239                    |       |
| Due  from related parties                                                                                              |       | 3,318                   |       | 1,447                  |       |
| Real estate held for  development and sale                                                                             |       | 259,994                 |       | 104,326                |       |
| Inventory not owned -  variable interest entities                                                                      |       | 68,250                  |       | 118,558                |       |
| Property,  plant and equipment                                                                                         |       | 521                     |       | 488                    |       |
| Investment in real estate  partnerships                                                                                |       | (53                     | )          | 1,029                  |       |
| Deferred  income tax                                                                                                   |       | 1,243                   |       | 821                    |       |
| Other  assets                                                                                                          |       | 6,130                   |       | 2,540                  |       |
| TOTAL  ASSETS                                                                                                          |       | $                       | 424,006    |                   | $          | 304,507 |   |
|                                                                                                                   |       |                    |       |                   |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                              |       |                    |       |                   |       |
| Accounts payable and accrued  liabilities                                                                              |       | $                       | 59,089     |                   | $          | 35,532 |   |
| Income  taxes payable                                                                                                  |       | 3,946                   |       | 290                    |       |
| Due to  related parties                                                                                                |       | 40                      |       | 148                    |       |
| Obligations related to  inventory not owned                                                                            |       | 63,850                  |       | 114,333                |       |
| Notes  payable                                                                                                         |       | 155,004                 |       | 65,684                 |       |
| Notes  payable–related parties                                                                                    |       | 3,263                   |       | 10,944                 |       |
| Distribution  payable                                                                                                  |       | 3,205                   |       | 12,655                 |       |
| TOTAL  LIABILITIES                                                                                                     |       | 288,397                 |       | 239,586                |       |
|                                                                                                                   |       |                    |       |                   |       |
| Commitments  and contingencies (Note 12)                                                                               |       |                    |       |                   |       |
|                                                                                                                   |       |                    |       |                   |       |
| Minority  interest                                                                                                     |       | 387                     |       | 2,695                  |       |
|                                                                                                                   |       |                    |       |                   |       |
| SHAREHOLDERS’ EQUITY                                                                                              |       |                    |       |                   |       |
| Class A common stock, $0.01  par value, 77,266,500 shares authorized, 11,538,609 and 9,160,608 issued and  outstanding |       | 115                     |       | 92                     |       |
| Class B common stock, $0.01  par value, 2,733,500 shares authorized, 2,733,500 issued and outstanding                  |       | 27                      |       | 27                     |       |
| Additional  paid-in capital                                                                                            |       | 128,958                 |       | 75,510                 |       |
| Unearned  Compensation                                                                                                 |       | (3,146                  | )          | (4,314                 | )          |
| Retained  earnings (accumulated deficit)                                                                               |       | 9,268                   |       | (9,089                 | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                       |       | 135,222                 |       | 62,226                 |       |
|                                                                                                                   |       |                    |       |                   |       |
| TOTAL LIABILITIES AND  SHAREHOLDERS’ EQUITY (DEFICIT)                                                             |       | $                       | 424,006    |                   | $          | 304,507 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTSOF OPERATIONS**

(Amounts in thousands,except share data)

 
| ** **                                                                          | ** ** | **Three  Months Ended Sept 30,** | ** ** | **Nine  Months Ended Sept 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                         | ** ** | **2004**                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                          | ** ** | ** **                       | ** ** | **Predecessor**                 | ** ** | ** ** | ** ** | **Predecessor** | ** ** |
| Revenues                                                                            |       |                             |       |                            |       |   |   |   |   |
| Sale of real estate—Homes                                                      |       | $                                | 72,409     |                            | $          | 23,395 |   | $ | 140,473 |   | $ | 67,649 |   |
| Other  revenue                                                                      |       | 6,028                            |       | 2,437                           |       | 6,604 |   | 7,165 |   |
| Total  revenue                                                                      |       | 78,437                           |       | 25,832                          |       | 147,077 |   | 74,814 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Expenses                                                                            |       |                             |       |                            |       |   |   |   |   |
| Cost of sales of real estate                                                        |       | 50,838                           |       | 13,897                          |       | 98,087 |   | 44,665 |   |
| Cost of sales of other                                                              |       | 3,118                            |       | 1,773                           |       | 3,138 |   | 5,419 |   |
| Selling,  general and administrative                                                |       | 6,562                            |       | 2,636                           |       | 17,222 |   | 9,546 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Operating  income                                                                   |       | 17,919                           |       | 7,526                           |       | 28,630 |   | 15,184 |   |
| Other  (income) expense, net                                                        |       | (463                             | )          | 241                             |       | (653 | ) | 301 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Income before minority  interest and equity in earnings of real estate partnerships |       | 18,382                           |       | 7,285                           |       | 29,283 |   | 14,883 |   |
| Minority  interest                                                                  |       | 6                                |       | 1,812                           |       | 14 |   | 4,360 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Income before equity in  earnings of real estate partnerships                       |       | 18,376                           |       | 5,473                           |       | 29,269 |   | 10,523 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Equity in earnings of real  estate partnerships                                     |       | 48                               |       | 35                              |       | 82 |   | 93 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Total  pre tax income                                                               |       | 18,424                           |       | 5,508                           |       | 29,351 |   | 10,616 |   |
| Income  taxes                                                                       |       | 6,941                            |       | —                          |       | 10,993 |   | — |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Net  income                                                                         |       | $                                | 11,483     |                            | $          | 5,508 |   | $ | 18,358 |   | $ | 10,616 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Basic  earnings per share                                                           |       | 0.82                             |       | 0.78                            |       | 1.47 |   | 1.50 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average  shares outstanding                                          |       | 13,987                           |       | 7,067                           |       | 12,491 |   | 7,067 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Diluted  earnings per share                                                         |       | 0.81                             |       | 0.78                            |       | 1.45 |   | 1.50 |   |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Diluted weighted average  shares outstanding                                        |       | 14,168                           |       | 7,067                           |       | 12,653 |   | 7,067 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**UNAUDITED CONSOLIDATED STATEMENTSOF CASH FLOWS**

(Amounts in thousands,except share data)

 
| ** **                                                                       | ** ** | **Nine  Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                                                       | ** ** | ** **                           | ** ** | **Predecessor** | ** ** |
| Cash flows from operating activities:                                            |       |                                 |       |   |   |
| Net  income                                                                      |       | $                                    | 18,358     |   | $ | 10,616 |   |
| Adjustment to reconcile net  income to net cash provided by operating activities |       |                                 |       |   |   |
| Depreciation                                                                     |       | 125                                  |       | 75 |   |
| Loss on disposal of assets                                                       |       | 9                                    |       | — |   |
| Minority  interest                                                               |       | 14                                   |       | 4,360 |   |
| Equity in earnings of real  estate partnerships                                  |       | (82                                  | )          | (93 | ) |
| Distributions from  investment in real estate partnerships                       |       | 164                                  |       | 90 |   |
| Amortization  of stock compensation                                              |       | 1,749                                |       | — |   |
| Deferred  income tax                                                             |       | (422                                 | )          | — |   |
| Changes in operating assets  and liabilities:                                    |       |                                 |       |   |   |
| Restricted  cash                                                                 |       | (5,647                               | )          | — |   |
| Receivables                                                                      |       | (7,088                               | )          | 1,070 |   |
| Due  from related parties                                                        |       | (1,871                               | )          | (2,057 | ) |
| Real estate held for  development and sale                                       |       | (155,668                             | )          | (10,487 | ) |
| Other  assets                                                                    |       | (3,765                               | )          | (2,935 | ) |
| Accounts payable and accrued  liabilities                                        |       | 23,555                               |       | 5,126 |   |
| Income  tax payable                                                              |       | 3,656                                |       | — |   |
| Due to  related parties                                                          |       | (108                                 | )          | (24 | ) |
| Net cash (used in) provided  by operating activities                             |       | (127,021                             | )          | 5,741 |   |
| Cash flows from investing activities:                                            |       |                                 |       |   |   |
| Purchase of property, plant,  and equipment                                      |       | (167                                 | )          | (187 | ) |
| Distributions of capital  from investments in real estate partnerships           |       | 1,000                                |       | — |   |
| Net cash provided by (used  in) investing activities                             |       | 833                                  |       | (187 | ) |
| Cash flows from financing activities:                                            |       |                                 |       |   |   |
| Proceeds  from notes payable                                                     |       | 182,666                              |       | 47,825 |   |
| Proceeds from related party  notes payable                                       |       | 444                                  |       | 8,988 |   |
| Payments  on notes payable                                                       |       | (93,346                              | )          | (47,900 | ) |
| Payments on related party  notes payable                                         |       | (8,125                               | )          | (144 | ) |
| Contribution  from minority shareholders                                         |       | 87                                   |       | — |   |
| Payment  of distribution payable                                                 |       | (9,450                               | )          | — |   |
| Distributions paid to  minority shareholders                                     |       | (2,409                               | )          | (11,901 | ) |
| Distributions  paid to shareholders                                              |       | —                               |       | (4,233 | ) |
| Proceeds from shares issued  under employee stock purchase plan                  |       | 81                                   |       | — |   |
| Net proceeds from follow on  offering                                            |       | 52,810                               |       | — |   |
| Net cash provided by (used  in) financing activities                             |       | 122,758                              |       | (7,365 | ) |
| Net (decrease) in cash and cash equivalents                                      |       | (3,430                               | )          | (1,811 | ) |
| Cash and cash equivalents, beginning of period                                   |       | 67,559                               |       | 17,160 |   |
| Cash and cash equivalents, end of period                                         |       | $                                    | 64,129     |   | $ | 15,349 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMEN****TS**

(Amounts in thousands,except per share data)

 

**1.****              ORGANIZATIONAND BASIS OF PRESENTATION**

 

Comstock Homebuilding Companies, Inc.(the “Company”) was incorporated on May 24, 2004 as a Delawarecorporation.

 

On December 17,2004, as a result of completing its initial public offering (“IPO”) of itsClass A Common Stock, the Company acquired 100% of the outstanding capitalstock of Comstock Holding Company, Inc. and subsidiaries (“ComstockHoldings”) by merger, which followed a consolidation that took placeimmediately prior to the closing of the IPO (the “Consolidation”). TheConsolidation was effected through the mergers of Sunset InvestmentCorp., Inc. and subsidiaries, Comstock Homes, Inc. and subsidiariesand Comstock Service Corp., Inc. and subsidiaries (“Comstock Service”) with andinto Comstock Holdings. Pursuant to the terms of the merger agreement, sharesof Comstock Holdings were canceled and replaced by 4,333 and 2,734 shares ofClass A and B Common Stock of the Company, respectively. Both Class A and BCommon Stock shares bear the same economic rights. However, for votingpurposes, Class A stockholders are entitled to one vote for each share heldwhile Class B stockholders are entitled to fifteen votes for each share held.

 

As a result of the IPO,the Company sold 3,960 Class A Common Shares at $16.00 per share, raisingproceeds, net of the underwriting discount, of approximately$56.0 million. On December 28, 2004, pursuant to the underwriters’exercise of their over-allotment option, the Company sold an additional594 shares resulting in additional proceeds, net of underwriting discount,of approximately $8.8 million.

 

On June 22, 2005 the Companycompleted a follow on offering in which 2,360 shares of Class A Common stockwere sold to the public at a price of $23.90 per share.  The offering resulted in total proceeds tothe Company, net of underwriting discounts, of approximately $53.4 million.

 

Our common stock istraded on the NASDAQ National Market under the symbol “CHCI”. We have no publictrading history prior to December 17, 2004.

 

The consolidatedfinancial statements and notes of the Company as of September 30, 2005 and forthe three and nine months ended September 30, 2005 and 2004 have been preparedby management without audit, pursuant to rules and regulations of theSecurities and Exchange Commission and should be read in conjunction with theDecember 31, 2004 audited financial statements contained in the Company’sAnnual Report on Form 10-K for the year then ended. In the opinion ofmanagement, all normal, recurring adjustments necessary for the fairpresentation of such financial information have been included. The preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes. Certain information and footnote disclosures normallyincluded in annual financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted. Certain amounts in the prior year’s financial statementshave been reclassified to conform to the current year’s presentation with noeffect on previously reported net income or stockholders’ equity.

 

The Company historicallyhas experienced and expects to continue to experience variability in quarterlyresults. The consolidated statement of operations for the three and nine monthsended September 30, 2005 is not necessarily indicative of the results to beexpected for the full year.

 

For purposes ofidentification and description, we are referred to as the “Predecessor” for theperiod prior to the IPO, the Company for the period subsequent to the IPO, and“we,” “us,” and “our” for both periods.

 

The Company develops,builds and markets single-family homes, townhouses and condominiums in theWashington D.C. and Raleigh, North Carolina metropolitan markets. The Companyalso provides certain management and administrative support services to certainrelated parties.

 

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**2.****              REAL ESTATE HELD FOR DEVELOPMENT AND SALE**

 

Real estate held fordevelopment and sale includes land, land development costs, interest and otherconstruction costs and is stated at cost or, when circumstances or eventsindicate that the real estate held for development or sale is impaired, atestimated fair value.

 

Land, land developmentand indirect land development costs are accumulated by specific area andallocated to various lots or housing units using specific identification andallocation based upon the relative sales value, unit or area methods. Directconstruction costs are assigned to housing units based on specificidentification. Construction costs primarily include direct construction costsand capitalized field overhead. Other costs are comprised of prepaid localgovernment fees and capitalized interest and real estate taxes. Selling costsare expensed as incurred.

 

Estimated fair value isbased on comparable sales of real estate in the normal course of business underexisting and anticipated market conditions. The evaluation takes intoconsideration the current status of the property, various restrictions,carrying costs, costs of disposition and any other circumstances which mayaffect fair value including management’s plans for the property. Due to thelarge acreage of certain land holdings, disposition in the normal course ofbusiness is expected to extend over a number of years. A write-down toestimated fair value is recorded when the carrying value of the propertyexceeds its estimated fair value. These evaluations are made on aproperty-by-property basis. The Company assesses the impairment of real estateassets whenever events or changes in circumstances indicate that the net bookvalue may not be recoverable.

 

Real estate held fordevelopment and sale consists of the following:

 
| ** **                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                   | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| Land and land  development costs                                             |       | $                 | 133,378    |             | $          | 65,545 |   |
| Cost of construction  (including capitalized interest and real estate taxes) |       | 126,616           |       | 38,781           |       |
|                                                                         |       | $                 | 259,994    |             | $          | 104,326 |   |

 

**3.****              CONSOLIDATION OF VARIABLE INTEREST ENTITIES**

 

The Company typicallyacquires land for development at market prices from various entities underfixed price purchase agreements. The purchase agreements require deposits thatmay be forfeited if the Company fails to perform under the agreements. Thedeposits required under the purchase agreements are in the form of cash orletters of credit in varying amounts. The Company may, at its option, choosefor any reason and at any time not to perform under these purchase agreementsby delivering notice of its intent not to acquire the land under contract. TheCompany’s sole legal obligation and economic loss for failure to perform underthese purchase agreements is typically limited to the amount of the depositpursuant to the liquidated damages provision contained within the purchaseagreement. As a result, none of the creditors of any of the entities with whichthe Company enters into forward fixed price purchase agreements have recourseto the general credit of the Company. The Company also does not share in anallocation of either the profit earned or loss incurred by any of theseentities with which the Company enters fixed price purchase agreements.

 

The Company has concludedthat whenever it options land or lots from an entity and pays a significantnon-refundable deposit as described above, a variable interest entity iscreated under the provisions of FIN 46-R. This is because the Company hasbeen deemed to have provided subordinated financial support, which refers tovariable interest that will absorb some or all of an entity’s expectedtheoretical losses if they occur. The Company, therefore, examines the entitieswith which the Company enters into fixed price purchase agreements for possibleconsolidation by the Company under FIN 46-R. This requires the Company tocompute expected losses and expected residual returns based on the probabilityof future cash flows as outlined in FIN 46-R. This calculation

 

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requires substantialmanagement judgments and estimates. In addition, because the Company does nothave any contractual or ownership interests in the entities with which itcontracts to buy the land, the Company does not have the ability to compelthese development entities to provide financial or other data to assist theCompany in the performance of the primary beneficiary evaluation.

 

The Company has evaluatedall of its fixed price purchase agreements and has determined that it is theprimary beneficiary of some of those entities. As a result, atDecember 31, 2004, the Company has consolidated five entities in theaccompanying consolidated balance sheet. The effect of the consolidation atDecember 31, 2004 was the inclusion of $118,558 in “Inventory not owned—variableinterest entities” with a corresponding inclusion of $114,333 (net of landdeposits paid of $4,225) to “Obligations related to inventory not owned.”During the nine months ended September 30, 2005, the Company consolidated threeentities in the accompanying consolidated balance sheet.  The effect of the consolidation at September30, 2005 was the inclusion of $68,250 in “Inventory not owned—variable interestentities” with a corresponding inclusion of $63,850 (net of land deposits paidof $4,400) to “Obligations related to inventory not owned.”  Creditors, ifany, of these variable interest entities have no recourse against the Company.

 

**4.****              WARRANTYRESERVE**

 

Warranty reserves forhouses sold are established to cover potential costs for materials and laborwith regard to warranty-type claims expected to arise during the one-yearwarranty period provided by the Company or within the five-year statutorilymandated structural warranty period. Since the Company subcontracts itshomebuilding work, subcontractors are required to provide the Company with anindemnity and a certificate of insurance prior to receiving payments for theirwork. Claims relating to workmanship and materials are generally the primaryresponsibility of the subcontractors and product manufacturers. The warrantyreserve is established at the time of closing, and is calculated based uponhistorical warranty cost experience and current business factors. Variablesused in the calculation of the reserve, as well as the adequacy of the reservebased on the number of homes still under warranty, are reviewed on a periodicbasis. Warranty claims are directly charged to the reserve as they arise. Thefollowing table is a summary of warranty reserve activity which is included inaccounts payable and accrued liabilities for the three and nine months endingSeptember 30, 2005 and 2004:

 
| ** **                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                        | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Balance at beginning of  period   |       | $                                    | 945        |                                | $          | 751 |   | $ | 916 |   | $ | 541 |   |
| Additions                         |       | 291                                  |       | 138                                 |       | 600 |   | 556 |   |
| Releases and/or charges  incurred |       | (155                                 | )          | (56                                 | )          | (435 | ) | (264 | ) |
| Balance at end of  period         |       | $                                    | 1,081      |                                | $          | 833 |   | $ | 1,081 |   | $ | 833 |   |

 

**5.****              CAPITALIZEDINTEREST AND REAL ESTATE TAXES**

 

Interest and real estatetaxes incurred relating to the development of lots and parcels are capitalizedto real estate held for development and sale during the active developmentperiod, which generally commences when borrowings are used to acquire realestate assets and ends when the properties are substantially complete. Interestis capitalized based on the interest rate applicable to specific borrowings orthe weighted average of the rates applicable to other borrowings during theperiod. Interest and real estate taxes capitalized to real estate held fordevelopment and sale are expensed as a component of cost of sales as relatedunits are sold.

 

8

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The followingtable is a summary of interest incurred and capitalized: 

 
| ** **                                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total interest incurred                                  |       | $                                    | 3,062      |                                | $          | 1,070 |   | $ | 8,824 |   | $ | 3,008 |   |
| Beginning interest  capitalized                          |       | 8,009                                |       | $                                   | 2,796      |   | 4,524 |   | $ | 1,428 |   |
| Plus: Interest incurred  on notes payable                |       | 3,001                                |       | 738                                 |       | 8,097 |   | 1,950 |   |
| Plus: Interest incurred  on related party notes payable  |       | 20                                   |       | 275                                 |       | 289 |   | 1,046 |   |
| Less: Interest expensed  as a component of cost of sales |       | (1,646                               | )          | (352                                | )          | (3,526 | ) | (967 | ) |
| Ending interest  capitalized                             |       | $                                    | 9,384      |                                | $          | 3,457 |   | $ | 9,384 |   | $ | 3,457 |   |

 

**6.****              EARNINGSPER SHARE**

 

The followingweighted average shares and share equivalents are used to calculate basic anddiluted earnings per share for the three and nine months ended September 30,2005 and 2004:

 
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                    | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic earnings per  share                     | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Income                                    |       | $                                    | 11,483     |                                | $          | 5,508 |   | $ | 18,358 |   | $ | 10,616 |   |
| Basic weighted-average  shares outstanding    |       | 13,987                               |       | 7,067                               |       | 12,491 |   | 7,067 |   |
| Per share amounts                             |       | $                                    | 0.82       |                                | $          | 0.78 |   | $ | 1.47 |   | $ | 1.50 |   |
| Dilutive earnings per  share                  |       |                                 |       |                                |       |   |   |   |   |
| Net income                                    |       | $                                    | 11,483     |                                | $          | 5,508 |   | $ | 18,357 |   | $ | 10,616 |   |
| Basic weighted-average  shares outstanding    |       | 13,987                               |       | 7,067                               |       | 12,491 |   | 7,067 |   |
| Stock options and  restricted stock grants    |       | 181                                  |       | —                              |       | 162 |   | — |   |
| Dilutive  weighted-average shares outstanding |       | 14,168                               |       | 7,067                               |       | 12,653 |   | 7,067 |   |
| Per share amounts                             |       | $                                    | 0.81       |                                | $          | 0.78 |   | $ | 1.45 |   | $ | 1.50 |   |

 

Shares issued to theowners of the Predecessor in exchange for their interests in connection withthe Consolidation have been reflected in weighted average shares as of thebeginning of the earliest period presented.

 

**Comprehensive income**

 

Forthe three and nine months ended September 30, 2005 and 2004, comprehensiveincome equaled net income; therefore, a separate statement of comprehensiveincome is not included in the accompanying combined consolidated financialstatements.

 

9

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**7.****              MINORITYINTERESTS**

 

During March 2005, theCompany purchased certain noncontrolling minority interests in its consolidatedsubsidiaries for a total purchase price of $2,242.  Because the underlyingbook value of the minority interests was $2,360, the Company allocated $118 asa reduction in the subsidiary’s real estate held for development and saleaccounts.

 

**8.****              INVESTMENTIN REAL ESTATE PARTNERSHIPS**

 

Prior to the Company’sacquisition of Comstock Service as discussed in Note 1, Comstock Service in2001 had invested $41 in North Shore Investors, LLC (“North Shore”) for a 50%ownership interest. North Shore was formed to acquire and develop residentiallots and construct single family and townhouse units. In 2002, as a result ofrecognizing its share of net losses incurred by North Shore, Comstock Servicereduced its investment in North Shore, to $0.

 

Since the inception to September30, 2005, North Shore has incurred losses of approximately $2,135.  On June 28, 2005 the Company received acapital call from North Shore in the amount of $719 so that North Shore maycomply with certain debt repayments. Because the Company may be obligated to provide future financial supportto cover certain debt repayments, the Company, during the three and nine monthsended September 30, 2005 recorded its share of losses incurred by North Shorein the accompanying financial statements in the amount of $27 and $53,respectively.

 

During the third quarterof 2005, the Company, as manager of an affiliated entity, exercised its optionrights to purchase the project acquisition, development and construction loan madefor the benefit of North Shore. The Company finalized the purchase of the loanson or about September 8, 2005, issued a notice of default under the acquisitionand development loan at maturity on September 30, 2005 and subsequently filedsuit for collection of the loans against one of the individual guarantors underthe loan on or about October 21, 2005.

 

As of September 30, 2005the Company carried the following amounts in its financial statements relatedto North Shore:

 
| Investment in real  estate partnerships       |   | $ | (53   | )      |
|-----------------------------------------------|--------|---|-------|--------|
| Due from affiliates                           |   | $ | 1,491 |   |
| Development and  construction loan receivable |   | $ | 1,741 |   |

 

In addition the Companymay be obligated in certain circumstances to provide additional capital tocover certain debt repayments to North Shore in the amount of $2 million. As ofNovember 8, 2005 the Company has not paid its share of the capital call and isexploring alternatives with all parties involved to reorganize or restructurethe partnership in order to maximize potential returns.  The Company has evaluated the carrying valueof its investment in and receivables from North Shore. At this time the Companydoes not believe an impairment reserve is warranted. However, it is possible thismay change in future periods.  Inaddition, based on results of negotiations, the Company may, in the future berequired to consolidate the North Shore entity.

 

**9.****              DEBT**

 

In September 2005, theCompany completed a purchase of a 316 unit condominium conversion projectlocated in Leesburg, Virginia.  Tofinance this transaction, the Company entered into a promissory note agreementrelating to $47,725 of indebtedness bearing interest at a rate of 1.9% + theone month LIBOR rate (3.86% at September 30, 2005).  At September 30, 2005, the Company owed atotal of $35,905 under this note.

 

**10.****       INCOME TAX**

 

Prior toDecember 17, 2004, the Predecessor had elected to be treated as an Scorporation under Subchapter S of the

 

10

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Internal Revenue Code andtherefore was not subject to income taxes. Taxable income or loss was passedthrough and reported by the individual shareholders. Subsequent to theConsolidation, the Company was reorganized as a C corporation under whichincome taxes are accounted for under the asset and liability method inaccordance with SFAS 109 “Accounting for Income Taxes.” Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax basis. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. The effect on the deferred tax assets and liabilities ofa change in tax rates is recognized in income in the period that includes theenactment date.

 

The Company’sincome tax provision consists of the following as of September 30, 2005:

 
| Current:                  | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|
| Federal                   |       | 9,557      |       |
| State                     |       | 1,813      |       |
|                      |       | 11,370     |       |
| Deferred:                 |       |       |       |
| Federal                   |       | 318        |       |
| State                     |       | 59         |       |
|                      |       | (377       | )          |
| Total income tax  expense |       | 10,993     |       |

 

Deferred income taxesreflect the net tax effects of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts used for income tax purposes. Components of the Company’s deferred taxassets and liabilities at September 30, 2005 were as follows:

 
| ** **                      | ** ** | **September 30,  2005** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| Deferred Tax Assets:            |       |                    |       |
| Inventory                       |       | 1,507                   |       |
| Warranty                        |       | 363                     |       |
| Deferred rent                   |       | 19                      |       |
| Accrued expenses                |       | 109                     |       |
| Stock-based compensation        |       | 534                     |       |
|                            |       | 2,532                   |       |
| Less — valuation allowance |       | (1,112                  | )          |
| Net deferred tax assets         |       | 1,420                   |       |
| Deferred tax  liabilities:      |       |                    |       |
| Depreciation and amortization   |       | (177                    | )          |
| Net deferred tax liabilities    |       | (177                    | )          |
| Net deferred tax assets         |       | 1,243                   |       |

 

The Company hasadequately provided for contingencies related to income taxes in accordancewith SFAS No. 5.  At September 30, 2005, the Company recorded a $514income tax reserve, which is on the balance sheet.  This tax reserverelates predominately to a potential dispute by taxing authorities over taxbenefits resulting from additional income tax basis in certain residentialhousing development projects.  The Company has also established a valuationallowance of approximately $1,112 as of September 30, 2005 related to adeferred tax asset of approximately $1,112 resulting from additional tax basisin residential real estate development projects.  In analyzing the needfor the provision of tax contingency reserves and the valuation allowance,management reviewed applicable statutes, rules,

 

11

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regulations andinterpretations and established these reserves based on past experience andjudgments about potential actions by taxing jurisdictions.

 

**11.****       RESTRICTEDSTOCK, STOCK OPTIONS, AND OTHER STOCK PLANS**

 

On December 13,2004, the Company adopted the 2004 Long-Term Incentive Compensation Plan (the“Plan”), which provides for the issuance of stock options, stock appreciationrights, or SARs, restricted stock, deferred stock, dividend equivalents, bonusstock and awards in lieu of cash compensation, other stock-based awards andperformance awards. The Plan provided for an initial authorization of 1,550shares of Class A Common stock for issuance thereunder, plus an additionalannual authorization effective January 1, 2006 equal to the lesser of (i) 3% ofthe Class A Common Stock outstanding on the date of determination, (ii) 500,000shares or (iii) such lesser amount as may be determined by the Company’s Boardof Directors.

 

Effective January 1,2004, the Company adopted SFAS No. 123R (revised 2004), “Share-BasedPayment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”) and supersedes APB OpinionNo. 25, “Accounting for Stock Issued to Employees.” SFAS 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements over the vestingperiod based on their fair values at the date of grant.

 

On July 6, 2005 theCompany issued 106,849 options to the certain officers and employees. Theoptions were issued at an exercise price of $23.90 per share and vest inincrements of 25% on December 31, 2006, June 30, 2007, December 31, 2007, andJune 30, 2008.

 

The following table setsforth information about the fair value of each option grant on the date ofgrant using the Black-Scholes option-pricing model and the weighted-averageassumptions used for such grants:

 
| Weighted-average fair  value of options granted |   | $         | 7.61   | ** ** |
|-------------------------------------------------|--------|-----------|--------|------------|
| Dividend yields                                 |   | N/A       |   |
| Expected volatility                             |   | 44.6      | %      |
| Risk-free interest  rates                       |   | 3.6       |   |
| Expected lives                                  |   | 2.5 Years |   |

 

In accordance with theprovisions of SFAS No. 123(R) and SFAS No. 148, $663 and $0 wasrecorded for total stock-based compensation expense for the three months endedSeptember 30, 2005 and 2004, respectively, and $1,749 and $0 respectively forthe nine months ended September 30, 2005 and 2004.  Of this amount $143and $254 was related to stock option grants for the three and nine months endedSeptember 30, 2005 and the remainder was related to restricted stock grants.

 

On September 30,2005 the following amounts were available for issuance:

 
| Shares Available for  issuance at December 31, 2004 |   | 1,168  |   |
|----------------------------------------------------------|--------|--------|--------|
| Adjustments:                                             |   |   |   |
| Restricted Stock Grants  – Issued                   |   | (16    | )      |
| Options – Issued                                    |   | (107   | )      |
| Restricted Stock Grants  – Forfeited                |   | 4      |   |
| Shares Available for  issuance at September 30, 2005     |   | 1,049  |   |

 

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**12.****       COMMITMENTSAND CONTINGENCIES**

 

**Litigation**

 

In the normal course ofits business, the Company and/or its subsidiaries are named as defendants incertain legal actions arising from its normal business activities. Managementbelieves that none of the litigation matters in which the Company or anysubsidiary is involved would have a material adverse effect on the consolidatedfinancial condition or operations of the Company.  Additional disclosures involving legalproceedings are discussed in Part II, Item I in this Form 10-Q.

 

**Letters of credit and performancebonds**

 

The Company hascommitments as a result of contracts entered into with certain third parties tomeet certain performance criteria as outlined in such contracts. The Company isrequired to issue letters of credit and performance bonds to these thirdparties as a way of ensuring that such commitments entered into are met by theCompany. At September 30, 2005, the Company has outstanding $5,069 in lettersof credit and $13,597 in performance and payment bonds to these third parties.No amounts have been drawn against these letters of credit and performancebonds.

 

**Operating leases**

 

The Company leases office space under non-cancelableoperating leases. Minimum annual lease payments under these leases at September30, 2005 approximate:

 
| **Year  Ended: Amount** | ** ** | ** ** | ** ** |
|-------------------------|------------|------------|------------|
| 2005                    |       | $          | 249        |   |
| 2006                    |       | 837        |       |
| 2007                    |       | 858        |       |
| 2008                    |       | 892        |       |
| 2009                    |       | 721        |       |
| 2010                    |       | 10         |       |
| Thereafter              |       | —     |       |
|                         |            |            |            |  |

 

Operating lease rental expense aggregated $492 and$269, respectively, for nine months ended September 30, 2005 and 2004.

 

**13.****       RELATED PARTYTRANSACTIONS**

 

In June 2002, thePredecessor entered into a promissory note agreement with TCG Fund I, LC tofund development projects. TCG Fund I, LC, is a related party in which theCompany has an equity investment. The promissory note agreement allows for theCompany to borrow up to $4 million. The note bears interest at 12% per annumand was paid in full during June 2005.

 

In September 2004, thePredecessor entered into a promissory note agreement with TCG Fund II, LC tofund development projects. TCG Fund II, LC is an entity which the companymanages as a non-member. The promissory note agreement allows the Company toborrow up to $10 million. The note bears interest at 12% per annum and is dueon September 7, 2007. As of September 30, 2005 and December 31, 2004 theCompany owed $2.6 and

 

13

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$2.4 million,respectively, under this promissory agreement. Accrued interest payable on thisnote totaled $26 and $49 at September 30, 2005 and December 31, 2004,respectively.

 

In April 2002 and January2004, the Predecessor entered into lease agreements for approximately 7.7 and8.8 square feet, respectively, for its corporate headquarters at 11465 SunsetHills Road, Reston, Virginia from Comstock Partners, L.C., an affiliate of ourpredecessor in which executive officers of the Company Christopher Clemente,Gregory Benson, and others are principals. Christopher Clemente owns a 45%interest, Gregory Benson owns a 5% interest, an entity which is owned orcontrolled by Christopher Clemente’s father-in-law, Dwight Schar, owns a 45%interest, and an unrelated third party owns a 5% interest in Comstock Partners.For the three and nine months ended September 30, 2004, total payments madeunder this lease agreement were $90 and $231, respectively.  On September30, 2004 the lease agreements were canceled and replaced with new leases for atotal of 20.6 square feet with Comstock Asset Management, L.C., an entity ownedby Christopher Clemente.  On August 1, 2005 the lease agreement wasamended for an additional 8.4 square feet. For the three months and nine monthsended September 30, 2005, total payments made under this lease agreement were$131 and $408, respectively.

 

In May 2003, the Predecessorhired a construction company, in which Christopher Clemente’s brother, LouisClemente, serves as the President and is a significant shareholder, to provideconstruction services and act as a general contractor at one of the Company’sdevelopments.  The Company paid $7.8million and $3.6 million to this construction company during the nine monthsended September 30, 2005 and 2004, respectively.

 

At September 30, 2005 andDecember 31, 2004, the Company had an outstanding note receivable from InvestorsManagement, LLC of $0 and $163 respectively, which accrues interest at a rateof 10% per annum. Investors Management, LLC is a related party, which is ownedpartially by Christopher Clemente, Gregory Benson and Bruce Labovitz (executiveofficers and/or shareholders of the Company).  At December 31, 2004accrued interest receivable on this note totaled $5. During February 2005 theCompany received payment in full on this note.

 

Christopher Clemente’smother-in-law, Janice Schar, and Gary Martin each invested $100 as minorityshareholders in one of our subsidiaries, and Judah and Deborah Labovitz, theparents of Bruce Labovitz, loaned approximately $300 to another of oursubsidiaries.  During the first quarter 2005, the Company repurchased theminority interests of Janice Schar and Gary Martin for an approximate purchaseprice of $136.  In April 2005, the Company paid the $300 loan to Judah andDeborah Labovitz in full.

 

During 2003, thePredecessor entered into agreements with I-Connect, L.C., a company in whichInvestors Management, LLC holds a 25% interest, for information technologyconsulting services and the right to use certain customized enterprise softwaredeveloped with input from the Company. The intellectual property rightsassociated with the software solution that was developed by I-Connect alongwith any improvements made thereto by the Company remained the property ofI-Connect. For the three months ended September 30, 2005 and 2004, the Companypaid $101 and $87, respectively, to I-Connect.  During the nine months endedSeptember 30, 2005 and 2004, the Company paid $361 and $326, respectively,to I-Connect.  Also, in March 2003, thePredecessor entered into a space sharing agreement with I-Connect, L.C. tooccupy and use 3,342 square feet of office space subleased by I-Connect, L.C.from a third party in Reston, Virginia. The Predecessor paid $0 and $4,respectively, under this agreement for the three months and nine monthsSeptember 30, 2005 and 2004. On June 24, 2003, the I-Connect, L.C. subleasewas assigned to Comstock Partners, L.C. (as landlord). The space sharingagreement with I-Connect ended on September 30, 2004.

 

For three months endedSeptember 30, 2005 and 2004, the Predecessor received revenue of approximately$0 and $909, respectively, by providing administrative and sales support toComstock Service Corp., Inc., a related party owned by Christopher Clemente andGregory Benson. During the nine months ended September 30, 2005 and 2004, theCompany received revenue of approximately $0 and $3 million, respectively.

 

For the three monthsended September 30, 2005 and 2004, the Predecessor received revenue ofapproximately $94 and $350, respectively, by providing administrative and salessupport to other related parties in which Christopher Clemente, Gregory Benson,and Christopher Clemente’s father-in-law, Dwight Schar, are shareholders.  For the nine months ended September 30,2005 and 2004, the Predecessor received revenue of approximately $465 and$1,060, respectively.

 

14

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In October 2004, thePredecessor entered into an agreement with Comstock Asset Management Inc., inwhich the Company would provide management services for a fee of $20 a month. For the three months and nine months ended September 30, 2005 the Companyrecorded $60 and $180, respectively, in revenue. At September 30, 2005 andDecember 31, 2004 the Predecessor recorded a receivable for $20 and $60,respectively, from this entity. In addition, the Company in November 2004,entered into an agreement with Comstock Asset Management to sell certain retailcondominium units at Potomac Yard for a total purchase price of $14,500. Inconnection with this sale, the Company received a deposit of $8,000 uponexecution of the agreement.

 

During the nine monthsended September 30, 2005 and 2004, the Company provided bookkeeping services tocertain related party entities at no charge.

 

In August 2004, thePredecessor entered into a $2,400 promissory note agreement with BelmontModels I, L.C., an entity managed by Investors Management. The note bearsan interest rate of 12%, which is payable monthly and matured July 2005. In March 2005, the Company sold four condominium units to Belmont Models I,L.C. under a sale and leaseback arrangement. The four condominium units weredelivered for a total purchase price of $2,000 and leased back at a rate of $20per month.  The Company expects the lease to continue for a period oftwenty-four months.  As a result of the deliveries, the promissory note wasreduced by the total purchase price.  At September 30, 2005 and December31, 2004 the Company owed $663 and $2,400, respectively. Accrued interestpayable on this note totaled $7 and $49, respectively, at September 30, 2005and December 31, 2004.

 

During nine months endedSeptember 30, 2005 and 2004 the Predecessor entered into sales contracts tosell homes to certain employees of the Company.  The Company, in order toattract, retain, and motivate employees maintains a home ownership benefit program. Under the home ownership benefits, an employee receives certain cost benefitsprovided by us when purchasing a home or having one built by us.  Sales ofhomes to employees for investment purposes are conducted at market prices.

 

In September2005, Comstock Foundation, Inc., an affiliate, was created. Comstock Foundationis a not-for-profit organization organized exclusively for charitable purposeswithin the meaning of Section 501(c)(3) of the Internal Revenue Code. Theaffairs of Comstock Foundation shall be managed by a five person board ofdirectors with Christopher Clemente, Gregory Benson, Bruce Labovitz and TracySchar (employee of the Company and spouse of Christopher Clemente) being fourof the five.  The Company will alsoprovide bookkeeping services to the affiliate.

 

15

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**COMSTOCK HOMEBUILDING COMPANIES,INC. AND SUBSIDIARIES**

**MANAGEMENTS DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**ITEM 2.****                                                     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

FORWARD-LOOKINGSTATEMENTS AND FACTORS THAT MAY AFFECT RESULTS

 

The following discussionof our financial condition and results of operations should be read inconjunction with the accompanying unaudited consolidated interim financialstatements and the notes thereto appearing elsewhere in the this report and ouraudited consolidated and combined financial statements and the notes theretofor the year ended December 31, 2004, appearing in our Annual Report on Form10-K for the year then ended (the “2004 Form 10-K”).

 

This report includesforward-looking statements that are made pursuant to the safe harbor provisionsof the Private Securities Litigation Reform Act of 1995. These forward-lookingstatements can be identified by the use of words such as “anticipate,”“believe,” “estimate,” “may,” “intend,” “expect,” “will,” “should,” “seeks” orother similar expressions. Forward-looking statements are based largely on ourexpectations and involve inherent risks and uncertainties, many of which arebeyond our control. You should not place undue reliance on any forward-lookingstatement, which speaks only as of the date made. Some factors which may affectthe accuracy of the forward-looking statements apply generally to the realestate industry, while other factors apply directly to us. Any number ofimportant factors which could cause actual results to differ materially fromthose in the forward-looking statements include, without limitation: generaleconomic and market conditions, including interest rate levels; our ability toservice our substantial debt; inherent risks in investment in real estate; ourability to compete in the Washington, D.C. and Raleigh, North Carolina realestate and home building markets; regulatory actions; fluctuations in operatingresults; our anticipated growth strategies; shortages and increased costs oflabor or building materials; the availability and cost of land in desirableareas; natural disasters; our ability to raise debt and equity capital and growour operations on a profitable basis; and our continuing relationships withaffiliates. Additional information concerning these and other important riskand uncertainties can be found under the heading “Risk Factors” in the 2004 Form10-K. Our actual results could differ materially from these projected orsuggested by the forward-looking statements.

 

**Overview**

 

We engage in the businessof residential land development, production home building, high-risecondominium development, condominium conversion and land sales in the greaterWashington, D.C. and Raleigh, North Carolina markets. Our business was startedin 1985 by Christopher Clemente, our Chief Executive Officer, as a residentialland developer and home builder focused on the luxury home market in thenorthern Virginia suburbs of Washington, D.C. In 1992, we repositionedourselves as a production home builder focused on moderately priced homes inareas where we could more readily purchase finished building lots throughoption contracts. In 1997, we entered the Raleigh, North Carolina market.

 

The following tablesummarizes certain information related to new orders, settlements, and backlogfor the three and nine month periods ended September 30, 2005 and 2004:

 

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| ** **                | ** ** | **Three Months Ended September  30,** | ** ** | **Nine Months Ended September  30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| New orders                |       | 117                                   |       | 287                                  |       | 523 |   | 490 |   |
| New order revenues        |       | $                                     | 34,423     |                                 | $          | 97,484 |   | $ | 197,760 |   | $ | 170,644 |   |
| Average new order price   |       | $                                     | 294        |                                 | $          | 340 |   | $ | 378 |   | $ | 348 |   |
| Settlements               |       | 202                                   |       | 74                                   |       | 403 |   | 208 |   |
| Settlement revenue        |       | $                                     | 72,409     |                                 | $          | 23,395 |   | $ | 140,473 |   | $ | 67,649 |   |
| Average settlement  price |       | $                                     | 358        |                                 | $          | 316 |   | $ | 349 |   | $ | 325 |   |
| Backlog                   |       | $                                     | 231,833    |                                 | $          | 135,442 |   | $ | 231,833 |   | $ | 135,442 |   |

 

At September 30, 2005, weeither owned or controlled under option agreements or non-binding letters ofintent over 4,802 building lots including non-consolidating joint ventures inwhich we are the manager.  We currently have communities under developmentin Arlington, Fairfax, Loudoun, Culpepper and Prince William counties inVirginia. In Maryland we are currently active in Frederick County. In NorthCarolina we have active communities in Raleigh and Wake counties. The followingchart summarizes certain information for our current and planned communities asof September 30, 2005:

 

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| ** **                                       | ** ** | **As  of September 30, 2005** | ** ** |
|--------------------------------------------------|------------|-------------------------------|------------|
| **Project**                                      | ** ** | **Status  (1)**               | ** ** | **Estimated  Units at  Completion** | ** ** | **Units  Settled** | ** ** | **Backlog(2)** | ** ** | **Lots  Owned  Unsold** | ** ** | **Lots under  Option  Agreement  Unsold** | ** ** | **Average  Sales Price** | ** ** |
| **Virginia**                                     |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Barrington Park                                  |       | Active                        |       | 148 |   | — |   | — |   | 148 |   | — |   | n/a |   |
| Commons at Bellemeade                            |       | Active                        |       | 316 |   | — |   | — |   | 316 |   | — |   | n/a |   |
| Blooms Mill TH 22’                          |       | Active                        |       | 113 |   | 70 |   | 12 |   | 31 |   | — |   | $ | 422,419 |   |
| Blooms Mill Carriage                             |       | Active                        |       | 91 |   | 57 |   | 23 |   | 11 |   | — |   | $ | 451,473 |   |
| Commons on Potomac Sq                            |       | Active                        |       | 192 |   | — |   | 20 |   | 172 |   | — |   | $ | 232,260 |   |
| Commons on Williams Sq                           |       | Active                        |       | 180 |   | 20 |   | 58 |   | 102 |   | — |   | $ | 360,339 |   |
| Countryside                                      |       | Active                        |       | 102 |   | 23 |   | 13 |   | 66 |   | — |   | $ | 287,904 |   |
| The Eclipse on Center Park                       |       | Active                        |       | 465 |   | — |   | 371 |   | 94 |   | — |   | $ | 397,682 |   |
| Penderbrook Square                               |       | Active                        |       | 424 |   | 143 |   | 12 |   | 269 |   | — |   | $ | 251,598 |   |
| River Club at Belmont Bay 5                      |       | Active                        |       | 84 |   | 54 |   | 19 |   | 11 |   | — |   | $ | 459,479 |   |
| Woodlands at Round Hill                          |       | Active                        |       | 65 |   | 23 |   | 21 |   | 21 |   | — |   | $ | 735,214 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  VA Active and Completed                   |       |                          |       | 2,180 |   | 390 |   | 549 |   | 1,241 |   | — |   | $ | 399,818 |   |
| Total VA Active and  Completed Weighted Avg(3)   |       |                          |       |   |   |   |   |   |   |   |   |   |   | $ | 352,927 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Aldie Singles                                    |       | Development                   |       | 15 |   | — |   | — |   | — |   | 15 |   | n/a |   |
| Blakes Crossing                                  |       | Development                   |       | 130 |   | — |   | — |   | 130 |   | — |   | n/a |   |
| Brandy Station                                   |       | Development                   |       | 350 |   | — |   | — |   | — |   | 350 |   | n/a |   |
| Carter Lake                                      |       | Development                   |       | 258 |   | — |   | — |   | — |   | 258 |   | n/a |   |
| Lake Pelham                                      |       | Development                   |       | 185 |   | — |   | — |   | — |   | 185 |   | n/a |   |
| Loudoun Station Condominiums                     |       | Development                   |       | 484 |   | — |   | — |   | — |   | 484 |   | n/a |   |
| Beacon Park at Belmont Bay  8&9              |       | Development                   |       | 600 |   | — |   | — |   | — |   | 600 |   | n/a |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  VA Development                            |       |                          |       | 2,022 |   | — |   | — |   | 130 |   | 1,892 |   |   |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  Virginia**                              | ** ** | ** **                    | ** ** | **4,202** | ** ** | **390** | ** ** | **549** | ** ** | **1,371** | ** ** | **1,892** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Maryland**                                     |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Emerald  Farm                                    |       | Active                        |       | 84 |   | 58 |   | 9 |   | 17 |   | — |   | $ | 437,721 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  Maryland**                              | ** ** | ** **                    | ** ** | **84** | ** ** | **58** | ** ** | **9** | ** ** | **17** | ** ** | **—** | ** ** | ** ** | ** ** |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **North  Carolina**                              |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Allyn’s  Landing                            |       | Active                        |       | 117 |   | 12 |   | — |   | 105 |   | — |   | $ | 208,911 |   |
| Beckett  Crossing                                |       | Active                        |       | 115 |   | 111 |   | 3 |   | 1 |   | — |   | $ | 313,914 |   |
| Delta  Rdge II Townhomes                         |       | Active                        |       | 41 |   | 40 |   | — |   | 1 |   | — |   | $ | 174,256 |   |
| Kelton  at Preston                               |       | Active                        |       | 56 |   | 28 |   | 1 |   | 27 |   | — |   | $ | 306,968 |   |
| Wakefield  Plantation                            |       | Active                        |       | 57 |   | 29 |   | 5 |   | 23 |   | — |   | $ | 474,379 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  North Carolina Active                     |       |                          |       | 386 |   | 220 |   | 9 |   | 157 |   | — |   | $ | 295,685 |   |
| Total North Carolina Active  Weighted Average(3) |       |                          |       |   |   |   |   |   |   |   |   |   |   | $ | 289,940 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Holland  Road                                    |       | Development                   |       | 90 |   | — |   | — |   | — |   | 90 |   | n/a |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  North Carolina Development                |       |                          |       | 90 |   | — |   | — |   | — |   | 90 |   |   |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total  North Carolina**                        | ** ** | ** **                    | ** ** | **476** | ** ** | **220** | ** ** | **9** | ** ** | **157** | ** ** | **90** | ** ** | ** ** | ** ** |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL  ACTIVE AND COMPLETED                      |       |                          |       | 2,650 |   | 668 |   | 567 |   | 1,415 |   | — |   |   |   |
| TOTAL  DEVELOPMENT                               |       |                          |       | 2,112 |   | — |   | — |   | 130 |   | 1,982 |   |   |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **TOTAL**                                        | ** ** | ** **                    | ** ** | **4,762** | ** ** | **668** | ** ** | **567** | ** ** | **1,545** | ** ** | **1,982** | ** ** | ** ** | ** ** |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Joint  Ventures**                              |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| North  Shore Condominiums                        |       | Active                        |       | 196 |   | — |   | 7 |   | 189 |   | — |   | $ | 286,361 |   |
| North  Shore Townhomes                           |       | Active                        |       | 163 |   | 33 |   | 7 |   | 123 |   | — |   | $ | 239,107 |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  Joint Ventures                            |       |                          |       | 359 |   | 33 |   | 14 |   | 312 |   | — |   |   |   |
|                                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **GRAND  TOTAL**                                 | ** ** | ** **                    | ** ** | **5,121** | ** ** | **701** | ** ** | **581** | ** ** | **1,857** | ** ** | **1,982** | ** ** | ** ** | ** ** |

 

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(1)               “Active” communitiesare open for sales. “Development” communities are in the development processand have not yet opened for sales.  “Completed”communities have settled all units during the three months ended September 30,2005.

(2)               “Backlog” means wehave an executed order with a buyer, inclusive of lot sales, but the settlementhas not yet taken place.

(3)               Weighted average iscalculated as total estimated homes at completion for projects with averagesales prices multiplied by Average sales price divided by total of estimatedhomes at completion (i.e.: å (estimated homes at completion  ́ average salesprice) ̧ å estimated homes at completion).

 

18

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**Resultsof Operations**

 

***Three and nine months ended September 30, 2005 compared tothree and nine months ended September 30, 2004***

 

*Ordersand Backlog*

 

New orders for the threemonths ended September 30, 2005 decreased $63.1 million, or 64.7%, to$34.4 million on 117 homes as compared to $97.5 million on 287 homesfor the three months ended September 30, 2004. The decrease was primarilyattributable to the Company’s Eclipse at Center Park project which opened forsale during the third quarter of 2004 and generated sales of 218 units.  The Company has stopped the sales ofadditional units until the project is near completion. Excluding the effect ofthe Eclipse at Center Park, new orders for the three months ended September 30,2005 increased $14.4 million, or 72%, to $34.4 million on 117 homes ascompared to $20.0 million on 69 homes for the three months ended September30, 2004.

 

New orders for the ninemonths ended September 30, 2005 increased $27.1 million, or 15.9%, to$197.8 million on 523 homes as compared to $170.6 million on 490homes for the nine months ended September 30, 2004. This increase in new orderswas primarily attributable to an increase in saleable inventory resulting fromthe opening of new projects including Penderbrook (155 sales), Commons onWilliams Square (63 sales), Villas at Countryside (36 sales) and the Eclipse atCenter Park (90 sales during the first quarter of 2005).

 

The following tablesummarizes our new orders by project for the three and nine months endedSeptember 30, 2005:

 
| ** **                   | ** ** | **Three months  ended** | ** ** | **Nine months  ended** | ** ** |
|------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                   | ** ** | **September 30, 2005**  | ** ** |
| ** **                   | ** ** | ** **              | ** ** | ** **             | ** ** |
| River Club as Belmont  Bay 5 |       | 2                       |       | 16                     |       |
| Blooms Mill Carriage         |       | (1                      | )          | 36                     |       |
| Blooms Mill TH 22’      |       | 1                       |       | 46                     |       |
| Blooms Mill Singles          |       | —                  |       | 1                      |       |
| Blooms Mill TH 20’      |       | —                  |       | 2                      |       |
| Emerald Farm                 |       | 3                       |       | 9                      |       |
| Wescott Ridge                |       | —                  |       | 3                      |       |
| Commoms on Williams Sq       |       | 4                       |       | 63                     |       |
| Commons on Potomac Sq        |       | —                  |       | 20                     |       |
| The Eclipse on Center  Park  |       | —                  |       | 90                     |       |
| Woodlands at Round Hill      |       | (1                      | )          | 20                     |       |
| Penderbrook                  |       | 69                      |       | 155                    |       |
| Villas at Countryside        |       | 36                      |       | 36                     |       |
| Wakefield Plantation         |       | 3                       |       | 7                      |       |
| Kelton at Preston            |       | —                  |       | 6                      |       |
| Delta Ridge II  Townhomes    |       | —                  |       | 3                      |       |
| Beckett Crossing             |       | 2                       |       | 11                     |       |
| Allyns Landing               |       | (1                      | )          | (1                     | )          |
| Total                        |       | 117                     |       | 523                    |       |

 

19

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The average sale priceper new order for the three months ended September 30, 2005 decreased by$46,000 to $294,000 as compared to $340,000 for the three months endedSeptember 30, 2004. The decrease was a result of significant amount of unitsales at Penderbrook and Villas at Countryside, condominium conversionprojects.  Penderbrook and Villas atCountryside are condominium conversion projects in which existing apartmentunits are being converted to condominiums.  By design, sales prices tend to be lower in these conversion projects ascompared to our new construction projects. Our strategy with respect toconversion projects, is to identify assets where we can offer lower priced,affordable product to first time home buyers. We focus on older assets where we can add value while maintaining pricepoints which are more attractive to our target buyers. Because we tend to bebuying, renovating, and selling older assets that are in prime locations we areable to position the assets to be more affordable, and therefore, average neworder prices are lower. Exclusive of the condominium conversion projects, ouraverage sales price per new order was $543,000 for the three months endedSeptember 30, 2005.

 

The average sale price pernew order for the nine months ended September 30, 2005 increased by $30,000 to$378,000 as compared to $348,000 for the nine months ended September 30, 2004.The increase was attributable to general price appreciation in the Washington,DC area, a shift in product mix that included a significant number ofhigher-priced newly built condominium and single family sales.  The average sales price per new order wasnegatively affected by the opening of Penderbrook and Villas at Countryside,both condominium conversion projects as discussed above. Exclusive of thecondominium conversion projects, our average sales price per new order was$447,000 for the nine months ended September 30, 2005.

 

The following tablesummarizes our average new order sales price by product type for the three andnine months ended September 30, 2005 and 2004:

 
| ** **             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **             | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **             | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Townhome               |       | $                                    | 660        |                                | $          | 430 |   | $ | 456 |   | $ | 351 |   |
| Single family          |       | 436                                  |       | 522                                 |       | 606 |   | 502 |   |
| Condominium            |       | 575                                  |       | 324                                 |       | 408 |   | 330 |   |
| Condominium conversion |       | 266                                  |       | n/a                                 |       | 259 |   | n/a |   |
|                        |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |

 

Our backlog at September30, 2005 increased $ 96.4 million, or 71.2%, to $231.8 million on 567homes as compared to our backlog at September 30, 2004 of $135.4 millionon 490 homes. This increase in backlog is the result of new projects and neworder revenue which exceeded settlement revenue.  Increases in backlog were incurred at theEclipse at Center Park ($70.1 million), Penderbrook ($2.7million), Villas atCountryside ($3.7 million), Commons on William Square ($21.5 million), Commonson Potomac Square ($4.6 million) and Woodlands at Round Hill ($13.9million).  In addition, as a result ofour merger with Comstock Service on December 17, 2004, our Raleigh operation,which had not previously been included in our reported backlog, representedbacklog of $4.2 million at September 30, 2005.

 

*Revenues.*

 

The number of homesdelivered for the three months ended September 30, 2005 increased by173.0% to 202 from 74 homes for the three months ended September 30, 2004.Average revenue per home delivered increased by approximately $42,000 to$358,000 for the three months ended September 30, 2005 as compared to $316,000for the three months ended September 30, 2004. For the three months endedSeptember 30, 2004 the Company sold 18 affordable dwelling units, (“ADU’s”) ata average price of approximately $75,000. ADU’s are units mandated by state andlocal authorities to be sold at a discounted price.  Excluding the 18 ADU units, average revenueper home delivered, for the three months ended September 31, 2005 decreased byapproximately $35,000 as compared to the three months ended September 30, 2004.

 

20

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Home building revenuesincreased by $49.0 million, or 209.5%, to $72.4 million for the threemonths ended September 30, 2005 as compared to $23.4 million for the threemonths ended September 30, 2004. The increase in deliveries and revenues forthe three months ended September 30, 2005 is primarily attributable to theCompany’s Penderbrook (69 units), Villas at Countryside (23 units)  and Summerland (20 units) projects and themerger with Comstock Service (8 units). Although selling prices have generally increased in the makets theCompany is in, the decrease in the average selling price, after excluding theeffect of ADU’s, is a result of the Penderbrook and Villas at Countrysideprojects.  Penderbrook and Villas atCountryside are condominium conversion projects in which existing apartmentunits are being converted to condominiums.  By design, sales prices tend to be lower in these conversion projects ascompared to our new construction projects.

 

The number of homesdelivered for the nine months ended September 30, 2005 increased by 93.8%to 403 from 208 homes for the nine months ended September 30, 2004. Averagerevenue per home delivered increased by approximately $23,000 to $349,000 forthe nine months ended September 30, 2005 as compared to $325,000 for the ninemonths ended September 30, 2004. Excluding the effect of 18 ADU units, asdiscussed above, average revenue per home delivered remained consistent atapproximately $349,000 over the respective periods.  Home building revenues increased by$72.8 million, or 107.7%, to $140.5 million for the nine months endedSeptember 30, 2005 as compared to $67.6 million for the nine months endedSeptember 30, 2004. The increase in deliveries and revenues for the nine monthsended September 30, 2005 is primarily attributable to the opening of theCompany’s Penderbrook (143 units), Villas at Countryside (23 units), andSummerland (20 units) projects and the merger with Comstock Service (26units).    Increases in average salesprices were effected by general price appreciation and shift in product mixwhich in turn was offset by our Penderbrook and Villas at Countryside projectsas discussed above.

 

*OtherRevenue*

 

Otherrevenue for the three months ended September 30, 2005 increased by $3.6million, or 147.4% to $6.0 million, as compared to $2.4 million for the threemonths ended September 30, 2005.  For thenine months ended September 30, 2005 other revenue  decreased by $561,000, or 7.8% to $6.6million, as compared to $7.2 million for the nine months ended September 30,2005.  Other revenue for the three andnine months ended September 30, 2005 and 2004 includes lot sales made to thirdparties, revenue associated with the Company’s Settlement Title Servicesdivision, management fees received from Comstock Asset Management Inc. (as discussedin Note 13), and revenue received from a marketing services alliance.  For the three and nine months ended September 30, 2004, other revenue includedrevenues associated with the management of Comstock Service, which was mergedinto Comstock Homebuilding on December 17, 2004. The increase in otherrevenue for the three months ended September 30, 2005, as compared to 2004, wasprimarily the result of 19 lots sold by the Company with corresponding revenueof $5.7 million.  The decrease in otherrevenue for the nine months ended September 30, 2005, as compared to 2004, wasprimarily the result of not recording management revenues from ComstockService, which was acquired in December 2004. 

 

*Cost ofsales*

 

Cost of sales for thethree months ended September 30, 2005 increased $36.9 million, or 265.8%,to $50.8 million, or 70.2% of homebuilding revenue, as compared to$13.9 million, or 59.4% of revenue, for the three months ended September30, 2004. The 10.8 percentage point increase in cost of sales as a percentageof revenue for the three months ended September 30, 2005 is primarilyattributable to lower margins on sales in the North Carolina market and theCompany’s condominium conversion projects. As discussed above, ComstockService, the Company’s North Carolina division, was merged into ComstockHomebuilding on December 17, 2004.  Dueto current market conditions in the North Carolina market, which have causedextended hold and carry periods between acquisition and delivery, the Companyexperienced lower margins on its North Carolina settlements primarily due toincreasing interest carrying costs and modest revenue concessions. In addition,the Company’s newly opened condo conversion projects, experienced lower marginsdue to the nature of a conversion project in which the Company buys an existingstructure, adds value through upgrades and sells the renovated units with afocus on affordability.  As a result,costs of sales tend to be higher as a percentage of revenue than our newconstruction projects.

 

For the nine months endedSeptember 30, 2005 cost of sales increased $53.4 million, or 119.6%, to$98.1 million, or 69.8% of homebuilding revenue, as compared to$44.7 million, or 66.0% of revenue, for the nine months ended September30, 2004.  The 3.8 percentage pointincrease in cost of sales for the nine months ended September 30,

 

21

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2005 was attributable tolower margins in the Company’s North Carolina division and the Company’scondominium conversion project for reasons discussed above.  Because the condominium conversion projectswere not as significant a percentage of total deliveries for the nine monthsended September 30, 2005 as it was for the three months ended September 302005, it did not have material negative impact on overall cost of sales andgross margins.

 

*Cost ofsales other*

 

Cost of sales other forthe three months ended September 30, 2005 increased by $1.4 million, or 75.8% to $3.1 million, as compared to $1.7 millionfor the three months ended September 30, 2005.  Forthe nine months ended September 30, 2005 cost of sales other  decreased by $2.3 million, or 42.1% to $3.1million, as compared to $5.4 million for the nine months ended September 30,2005.  Cost of sales for the threeand nine months ended September 2005 and 2004 includes expenses associated with lot sales made to third parties andexpenses associated with the management of the Company’s Settlement TitleServices division.  For the three andnine months ended September 2004, cost of sales other also included expensesassociated with the management of Comstock Service, which was merged intoComstock Homebuilding on December 17, 2004. The increase in cost of sales other for three months ended September 30,2005, as compared to 2004, was primarily the result of 19 lots sold by theCompany with corresponding costs of $3.1 million.  The decrease in cost of sales other for thenine months ended September 30, 2005, as compared to 2004, was primarily theresult of not recording costs associated with the management of ComstockService, which was acquired in December 2004. 

 

*Selling,general and administrative*

 

Selling, general andadministrative costs for the three months ended September 30, 2005 increased$4 million or 148.9% to $6.6 million, as compared to$2.6 million for the three months ended September 30, 2004. Selling,general and administrative expenses represented 8.4% of total revenue for thethree months ended September 30, 2005, as compared to 10.2% for the threemonths ended September 30, 2004.  Thisincrease for the three months ended September 30, 2005 was the result ofbonuses under our incentive plans ($600,000), computer and legal expenses($475,000), board fees and stock compensation ($900,000), commission fees($425,000), promotion and model rent ($600,000), salaries and employeerelations (650,000) and other miscellaneous expenses associated with our growthin staffing and land acquisition efforts ($350,000).

 

Selling, general andadministrative costs for the nine months ended September 30, 2005 increased$7.7 million, or 80.4% to $17.2 million, as compared to$9.5 million, for the nine months ended September 30, 2004. This increasefor the nine months ended September 30, was the result of additional staffingcosts and compensation ($2.4 million), legal expenses ($350,000), board feesand stock compensation ($1,550,000), insurance costs ($250,000), consultingfees ($825,000), office and model rent ($225,000) and other miscellaneousexpenses associated with our growth in staffing and land acquisition efforts($1.1 million). In addition, our consolidation with Comstock Service increasedour selling, general and administrative expenses by $1 million.  Selling,general and administrative expenses represented 11.7% and 12.8% of totalrevenue for the nine months ended September 30, 2005 and 2004, respectively.

 

*Operatingincome*

 

Operating income for thethree months ended September 30, 2005 increased $10.4 million to$17.9 million, as compared to $7.5 million for the three months endedSeptember 30, 2004. Operating margin for the three months ended September 31,2005 was 22.9%, as compared with 29.1% for the three months ended September 30,2004. The 6.3 percentage point decrease in operating margin is primarilyattributable to an increase in cost of sales as a percentage of revenue asdiscussed above.

 

Operating income for thenine months ended September 30, 2005 increased $13.4 to$28.6 million, as compared to $15.1 million for the nine months endedSeptember 30, 2004. Operating margin for the nine months ended September 30,2005 was consistent with the prior comparable period at approximately 20.0%.

 

*Other(income) expense, net*

 

Other (income) expense,net increased by $704,000 to a net income of $463,000 for the three months endedSeptember 30, 2005, as compared to net expense of $241,000 for the three monthsended September 30, 2004. For the nine months ended September 30, 2005 other(income) expense, net increased by $954,000 to net income of $653,000 for thenine months ended September 30, 2005 as compared to net expense of $301,000 forthe nine months ended September 30, 2004. The increase in other (income)expense is primarily attributable to interest

 

22

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earned on the Company’scash balances generated as a result of the proceeds from theCompany’s initial and follow on public offering.

 

*Minorityinterest*

 

Minority interest expensedecreased by $1.8 million to $6,000 for the three months ended September30, 2005, as compared to the three months ended September 30, 2004. Forthe nine months ended September 30, 2005 minority interest expense decreased by$4.3 million to $14,000, as compared to the nine months endedSeptember 30, 2004. This decrease is the result of our repurchase orredemption of substantially all of the minority interests in four of ourlimited liability company subsidiaries including Comstock Investors V, L.C.,Comstock Investors VI, L.C., Comstock Potomac Yard, L.C. and Comstock NorthCarolina, L.L.C.

 

*Income taxes*

 

On December 17,2004, the Company reorganized from a group of S corporations to a Ccorporation. As a result, income tax expense increased $6.9 and $11.0 millionfor the three and nine months ended September 30, 2005, as compared to noincome tax expense for the three and nine months ended September 30,2004.  The Company’s combined effective tax rate including both currentand deferred provisions for the nine months ended September 30, 2005 was 37.5%.

 

**Liquidityand Capital Resources**

 

We require capital topost deposits on new deals, to purchase and develop land, to construct homes,to fund related carrying costs and overhead and to fund various advertising andmarketing programs to facilitate sales. These expenditures include engineering,entitlement, architecture, site preparation, roads, water and sewer lines,impact fees and earthwork, as well as the construction costs of the homes andamenities. Our sources of capital include, and we anticipate will continue toinclude, funds derived from various secured and unsecured borrowings,operations which include the sale of constructed homes and finished lots, andthe sale of equity securities. Our currently owned and controlled inventory ofhome sites will require substantial capital to develop and construct.

 

In production homebuilding, it is common for builders such as us to employ revolving creditfacilities whereby the maximum funding available under the facility exceeds themaximum outstanding balance allowed at any given time. Our overall borrowingcapacity may be constrained by loan covenants which limit the ratio of ourtotal liabilities to our total equity. This revolving debt will typicallyprovide for funding of an amount up to a pre-determined percentage of the costof each asset funded. The balance of the funding for that asset is provided forby us as equity. The efficiency of revolving debt in production home buildingallows us to operate with less overall debt capital than would be required ifwe built each project with long-term amortizing debt. At September 30, 2005, wehad approximately $161.5 million of debt financing (including our distributionpayable to our pre-initial public offering stockholders) and $64.1 million ofunrestricted cash. We believe that internally generated cash, borrowingsavailable under our credit facilities and access to public debt and equitymarkets will provide us with sufficient capital to meet our existing andexpected capital needs.

 

***Credit Facilities***

 

At September 30, 2005, wehad approximately $172 million available under existing secured revolvingdevelopment and construction loans for planned construction and developmentexpenditures. A majority of our debt is variable rate, based on LIBOR or theprime rate plus a specified number of basis points, typically ranging from 190to 375 basis points over the LIBOR rate and 50 basis points over the primerate. As a result, we are exposed to market risk in the area of interest ratechanges. At September 30, 2005, the one-month LIBOR and prime rates of interestwere 3.86% and 6.75%, respectively, and the interest rates in effect under ourexisting secured revolving development and construction credit facilitiesranged from 5.76% to 9.85%. For information regarding risks associated with ourlevel of debt and changes in interest rates, see Item 3 “Quantitative andQualitative Disclosures about Market Risk.”

 

23

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We have generallyfinanced our development and construction activities on a project basis sothat, for each project we develop and build, we have a separate creditfacility. Accordingly, we have numerous credit facilities. During the thirdquarter 2005 as a result of entering into a $47.7 million borrowing agreementto finance a condominium project, the Company is now subject to certainfinancial covenants. The covenants require the Company to: (1) maintain aminimum tangible net worth, adjusted for certain items, in the amount of $65.0million and (2) maintain a debt to tangible net worth below 3.5:1.  As of September30, 2005, we were in compliance with the financial covenants set forth in ourloan agreements.

 

From time to time, weemploy subordinated and unsecured credit facilities to supplement our capitalresources or a particular project or group of projects. Our lenders under thesecredit facilities will typically charge interest rates that are substantiallyhigher than those charged by the lenders under our senior and secured creditfacilities. These credit facilities will vary with respect to terms and costs.As of September 30, 2005, the annual rate of interest on these facilitiesranged from 6.86% to 16%. At September 30, 2005, we had approximately $30.4million outstanding under these subordinate and unsecured facilities. We intendto continue to use these types of facilities on a selected basis to supplementour capital resources.

 

We are consideringreplacing our credit facilities with one or more larger facilities, which mayreduce our aggregate debt financing costs. We would be the borrower and primaryobligor under this larger facility or facilities, and we anticipate theindebtedness would be secured, nonrecourse and based on an available borrowingbase.

 

***Cash Flow***

 

Net cash providedby/(used in) operating activities was ($127.0) million for the nine monthsended September 30, 2005, as compared to $5.7 million for the nine months endedSeptember 30, 2004. For the nine months ended September 30, 2005, the decreasein cash was primarily attributable to the Company’s continued investments inreal estate held for development and sale.  For the nine months endedSeptember 30, 2004, the increase in cash from operating activities wasprimarily attributable to increases in accounts payable.

 

Net cash providedby/(used in) investing activities was $833,000 for the nine months endedSeptember 30, 2005 and $(187,000) for the nine months ended September 30, 2004.For the nine months ended September 30, 2005 and 2004, the increase in cashfrom investing activities was attributable to the repayment of the Company’s capitalinvestment in TCG Fund I.

 

Net cash providedby/(used in) financing activities was $122.8 million for the nine months endedSeptember 30, 2005 and $(7.4 million) for the nine months ended September 30,2004.  The increase in cash from financing activities for the nine monthsended September 30, 2005, was primarily attributable to proceeds from ourfollow on offering and proceeds from notes payable to finance our acquisitionsof real estate held for development and sale. The decrease in cash from financingactivities for the nine months ended September 30, 2004 was primarilyattributable to the payments made on notes payable as a result of settlementsand distributions made to minority share holders.

 

***Material Acquisitions & Subsequent Events***

 

We are currently party tothe following option contracts and non-binding letters of intent:

 

•                  InJune 2005 we entered into an option contract to purchase anexisting 258 unit apartment complex in Reston, Virginia to be convertedinto affordable condominiums. We expect to close in January of 2006 for apurchase price of approximately $33.0 million;

 

•                  InAugust 2005 we entered into an option contract to purchase a 232 unitto-be-built high rise project in the southern part of Fairfax County, Virginia;

 

•                  InNovember 2005 the Company entered into an agreement to sell its Blakes Crossingproject to a third party.  Under theterms of the agreement, the selling price is $4.3 million and is subject to astudy period expiring November 15, 2005. 

 

In November 2005 we expect to enter into a contract topurchase land, to build 48 townhouse units, in Bethany, Delaware for a purchaseprice of approximately $6.0 million

 

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There is no guaranteethat we will execute a purchase contract with respect to any of theseproperties or that we will complete any of these acquisitions.

 

***Recent Accounting Pronouncements***

 

On June 29, 2005, the Emerging Issues Task Force(“EITF”) reached a consensus on EITF Issue No. 04-05, “Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights”(“EITF 04-05”). The scope of EITF 04-05 is limited to limited partnerships orsimilar entities (such as limited liability companies that have governingprovisions that are the functional equivalent of a limited partnership) thatare not variable interest entities under FIN 46 and provides a new frameworkfor addressing when a general partner in a limited partnership, or managingmember in the case of a limited liability company, controls the entity. UnderEITF 04-05, we may be required to consolidate certain investments, that are notvariable interest entities, in which we hold a general partner or managing memberinterest. EITF 04-05 is effective after June 29, 2005 for new entities formedafter such date and for existing entities for which the agreements aresubsequently modified and is effective for our fiscal year beginning January 1,2006 for all other entities. The adoption of EITF 04-05 did not have any impacton our financial statements as of September 30, 2005.

 

FAS 154 AccountingChanges and Error replace APB Opinion No. 20, and FASB StatementNo. 3. Opinion 20 previously required that most voluntary changes inaccounting principle be recognized by including in net income of the period of the change thecumulative effect of changing to the new accounting principle. This Statementrequires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change. When it isimpracticable to determine the period-specific effects of an accounting changeon one or more individual prior periods presented, this Statement requires thatthe new accounting principle be applied to the balances of assets andliabilities as of the beginning of the earliest period for which retrospectiveapplication is practicable and that a corresponding adjustment be made to theopening balance of retained earnings (or other appropriate components of equityor net assets in the statement of financial position) for that period ratherthan being reported in an income statement. When it is impracticable todetermine the cumulative effect of applying a change in accounting principle toall prior periods, this Statement requires that the new accounting principle beapplied as if it were adopted prospectively from the earliest date practicable.

 

**Critical Accounting Policies andEstimates**

 

There have been no significant changes to our criticalaccounting policies and estimates during the nine months ended September 30,2005 compared with those disclosed in Item 7, *Management’sDiscussion and Analysis of Financial Condition and Results of Operations*includedin our annual report on Form 10-K for the year ended December 31, 2004.

 

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**ITEM3.****                                                     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risk representsthe risk of loss that may impact our financial position, results of operationsor cash flows, due to adverse changes in financial and commodity market pricesand interest rates. We are exposed to market risk in the area of interest ratechanges. A majority of our debt is variable rate based on LIBOR and prime rate,and, therefore, affected by changes in market interest rates. Based on currentoperations, as of September 30, 2005, an increase/decrease in interest rates of100 basis points on our variable rate debt would have resulted in acorresponding increase/decrease in interest actually incurred by us ofapproximately $1.3 million in a fiscal year, a significant portion of whichwould be capitalized and included in cost of sales as homes are delivered. As aresult, the effect on net income would be deferred until the underlying unitssettled and the interest was released to cost of goods sold. Changes in theprices of commodities that are a significant component of home constructioncosts, particularly lumber and concrete, may result in unexpected short-termincreases in construction costs. Because the sales price of our homes is fixedat the time a buyer enters into a contract to acquire a home and we generallycontract to sell our homes before construction begins, any increase in costs inexcess of those anticipated at the time of each sale may result in lowerconsolidated operating income for the homes in our backlog. We attempt tomitigate the market risks of the price fluctuation of commodities by enteringinto fixed price contracts with our subcontractors and material suppliers for aspecified period of time, generally commensurate with the building cycle. Thesecontracts afford us the option to purchase materials at fixed prices but do notobligate us to any specified level of purchasing.

 

**ITEM4.****                                                     CONTROLSAND PROCEDURES**

 

As of the end of theperiod covered by this report, our Chairman and Chief Executive Officer andChief Financial Officer have reviewed and evaluated the effectiveness of ourdisclosure controls and procedures, which included inquiries made to certainother employees.  Based on their evaluation, our Chairman and ChiefExecutive Officer and Chief Financial Officer have each concluded that ourdisclosure controls and procedures are effective and sufficient to ensure thatwe record, process, summarize, and report information required to be disclosedby us in our periodic reports filed under the Securities Exchange Act withinthe time periods specified by the Securities and Exchange Commission’s rulesand forms.  During the quarterly period covered by this report, there havenot been any changes in our internal controls over financial reporting thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

We do not expect that ourdisclosure controls and internal controls will prevent all error and all fraud.A control system, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met. Further, the design of a control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, with the Company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty and that breakdowns can occur because of simpleerror or mistake. Additionally, controls can be circumvented by the individualacts of some persons, by collusion of two or more people or by managementoverride of the controls.

 

The design of any systemof controls also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions; over time, acontrol may become inadequate because of changes in conditions or the degree ofcompliance with the policies or procedures may deteriorate. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and may not be detected.

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.****                                                     LEGALPROCEEDINGS.**

 

TheCompany, as manager of an affiliated entity, exercised its option rights topurchase the project acquisition, development and construction loans made forthe benefit of North Shore.  The Companysubsequently issued a notice of default under the acquisition and developmentloan at maturity on September 30, 2005 and thereafter filed suit for collectionof the loans against one of the individual guarantors under the loan on orabout October 21, 2005.  The claim amountas of the date of filing was $1,8 million.

 

On August 11, 2005, theCompany was served with a motion to compel arbitration resulting from anallegation of a loan brokerage fee being owed for placement of a $147.0 millionproject loan for the Potomac Yard project. The claim in the base amount of $2.0 million plus interest and costs isbased on breach of contract and equitable remedies of unjust enrichment andquantum meruit.  The claims have beendenied by the Company.

 

Other than the foregoing,we are not currently subject to any material legal proceedings. From time totime, however, we are named as a defendant in legal actions arising from ournormal business activities. Although we cannot accurately predict the amount ofour liability, if any, that could arise with respect to legal actions currentlypending against us, we do not expect that any such liability will have amaterial adverse effect on our financial position, operating results or cashflows.

 

We believe that we haveobtained adequate insurance coverage or rights to indemnification, or whereappropriate, have established reserves in connection with these legalproceedings.

 

**ITEM 2.****                                                     UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

 

None.

 

**ITEM 3.****                                                     DEFAULTSUPON SENIOR SECURITIES.**

 

None.

 

**ITEM 4.****                                                     SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None.

 

**ITEM 5.****                                                     OTHERINFORMATION.**

 

None.

 

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**ITEM 6.****                                                     EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                                              |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Amended and Restated  Certificate of Incorporation (incorporated by reference to an exhibit to the  Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004)                                   |
|                |       |                                                                                                                                                                                                                     |
| 3.2                 |       | Amended and Restated  Bylaws (incorporated by reference to an exhibit to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 2004)                                                         |
|                |       |                                                                                                                                                                                                                     |
| 4.1                 |       | Specimen Stock  Certificate (incorporated by reference to an exhibit to the Registrant’s  Amendment No. 6 to the Registration Statement on Form S-1 filed with the  Commission on December 9, 2004 (No. 333-118193) |
|                |       |                                                                                                                                                                                                                     |
| 10.1                |       | Agreement of Purchase  and Sale, dated June 23, 2005, by and between Comstock Carter Lake, L.C. and  E.R. Carter, L.L.C.                                                                                                 |
|                |       |                                                                                                                                                                                                                     |
| 10.2                |       | Agreement of Sale,  dated September 28, 2005, by and between Comstock Bellemeade, L.C. and  Bellemeade Farms Investors, LLC et. al.                                                                                      |
|                |       |                                                                                                                                                                                                                     |
| 10.3                |       | Loan Agreement, dated  September 28, 2005, by and between Comstock Bellemeade, L.C. and Bank of  America, N.A.                                                                                                           |
|                |       |                                                                                                                                                                                                                     |
| 10.4                |       | Guaranty Agreement,  dated September 28, 2005, by the Registrant in favor of Bank of America, N.A.                                                                                                                       |
|                |       |                                                                                                                                                                                                                     |
| 31.1                |       | Certification of  Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule  15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended                                                 |
|                |       |                                                                                                                                                                                                                     |
| 31.2                |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated  under the Securities Act of 1934, as amended                                                                       |
|                |       |                                                                                                                                                                                                                     |
| 31.3                |       | Certification of  Chairman and Chief Executive Officer and Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                            |

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                    | COMSTOCK HOMEBUILDING  COMPANIES, INC. |
|-------------------------|----------------------------------------|
|                    |                                   |   |
|                    |                                   |   |
| Date: November 10, 2005 | By:                                    | /s/ Christopher  Clemente | . |
|                    |                                   | Christopher Clemente |   |
|                    |                                   | Chairman and Chief Executive  Officer |   |
|                    |                                   |   |
|                    |                                   |   |
|                    | By:                                    | /s/ Bruce J.  Labovitz |   |
|                    |                                   | Bruce J. Labovitz |   |
|                    |                                   | Chief Financial Officer |   |
|                         |                                        |  |  |  |

 

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