form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q



x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2013
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 001-07395
 
AV HOMES, INC.
(Exact name of registrant as specified in its charter)
 

Delaware
 
23-1739078
(State or other Jurisdiction of Incorporation or Organization)
 
(I.R.S.  Employer Identification No.)

8601 N. Scottsdale Rd., Suite 225, Scottsdale, Arizona
 
85253
(Address of Principal Executive Offices)
 
(Zip Code )

(480) 214-7400
(Registrant’s telephone number, including area code)

 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”  “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer: o
Accelerated filer: þ
Non-accelerated filer: o
Smaller reporting company: o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

12,787,377 shares of AV Homes' common stock ($1.00 par value) were outstanding as of May 6, 2013.
 


 
 

 

AV HOMES, INC. AND SUBSIDIARIES

INDEX
 
 
 
 
PAGE
PART I.    Financial Information
 
 
 
 
 
 
Item 1.    Financial Statements:
 
 
 
 
 
 
 
1
 
 
 
 
 
 
2
 
 
 
 
 
 
3
 
 
 
 
 
 
4
 
 
 
 
 
19
 
 
 
 
 
29
 
 
 
 
 
Item 4.     Controls and Procedures
29
 
 
 
 
PART II.   Other Information
 
 
 
 
 
 
Item 1A.    Risk Factors
30
 
 
 
 
 
Item 6.       Exhibits
41
 
 
 
 
 
42
 
 
i

 
PART  I  --  FINANCIAL  INFORMATION

Item 1.
Financial  Statements
 
 AV HOMES, INC. AND SUBSIDIARIES
 Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
 
 
 
March 31,
2013
 
 
December 31,
2012
 
Assets
 
(unaudited)
 
 
 
 
Cash and cash equivalents
 
$
71,087
 
 
$
79,815
 
Restricted cash
 
 
4,727
 
 
 
4,682
 
Land and other inventories
 
 
180,826
 
 
 
171,044
 
Receivables, net
 
 
6,362
 
 
 
6,730
 
Income tax receivable
 
 
1,293
 
 
 
1,293
 
Property and equipment, net
 
 
36,395
 
 
 
36,661
 
Investments in and notes receivable from unconsolidated entities
 
 
1,240
 
 
 
1,220
 
Prepaid expenses and other assets
 
 
10,156
 
 
 
10,777
 
Assets held for sale
 
 
20,191
 
 
 
25,649
 
Total Assets
 
$
332,277
 
 
$
337,871
 
 
 
 
 
 
 
 
 
 
Liabilities and Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Accounts payable
 
$
4,719
 
 
$
4,656
 
Accrued and other liabilities
 
 
11,576
 
 
 
12,978
 
Customer deposits and deferred revenues
 
 
2,156
 
 
 
1,985
 
Estimated development liability for sold land
 
 
32,955
 
 
 
32,974
 
Notes Payable
 
 
105,402
 
 
 
105,402
 
Total Liabilities
 
 
156,808
 
 
 
157,995
 
 
 
 
 
 
 
 
 
 
Equity
 
 
 
 
 
 
 
 
Common Stock, par value $1 per share
 
 
 
 
 
 
 
 
Authorized:  50,000,000 shares
 
 
 
 
 
 
 
 
Issued:          12,898,251 shares at March 31, 2013
               
                   12,938,157 shares at December 31, 2012
 
 
12,898
 
 
 
12,938
 
Additional paid-in capital
 
 
262,651
 
 
 
262,363
 
Retained (deficit) earnings
 
 
(110,869
)
 
 
(106,110
)
 
 
 
164,680
 
 
 
169,191
 
 
 
 
 
 
 
 
 
 
Treasury stock: at cost, 110,874 shares at March 31, 2013 and December 31, 2012
 
 
(3019
)
 
 
(3,019
)
Total AV Homes stockholders’ equity
 
 
161,661
 
 
 
166,172
 
Non-controlling interest
 
 
13,808
 
 
 
13,704
 
Total Equity
 
 
175,469
 
 
 
179,876
 
 
 
 
 
 
 
 
 
 
Total Liabilities and Equity
 
$
332,277
 
 
$
337,871
 

See notes to consolidated financial statements.
 
 
1


AV HOMES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income (Loss)
For the three months ended March 31, 2013 and 2012
(unaudited)
 (Dollars in thousands except per-share amounts)

 
 
Three Months
 
 
 
2013
 
 
2012
 
Revenues
 
 
 
 
 
 
Real estate revenues
 
   
 
 
     
Homebuilding
 
$
22,548
   
$
17,438
 
Commercial and industrial and other land sales
   
2,305
     
9,058
 
Other real estate
   
257
     
144
 
Total real estate revenues
   
25,110
     
26,640
 
Interest income
 
 
9
 
 
 
31
 
Other
 
 
-
 
 
 
39
 
Total revenues
 
 
25,119
 
 
 
26,710
 
 
 
 
 
 
 
 
 
 
Expenses
 
 
 
 
 
 
 
 
Real estate expenses
 
 
 
 
 
 
 
 
Homebuilding
   
22,765
     
19,881
 
Commercial and industrial and other land sales
   
865
     
5,967
 
Other real estate
   
707
     
2,054
 
Total real estate expenses
   
24,337
     
27,902
 
Impairment charges
 
 
-
 
 
 
152
 
General and administrative expenses
 
 
3,705
 
 
 
3,306
 
Interest expense
 
 
1,773
 
 
 
2,237
 
Total expenses
 
 
29,815
 
 
 
33,597
 
 
 
 
 
 
 
 
 
 
Loss from unconsolidated entities
 
 
(63
)
 
 
(36
)
 
 
 
 
 
 
 
 
 
Loss before income taxes
 
 
(4,759
)
 
 
(6,923
)
Income tax (expense) benefit
 
 
-
 
 
 
-
 
 
 
 
 
 
 
 
 
 
Net loss and comprehensive loss
 
 
(4,759
)
 
 
(6,923
)
 
 
 
 
 
 
 
 
 
Net loss attributable to non-controlling interests in consolidated entities
 
 
-
 
 
 
(1,528
)
 
 
 
 
 
 
 
 
 
Net loss and comprehensive loss attributable to AV Homes stockholders
 
$
(4,759
)
 
$
(8,451
)
 
 
 
 
 
 
 
 
 
Basic and Diluted Loss Per Share
 
$
(0.38
)
 
$
(0.68
)

See notes to consolidated financial statements.
 
 
2

 
AV HOMES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
For the three months ended March 31, 2013 and 2012
(Dollars in thousands)
 
    Three Months  
 
 
2013
 
 
2012
 
OPERATING ACTIVITIES
 
 
 
 
 
 
Net loss
 
$
(4,759
)
 
$
(6,923
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
   
 
 
 
 
Depreciation and amortization
 
 
645
 
 
 
942
 
Amortization of stock-based compensation
 
 
282
 
 
 
420
 
Impairment of land and other inventories
 
 
-
 
 
 
152
 
Loss from unconsolidated entities
 
 
63
 
 
 
36
 
Changes in operating assets and liabilities:
 
 
   
 
 
 
 
Restricted cash
 
 
(45
)
 
 
851
 
Receivables, net
 
 
368
 
 
 
(1,836
)
Land and other inventories
 
 
(9,782
)
 
 
5,994
 
Assets held for sale
 
 
5,458
 
 
 
3,949
 
Prepaid expenses and other assets
 
 
621
 
 
 
(167
)
Accounts payable estimated development liability and accrued and other liabilities
 
 
(1,358
)
 
 
(5,248
)
Customer deposits and deferred revenues
 
 
171
 
 
 
(284
)
NET CASH USED IN OPERATING ACTIVITIES
 
 
(8,336
)
 
 
(2,114
)
 
 
 
   
 
 
 
 
INVESTING ACTIVITIES
 
 
   
 
 
 
 
Investment in property and equipment
 
 
(379
)
 
 
(316
)
Return of capital from unconsolidated entities
 
 
-
 
 
 
10
 
Investment in unconsolidated entities
 
 
(83
)
 
 
(30
)
NET CASH USED IN INVESTING ACTIVITIES
 
 
(462
)
 
 
(336
)
 
 
 
   
 
 
 
 
FINANCING ACTIVITIES
 
 
   
 
 
 
 
Contributions from consolidated joint venture partner
 
 
104
 
 
 
113
 
Distributions to consolidated joint venture partner
 
 
-
 
 
 
(1,785
)
Payment of withholding taxes related to restricted stock and units withheld
 
 
(34
)
 
 
(36
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
 
70
 
 
 
(1,708
)
 
 
 
   
 
 
 
 
DECREASE IN CASH AND CASH EQUIVALENTS
 
 
(8,728
)
 
 
(4,158
)
Cash and cash equivalents at beginning of period
 
 
79,815
 
 
 
124,316
 
 
 
 
   
 
 
 
 
CASH AND CASH EQUIVALENTS AT END OF  PERIOD
 
$
71,087
 
 
$
120,158
 

See notes to consolidated financial statements.
 
 
3

 
 AV HOMES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
March 31, 2013
(Dollars in thousands except share and per share data)
 
Note A - Basis of Financial Statement Presentation and Summary of Significant Accounting Policies
 
The accompanying consolidated financial statements include the accounts of AV Homes, Inc. and all subsidiaries, partnerships and other entities in which AV Homes, Inc. (“AV Homes”, “we”, “us”, “our”, or “the Company”) has a controlling interest. Our investments in unconsolidated entities in which we have less than a controlling interest are accounted for using the equity method.  All significant intercompany accounts and transactions have been eliminated in consolidation.
 
The consolidated balance sheets as of March 31, 2013 and December 31, 2012, and the related consolidated statements of operations and comprehensive income (loss) for the three months ended March 31, 2013 and 2012 and the consolidated statements of cash flows for the three months ended March 31, 2013 and 2012 have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Such adjustments consisted only of normal recurring items. Interim results are not necessarily indicative of results for a full year.
 
The preparation of our consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
The consolidated balance sheet as of December 31, 2012 was derived from consolidated financial statements included in our 2012 Annual Report on Form 10-K but does not include all disclosures required by GAAP. These consolidated financial statements should be read in conjunction with our December 31, 2012 consolidated financial statements included in our 2012 Annual Report on Form 10-K and the notes to the consolidated financial statements included therein.
 
Note B - Cash and Cash Equivalents
 
We consider all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents. As of March 31, 2013, our cash and cash equivalents were invested primarily in money market accounts that invest in U.S. government securities. Due to the short maturity period of the cash equivalents, the carrying amount of these instruments approximates their fair values.
 
Our cash items that are restricted as to withdrawal or usage include deposits of $4,727 and $4,682 as of March 31, 2013 and December 31, 2012, respectively. The balance as of March 31, 2013 is comprised primarily of $3,615 on deposit with Citibank to collateralize letters of credit outstanding, $477 in land escrow accounts and $584 of housing deposits from customers that will become available when the housing contracts close.
 
 
4

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note C - Receivables, net
 
Receivables, net includes amounts in transit or due from title companies for home closings, membership dues related to our amenity operations, and contracts and mortgage notes receivable from the sale of land.
 
Note D - Income Tax Receivable
 
Income tax receivable consists of tax refunds we expect to receive within one year. As of both March 31, 2013 and December 31, 2012, we had $1,293 of income tax receivable.
 
Note E - Land and Other Inventories
 
Land and Other Inventories are stated at cost unless the asset is determined to be impaired, in which case the asset is written down to its fair value.  Land and Other Inventories include expenditures for land acquisition, construction, land development and direct and allocated costs. Land and Other Inventories owned and constructed by us also include interest cost capitalized until development and construction are substantially completed. Land and development costs, construction and direct and allocated costs are assigned to components of Land and Other Inventories based on specific identification or other allocation methods based upon GAAP.
 
In accordance with ASC 360-10, Property, Plant and Equipment (“ASC 360-10”), we review our Land and Other Inventories for indicators of impairment.
 
For assets held and used, if indicators are present, we perform an impairment test in which the asset is reviewed for impairment by comparing the estimated future undiscounted cash flows to be generated by the asset to its carrying value. If such cash flows are less than the asset’s carrying value, the carrying value is written down to its estimated fair value.  Generally, fair value is determined by discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the asset and related estimated cash flow streams. The discount rate used in the determination of fair value would range between 15% and 28%, depending on the state of development. Assumptions and estimates used in the determination of the estimated future cash flows are based on expectations of future operations and economic conditions and certain factors described below. Changes to these assumptions could significantly affect the estimates of future cash flows, which could affect the potential for future impairments. Due to the uncertainties of the estimation process, actual results could differ significantly from such estimates.
 
For assets held for sale (such as homes completed or under construction or vacant land parcels available for sale), we perform an impairment test in which the asset is reviewed for impairment by comparing the fair value (estimated sales price) less cost to sell the asset to its carrying value. If such fair value less cost to sell is less than the asset’s carrying value, the carrying value is written down to its estimated fair value less cost to sell.
 
We evaluate our Land and Other Inventories for impairment on a quarterly basis to reflect market conditions, including a significant oversupply of homes available for sale, higher foreclosure activity and significant competition. During the three months ended March 31, 2013 and 2012, our impairment assessment resulted in impairment charges of $0 and $152, respectively, which related to homes completed or under construction. Our evaluation of land developed and/or held for future development or sale did not result in impairment charges during the three months ended March 31, 2013 or March 31, 2012.
 
 
5

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note E - Land and Other Inventories – continued
 
Land and Other Inventories that are subject to a review for indicators of impairment include our: (i) housing communities (active adult and primary residential, including scattered lots) and (ii) land developed and/or held for future development or sale. A discussion of the factors that impact our impairment assessment for these categories follows.
 
Housing communities: Activities include the development of active adult and primary residential communities and the operation of amenities. The operating results and losses generated from active adult and primary residential communities during the three months ended March 31, 2013 and 2012 include operating expenses relating to the operation of the amenities in our communities as well as divisional overhead allocated among several communities.
 
Our active adult and primary residential communities are generally large master-planned communities in Florida and in Arizona. Several of these communities are long term projects on land we have owned for many years. In reviewing each of our communities, we determine if potential impairment indicators exist by reviewing various factors such as actual contribution margins on homes closed in recent months, projected contribution margins on homes in backlog, projected contribution margins on speculative homes, average selling prices, sales activities and local market conditions. If indicators are present, the asset is reviewed for impairment.  In determining estimated future cash flows for purposes of the impairment test, the estimated future cash flows are significantly impacted by specific community factors such as: (i) sales absorption rates; (ii) estimated sales prices and sales incentives; and (iii) estimated cost of home construction, estimated land development costs, interest costs, indirect construction and overhead costs, and selling and marketing costs. In addition, our estimated future cash flows are also impacted by general economic and local market conditions, competition from other homebuilders, foreclosures and depressed home sales in the areas in which we build and sell homes, product desirability in our local markets and the buyers’ ability to obtain mortgage financing. Except for those primary residential communities recently acquired in conjunction with a portfolio of real estate assets in Arizona and Florida in October 2010 (the "JEN Transaction"), build-out of our active adult and primary residential communities generally exceeds five years. Our current assumptions are based on current activity and recent trends at our active adult and primary residential communities.  There are a significant number of assumptions with respect to each analysis. Many of these assumptions extend over a significant number of years.  The substantial number of variables to these assumptions could significantly affect the potential for future impairments.
 
Declines in contribution margins below those realized from our current sales prices and estimations could result in future impairment losses in one or more of our housing communities.
 
Land developed and/or held for future development or sale: Our land developed and/or held for future development or sale represents land holdings for the potential development of future active adult and/or primary residential communities, commercial and industrial uses. For land developed and/or held for future development or sale, indicators of potential impairment include changes in use, changes in local market conditions, declines in the selling prices of similar assets and increases in costs. If indicators are present, the asset is reviewed for impairment. In determining estimated future cash flows for purposes of the impairment test, the estimated future cash flows are significantly impacted by specific community factors such as: (i) sales absorption rates; (ii) estimated sales prices and sales incentives; and (iii) estimated costs of home construction, estimated land and land development costs, interest costs, indirect construction and overhead costs, and selling and marketing costs. In addition, our estimated future cash flows are also impacted by general economic and local market conditions, competition from other homebuilders, foreclosures and depressed home sales in the areas where we own land for future development, product desirability in our local markets and the buyers’ ability to obtain mortgage financing. Factors that we consider in determining the appropriateness of moving forward with land development or whether to write-off the related amounts capitalized include: our current inventory levels, local market economic conditions, availability of adequate resources and the estimated future net cash flows to be generated from the project.
 
 
6

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note E - Land and Other Inventories – continued
 
Land and Other Inventories consist of the following:
 
 
 
March 31,
2013
 
 
December 31,
2012
 
Land developed and in process of development
 
$
93,642
 
 
$
86,931
 
Land held for future development or sale
 
 
53,857
 
 
 
53,526
 
Homes completed or under construction
 
 
33,303
 
 
 
30,563
 
Other
 
 
24
 
 
 
24
 
 
 
$
180,826
 
 
$
171,044
 
 
See “Note U - Business Segments” below.
 
Note F - Property and Equipment
 
Property and Equipment are stated at cost and depreciation is computed using the straight-line method over the following estimated useful lives of the assets: land improvements 10 to 25 years; buildings and improvements 8 to 39 years; and machinery, equipment and fixtures 3 to 7 years. Maintenance and operating expenses of equipment utilized in the development of land are capitalized as land inventory cost.  Repairs and maintenance are expensed as incurred.
 
Property and Equipment includes the cost of amenities, such as club facilities on properties, owned by us. The cost of amenities includes expenditures for land acquisition, construction, land development and direct and allocated costs. Property and Equipment owned and constructed by us also includes interest cost incurred during development and construction.
 
Each reporting period, we review our Property and Equipment for indicators of impairment in accordance with ASC 360-10. For our amenities, which are located within our housing communities, indicators of potential impairment are similar to those of our housing communities (described above) as these factors may impact our ability to generate revenues at our amenities or cause construction costs to increase. In addition, we factor in the collectability and potential delinquency of the fees due for our amenities.  For the three months ended March 31, 2013 and March 31, 2012, we did not identify indicators of impairments for Property and Equipment.
 
Note G - Poinciana Parkway
 
The population of the Poinciana community is approximately 70,000 and we expect the population to grow in the coming years.  We currently own over 5,000 lots and nearly 10,000 acres of additional real estate in the community of Poinciana, Florida. While Poinciana has adequately accommodated the growing population with residential housing, including our Solivita development, the accompanying traffic infrastructure is constrained by Poinciana’s location in the midst of Reedy Creek Wetland System and Disney’s Wilderness Preserve.  Currently, there is only one four-lane arterial roadway connecting Poinciana to the regional road network.   All other access roads are two-lane roads with limited capacity.  The proposed Poinciana Parkway is approximately ten miles long, beginning in Poinciana and connecting to the US17/US92 in Polk County.  Once built, this roadway will provide significant relief to the currently constrained roadway infrastructure that accommodates the daily commuter traffic in Poinciana.  This relief will allow for continued growth in residential, commercial, and employment in the Poinciana community, all of which we believe will enhance its sales and land values in Poinciana.
 
In October of 2012, Osceola County, Polk County, the Osceola County Expressway Authority (the “Expressway Authority”) and Avatar Properties Inc. (“API”), one of our wholly owned subsidiaries, entered in to an Agreement for Development (the “Development Agreement”) of the Poinciana Parkway.  

Pursuant to the Development Agreement, API has assigned to the Expressway Authority all of API’s current plans for the Poinciana Parkway.  The Expressway Authority is in the process of selecting a general contractor to design the final configuration the Poinciana Parkway and to construct the roadway once bond financing is obtained.  Construction is contingent on bond financing obtained by Osceola County and cash contributions by Polk and Osceola Counties which may be funded by grant monies or other sources to be determined.  If all required funds are obtained and the Development Agreement is closed, API will (i) assign at no cost its current permits for the Poinciana Parkway to the Expressway Authority and (ii) donate to Polk County or Osceola County, as applicable, certain rights of way for the Poinciana Parkway and certain additional rights of way that will accommodate both the arterial and southern connector facilities to Osceola and Polk Counties.  The Expressway Authority shall be responsible for construction of the Poinciana Parkway at no cost to API.  The toll portion of the Poinciana Parkway shall be operated and maintained by the Expressway Authority and all excess toll revenues shall be used to fund transportation facilities in the Poinciana area.  Other portions of the Poinciana Parkway will be owned by Polk County or Osceola County, as applicable.
 
If funding and construction of the Poinciana Parkway cannot be achieved as contemplated by the Development Agreement, the counties have no right to obtain damages or seek specific performance for API’s failure to perform under prior agreements with Polk and Osceola Counties regarding its obligation to fund and construct the Poinciana Parkway.   If the Development Agreement is terminated because funding of the Poinciana Parkway construction does not occur,  API shall be entitled to a one year extension of certain of its prior agreements with Osceola County.  If during such extension, API cannot obtain financing and begin construction of the Poinciana Parkway:  (i) a portion of API’s land in Osceola County will become subject to Osceola traffic concurrency requirements applicable generally to other home builders in the county and (ii) API will be required to contribute approximately $1,900 towards the construction cost of certain traffic improvements in Osceola County that we otherwise might have been obligated to build or fund if we had not agreed to construct the Poinciana Parkway.
 
 
7

 
We reviewed the recoverability of the carrying value of the Poinciana Parkway on a quarterly basis in accordance with authoritative accounting guidance.  In the fourth quarter of 2012, we determined that the probability of public funding to occur is high, and as a result, we recorded a non-cash charge of $7,659 related to our expected transfer of mitigation credits carried on our books and the carrying value of contributed right-of-way parcels.  The remaining mitigation credits' book value of $749 was reclassified to Prepaid Expenses and Other Assets on our balance sheet as of December 31, 2012.
 
Note H - Notes Payable
 
4.50% Convertible Senior Notes due 2024
 
On March 30, 2004, we issued $120,000 aggregate principal amount of our 4.50% Convertible Senior Notes due 2024 (the “4.50% Notes”) in a private offering.  The 4.50% Notes mature on April 1, 2024 unless earlier converted, redeemed or repurchased.

Interest: Interest on the 4.50% Notes is 4.50% per year, payable semi-annually in arrears in cash on April 1 and October 1 of each year, commencing October 1, 2004.

Conversion: The 4.50% Notes are convertible into our common stock upon the occurrence of certain triggers described in the Indenture dated March 30, 2004 between us and the trustee named therein (the “4.50% Indenture”).  Shares of our common stock, into which the 4.50% Notes are convertible, have been reserved for issuance.

Repurchase Right/Redemption Right: Holders of the 4.50% Notes had the right to require us to repurchase the 4.50% Notes for cash on April 1, 2011 and have the right to require us to repurchase the 4.50% Notes for cash on April 1, 2014 and April 1, 2019 or upon the occurrence of a “fundamental change” (as defined in the 4.50% Indenture) or a “termination of trading” (as defined in the 4.50% Indenture).  We may, at any time, at our option, redeem for cash all or any portion of the outstanding 4.50% Notes.  In the case of a repurchase or redemption, we will pay a repurchase or redemption price, as applicable, equal to 100% of the principal amount, plus accrued and unpaid interest, if any.

On February 4, 2011, we repurchased $17,765 principal amount of the 4.50% Notes for approximately $18,171 using proceeds from the issuance of our 7.50% Notes discussed below.  On April 1, 2011, holders of $41,637 principal amount of the 4.50% Notes exercised their right to require us to repurchase the 4.50% Notes.

FASB ASC 470-20 requires the issuer of certain convertible debt instruments that may be settled in cash on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate.  ASC 470-20 requires bifurcation of the instrument into a debt component that is initially recorded at fair value and an equity component.  The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity.  The excess of the principal amount of the liability component over its carrying amount and the debt issuance costs are amortized to interest cost using the interest method over the expected life of a similar liability that does not have an associated equity component.  The discount on the liability component of the 4.50% Notes is amortized using the effective interest method based on an effective rate of 7.50%, which was the estimated market interest rate for similar debt without a conversion option on the issuance date.  The discount was amortized from the issuance date in 2004 through April 1, 2011, the first date that holders of the 4.50% Notes could require us to repurchase the 4.50% Notes.  The discount was fully amortized in 2011.

As of March 31, 2013 and December 31, 2012, $5,402 aggregate principal amount of the 4.50% Notes remain outstanding.

7.50% Senior Convertible Notes due 2016
 
On February 4, 2011, we completed an underwritten public offering for $100,000 aggregate principal amount of our 7.50% Senior Convertible Notes due 2016 (the “7.50% Notes”).  The 7.50% Notes mature on February 15, 2016 unless earlier converted, redeemed or repurchased.  The 7.50% Notes are governed by the Indenture and the First Supplemental Indenture, each dated February 4, 2011 (collectively, the “First Supplemental Indenture”), between us and the trustee named therein.

Interest: Interest on the 7.50% Notes is 7.50% per year, payable semi-annually in arrears in cash on February 15 and August 15 of each year, commencing August 15, 2011.
 
 
8

 
Conversion: Holders may convert the 7.50% Notes into shares of our common stock at any time on or prior to the close of business on the business day immediately preceding the maturity date of February 15, 2016.  The 7.50% Notes are convertible at an initial conversion rate of 33.3333 shares of common stock per $1 principal amount of the 7.50% Notes (equivalent to an initial conversion price of approximately $30.00 per share).  The conversion rate, and thus the conversion price, may be adjusted under certain circumstances, including upon the occurrence of a “non-stock change of control” as such term is defined in the First Supplemental Indenture.  Upon any conversion, subject to certain exceptions, holders will not receive any cash payment representing accrued and unpaid interest.  Shares of our common stock, into which the 7.50% Notes are convertible, have been reserved for issuance.
 
Financial covenants: The First Supplemental Indenture includes the following financial covenants:
 
 
·
until February 15, 2014, we will maintain, at all times, cash and cash equivalents of not less than $20,000;
 
 
·
until February 4, 2013, our total consolidated indebtedness (as “indebtedness” is defined in the First Supplemental Indenture) may not exceed $150,000;
 
 
·
until February 4, 2013, our total consolidated indebtedness (as “indebtedness” is defined in the First Supplemental Indenture) shall not exceed $50,000 at any time, excluding for purposes of this covenant: (a) the 7.50% Notes, and (b) any indebtedness with a maturity date after February 15, 2014, which indebtedness does not provide the holder with a unilateral put right prior to February 15, 2014.
 
           Repurchase Right: Holders of the 7.50% Notes have the right to require us to repurchase the 7.50% Notes on February 15, 2014 or upon the occurrence of a “fundamental change” (as defined in the First Supplemental Indenture), in each case at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest.  The holders of the 7.50% Notes also have the right to require us to repurchase 50% of the 7.50% Notes upon the occurrence of a breach of any of the above financial covenants at a repurchase price equal to 110% of the principal amount, plus accrued and unpaid interest.
 
 Redemption Right : We may, at any time on or after February 15, 2014, at our option, redeem for cash all or any portion of the outstanding 7.50% Notes at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest, but only if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the trading day before the date that we provide the notice of redemption to holders exceeds 130% of the conversion price in effect on each such trading day and certain other conditions described in the First Supplemental Indenture are met.
 
As of March 31, 2013 and December 31, 2012, $55,500 aggregate principal amount of the 7.50% Notes remain outstanding.
 
7.50% Senior Exchange Convertible Notes due 2016
 
 In July 2012, we entered into exchange agreements under which we retired $44,500 in aggregate principal amount of our 7.50% Notes, in exchange for the issuance of $44,500 in aggregate principal of new 7.50% Senior Exchange Convertible Notes due 2016 (“7.50% Exchange Notes”).  The 7.50% Exchange Notes mature on February 15, 2016 unless earlier converted, redeemed or repurchased.  The 7.50% Exchange Notes are governed by the Indenture dated February 4, 2011 and the Second Supplemental Indenture dated July 25, 2012 between us and the trustee named therein (collectively, the “Second Supplemental Indenture”).

Interest: Interest on the 7.50% Exchange Notes is 7.50% per year, payable semi-annually in arrears in cash on February 15 and August 15 of each year, commencing February 15, 2013.

Conversion: The 7.50% Exchange Notes are convertible and have an initial conversion rate of 55.5555 shares of common stock per $1 principal amount of notes (equivalent to a conversion price of approximately $18.00 per share), subject to adjustment in certain events. We have the right, but not an obligation, to require holders to convert the 7.50% Exchange Notes in whole or in part if the closing price of our common stock equals or exceeds 130% of the conversion price then in effect for a specified period and certain other conditions are satisfied.  Shares of our common stock, into which the 7.50% Exchange Notes are convertible, have been reserved for issuance.

Financial covenants: The Second Supplemental Indenture includes the same financial covenants as those governing the 7.50% Notes, except that the outstanding 7.50% Exchange Notes, as well as the 7.50% Notes, are excluded from the third covenant.  We may suspend the operation of these financial covenants with respect to the 7.50% Exchange Notes if the aggregate principal amount outstanding of the 7.50% Notes and the 7.50% Exchange Notes does not exceed $33,000.

Repurchase Right: Unlike the 7.50% Notes, the 7.50% Exchange Notes do not provide that the holders may require us to repurchase the 7.50% Exchange Notes on February 15, 2014. However, holders of the 7.50% Exchange Notes have the right to require us to repurchase the 7.50% Exchange Notes upon the occurrence of a “fundamental change” (as defined in the Second Supplemental Indenture).  The holders of the 7.50% Exchange Notes also have the right to require us to repurchase 50% of the 7.50% Exchange Notes upon the occurrence of a breach of any of the above financial covenants at a repurchase price equal to 110% of the principal amount, plus accrued and unpaid interest.
 
 
9

 
Redemption Right: We have the right to redeem the 7.50% Exchange Notes on or after February 15, 2015.  Prior to that date, the 7.50% Exchange Notes are redeemable, on one occasion only, upon the occurrence of certain events and the satisfaction of certain conditions (as described in the Second Supplemental Indenture).  In each case, the redemption price is equal to 100% of the principal amount, plus accrued and unpaid interest.
 
We have assessed the 7.50% Exchange Notes and concluded that the impact of any embedded derivative features are not material as of March 31, 2013, subject to further review over the life of the 7.50% Exchange Notes.  As of March 31, 2013 and December 31, 2012, $44,500 aggregate principal amount of the 7.50% Exchange Notes remain outstanding.
 
The following table represents interest incurred, interest capitalized, and interest expense for the three months ended March 31, 2013 and 2012:
 
 
 
2013
 
 
2012
 
Interest incurred
 
$
2,324
 
 
$
2,349
 
Interest capitalized
 
 
(551
)
 
 
(112
)
Interest expense
 
$
1,773
 
 
$
2,237
 
 
We made interest payments of $3,935 and $3,766 during the three months ended March 31, 2013 and 2012, respectively.
 
 
10

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note I - Warranty Costs
 
Warranty reserves for houses are established to cover estimated costs for materials and labor with regard to warranty-type claims to be incurred subsequent to the closing of a house. Reserves are determined based on historical data and other relevant factors. We may have recourse against subcontractors for claims relating to workmanship and materials. Warranty reserves are included in Accrued and Other Liabilities in the consolidated balance sheets.
 
During the three months ended March 31, 2013 and 2012, changes in the warranty reserve consisted of the following:
 
 
 
Three Months
 
 
 
2013
 
 
2012
 
Accrued warranty reserve, beginning of period
 
$
549
 
 
$
537
 
Estimated warranty expense
 
 
108
 
 
 
163
 
Amounts charged against warranty reserve
 
 
(204
)
 
 
(99
)
Accrued warranty reserve, end of period
 
$
453
 
 
$
601
 
 
Note J - Loss Per Share
 
We present loss per share in accordance with ASC 260, Earnings Per Share (“ASC 260”). Basic earnings (loss) per share is computed by dividing earnings (loss) attributable to AV Homes stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of AV Homes. In accordance with ASC 260, the computation of diluted earnings (loss) per share for the three months ended March 31, 2013 and 2012 did not assume the effect of restricted stock units, employee stock options, the 7.50% Notes, the 7.50% Exchange Notes, or the 4.50% Notes because the effects were antidilutive.
 
The weighted average number of shares outstanding in calculating basic loss per share includes the cancellation of 2,364 shares of common stock and the issuance of 6,734 shares of common stock for the three months ended March 31, 2013, and cancellation of 5,072 shares of common stock for the three months ended March 31, 2012.  In accordance with ASC 260, non-vested restricted shares are not included in basic earnings per share until the vesting requirements are met.
 
The following table represents the net loss and weighted average shares outstanding for the calculation of basic and diluted loss per share for the three months ended March 31, 2013 and 2012:
 
 
 
Three Months
 
 
 
2013
 
 
2012
 
Numerator:
 
 
 
 
 
 
Basic and diluted loss per share – net loss
 
$
(4,759
)
 
$
(8,451
)
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
Basic and diluted weighted average shares outstanding
 
 
12,654,466
 
 
 
12,521,483
 
 
 
11

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note K - Repurchase of Common Stock
 
On October 13, 2008, our Board of Directors amended its June 2005 authorization to purchase the 4.50% Notes and/or common stock to allow expenditures up to $30,000, including the $9,864 previously authorized. On October 17, 2008, we repurchased $35,920 principal amount of the 4.50% Notes for approximately $28,112, including accrued interest. On December 12, 2008, our Board of Directors amended its June 2005 authorization to purchase the 4.50% Notes and/or common stock to allow expenditures up to $30,000, including the $1,888 remaining after the October 2008 activities.  In 2009, we repurchased $14,076 principal amount of the 4.50% Notes for approximately $11,696, including accrued interest.  As of March 31, 2013, the remaining authorization is $18,304.
 
Note L - Non-controlling Interest
 
AV Homes has consolidated certain limited liability companies (the "LLCs"), which qualify as variable interest entities (“VIEs”) because we determined that AV Homes is the primary beneficiary. Therefore, the LLCs’ financial statements are consolidated in AV Homes’ consolidated financial statements and the other partners’ equity in each of the LLCs is recorded as non-controlling interest as a component of consolidated stockholders’ equity.  At March 31, 2013 and December 31, 2012, non-controlling interest was $13,808 and $13,704, respectively.
 
Note M - Comprehensive Loss
 
Net loss and comprehensive loss are the same for the three months ended March 31, 2013 and 2012.
 
Note N - Share-Based Payments and Other Executive Compensation
 
On June 2, 2011, our stockholders approved the Amended and Restated 1997 Incentive and Capital Accumulation Plan (2011 Restatement) (the "Incentive Plan") to, among other things, increase the aggregate number of shares of our common stock, par value $1.00 per share, authorized for issuance under the Incentive Plan by 700,000 shares from 1,500,000 shares to 2,200,000 shares and extend the term of the Incentive Plan until October 25, 2020. The Incentive Plan provides for the grant of stock options, stock appreciation rights, stock awards, performance awards, and stock units to our officers, employees and directors. The exercise price of stock options may not be less than the stock exchange closing price of our common stock on the date of grant. Stock option awards under the Incentive Plan generally expire 10 years after the date of grant.
 
As of March 31, 2013, an aggregate of 1,126,535 shares of our common stock, subject to certain adjustments, were reserved for issuance under the Incentive Plan, including an aggregate of 328,152 options, restricted stock units and stock units granted. There were 798,383 shares available for grant at March 31, 2013.
 
During the quarter, we cancelled the issuance of 114,750 restricted shares granted in 2011 to certain executives and issued additional performance-based restricted shares in exchange.  We also issued performance-based restricted shares to other members of management.  Vesting is contingent upon the achievement of certain performance objectives, some of which are subjective in nature.  Compensation cost for these awards is recognized over the service period, and variable accounting is applied where by the fair value of the award is remeasured each reporting period until vesting occurs.  The cancellation and issuance of shares was accounted for as a modification with the future compensation expense computed using the greater of unamortized fair value of the cancelled awards or the incremental fair value as remeasured each reporting period.
 
Compensation expense related to the stock option, restricted stock, and restricted stock unit awards during the three months ended March 31, 2013 and 2012 was $282 and $420, respectively, all of which relates to restricted stock units. During the quarter, we executed amendments to the Amended and Restated Employment Agreements with two of our executives.  Under the terms of these amendments, 114,750 restricted shares were cancelled and replaced with new awards.  During the three months ended March 31, 2013, we granted 77,974 shares of restricted stock, which have a weighted average grant date fair value of $19.97 per share. During the three months ended March 31, 2012, we granted 377,500 shares of restricted stock, which have a weighted average grant date fair value of $7.16 per share.
 
As of March 31, 2013, there was $2,342 of unrecognized compensation expense related to unvested restricted stock units. That expense is expected to be recognized over a weighted-average period of 1.96 years.
 
Note O - Retirement of Treasury Stock
 
In March 2012, we retired 1,141,400 shares of treasury stock, which shares also remain as authorized but unissued.  This treasury stock retirement resulted in reductions to common stock of $1,141, treasury stock of $42,905, retained earnings of $18,845 and paid in capital of $22,919.  There was no effect on the total stockholders’ equity position as a result of the retirement.
 
 
12

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note P - Income Taxes
 
Income taxes have been provided using the liability method under ASC 740, Income Taxes (“ASC 740”).  The liability method is used in accounting for income taxes where deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse.
 
In accordance with ASC 740, AV Homes evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During 2008, we established a valuation allowance against our deferred tax assets. Our cumulative loss position over the evaluation period and the uncertain and volatile market conditions provided significant evidence supporting the need for a valuation allowance. During the three months ended March 31, 2013 we recognized an increase of $1,900 in the deferred tax valuation allowance against net deferred tax assets generated from the pretax loss for the quarter. As of March 31, 2013, our deferred tax asset valuation allowance was $128,433.  In future periods, the allowance could be reduced based on sufficient evidence indicating that it is more likely than not that a portion of our deferred tax assets will be realized.
 
On October 25, 2010, we received notification from the Internal Revenue Service (the “IRS”) that our federal income tax returns for tax years 2004, 2005, 2006 and 2009 were being examined.  On February 10, 2012, AV Homes agreed with the IRS’s Notice of Proposed Adjustment to the 2009 net operating loss carryback.  This adjustment generated an income tax expense of $473 for 2011 with a reduction in the anticipated income tax receivables in the same amount.  Income tax receivable as of March 31, 2013 and December 31, 2012 consists of $1,293 in anticipated income tax refunds.
 
In 2006, we sold property we owned in Marion County, Florida to the Board of Trustees of the Internal Improvement Trust Fund of the State of Florida under threat of condemnation. The bulk of the land was transferred in 2006 and the final closing took place in 2007. These transactions and subsequent correspondence with the IRS entitled us to defer payment of income taxes of $24,355 from the gain on these sales until replacement property is sold provided we obtained qualifying replacement property for the Marion property by December 31, 2010. We believe that we acquired appropriate replacement properties by December 31, 2010. If the IRS determines in the future that some or all of the properties acquired by us as replacement properties do not qualify as replacement properties, we may be required to make an income tax payment plus interest on the value of the portion of the properties determined not to qualify as replacement property.
 
Note Q - Fair Value Disclosures
 
ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), provides guidance for using fair value to measure assets and liabilities, defines fair value, establishes a framework for measuring fair value under GAAP, expands disclosures about fair value measurements, and establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
 
ASC 820-10-65, Fair Value Measurements and Disclosures – Overall – Transition and Open Effective Date Information provides guidelines for making fair value measurements more consistent with the principles presented in ASC 820-10, Fair Value Measurements and Disclosures - Overall . This topic provides additional authoritative guidance in determining whether a market is active or inactive, and whether a transaction is distressed, is applicable to all assets and liabilities (i.e. financial and nonfinancial), and requires enhanced disclosures.
 
 
13

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note Q - Fair Value Disclosures – continued
 
The accounting standards require that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
 
 
Level 1:
Fair value determined based on quoted market prices in active markets for identical assets and liabilities.

 
Level 2:
Fair value determined using significant observable inputs, such as quoted prices for similar assets or liabilities or quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that are derived principally from or corroborated by observable market data, by correlation or other means.

 
Level 3:
Fair value determined using significant unobservable inputs, such as discounted cash flows, or similar techniques.

The carrying value of cash and cash equivalents, restricted cash, receivables, income tax receivable and accounts payable approximates the fair value due to their short-term maturities.
 
The majority of our non-financial instruments, which include Land and Other Inventories and Property and Equipment, are not required to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment, a resulting asset impairment would require that the non-financial instrument be recorded at the lower of historical cost or its fair value.
 
AV Homes did not have any assets measured at fair value as of March 31, 2013.
 
For assets held for sale (such as homes completed or under construction or vacant land parcels available for sale), we perform an impairment test in which the asset is reviewed for impairment by comparing the fair value (estimated sales price) less cost to sell the asset to its carrying value. If such fair value less cost to sell is less than the asset’s carrying value, the carrying value is written down to its estimated fair value less cost to sell.
 
For assets held and used, if indicators are present, we perform an impairment test in which the asset is reviewed for impairment by comparing the estimated future undiscounted cash flows to be generated by the asset to its carrying value. If such cash flows are less than the asset’s carrying value, the carrying value is written down to its estimated fair value.  Generally, fair value is determined by discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the asset and related estimated cash flow streams. The discount rate used in the determination of fair value would range between 15 and 28% depending on the stage of development. Assumptions and estimates used in the determination of the estimated future cash flows are based on expectations of future operations and economic conditions and certain factors described below. Changes to these assumptions could significantly affect the estimates of future cash flows which could affect the potential for future impairments. Due to the uncertainties of the estimation process, actual results could differ significantly from such estimates.
 
 
14

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note Q - Fair Value Disclosures – continued
 
The carrying amounts and fair values of our financial instruments at March 31, 2013 and December 31, 2012 are as follows:
 
 
 
March 31, 2013
 
 
December 31, 2012
 
 
 
Carrying
Amount
 
 
Fair
Value
 
 
Carrying
Amount
 
 
Fair
Value
 
Notes, mortgage notes and other debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4.50% Notes
 
$
5,402
 
 
$
5,336
 
 
$
5,402
 
 
$
5,343
 
7.50% Notes and 7.50% Exchange Notes
 
$
100,000
 
 
$
101,790
 
 
$
100,000
 
 
$
101,500
 
 
In estimating the fair value of financial instruments, we used the following methods and assumptions:
 
7.50% Notes, 7.50% Exchange Notes, and 4.50% Notes: At March 31, 2013 and December 31, 2012, the fair value of the 7.50% Notes, 7.50% Exchange Notes, and the 4.50% Notes is estimated, based on quoted or estimated market prices.  These fall within Level 2 of the fair value hierarchy.
 
Note R - Variable Interest Entities
 
GAAP requires a variable interest entity (“VIE”)  to be consolidated with a company that is the primary beneficiary. The primary beneficiary of a VIE is the entity that has both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. Entities determined to be VIEs, for which we are not the primary beneficiary, are accounted for under the equity method.
 
AV Homes' variable interest in VIEs may be in the form of (1) equity ownership, (2) contracts to purchase assets and/or (3) loans provided by AV Homes to a VIE. We examine specific criteria and use judgment when determining if AV Homes is the primary beneficiary of a VIE. Factors considered in determining whether we are the primary beneficiary include risk and reward sharing, experience and financial condition of other partner(s), voting rights, involvement in day-to-day capital and operating decisions, level of economic disproportionality between AV Homes and the other partner(s) and contracts to purchase assets from VIEs.
 
We participate in entities with equity interests ranging from 20% to 58.2% for the purpose of acquiring and/or developing land in which we may or may not have a controlling interest. These entities are VIEs and our investments in these entities, along with other arrangements represent variable interests, depending on the contractual terms of the arrangement. We analyze these entities when they are entered into or upon a reconsideration event.
 
 
15

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note R - Variable Interest Entities - continued
 
Consolidation of Variable Interest Entities
 
During 2009, we entered into two separate agreements with unrelated third parties providing for the formation of two LLCs. We subsequently sold developed, partially developed and undeveloped land to each of the newly formed companies for a combination of cash and purchase money notes. We acquired a minority ownership interest in each of the LLCs and participate in the management of each of the LLCs. We also entered into land option contracts with these newly formed LLCs. Under such land option contracts, we paid a specified option deposit in consideration for the right, but not the obligation, to purchase developed lots in the future at predetermined prices.
 
In May 2012, we entered into an agreement with JEN Arizona 4, LLC to form a limited liability company, EM 646, LLC (“EM 646”).  We hold a 58.2% interest in the venture, which was organized for the purpose of acquiring, entitling, developing, and distributing specific sections of real property located in Mesa, Arizona.  The property was acquired in November 2012, and will be distributed to the partners at cost, once certain entitlements and development activities are completed.

We determined that these entities qualify as VIEs, which require consolidation by the entity determined to be the primary beneficiary.  As a result of our analyses, we hold a variable interest in the VIEs through the purchase money notes, the land option contracts and an economic interest in these LLCs.  As of March 31, 2013, our consolidated balance sheets include $32,972 in Land and Other Inventories from these LLCs. As of December 31, 2012, our consolidated balance sheets include $32,659 in Land and Other Inventories from these LLCs.
 
In January 2012, all of the real property owned by one of our consolidated joint ventures was sold to an unrelated third party.  The net gain on this sale of approximately $2,731 is fully recognized and included as a component of net loss on our consolidated statement of operations and comprehensive income (loss).  We present the joint venture partner's 60% share of this income, $1,639, on our consolidated statement of operations and comprehensive income (loss) as a component of net income (loss) attributable to non-controlling interests in consolidated entities.
 
AV Homes and its equity partners make initial or ongoing capital contributions to these consolidated entities on a pro rata basis. The obligation to make capital contributions is governed by each consolidated entity’s respective operating agreement.
 
As of March 31, 2013, these consolidated entities were financed by partner equity and do not have third-party debt. In addition, we have not provided any guarantees to these entities or our equity partners. The assets of our VIEs can only be used to settle obligations of the VIEs.
 
Unconsolidated Variable Interest Entities
 
We participate in entities with equity interests ranging from 20% to 50% for the purpose of acquiring and/or developing land in which we do not have a controlling interest.  We analyze these entities when they are entered into or upon a reconsideration event.  All of such entities in which we had an equity interest at March 31, 2013 and December 31, 2012 are accounted for under the equity method.
 
AV Homes shares in the profits and losses of these unconsolidated entities generally in accordance with its ownership interests. AV Homes and its equity partners make initial or ongoing capital contributions to these unconsolidated entities on a pro rata basis. The obligation to make capital contributions is governed by each unconsolidated entity’s respective operating agreement.
 
Prior to 2010, we entered into various transactions with unaffiliated third parties providing for the formation of LLCs, and we subsequently sold developed and partially developed land to each of these LLCs.  We acquired a minority ownership interest in each of the LLCs and share in the management of each. AV Homes made contributions totaling $83 and $30 to its unconsolidated entities during the three months ended March 31, 2013 and 2012, respectively.
 
As of March 31, 2013, these unconsolidated entities were financed by partner equity and do not have third-party debt. In addition, we have not provided any guarantees to these entities or our equity partners.
 
 
16

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note R - Variable Interest Entities - continued
 
The following are the consolidated condensed balance sheets of our unconsolidated entities as of March 31, 2013 and December 31, 2012:
 
 
 
March 31,
 
 
December 31,
 
 
 
2013
 
 
2012
 
Assets:
 
 
 
 
 
 
Cash
 
$
147
 
 
$
53
 
Land and other inventory
 
 
6,126
 
 
 
6,126
 
Other assets
 
 
6
 
 
 
6
 
Total assets
 
$
6,279
 
 
$
6,185
 
 
 
 
 
 
 
 
 
 
Liabilities and Partners’ Capital:
 
 
 
 
 
 
 
 
Accounts payable and accrued liabilities
 
$
82
 
 
$
83
 
Partners’ Capital of:
 
 
 
 
 
 
 
 
AV Homes
 
 
1,240
 
 
 
1,220
 
Equity partners
 
 
4,957
 
 
 
4,882
 
Total liabilities and partners’ capital
 
$
6,279
 
 
$
6,185
 
 
The following are the consolidated condensed statements of operations of our unconsolidated entities for the three months ended March 31, 2013 and 2012:
 
 
 
2013
 
 
2012
 
 
 
 
 
 
 
 
Revenues
 
$
-
 
 
$
-
 
Costs and expenses
 
 
138
 
 
 
91
 
Net loss from unconsolidated entities
 
$
(138
)
 
$
(91
)
AV Homes' share of loss from unconsolidated entities
 
$
(63
)
 
$
(36
)
 
Note S - Estimated Development Liability for Sold Land
 
The estimated development liability consists primarily of utilities improvements in Poinciana and Rio Rico for more than 8,000 homesites previously sold and is summarized as follows:
 
 
 
March 31,
2013
 
 
December 31,
2012
 
Gross estimated unexpended costs
 
$
35,860
 
 
$
35,879
 
Less costs relating to unsold homesites
 
 
(2,905
)
 
 
(2,905
)
Estimated development liability for sold land
 
$
32,955
 
 
$
32,974
 
 
The estimated development liability for sold land is reduced by actual expenditures and is evaluated and adjusted, as appropriate, to reflect management’s estimate of anticipated costs.  In addition, we obtain third-party engineer evaluations and adjust this liability to reflect changes in the estimated costs. We recorded charges associated with these obligations of $19 and $100 during the three months ended March 31, 2013 and 2012, respectively. Future increases or decreases of costs for construction, material and labor as well as other land development and utilities infrastructure costs may have a significant effect on the estimated development liability.
 
 
17

 
Notes to Consolidated Financial Statements (dollars in thousands except share and per share data) (Unaudited) – continued
 
Note T - Commitments and Contingencies
 
We are involved in various pending litigation matters primarily arising in the normal course of our business. These cases are in various procedural stages. Although the outcome of these matters cannot be determined, AV Homes believes it is probable in accordance with ASC 450-20, Loss Contingencies , that certain claims may result in costs and expenses estimated at approximately $36 and $258, which have been accrued in the accompanying consolidated balance sheets as of March 31, 2013 and December 31, 2012, respectively. Liabilities or costs arising out of these and other currently pending litigation is not expected to have a material adverse effect on our business, consolidated financial position or results of operations.
 
Performance bonds, issued by third-party entities, are used primarily to guarantee our performance to construct improvements in our various communities. As of March 31, 2013, we had outstanding performance bonds of approximately $2,888. We do not believe that it is likely any of these outstanding performance bonds will be drawn upon.
 
Note U - Business Segments
 
The following table summarizes AV Homes' information for reportable segments for the three months ended March 31, 2013 and 2012:
 
 
 
Three Months
 
Revenues:
 
2013
 
 
2012
 
Segment revenues
 
 
 
 
 
 
Active adult communities
 
$
12,006
 
 
 
9,805
 
Primary residential
 
 
10,542
 
 
 
7,633
 
Commercial and industrial and other land sales
 
 
2,305
 
 
 
9,058
 
Other operations
 
 
257
 
 
 
144
 
 
 
 
25,110
 
 
 
26,640
 
Unallocated revenues
 
 
   
 
 
 
 
Interest income
 
 
9
 
 
 
31
 
Other
 
 
-
 
 
 
39
 
Total revenues
 
$
25,119
 
 
 
26,710
 
 
 
 
   
 
 
 
 
Operating income (loss):
 
 
   
 
 
 
 
Segment operating income (loss)
 
 
   
 
 
 
 
Active adult communities
 
$
(879
)
 
 
(2,647
)
Primary residential
 
 
662
 
 
 
204
 
Commercial and industrial and other land sales
 
 
1,440
 
 
 
3,091
 
Other operations
 
 
189
 
 
 
50
 
 
 
 
1,412
 
 
 
698
 
Unallocated income (expenses)
 
 
   
 
 
 
 
Interest income
 
 
9
 
 
 
31
 
Equity loss from unconsolidated entities
 
 
(63
)
 
 
(36
)
Net (gain)/loss attributable to non-controlling interests
 
 
-
 
 
 
(1,528
)
General and administrative expenses
 
 
(3,705
)
 
 
(3,306
)
Interest expense
 
 
(1,773
)
 
 
(2,237
)
Other real estate expenses
 
 
(639
)
 
 
(2,073
)
Loss attributable to AV Homes
 
$
(4,759
)
 
$
(8,451
)
 
 
18

 
Item 2.
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q.
 
In the preparation of our financial statements, we apply GAAP. The application of GAAP may require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying results. For a description of our accounting policies, refer to our Annual Report on Form 10-K for the year ended December 31, 2012.
 
Certain statements discussed in Item 2 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) and elsewhere in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and other important factors include, among others: the stability of certain financial markets; disruption of the credit markets and reduced availability and more stringent financing requirements for commercial and residential mortgages of all types; the number of investor and speculator resale homes for sale and homes in foreclosure in our communities and in the geographic areas in which we develop and sell homes; the increased level of unemployment; the decline in net worth and/or of income of potential buyers; the decline in consumer confidence; the failure to successfully implement our business strategy (including our intentions to focus primarily on the development of active adult communities in the future); shifts in demographic trends affecting demand for active adult and primary housing; the level of immigration and migration into the areas in which we conduct real estate activities; our access to financing; construction defect and home warranty claims; changes in, or the failure or inability to comply with, government regulations; the failure to successfully integrate acquisitions into our business, including our JEN Transaction and other factors as are described in Item 1A (“Risk Factors”) of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2013.  Readers are cautioned not to place undue reliance on any forward-looking statements contained herein, which reflect management’s opinions only as of the date hereof.
 
Executive Overview and Outlook
 
We are engaged in the business of homebuilding, community development, and land sales in Florida and Arizona. Our residential community activities have been adversely affected by economic conditions in both markets, although home sales have improved from previous low levels. We also engage in other activities such as the operation of amenities and the sale of commercial and industrial land for third-party development, which activities have also been adversely affected by economic conditions.
 
Our primary business strategy is the development of residential communities for people age 55 and older, including the construction and sales of residences within those communities.  We believe the demographic trends and lifestyle aspirations of aging Baby Boomers provide us with a favorable environment for future business.

Solivita and Vitalia at Tradition, our active adult communities in Central Florida, and CantaMia in Goodyear, Arizona, serve as our flagship active adult communities.  In the first quarter of 2013 we saw marked improvement in customer traffic at all three communities, resulting in year over year improvement in sales.  We anticipate adding two or three more communities that will broaden our geographic footprint and product offering, which will provide us with future participation in the longer term growth of demand from the wave of Baby Boomers entering their retirement years.
 
We also remain engaged in the construction and sale of primary residences for people of all ages, some of which are located in communities we developed.  Currently, we are selling from three primary locations, two in Florida and one in Arizona.  Based on our internal projections, we expect to sell out of lots at all three communities within the next 12 to 15 months and are actively looking for replacement lot positions.  These replacement positions may require new acquisitions of developed or undeveloped lots, or we may decide to develop current land holdings, depending on market conditions within the vicinity of these assets.
 
Our business remains capital intensive and requires or may require increased expenditures for land and infrastructure development and housing construction, funding of operating deficits, real estate taxes, homeowner association (“HOA”) deficits, interest expense and working capital, as well as potential new acquisitions of real estate and real estate-related assets.  We plan to carefully manage our inventory levels through monitoring land development and home starts.  In that regard, our planned asset sales will help reduce and diversify land holdings and associated carry costs.

Our cash flow from operations in the first quarter of 2013 was insufficient to cover our primary recurring costs for interest payments, real estate taxes, HOA subsidies, and unallocated general & administrative expenses.  We anticipate that we will continue to generate operating losses during 2013.  We believe that we have sufficient available cash to fund these losses; however, our 7.50% Notes may be put to us in February 2014 which may significantly impair our ability to make additional investments and potentially to continue to fund operating losses.  We anticipate using available cash and may be reliant, in part, upon asset sales to fund repayment of the 7.50% Notes or make new investments or engage in new initiatives that are consistent with our strategy.  We also anticipate being reliant upon access to the capital markets to fully fund these activities and to repay debt upon maturity.
 
 
19

 
During the quarter ended March 31, 2013, our homebuilding results reflected some improvement over 2012.  Although we have experienced a strengthening market, it remains unclear if any sustained recovery in the industry will be reflected in our future results.  Sales and customer traffic both increased during the first quarter compared to the same period last year.  During the quarter we signed 135 sales contracts, net of cancellations, and closed 81 sales generating $20,155 of revenue as compared to signing 106 sales contracts, net of cancellations, and closing 63 sales generating $14,682 in the first quarter of 2012.  Our average price per unit of homes closed in the quarter was $249 per unit, a 7% increase from the same period last year.  However, our sales are seasonal, in particular at the active adult communities, where traffic typically declines as summer approaches.  In addition, our residential community activities, along with other real estate activities such as the sale of commercial and industrial land, are heavily concentrated in the Poinciana, Florida submarket.  These factors have a significant impact on our ability to participate in a market recovery.  If the real estate market does not continue to stabilize or declines further, it may be necessary to take additional charges against our earnings for inventory impairments or write-downs of our investments in unconsolidated entities and other assets.
 
We continue our ongoing efforts to improve our operating efficiencies by identifying areas of our business where we can reduce our expenses.  We are introducing strategies and procedures that are designed to streamline our homebuilding operations by simplifying processes and employing value-engineering practices to help us deliver quality, well-built homes.  In addition, we will continue to examine our assets to determine which assets fit within our primary business strategy.
 
 
20


RESULTS OF OPERATIONS
 
The following table provides a comparison of certain financial data related to our operations for the three months ended March 31, 2013 and 2012:
 
 
 
Three Months
 
 
 
2013
 
 
2012
 
Operating income (loss):
 
 
 
 
 
 
Active adult communities
 
 
 
 
 
 
Revenues (1)
 
$
12,006
 
 
 
9,805
 
Expenses (2)
 
 
12,885
 
 
 
12,452
 
Segment operating loss
 
 
(879
)
 
 
(2,647
)
 
 
 
   
 
 
 
 
Primary residential
 
 
   
 
 
 
 
Revenues (3)
 
 
10,542
 
 
 
7,633
 
Expenses
 
 
9,880
 
 
 
7,429
 
Segment operating income (loss)
 
 
662
 
 
 
204
 
 
 
 
   
 
 
 
 
Commercial and industrial and other land sales
 
 
   
 
 
 
 
Revenues
 
 
2,305
 
 
 
9,058
 
Expenses
 
 
865
 
 
 
5,967
 
Segment operating income
 
 
1,440
 
 
 
3,091
 
 
 
 
   
 
 
 
 
Other operations
 
 
   
 
 
 
 
Revenues
 
 
257
 
 
 
144
 
Expenses
 
 
68
 
 
 
94
 
Segment operating income
 
 
189
 
 
 
50
 
 
 
 
   
 
 
 
 
Operating income
 
 
1,412
 
 
 
698
 
 
 
 
   
 
 
 
 
Unallocated income (expenses):
 
 
   
 
 
 
 
Interest income
 
 
9
 
 
 
31
 
Equity loss from unconsolidated entities
 
 
(63
)
 
 
(36
)
Net (gain)/loss attributable to non-controlling interests
 
 
-
 
 
 
(1,528
)
General and administrative expenses
 
 
(3,705
)
 
 
(3,306
)
Interest expense
 
 
(1,773
)
 
 
(2,237
)
Other real estate expenses
 
 
(639
)
 
 
(2,073
)
Loss before income taxes
 
 
(4,759
)
 
 
(8,451
)
Income tax benefit
 
 
-
 
 
 
-
 
Net loss attributable to AV Homes
 
$
(4,759
)
 
 
(8,451
)
 
(1)  Includes homebuilding revenues of $10,222 and amenity revenues of $1,784 for the three months ended March 31, 2013.
 
(2)  Includes impairment charges for inventory of approximately $0 and $152 for the three months ended March 31, 2013 and 2012, respectively.

(3) Includes homebuilding revenues of $9,933 and amenity revenues of $609 for the three months ended March 31, 2013.
 
 
21


Data from closings for the active adult and primary residential homebuilding segments for the three months ended March 31, 2013 and 2012 is summarized as follows:
 
For the three months ended March 31,
 
Number of Units
 
 
Revenues
 
 
Average Price Per Unit
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
39
 
 
$
10,222
 
 
$
262
 
Primary residential
 
 
42
 
 
 
9,933
 
 
$
237
 
Total
 
 
81
 
 
$
20,155
 
 
$
249
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
32
 
 
$
7,984
 
 
$
250
 
Primary residential
 
 
31
 
 
 
6,698
 
 
$
216
 
Total
 
 
63
 
 
$
14,682
 
 
$
233
 
 
Data from contracts signed for the active adult and primary residential homebuilding segments for the three months ended March 31, 2013 and 2012 is summarized as follows:
 
For the three months ended March 31,
 
Gross Number
of Contracts
Signed
 
 
Cancellations
 
 
Contracts Signed,
Net of
Cancellations
 
 
Dollar
Value
 
 
Average
Price Per
Unit
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
97
     
(13
)
   
84
 
 
$
19,038
 
 
$
227
 
Primary residential
 
 
72
     
(21
)
   
51
 
 
 
10,353
 
 
$
203
 
Total
 
 
169
     
(34
)
   
135
 
 
$
29,391
 
 
$
218
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
66
 
 
 
(24
)
 
 
42
 
 
$
10,536
 
 
$
251
 
Primary residential
 
 
75
 
 
 
(11
)
 
 
64
 
 
 
12,668
 
 
$
198
 
Total
 
 
141
 
 
 
(35
)
 
 
106
 
 
$
23,204
 
 
$
219
 
 
 
22

 
Backlog for the active adult and primary residential homebuilding segments as of March 31, 2013 and 2012 is summarized as follows:
 
 
 
As of March 31,
 
Number of
 Units
 
 
Dollar
Volume
 
 
Average Price
Per Unit
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
108
   
$
25,440
   
$
236
 
Primary residential
 
 
131
     
27,713
   
$
212
 
Total
 
 
239
   
$
53,153
   
$
222
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
Active adult communities
 
 
55
 
 
$
14,243
 
 
$
259
 
Primary residential
 
 
86
 
 
 
15,819
 
 
$
184
 
Total
 
 
141
 
 
$
30,062
 
 
$
213
 
 
The number of net housing contracts signed during the three months ended March 31, 2013 compared to the same period in 2012 increased 27%. The dollar value of housing contracts signed increased 27%. The year-over-year increase in volume of housing contracts signed for the three months ended March 31 indicates improved market conditions for both of our homebuilding segments. During the three months ended March 31, 2013, cancellations of previously signed contracts totaled 34 compared to 35 during the three months ended March 31, 2012. As a percentage of the gross number of contracts signed, this represents 20% and 25%, respectively.
 
As of March 31, 2013 our inventory of unsold (speculative) homes, both completed and under construction, was 72 units, as compared to 62 units as of December 31, 2012.  As of March 31, 2013, approximately 40% of unsold homes were completed compared to approximately 34% as of December 31, 2012.
 
During the three months ended March 31, 2013 compared to the three months ended March 31, 2012, the number of homes closed increased by 29% and the related revenues increased by 37%. Our average sales price for homes closed during the three months ended March 31, 2013 increased to $249 compared to $233 for the three months ended March 31, 2012. We anticipate that we will close in excess of 80% of the homes in backlog as of March 31, 2013 during the subsequent 12-month period, subject to cancellations by purchasers prior to scheduled delivery dates.
 
Net loss for the three months ended March 31, 2013 was $4,759 or $0.38 per basic and diluted share compared to $8,451 or $0.68 per basic and diluted share for the three months ended March 31, 2012.  The decrease in net loss for the three months ended March 31, 2013 compared to the same period in 2012 was primarily due to an increase in operating income, a decrease in other real estate expenses, and a decrease in gains attributable to non-controlling interests.
 
Combined operating loss from active adult communities and primary residential homebuilding was $217 for the three months ended March 31, 2013 as compared to $2,443 for the same period in 2012.  The decrease in net loss was primarily attributable to 18 additional home closings, a favorable mix of homes closed, and reduced divisional overhead in the first quarter of 2013 versus the first quarter of 2012.
 
Revenues from active adult operations increased $2,201 or 22% for the three months ended March 31, 2013 compared to the same period in 2012.  Expenses from active adult operations increased $433 or 3% for the three months ended March 31, 2013 compared to the same period in 2012. The increase in revenues is primarily attributable to seven additional closings and a favorable change in mix of homes closed, primarily at Solivita, for the three months ended March 31, 2013 than for the three months ended March 31, 2012.  The increase in expenses is attributable to increased closings and a change in the mix of homes closed, offset in part by reduced operating expenses in the first quarter of 2013 as compared to the first quarter of 2012.  During the three months ended March 31, 2013, we did not record any impairment charges in our active adult operations from homes completed or under construction, compared to impairments of approximately $152 for the three months ended March 31, 2012. The average sales price on closings from active adult homebuilding operations during the three months ended March 31, 2013 was $262 compared to $250 during the same period in 2012.
 
 
23


The average contribution margin (excluding impairment charges) on closings from active adult homebuilding operations during the three months ended March 31, 2013 was approximately 15% compared to approximately 14% during the same period in 2012.  The increase in average contribution margins is generally attributable to a change in mix of homes closed.  Both Solivita and CantaMia contributed to improved contribution margins in the first quarter as compared to the same period in 2012 with higher revenues per home closed and lower home construction costs per home closed.   Included in the results from active adult operations are divisional overhead allocated among several communities and our amenity operations.
 
Revenues from primary residential operations increased $2,909 or 38% for the three months ended March 31, 2013 compared to the same period in 2012. Expenses from primary residential operations increased $2,451 or 33% for the three months ended March 31, 2013 compared to the same period in 2012. The increase in revenues is primarily attributable to 11 additional closings, a favorable change in mix of homes closed in the first quarter of 2013 as compared to the first quarter of 2012, and our ability to increase sales prices in this segment as market conditions improved.  The increase in expenses is attributable to increased closings, a change in mix of homes closed, and increased operating expenses in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. During the three months ended March 31, 2013 and the three months ended March 31, 2012, we did not record any impairment charges in our primary residential operations from homes completed or under construction. The average sales price on closings from primary residential homebuilding operations for the three months ended March 31, 2013 was $237 compared to $216 for the same period in 2012.

The average contribution margin (excluding impairment charges) on closings from primary residential homebuilding operations for the three months ended March 31, 2013 was approximately 18% compared to approximately 13% for the same period in 2012. The increase in average contribution margins in the first quarter of 2013 as compared to the first quarter of 2012 is attributable to a favorable change in mix of homes closed coupled with sales price increases in our Phoenix primary homebuilding operations, and the first closings from our newest Central Florida community, Bellalago, which generally produces higher margins than our other offerings in this segment.  Included in the results from primary residential operations are divisional overhead allocated among several communities and our amenity operations.
 
Revenues and expenses from commercial and industrial and other land sales were $2,305 and $865, respectively, in the three months ended March 31, 2013, resulting in net income of $1,440.  Revenues and expenses from commercial and industrial and other land sales were $9,058 and $5,967, respectively, in the three months ended March 31, 2012, resulting in net income of $3,091.
 
Revenues from other operations increased $113 or 78% for the three months ended March 31, 2013 compared to the same period in 2012. Expenses from other operations decreased $26 or 28% for the three months ended March 31, 2013 compared to the same period in 2012. The increase in revenues is primarily attributable to increased leasing activities in the first quarter of 2013 as compared to the first quarter of 2012.
 
General and administrative expenses increased $399 or 12% for the three months ended March 31, 2013 compared to the same period in 2012. The increase was primarily due to increased IT and marketing consulting fees, professional accounting services related to the year-end audit, and increased testing required as a result of our new accounting and operational software system in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.  These increases were offset in part by a decrease in legal fees in the first quarter of 2013 as compared to the same period in 2012.
 
Interest expense decreased $464 or 21% for the three months ended March 31, 2013 compared to the same period in 2012. The decrease in interest expense is primarily attributable to an increase in the amount of interest expense we capitalized to homes under construction in the first quarter of 2013 as compared to the same period in 2012.

Other real estate expenses, net, represented by real estate taxes, property maintenance and miscellaneous income not allocable to specific operations, decreased by $1,434 or 69% for the three months ended March 31, 2013 compared to the same period in 2012. The decrease in other real estate expenses for the three months ended March 31, 2013 is primarily attributable to a loss recognized in 2012 from land notes receivables write offs and restructuring of $541, and the 2012 write-off of an abandoned maintenance facility in Poinciana of $541.
 
In accordance with ASC 740, AV Homes evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During 2008, we established a valuation allowance against our deferred tax assets. Our cumulative loss position over the evaluation period and the uncertain and volatile market conditions provided significant evidence supporting the need for a valuation allowance. During the three months ended March 31, 2013, we recognized an increase of $1,900 in the valuation allowance.  As of March 31, 2013, our deferred tax asset valuation allowance was $128,433.  In future periods, the allowance could be reduced based on sufficient evidence indicating that it is more likely than not that a portion of our deferred tax assets will be realized.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Our primary business activities are capital intensive in nature. Significant capital resources are required to finance planned active adult and primary residential communities, homebuilding construction in process, community infrastructure, selling expenses, new projects and working capital needs, including funding of debt service requirements, operating deficits and the carrying costs of land.
 
Cash Flows
 
As of March 31, 2013, our cash and cash equivalents totaled $71,087, compared to cash and cash equivalents of $79,815 as of December 31, 2012. As of March 31, 2013 and December 31, 2012, total consolidated indebtedness was $105,402, including $100,000 carrying amount of our 7.50% Notes and 7.50% Exchange Notes and $5,402 carrying amount of our 4.50% Notes. Additionally, as of March 31, 2013, we had $4,727 in restricted cash, of which $3,615 is posted to collateralize outstanding letters of credit, compared to $4,682 in restricted cash as of December 31, 2012.
 
Our operating cash flows fluctuate relative to the status of development within existing communities, expenditures for land, new developments and other real estate activities, and sales of various homebuilding product lines within those communities and other developments and to fund operating deficits.
 
 
24

 
For the three months ended March 31, 2013, net cash used in operating activities amounted to $8,336, primarily to fund our operating losses, development, and home construction. Net cash used in investing activities amounted to $462, primarily due to investments in property and equipment.  Net cash provided by financing activities of $70, primarily attributable to contributions from joint venture partners, offset in part by the payment of withholding taxes related to restricted stock.
 
For the three months ended March 31, 2012, net cash used in operating activities amounted to $2,114, primarily to fund our operating losses. Net cash used in investing activities amounted to $336 due to part by sales of property and equipment, including a vacant building in Rio Rico. Net cash used in financing activities of $1,708 was attributable to a distribution to a joint venture partner from the sale of the assets of the joint venture and payment of withholding taxes related to restricted stock.
 
Financing
 
4.50% Convertible Senior Notes due 2024
 
On March 30, 2004, we issued $120,000 aggregate principal amount of our 4.50% Convertible Senior Notes due 2024 (the “4.50% Notes”) in a private offering.  The 4.50% Notes mature on April 1, 2024 unless earlier converted, redeemed or repurchased.

Interest: Interest on the 4.50% Notes is 4.50% per year, payable semi-annually in arrears in cash on April 1 and October 1 of each year, commencing October 1, 2004.

Conversion: The 4.50% Notes are convertible into our common stock upon the occurrence of certain triggers described in the Indenture dated March 30, 2004 between us and the trustee named therein (the “4.50% Indenture”).  Shares of our common stock, into which the 4.50% Notes are convertible, have been reserved for issuance.

Repurchase Right/Redemption Right: Holders of the 4.50% Notes had the right to require us to repurchase the 4.50% Notes for cash on April 1, 2011 and have the right to require us to repurchase the 4.50% Notes for cash on April 1, 2014 and April 1, 2019 or upon the occurrence of a “fundamental change” (as defined in the 4.50% Indenture) or a “termination of trading” (as defined in the 4.50% Indenture).  We may, at any time, at our option, redeem for cash all or any portion of the outstanding 4.50% Notes.  In the case of a repurchase or redemption, we will pay a repurchase or redemption price, as applicable, equal to 100% of the principal amount, plus accrued and unpaid interest, if any.

On February 4, 2011, we repurchased $17,765 principal amount of the 4.50% Notes for approximately $18,171 using proceeds from the issuance of our 7.50% Notes discussed below.  On April 1, 2011, holders of $41,637 principal amount of the 4.50% Notes exercised their right to require us to repurchase the 4.50% Notes.

FASB ASC 470-20 requires the issuer of certain convertible debt instruments that may be settled in cash on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate.  ASC 470-20 requires bifurcation of the instrument into a debt component that is initially recorded at fair value and an equity component.  The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity.  The excess of the principal amount of the liability component over its carrying amount and the debt issuance costs are amortized to interest cost using the interest method over the expected life of a similar liability that does not have an associated equity component.  The discount on the liability component of the 4.50% Notes is amortized using the effective interest method based on an effective rate of 7.50%, which was the estimated market interest rate for similar debt without a conversion option on the issuance date.  The discount was amortized from the issuance date in 2004 through April 1, 2011, the first date that holders of the 4.50% Notes could require us to repurchase the 4.50% Notes.  The discount was fully amortized in 2011.

As of March 31, 2013 and December 31, 2012, $5,402 aggregate principal amount of the 4.50% Notes remain outstanding.

7.50% Senior Convertible Notes due 2016
 
On February 4, 2011, we completed an underwritten public offering for $100,000 aggregate principal amount of our 7.50% Senior Convertible Notes due 2016 (the “7.50% Notes”).  The 7.50% Notes mature on February 15, 2016 unless earlier converted, redeemed or repurchased.  The 7.50% Notes are governed by the Indenture and the First Supplemental Indenture, each dated February 4, 2011 (collectively, the “First Supplemental Indenture”), between us and the trustee named therein.
 
 
25


Interest: Interest on the 7.50% Notes is 7.50% per year, payable semi-annually in arrears in cash on February 15 and August 15 of each year, commencing August 15, 2011.
 
Conversion: Holders may convert the 7.50% Notes into shares of our common stock at any time on or prior to the close of business on the business day immediately preceding the maturity date of February 15, 2016.  The 7.50% Notes are convertible at an initial conversion rate of 33.3333 shares of common stock per $1 principal amount of the 7.50% Notes (equivalent to an initial conversion price of approximately $30.00 per share).  The conversion rate, and thus the conversion price, may be adjusted under certain circumstances, including upon the occurrence of a “non-stock change of control” as such term is defined in the First Supplemental Indenture.  Upon any conversion, subject to certain exceptions, holders will not receive any cash payment representing accrued and unpaid interest.  Shares of our common stock, into which the 7.50% Notes are convertible, have been reserved for issuance.
 
Financial covenants: The First Supplemental Indenture includes the following financial covenants:
 
 
·
until February 15, 2014, we will maintain, at all times, cash and cash equivalents of not less than $20,000;
 
 
·
until February 4, 2013, our total consolidated indebtedness (as “indebtedness” is defined in the First Supplemental Indenture) may not exceed $150,000;
 
 
·
until February 4, 2013, our total consolidated indebtedness (as “indebtedness” is defined in the First Supplemental Indenture) shall not exceed $50,000 at any time, excluding for purposes of this covenant: (a) the 7.50% Notes, and (b) any indebtedness with a maturity date after February 15, 2014, which indebtedness does not provide the holder with a unilateral put right prior to February 15, 2014.
 
Repurchase Right: Holders of the 7.50% Notes have the right to require us to repurchase the 7.50% Notes on February 15, 2014 or upon the occurrence of a “fundamental change” (as defined in the First Supplemental Indenture), in each case at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest.  The holders of the 7.50% Notes also have the right to require us to repurchase 50% of the 7.50% Notes upon the occurrence of a breach of any of the above financial covenants at a repurchase price equal to 110% of the principal amount, plus accrued and unpaid interest.
 
 Redemption Right : We may, at any time on or after February 15, 2014, at our option, redeem for cash all or any portion of the outstanding 7.50% Notes at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest, but only if the last reported sale price of our common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the trading day before the date that we provide the notice of redemption to holders exceeds 130% of the conversion price in effect on each such trading day and certain other conditions described in the First Supplemental Indenture are met.
 
As of March 31, 2013 and December 31, 2012, $55,500 aggregate principal amount of the 7.50% Notes remain outstanding.
 
7.50% Senior Exchange Convertible Notes due 2016
 
 In July 2012, we entered into exchange agreements under which we retired $44,500 in aggregate principal amount of our 7.50% Notes, in exchange for the issuance of $44,500 in aggregate principal of new 7.50% Senior Exchange Convertible Notes due 2016 (“7.50% Exchange Notes”).  The 7.50% Exchange Notes mature on February 15, 2016 unless earlier converted, redeemed or repurchased.  The 7.50% Exchange Notes are governed by the Indenture dated February 4, 2011 and the Second Supplemental Indenture dated July 25, 2012 between us and the trustee named therein (collectively, the “Second Supplemental Indenture”).

Interest: Interest on the 7.50% Exchange Notes is 7.50% per year, payable semi-annually in arrears in cash on February 15 and August 15 of each year, commencing February 15, 2013.

Conversion: The 7.50% Exchange Notes are convertible and have an initial conversion rate of 55.5555 shares of common stock per $1 principal amount of notes (equivalent to a conversion price of approximately $18.00 per share), subject to adjustment in certain events. We have the right, but not an obligation, to require holders to convert the 7.50% Exchange Notes in whole or in part if the closing price of our common stock equals or exceeds 130% of the conversion price then in effect for a specified period and certain other conditions are satisfied.  Shares of our common stock, into which the 7.50% Exchange Notes are convertible, have been reserved for issuance.

Financial covenants: The Second Supplemental Indenture includes the same financial covenants as those governing the 7.50% Notes, except that the outstanding 7.50% Exchange Notes, as well as the 7.50% Notes, are excluded from the third covenant.  We may suspend the operation of these financial covenants with respect to the 7.50% Exchange Notes if the aggregate principal amount outstanding of the 7.50% Notes and the 7.50% Exchange Notes does not exceed $33,000.

Repurchase Right: Unlike the 7.50% Notes, the 7.50% Exchange Notes do not provide that the holders may require us to repurchase the 7.50% Exchange Notes on February 15, 2014. However, holders of the 7.50% Exchange Notes have the right to require us to repurchase the 7.50% Exchange Notes upon the occurrence of a “fundamental change” (as defined in the Second Supplemental Indenture).  The holders of the 7.50% Exchange Notes also have the right to require us to repurchase 50% of the 7.50% Exchange Notes upon the occurrence of a breach of any of the above financial covenants at a repurchase price equal to 110% of the principal amount, plus accrued and unpaid interest.

 
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Redemption Right: We have the right to redeem the 7.50% Exchange Notes on or after February 15, 2015.  Prior to that date, the 7.50% Exchange Notes are redeemable, on one occasion only, upon the occurrence of certain events and the satisfaction of certain conditions (as described in the Second Supplemental Indenture).  In each case, the redemption price is equal to 100% of the principal amount, plus accrued and unpaid interest.
 
We have assessed the 7.50% Exchange Notes and concluded that the impact of any embedded derivative features are not material as of March 31, 2013, subject to further review over the life of the 7.50% Exchange Notes.  As of March 31, 2013 and December 31, 2012, $44,500 aggregate principal amount of the 7.50% Exchange Notes remain outstanding.
 
Performance Bonds

Performance bonds, issued by third party entities, are used primarily to guarantee our performance to construct improvements in our various communities. As of March 31, 2013, we had outstanding performance bonds of approximately $2,888. We do not believe that it is likely any of these outstanding performance bonds will be drawn upon.
 
Poinciana Parkway
 
The population of the Poinciana, Florida community is approximately 70,000 and we expect the population to grow in the coming years.  We currently own over 5,000 lots and nearly 10,000 acres of additional real estate in this community. While Poinciana has adequately accommodated the growing population with residential housing, including our Solivita development, the accompanying traffic infrastructure is constrained by Poinciana’s location in the midst of Reedy Creek Wetland System and Disney’s Wilderness Preserve.  Currently, there is only one four-lane arterial roadway connecting Poinciana to the regional road network.   All other access roads are two-lane roads with limited capacity.  The proposed Poinciana Parkway is approximately ten miles long, beginning in Poinciana and connecting to the US17/US92 in Polk County.  Once built, this roadway will provide significant relief to the currently constrained roadway infrastructure that accommodates the daily commuter traffic in Poinciana.  This relief will allow for continued growth in residential, commercial, and employment in the Poinciana community, all of which we believe will enhance our sales and land values in Poinciana.
 
In October of 2012, Osceola County, Polk County, the Osceola County Expressway Authority and Avatar Properties Inc., one of our wholly owned subsidiaries, entered in to an Agreement for Development of the Poinciana Parkway.  

Pursuant to the Development Agreement, API has assigned to the Expressway Authority all of API’s current plans for the Poinciana Parkway.  The Expressway Authority is in the process of selecting a general contractor to design the final configuration the Poinciana Parkway and to construct the roadway once bond financing is obtained.  Construction is contingent on bond financing obtained by Osceola County and cash contributions by Polk and Osceola Counties which may be funded by grant monies or other sources to be determined.  If all required funds are obtained and the Development Agreement is closed, API will (i) assign at no cost its current permits for the Poinciana Parkway to the Expressway Authority and (ii) donate to Polk County or Osceola County, as applicable, certain rights of way for the Poinciana Parkway and certain additional rights of way that will accommodate both the arterial and southern connector facilities to Osceola and Polk Counties.  The Expressway Authority shall be responsible for construction of the Poinciana Parkway at no cost to API.  The toll portion of the Poinciana Parkway shall be operated and maintained by the Expressway Authority and all excess toll revenues shall be used to fund transportation facilities in the Poinciana area.  Other portions of the Poinciana Parkway will be owned by Polk County or Osceola County, as applicable.
 
If funding and construction of the Poinciana Parkway cannot be achieved as contemplated by the Development Agreement, the counties have no right to obtain damages or seek specific performance for API’s failure to perform under prior agreements with Polk and Osceola Counties regarding its obligation to fund and construct the Poinciana Parkway.   If the Development Agreement is terminated because funding of the Poinciana Parkway construction does not occur,  API shall be entitled to a one year extension of certain of its prior agreements with Osceola County.  If during such extension, API cannot obtain financing and begin construction of the Poinciana Parkway:  (i) a portion of API’s land in Osceola County will become subject to Osceola traffic concurrency requirements applicable generally to other home builders in the county and (ii) API will be required to contribute approximately $1,900 towards the construction cost of certain traffic improvements in Osceola County that we otherwise might have been obligated to build or fund if we had not agreed to construct the Poinciana Parkway.

 
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We review the recoverability of the carrying value of the Poinciana Parkway on a quarterly basis in accordance with authoritative accounting guidance.  In the fourth quarter of 2012, we determined that the probability of public funding to occur is high, and as a result, we recorded a non-cash charge of $7,659 related to our expected transfer of mitigation credits carried on our books and the carrying value of contributed right-of-way parcels.  The remaining mitigation credits' book value of $749 was reclassified to Prepaid Expenses and Other Assets on our balance sheet as of December 31, 2012.
 
Other
 
On October 13, 2008, our Board of Directors amended its June 2005 authorization to purchase the 4.50% Notes and/or common stock to allow expenditures up to $30,000, including the $9,864 previously authorized. On October 17, 2008, we repurchased $35,920 principal amount of the 4.50% Notes for approximately $28,112 including accrued interest. On December 12, 2008, our Board of Directors amended its June 2005 authorization to purchase the 4.50% Notes and/or common stock to allow expenditures up to $30,000, including the $1,888 remaining after the October 2008 activities. During 2009, we repurchased $14,076 principal amount of the 4.50% Notes for approximately $11,696, including accrued interest. As of March 31, 2013, the remaining authorization is $18,304.
 
Assuming that no additional significant adverse changes in our business occur, we anticipate the aggregate cash on hand, cash flow generated through homebuilding and related operations, and sales of commercial and industrial and other land will provide sufficient liquidity to fund our business for 2013.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
There have been no significant changes to our critical accounting policies and estimates during the three months ended March 31, 2013 as compared to those we disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2012.
 
 
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There have been no material changes in AV Homes' market risk during the three months ended March 31, 2013. For additional information regarding AV Homes' market risk, refer to Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the year ended December 31, 2012.
 
 
Disclosure Controls and Procedures
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based upon that evaluation, our Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
 
Internal Control Over Financial Reporting
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer, we have determined that, during the fiscal quarter ended March 31, 2013, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
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PART II -- OTHER INFORMATION
 
Item 1A.
 
In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012, which could materially affect our business, financial condition, or future results.

The homebuilding industry, which is cyclical and affected by a variety of factors, has undergone a significant downturn.  Although certain markets have begun to recover, including our primary markets of Florida and Arizona, homebuilding remains below historic levels and the duration and ultimate speed of recovery remain uncertain.  Deterioration in industry conditions or in broader economic conditions could have additional material adverse effects on our business and financial results.
 
The homebuilding industry is highly cyclical and is significantly affected by changes in industry conditions, as well as in global and local economic conditions, such as changes in:
 
 
·
employment and income levels;
 
·
availability of financing for homebuyers;
 
·
interest rates;
 
·
consumer confidence;
 
·
levels of new and existing homes for sale;
 
·
demographic trends; and
 
·
housing demand.
 
Changes in these conditions may occur on a national scale, as is the case in the current downturn and nascent recovery, or may acutely affect some of the regions or markets in which we operate more than others. When adverse conditions affect markets, they could have a proportionately greater impact on us than on other homebuilding companies with smaller presences in these locally affected markets. Our operations are concentrated entirely in the markets of Florida and Arizona, which have been more adversely affected by the recent downturn and as a result the downturn has, and could continue to have, a more substantial impact on our business and financial results.
 
An oversupply of alternatives to new homes and reduction in homebuyer demand can adversely impact our ability to sell new homes.
 
An oversupply of alternatives to new homes, including foreclosed homes, homes held for sale by investors and speculators, and other existing homes and rental properties, can also adversely impact our ability to sell new homes and can depress new home prices and reduce our margins on the sales of new homes. High levels of foreclosures not only contribute to additional inventory available for sale, but also reduce appraisal valuations for new homes, potentially resulting in lower sales prices. It is difficult to calculate the total number of units at foreclosure risk due to potential “shadow inventory.”  Shadow inventory can occur when lenders put properties that have been foreclosed or forfeited to lenders on the market gradually, rather than all at once, or delay the foreclosure process.
 
The recent downturn in the homebuilding industry was one of the most severe housing downturns in U.S. history. The significant decline in the demand for new homes, the significant oversupply of homes in some markets and the significant reductions in the availability of financing for homebuyers that marked the downturn are continuing and may continue for some time. We experienced material reductions in our home sales and homebuilding revenues, and we have incurred and may incur in the future material inventory impairments and losses from our joint venture interests and other write-offs. It is not clear when or if these trends will reverse or when we may return to profitability. The reversal of the nascent recovery or slower than anticipated improvements in the market would have a further material adverse effect on our business, liquidity and results of operations.
 
Our ability to respond to these factors is limited. The significant number of home mortgage foreclosures has increased supply and driven down prices, making the purchase of a foreclosed home an attractive alternative to purchasing a new home, although this trend is moderating in the Arizona market. However, due to the nature of Florida’s judicial foreclosure process, we believe that foreclosed homes coming onto the market in Florida will be an issue for the near term. The judicial foreclosure process had delayed the initiation of actions in Florida generally, as compared to other markets, and we have begun to experience an increase in foreclosure notifications on homes within our communities within the last several months. We believe this is a broader market trend. Homebuilders have responded to declining sales and increased cancellation rates with significant concessions, further adding to the price declines. The price declines, in some cases, may cause current homeowners, particularly those in our active adult demographic, to delay the resale of their current home, impacting potential purchases of our new homes. With the decline in the values of homes and the inability of many homeowners to make their mortgage payments, the credit markets have been significantly disrupted, putting strains on many households and businesses. In the face of these conditions, the overall economy has weakened significantly, with high unemployment levels and substantially reduced consumer spending and confidence. As a result, demand for new homes remains at historically low levels, and such current, and any future, weakened homebuyer demand could have an adverse effect on us.
 
 
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Our ability to generate sufficient cash or access our limited other sources of liquidity in order to operate our business and service our debt depends on many factors, some of which are beyond our control.
 
Our ability in the future to make payments on our outstanding indebtedness and to fund planned capital expenditures for construction and development costs will depend on our ability to generate sufficient cash flow and access other sources of capital.  Assuming all of our existing notes remain outstanding, we estimate our annualized interest incurred for the next twelve months will be approximately $7,740. For the years ended December 31, 2007 through 2012, our earnings were insufficient to cover our fixed charge obligations.
 
To a large extent, our ability to generate cash flow is subject to general economic, financial, competitive, legislative and regulatory factors, and other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to pay principal and interest on the debt or to fund our other liquidity needs. As a result, we may need to refinance all or a portion of our debt on or before the maturity thereof, or incur additional debt. We cannot assure you that we will be able to refinance such debt or incur additional debt. If we are unable to refinance our debt on a timely basis or at all, we may need to dispose of certain assets, reduce capital expenditures, or take other steps that could be detrimental to our business. We cannot assure you that any of these alternatives would be available to us, if at all, on satisfactory terms or on terms that would not require us to breach the terms and conditions of our existing or future debt agreements. Any inability to generate sufficient cash flow or refinance our debt or incur additional debt could have a material adverse effect on our financial condition and could cause us to be unable to service our debt.
 
In addition, we use letters of credit and surety bonds to secure our performance under various construction and land development agreements, escrow agreements, financial guarantees and other arrangements. Should our future performance or economic conditions continue to make such letters of credit and surety bonds costly or difficult to obtain or lead to us being required to collateralize such instruments to a greater extent than previously, our business and financial results could be adversely affected.
 
We could be adversely affected by negative changes in our creditworthiness.
 
Our ability to access capital in the future is a key factor in our ability to service our indebtedness to cover our operating expenses and to fund our other liquidity needs.  Deterioration in our creditworthiness will require significant management time and effort in addition to management's primary task of running our homebuilding business and make it difficult and costly for us to access debt capital or engage in other ordinary course financing transactions, including the provision of credit support to community infrastructure financing transactions relating to our new developments.
 
Our indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations under our debt.
 
Our debt and debt service obligations increased significantly as a result of the issuance of the 7.50% Convertible Notes due 2016 (the “7.50% Notes”.) As of March 31, 2013, total consolidated indebtedness was $105,402. Cash and cash equivalents at March 31, 2013 was approximately $71,087. This level of debt could affect our future operations.  During the three months ended September 30, 2012, we entered into exchange agreements under which we retired $44,500 in aggregate principal amount of our 7.50% Notes, in exchange for the issuance of $44,500 in aggregate principal of new 7.50% Senior Exchange Convertible Notes due 2016 (“7.50% Exchange Notes”).  Following these transactions, $55,500 in aggregate principal amount of the 7.50% Notes remained outstanding for a total indebtedness under the 7.50% Notes and the 7.50% Exchange Notes of $100,000.
 
We classify the 7.50% Notes as current debt as the holders of such notes may require us to repurchase them on February 15, 2014.  Unlike the 7.50% Notes, the 7.50% Exchange Notes do not provide that the holder may require us to repurchase them on February 15, 2014.
 
As of March 31, 2013, total consolidated indebtedness was $105,402.  Cash and cash equivalents at March 31, 2013 was approximately $71,087.  This level of debt could affect our future operations in a number of ways, including, among others:
 
 
·
exposing us to the risks of an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which event of default could result in all of our debt becoming immediately due and payable;
 
 
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·
reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes;
 
·
subjecting us to the risk of increased interest rates on our indebtedness upon maturity;
 
·
limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industry in which we operate and the general economy; and
 
·
placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged.
 
Any of the above-listed factors could have a material adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under the 7.50% Notes, the 7.50% Exchange Notes, the 4.50% Convertible Senior Notes due 2024 (the “4.50% Notes") and our other debt.
 
A higher level of indebtedness increases the risk that we may default on our debt obligations. We cannot assure that we will be able to generate sufficient cash flow to pay the interest on our debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt and to fund potential future acquisitions of real estate and real-estate related assets.
 
Each indenture governing our 7.50% Notes, the 7.50% Exchange Notes, the 4.50% Notes, and any future indebtedness, contain or may contain financial and operating restrictions that may affect our ability to operate our business.
 
Each indenture governing the 7.50% Notes, the 7.50% Exchange Notes, and the 4.50% Notes contain various covenants that, among other things, require the maintenance of a certain amount of cash and cash equivalents and limit our ability to merge or sell assets. In addition, the indentures governing any future indebtedness may contain restrictions on our ability to incur indebtedness, grant certain liens to support indebtedness,  enter into certain affiliate transactions and make certain distributions. These covenants could adversely affect our ability to finance our future operations or capital needs, engage in, expand or pursue our business activities and prevent us from engaging in certain transactions that might otherwise be considered beneficial to us. In particular, any future restrictions on our ability to incur additional indebtedness may limit our ability to undertake new large scale master-planned development opportunities, and may thereby adversely affect our future growth and results of operations.
 
We may be unable to purchase the notes on certain specified dates or upon a fundamental change or designated event.
 
The holders of the 7.50% Notes have the right to require us to repurchase the 7.50% Notes on February 15, 2014 and the holders of the 4.50% Notes have the right to require us to repurchase the 4.50% Notes on April 1, 2014 and April 1, 2019, in each case at 100% of the principal amount thereof, plus accrued and unpaid interest to the date of repurchase.  We may not have the funds necessary on any such date to make the required repurchase of notes.  In addition, we may not have the funds necessary to fulfill our obligations under the 7.50% Notes, the 7.50% Exchange Notes, or the 4.50% Notes following a “fundamental change” as defined in each indenture governing the 7.50% Notes and the 7.50% Exchange Notes or a “designated event” as defined in the indenture governing the 4.50% Notes.  Upon the occurrence of a defined fundamental change, which definition includes a change of control (whether it be voluntary or involuntary), or a defined designated event, we will be required to offer to repurchase all of the applicable outstanding notes at 100% of the principal amount thereof, plus accrued and unpaid interest to the date of repurchase.  However, we may not have sufficient funds at the time of any such event to make the required repurchase of the notes.  Our failure to make or complete an offer to repurchase notes in connection with any such event would place us in default under each indenture governing the applicable notes.
 
We could enter into significant transactions that would not constitute a change of control requiring us to repurchase the notes, but that could adversely affect our risk profile.
 
We could, in the future, enter into certain transactions, including certain recapitalizations, that would not result in a change of control, but would increase the amount of indebtedness outstanding at such time or otherwise affect our capital structure or credit ratings. Such restrictions in each indenture governing the notes can be waived with the consent of the holders of a majority in principal amount of the notes then outstanding. If we were to significantly increase our indebtedness, we may have increased difficulty servicing our obligations and our results of operations may suffer.  See “Our indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations under our debt.”
 
 
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We have contingent liabilities, and if any of such liabilities are called upon, it could have a material adverse effect on our liquidity and results of operations.
 
The population of the Poinciana community is approximately 70,000 and we expect the population to grow in the coming years.  The Company currently owns over 5,000 lots and nearly 10,000 acres of additional real estate in the community of Poinciana, Florida. While Poinciana has adequately accommodated the growing population with residential housing, including our Solivita development, the accompanying traffic infrastructure is constrained by Poinciana’s location in the midst of Reedy Creek Wetland System and Disney’s Wilderness Preserve.  Currently, there is only one four-lane arterial roadway connecting Poinciana to the regional road network.   All other access roads are two-lane roads with limited capacity.  The proposed Poinciana Parkway is approximately ten miles long, beginning in Poinciana and connecting to the US17/US92 in Polk County.  Once built, this roadway will provide significant relief to the currently constrained roadway infrastructure that accommodates the daily commuter traffic in Poinciana.  This relief will allow for continued growth in residential, commercial, and employment in the Poinciana community, all of which the Company believes will enhance its sales and land values in Poinciana.
 
In October of 2012, Osceola County, Polk County, the Osceola County Expressway Authority and Avatar Properties Inc., one of our wholly owned subsidiaries, entered in to an Agreement for Development of the Poinciana Parkway.  

Pursuant to the Development Agreement, API has assigned to the Expressway Authority all of API’s current plans for the Poinciana Parkway.  The Expressway Authority is in the process of selecting a general contractor to design the final configuration the Poinciana Parkway and to construct the roadway once bond financing is obtained.  Construction is contingent on bond financing obtained by Osceola County and cash contributions by Polk and Osceola Counties which may be funded by grant monies or other sources to be determined.  If all required funds are obtained and the Development Agreement is closed, API will (i) assign at no cost its current permits for the Poinciana Parkway to the Expressway Authority and (ii) donate to Polk County or Osceola County, as applicable, certain rights of way for the Poinciana Parkway and certain additional rights of way that will accommodate both the arterial and southern connector facilities to Osceola and Polk Counties.  The Expressway Authority shall be responsible for construction of the Poinciana Parkway at no cost to API.  The toll portion of the Poinciana Parkway shall be operated and maintained by the Expressway Authority and all excess toll revenues shall be used to fund transportation facilities in the Poinciana area.  Other portions of the Poinciana Parkway will be owned by Polk County or Osceola County, as applicable.
 
If funding and construction of the Poinciana Parkway cannot be achieved as contemplated by the Development Agreement, the counties have no right to obtain damages or seek specific performance for API’s failure to perform under prior agreements with Polk and Osceola Counties regarding its obligation to fund and construct the Poinciana Parkway.   If the Development Agreement is terminated because funding of the Poinciana Parkway construction does not occur,  API shall be entitled to a one year extension of certain of its prior agreements with Osceola County.  If during such extension, API cannot obtain financing and begin construction of the Poinciana Parkway:  (i) a portion of API’s land in Osceola County will become subject to Osceola traffic concurrency requirements applicable generally to other home builders in the county and (ii) API will be required to contribute approximately $1,900 towards the construction cost of certain traffic improvements in Osceola County that we otherwise might have been obligated to build or fund if we had not agreed to construct the Poinciana Parkway.
 
In addition, certain of our communities have HOAs and we plan to have HOAs at most of our future communities.  In most of our existing communities, HOA dues paid by residents are insufficient to pay for all operating expenses and, therefore, we subsidize those HOAs.  We expect that to be the case in new communities as well in the early stages of selling out those communities.  Pursuant to these arrangements, we may become obligated to make greater payments, if assessments levied on and paid by homeowners are insufficient to cover such operating expenses when due.
 
In the event that we are called upon to satisfy any of these contingent liabilities, or any other contingent liabilities that may arise in the ordinary course of business but that have not come to our attention to date, it could significantly affect our liquidity and ability to generate cash flow, which could have a material adverse effect on our results of operations and financial condition.
 
We have a significant number of development liabilities related to our predecessor and its affiliates, over which we have little or no control as to the dates that payment may be required, and which could have a material adverse effect on our liquidity and results of operations.
 
Most of these liabilities relate to class action settlement agreements entered into by us in 1974 and the bankruptcy of our predecessor and its affiliates in the mid-1970s (collectively, the “Orders”).  Among other things, under the Orders, we are obligated to install certain utility infrastructure to lots sold by us in Rio Rico and Poinciana prior to such Orders (“Affected Lots”). Historically, we have identified such contingent obligations respecting the Orders in our Securities and Exchange Commission (“SEC”) filings supported by the report of an independent engineer.  In 2011, our management determined that such engineer estimates should be further evaluated by another independent engineer.  The second engineer’s report reflected a much greater cost to complete the utility infrastructure at Rio Rico as a result of more accurate measurements of linear feet of utility lines required, cost updates and advanced techniques in identifying the location and number of Affected Lots.  Our management also determined that an error was made in 2005 when the total mileage of water pipe mains required was reduced based on assumptions that are not supported by our current research.  Our estimate of the liability has been accrued and is included in the Estimated Development Liability for Sold Land line item in our consolidated balance sheet as of March 31, 2013.  If a significant number of the owners of the Affected Lots require AV Homes to install infrastructure in Rio Rico or Poinciana, it is possible that AV Homes may not have adequate liquidity to meet its obligations.
 
 
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The reduction in availability of mortgage financing has adversely affected our business, and the duration and ultimate severity of the effects are uncertain.
 
Lenders, regulators and others have questioned the adequacy of lending standards and other credit requirements for several loan products and programs offered in recent years.  Credit requirements have tightened, and investor demand for mortgage loans and mortgage-backed securities has declined.  The deterioration in credit quality has caused almost all lenders to stop offering subprime mortgages and most other loan products that are not eligible for sale to Fannie Mae or Freddie Mac or loans that do not meet Federal Housing Administration (“FHA”) and Veterans Administration (“VA”) requirements.  Fewer loan products, tighter loan qualifications and a reduced willingness of lenders to make loans, in turn, have made it more difficult for many buyers to sell their homes or to finance the purchase of our homes.  These factors have served to reduce the pool of qualified home buyers.  These reductions in demand have adversely affected our business and financial results, and the duration and severity of their effects are uncertain.  The liquidity provided by Fannie Mae and Freddie Mac to the mortgage industry historically has been very important to the housing market. Any changes in the ongoing role of these entities could have a material impact on the financing market, and our ability to sell homes.
 
While the use of down payment assistance programs by our home buyers has decreased significantly, some of our customers still utilize 100% financing through programs offered by the VA and United States Department of Agriculture.  There can be no assurance that these programs or other programs will continue to be available or will be as attractive to our customers as the programs currently offered, which could negatively affect our sales.
 
Because many of our customers require mortgage financing, increases in interest rates and changes in federal lending programs or other regulations could lower demand for our products, limit our marketing effectiveness and limit our ability to fully realize our backlog.
 
A significant percentage of our customers finance their home purchases through lenders that provide mortgage financing.  Increases in interest rates could lower demand for new homes because monthly mortgage costs to potential homebuyers would increase.  Even if potential new homebuyers do not need financing, changes in interest rates could make it harder for them to sell their existing homes to potential buyers who need financing.  This could prevent or limit our ability to attract new customers as well as our ability to fully realize our backlog because our sales contracts often include a financing or sale contingency.  Financing contingencies permit buyers to cancel sales contracts in the event that mortgage financing at prevailing interest rates is unobtainable within the period specified in the contract.  This contingency period is typically four to eight weeks following the date of execution of the sales contract.  Our exposure to such financing contingencies renders us vulnerable to changes in prevailing interest rates.
 
In addition, as a result of the turbulence in the credit markets and mortgage finance industry, the federal government has taken on a significant role in supporting mortgage lending through its conservatorship of Fannie Mae and Freddie Mac, both of which purchase home mortgages and mortgage-backed securities originated by mortgage lenders, and its insurance of mortgages originated by lenders through the FHA and the VA. The availability and affordability of mortgage loans, including consumer interest rates for such loans, could be adversely affected by a curtailment or cessation of the federal government’s mortgage-related programs or policies. The FHA may continue to impose stricter loan qualification standards, raise minimum down payment requirements, impose higher mortgage insurance premiums and other costs, and/or limit the number of mortgages it insures. Due to growing federal budget deficits, the U.S. Treasury may not be able to continue supporting the mortgage-related activities of Fannie Mae, Freddie Mac, the FHA and the VA at present levels, or it may revise significantly the federal government’s participation in and support of the residential mortgage market. Because the availability of Fannie Mae, Freddie Mac, FHA- and VA-backed mortgage financing is an important factor in marketing and selling many of our homes, any limitations, restrictions or changes in the availability of such government-backed financing could reduce our home sales, which could have a material adverse effect on our business, prospects, liquidity, financial condition and results of operations.
 
Furthermore, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. This legislation provides for a number of new requirements relating to residential mortgages and mortgage lending practices, many of which are to be developed further by implementing rules. These include, among others, minimum standards for mortgages and lender practices in making mortgages, limitations on certain fees and incentive arrangements, retention of credit risk and remedies for borrowers in foreclosure proceedings. The effect of such provisions on lending institutions will depend on the rules that are ultimately enacted. However, these requirements, as and when implemented, are expected to reduce the availability of loans to borrowers and/or increase the costs to borrowers to obtain such loans. Any such reduction could result in a decline of our home sales, which could materially and adversely affect us.
 
 
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Cancellations of home sales orders in backlog may increase as homebuyers choose to not honor their contracts.
 
We believe that the elevated cancellation rate experienced each of the last four years was largely a result of reduced homebuyer confidence, due principally to continued price declines, the growing number of foreclosures and continued high unemployment.  A more restrictive mortgage lending environment and the inability of some buyers to sell their existing homes have also impacted cancellations.  Many of these factors are beyond our control, and it is uncertain whether they will cause cancellation rates to rise again in the future.  Any increase in cancellations of home sales orders in backlog may have a material adverse impact on our results of operations.
 
Declines in home prices and sales order activities in Florida and Arizona would materially and adversely impact our results of operations because we conduct our homebuilding business in these states.
 
Our operations are concentrated in regions that were among the most severely affected by the economic downturn. Home prices and sales activities in these states declined significantly since the end of 2006 and at a greater rate than the country as a whole. If these states continue to experience economic difficulties, including elevated levels of unemployment and precarious budget situations at the state and local government level, such conditions may materially adversely affect the market for our homes in those affected areas. Because we do not have operations in other states, declines in home prices and sales activity in Florida and Arizona adversely affect our results of operations.
 
Inflation could adversely affect our business and financial results, particularly in a period of oversupply of homes.
 
Inflation can adversely affect us by increasing costs of land, materials and labor. However, we may not be able to offset any such cost increases with higher sales prices because a continuation of the oversupply of homes relative to demand. In addition, inflation is often accompanied by higher interest rates, which have a negative impact on housing demand. In such an environment, we may not be able to raise home prices sufficiently to keep up with the rate of inflation and our margins could decrease. Moreover, with inflation, our costs of capital increase, and the purchasing power of our cash resources can decline.
 
Supply shortages and other risks related to demand for building materials and skilled labor could increase our costs and delay deliveries.
 
The purchase price of building materials is increasing; most notably the price of wood, drywall, steel and insulation. The related shipping costs are also increasing. Should these trends continue, our results of operations may be adversely impacted. The homebuilding industry has from time to time experienced significant difficulties that can affect the cost or timing of construction including:
 
 
·
shortages of qualified trades people;
 
·
reliance on local subcontractors, manufacturers and distributors who may be inadequately capitalized;
 
·
shortages of materials; and
 
·
volatile increases in the cost of materials, particularly increases in the price of lumber, drywall and cement, which are significant components of home construction costs.
 
These difficulties may cause us to take longer or incur more costs to build our homes and materially adversely affect our revenues and margins. To the extent the housing market recovers and demand for labor and materials increase, our average per home cost of labor and building materials will likely increase, and our operating margins and results of operations may be adversely affected. In Arizona, we will need to replenish our inventory of improved or finished lots for construction in 2013 and beyond.
 
Our business and results of operations are dependent on the availability and skill of subcontractors.
 
Substantially all of our construction work is done by third-party subcontractors with us acting as the general contractor. Accordingly, the timing and quality of our construction depend on the availability and skill of our subcontractors. While we generally anticipate being able to obtain sufficient materials and reliable subcontractors and believe that our relationships with subcontractors are good, the availability of qualified subcontractors in our markets has at times been constrained.  We do not have long-term contractual commitments with any subcontractors, and there can be no assurance that skilled subcontractors will continue to be available at reasonable rates and in the areas in which we conduct our operations. The inability to contract with skilled subcontractors at reasonable costs on a timely basis could have a material adverse effect on our business, prospects, liquidity, financial condition and results of operations.
 
In addition, despite our quality control efforts, we may discover that our subcontractors were engaging in improper construction practices or installing defective materials in our homes. Any such issues may increase our warranty and customer service costs, subject us to fines or other penalties or injure our reputation.
 
 
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Elimination or reduction of the tax benefits associated with owning a home could prevent potential customers from buying our homes and adversely affect our business or financial results.
 
Significant expenses of owning a home, including mortgage interest and real estate taxes, generally are deductible expenses for an individual’s federal, and in some cases, state income taxes, subject to various limitations under current tax law and policy. If the federal government or a state government changes its income tax laws, as has been discussed from time to time, to eliminate or substantially modify these income tax deductions, the after-tax cost of owning a new home would increase for many of our potential customers. The resulting loss or reduction of homeowner tax deductions, if such tax law changes were enacted without offsetting provisions, would adversely impact demand for and sales prices of new homes. In addition, increases in property tax rates by local governmental authorities can adversely affect the ability of potential customers to obtain financing or the desire of potential customers to purchase new homes.
 
Homebuilding is subject to home warranty and construction defect claims and other litigation risks in the ordinary course of business that can be significant. Our operating expenses could increase if we are required to pay higher insurance premiums or incur substantial litigation costs with respect to such claims and risks.
 
As a homebuilder, we are subject to home warranty and construction defect claims arising in the ordinary course of business. We record customer service and warranty reserves for the homes that we sell based on historical experience in our markets and our judgment of the qualitative risks associated with the types of homes built. Because of the uncertainties inherent in these matters, we cannot provide assurance that our reserves will be adequate to address all of our warranty and construction defect claims in the future. Increasingly in recent years, individual and class action lawsuits have been filed against homebuilders asserting claims of personal injury and property damage caused by a variety of issues, including faulty materials and the presence of mold in residential dwellings.
 
Furthermore, decreases in home values as a result of general economic conditions may result in an increase in construction defect claims, as well as claims based on marketing and sales practices. Our reserves may not cover all of the claims arising from such issues or we may experience litigation costs and losses that could impact our profitability. Even if we are successful in defending such claims, we may incur significant costs.
 
Since 2009, we determined that six of our homes, constructed in Central Florida contained reactive drywall manufactured in China (“Chinese drywall”).  All of such homes have been fully remediated at minimal cost to AV Homes due to reimbursement by the supplier or manufacturer of the Chinese drywall.
 
In Vitalia at Tradition we completed construction of the substantially and partially completed homes we acquired, including replacement of Chinese drywall that was placed in such homes during the time they were owned by the original builder. If and to the extent the scope of the Chinese drywall issues prove to be significantly greater than we currently believe, and our existing warranty reserves together with our insurance and any recovery from the supplier and/or manufacturer is not sufficient to cover claims, losses or other issues related to the Chinese drywall, we could incur costs or liabilities related to this issue that could have a material adverse effect on our results of operations, financial position and cash flows.
 
Homebuilding is very competitive, and competitive conditions could adversely affect our business or financial results.
 
The homebuilding industry is highly competitive. Homebuilders compete not only for home buyers, but also for desirable properties, financing, raw materials and skilled labor. We compete with other local, regional and national homebuilders, often within larger subdivisions designed, planned and developed by such homebuilders. We also compete with home sales by others, foreclosures and rental properties. In addition, the consolidation of some homebuilding companies may create additional competitors that have greater financial, marketing and sales resources than we do and thus are able to compete more effectively against us, and there may be new entrants in the markets in which we currently conduct business. These competitive conditions in the homebuilding industry can affect our business and financial results through:
 
 
·
lower sales;
 
·
lower selling prices;
 
·
increased selling incentives;
 
·
lower profit margins;
 
·
impairments in the value of inventory and other assets;
 
·
difficulty in acquiring suitable land, raw materials, and skilled labor at acceptable prices or terms; and
 
·
delays in construction of our homes.
 
 
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Our success depends on the availability of suitable undeveloped land and improved lots at acceptable prices and our having sufficient liquidity to acquire such properties.
 
Our success in developing land and in building and selling homes depends in part upon the continued availability of suitable undeveloped land and improved lots at acceptable prices. The availability of undeveloped land and improved lots for purchase at favorable prices depends on a number of factors outside of our control, including the risk of competitive over-bidding on land and lots and restrictive governmental regulation. Should suitable land opportunities become less available, the number of homes we may be able to build and sell would be reduced, which would have an adverse effect on our revenue and profits. In addition, our ability to make land purchases will depend upon us having sufficient liquidity to fund such purchases. We may be at a disadvantage in competing for land due to our debt obligations and restrictive covenants, and as a result of our reduced access to capital compared to some of our competitors.
 
If we are unable to develop our communities successfully or within expected timeframes, our results of operations could be adversely affected.
 
Before a community generates any revenues, time and material expenditures are required to acquire land, obtain development approvals and construct significant portions of project infrastructure, amenities, model homes and sales facilities. A decline in our ability to develop and market our communities successfully and to generate positive cash flow from these operations in a timely manner would have a material adverse effect on our business and results of operations and on our ability to service our debt and to meet our working capital requirements.
 
 Our business is seasonal in nature, and our quarterly operating results can fluctuate.
 
Our quarterly operating results generally fluctuate by season. We typically experience the highest new home order activity in the winter and spring months, although new order activity is also highly dependent on the number of actively selling communities and the timing of new community openings as well as other market factors. Our revenues from homebuilding operations are fairly consistent throughout the calendar year, but we may experience higher liquidity demands during the first half of the calendar year as we incur the costs associated with new construction resulting from the increased sales volume. If, due to construction delays or other reasons, we are unable to deliver our expected number of homes in the second half of the calendar year, our full year results of operations may be adversely affected.
 
We may be adversely affected by weather conditions and natural disasters.
 
Weather conditions and natural disasters, such as hurricanes, tornadoes, earthquakes, wildfires, droughts and floods can harm our homebuilding business. These can delay home closings, adversely affect the cost or availability of materials or labor, or damage homes under construction. The climates of the states in which we operate present increased risks of adverse weather or natural disasters. In particular, a large portion of our homebuilding operations is concentrated in Florida, which is subject to increased risk of hurricanes. Furthermore, if our insurance does not fully cover losses resulting from these events or any related business interruption, our assets, financial condition and capital resources could be adversely affected.
 
Resource shortages or rate fluctuations could have an adverse effect on our operations.
 
The areas in which we operate are subject to resource shortages, including significant changes to the availability of water. Shortages of natural resources, particularly water, may make it more difficult for us to obtain regulatory approval of new developments. We may incur additional costs and may not be able to complete construction on a timely basis if such shortages continue. Furthermore, these shortages may adversely affect the regional economies in which we operate, which may reduce demand for our homes. In addition, the cost of petroleum products, which are used both to deliver our materials and to transport our employees to our job sites, fluctuates and may increase as a result of geopolitical events or accidents. This could also result in higher prices for any product utilizing petrochemicals. These cost increases may have an adverse effect on our operating margin and results of operations.
 
Values of, and costs associated with, our land and lot inventory could adversely affect our business or financial results.
 
The risks inherent in controlling or purchasing, holding and developing land for new home construction are substantial and increase as consumer demand for housing decreases. The value of undeveloped land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions. If the fair market value of the land, lots and inventories we hold decreases, we may be required to reduce the carrying value of these assets and take significant impairment charges as we did in 2012. We may have acquired options on or bought and developed land at a cost we will not be able to recover fully or on which we cannot build and sell homes profitably. In addition, our deposits for building lots controlled under option or similar contracts may be put at risk. In certain circumstances, a grant of entitlements or development agreement with respect to a particular piece of land may include restrictions on the transfer of such entitlements to a buyer of such land, which may increase our exposure to decreases in the price of such entitled land by restricting our ability to sell it for its full entitled value. In addition, inventory carrying costs can be significant and can result in reduced margins or losses in a poorly performing community or market. In the present weak market conditions, we have sold homes and land for lower margins or at a loss and we have recorded significant inventory impairment charges and such conditions may persist. Because future market conditions are uncertain, we cannot provide assurance that we will be successful in managing our future inventory risks or avoiding future impairment charges.  Any material write-downs of assets could have a material adverse effect on our business, prospects, liquidity, financial condition and results of operations.
 
 
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In addition, some real estate investments are relatively difficult to sell quickly. As a result, our ability to promptly sell one or more properties in response to changing economic, financial and investment conditions may be limited and we may be forced to hold non-income producing assets for an extended period of time. We cannot predict whether we will be able to sell any property for the price or on the terms that we set or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property.
 
Reduced home sales may impair our ability to recoup development costs or force us to absorb additional costs.
 
We incur many costs before we begin to build homes in a community.  Depending on the stage of development a land parcel is in when acquired, such costs may include costs of preparing land; finishing and entitling lots; installing roads, sewers, water systems and other utilities; building amenities in our age-restricted and age targeted communities; taxes and other costs related to ownership of the land on which we plan to build homes; and promotional marketing and overhead expenses to prepare for the opening of a new home community for sales. In addition, local municipalities may impose requirements resulting in additional costs.  If the rate at which we sell and deliver homes slows or falls, or if we delay the opening of new home communities for sales due to adjustments in our marketing strategy or other reasons, each of which has occurred throughout the housing downturn, we may incur additional costs and it will take a longer period of time for us to recover our costs.
 
Although we operate in two primary markets, we have a high concentration of land assets in the Poinciana area market and are particularly susceptible to market fluctuations in that region.
 
Historically, our goals for the ownership and control of land and building lots were based on management’s expectations for future volume growth in Florida, and in particular, the Poinciana/Kissimmee area. In light of weak market conditions encountered since 2006, prior projections were not realized and we have a very high concentration of assets in this market. Because future market conditions are uncertain, and our assets are so highly concentrated, we are limited in the amount of land we can dispose of to supplement cash flow from home sales. Our flexibility in responding to changes in market conditions, including our ability to respond to further declines in the housing market or to benefit from a return to growth, has also been reduced as a result of our land and lot positions in such a concentrated area.
 
We are dependent on the services of our senior management team and certain of our key employees, and the loss of their services could hurt our business.
 
We believe that our management’s experience in the homebuilding industry is a competitive strength, and that our future success depends upon our ability to retain these executives. In addition, we believe that our ability to attract, train, assimilate and retain new skilled personnel is important to the success of our business. If we are unable to retain our senior management team and certain of our key employees, or attract, train, assimilate or retain other skilled personnel in the future, it could hinder the execution of our business strategy.
 
We continue to consider growth or expansion of our operations, which could have a material adverse effect on our cash flows or profitability.
 
We continue to consider opportunities for growth, in both our existing markets, and in new markets. Additional growth of our business, either through increased land purchases, the development of larger projects, or into new business lines may have a material adverse effect on our cash flows or profitability. Any expansion of our business into new markets or new businesses could divert the attention of senior management from our existing business and could fail due to our relative lack of experience in those markets or businesses. In addition, opportunities may arise in the future to acquire other companies from third parties, and any acquisition could be difficult to integrate with our operations and could require us to assume unanticipated liabilities or expenses.
 
Government regulations could increase the cost and limit the availability of our development and homebuilding projects and adversely affect our business or financial results.
 
We are subject to extensive and complex regulations that affect land development and home construction, including zoning, density restrictions, building design and building standards. These regulations often provide broad discretion to the administering governmental authorities as to the conditions we must meet prior to being approved, if approved at all. Land parcels we acquire are generally undeveloped and typically do not have all (or sometimes any) of the governmental approvals necessary to develop and construct homes.  If we are unable to obtain these approvals or obtain approvals that restrict our ability to use the land in ways we do not anticipate, the value of the parcel will be negatively impacted.  We are subject to determinations by these authorities as to the adequacy of water and sewage facilities, roads and other local services. New housing developments may also be subject to various assessments for schools, parks, streets and other public improvements. Furthermore, restrictions on immigration can create a shortage of skilled labor. Any of these regulatory issues can limit or delay home construction and increase our operating costs. We are also subject to a variety of local, state and federal laws and regulations concerning protection of health, safety and the environment. These matters may result in delays, may cause us to incur substantial compliance, remediation, mitigation and other costs or subject us to costs from fines, penalties and related litigation. These laws and regulations can also prohibit or severely restrict development and homebuilding activity in environmentally sensitive areas.
 
 
38

 
We may not realize our deferred income tax assets. In addition, our net operating loss carryforwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.
 
Since the end of our 2007 fiscal year, we have generated significant net operating losses (“NOL”), and we may generate additional NOL in 2013.  Under federal tax laws, we can use our NOL (and certain related tax credits) to reduce our future taxable income for up to 20 years, after which they expire for such purposes. Until they expire, we can carry forward our NOL (and certain related tax credits) that we do not use in any particular year to reduce our taxable income in future years, and we have recorded a valuation allowance against our net deferred tax assets that include the NOL (and certain related tax credits) that we have generated but have not yet realized.  At March 31, 2013, we had deferred tax assets, net of deferred tax liabilities, totaling $128,433 against which we have provided a full valuation allowance.  Our ability to realize our net deferred tax assets is based on the extent to which we generate sustained profits and we cannot provide any assurances as to when and to what extent we will generate sufficient future taxable income to realize our net deferred tax assets, whether in whole or in part.
 
The majority of our net deferred tax asset is federal related and is valued at a 35% corporate income tax rate.  If, as some lawmakers have proposed, the U.S. corporate income tax rate is lowered, we would be required to write down a roughly proportionate amount of the value of our federal net deferred tax asset to account for this lower rate.  We would also need to record a corresponding write down of our valuation allowance.  The lower tax rate would reduce our future federal taxes, which may put a portion of our tax credits at risk of expiring before we could use them.
 
In addition, the benefits of our NOL, built-in losses and tax credits would be reduced or eliminated if we experience an “ownership change,” as determined under Internal Revenue Code Section 382 (“Section 382”).  A Section 382 ownership change occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period.  If an ownership change were to occur, Section 382 would impose an annual limit on the amount of NOL we could use to reduce our taxable income equal to the product of the total value of our outstanding equity immediately prior to the ownership change (reduced by certain items specified in Section 382) and the federal long-term tax-exempt interest rate in effect for the month of the ownership change.  A number of complex rules apply in calculating this annual limit.
 
While the complexity of Section 382’s provisions and the limited knowledge any public company has about the ownership of its publicly-traded stock make it difficult to determine whether an ownership change has occurred, we currently believe that an ownership change has not occurred.  However, if an ownership change were to occur, the annual limit Section 382 may impose could result in a material amount of our NOL expiring unused.  This would significantly impair the value of our NOL and, as a result, have a material negative impact on our consolidated financial statements.
 
We may be required to pay taxes and interest to the IRS as a result of the sale of certain land to the Internal Improvement Trust Fund of Florida if the IRS determines that we did not acquire adequate replacement properties.
 
In 2006, we sold property we owned in Marion County, Florida to the Board of Trustees of the Internal Improvement Trust Fund of the State of Florida under threat of condemnation.  The bulk of the land was transferred in 2006 and the final closing took place in 2007.  These transactions and subsequent correspondence with the Internal Revenue Service entitled us to defer payment of income taxes of approximately $24,400 from the gain on these sales until we sell replacement property provided we obtained qualifying replacement property for the Marion property by December 31, 2010.  We believe that we acquired appropriate replacement properties by December 31, 2010.  If the Internal Revenue Service determines in the future that some or all of the properties acquired by us as replacement properties do not qualify as replacement properties, we may be required to make an income tax payment plus interest on the value of the portion of the properties determined not to qualify as replacement property.
 
We may incur additional operating expenses or delays due to compliance requirements or fines, penalties and remediation costs pertaining to environmental regulations within our markets.
 
We are subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning land use and the protection of health and the environment including those governing the discharge of pollutants to water and air, the handling of hazardous materials and the cleanup of contaminated sites. The particular impact and requirements of environmental laws that apply to any given community vary greatly according to the community site, the site’s environmental conditions and the present and former use of the site. We expect that increasingly stringent requirements will be imposed on homebuilders in the future. Environmental laws may result in delays, cause us to implement time consuming and expensive compliance programs and prohibit or severely restrict development in certain environmentally sensitive regions or areas. Environmental regulations can also have an adverse impact on the availability and price of certain raw materials, such as lumber. Furthermore, we could incur substantial costs, including cleanup costs, fines, penalties and other sanctions and damages from third-party claims for property damage or personal injury, as a result of our failure to comply with, or liabilities under, applicable environmental laws and regulations. This is particularly true in the event that we commence construction of the Poinciana Parkway as it runs through the Reedy Creek Mitigation Bank. In addition, we are subject to third-party challenges under environmental laws and regulations to the permits and other approvals required for our projects and operations.
 
 
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Changes in global or regional environmental conditions and governmental actions in response to such changes may adversely affect us by increasing the costs of or restricting our planned or future growth activities.
 
There is growing concern from members of the scientific community and the general public that an increase in global average temperatures due to emissions of greenhouse gases and other human activities have or will cause significant changes in weather patterns and increase the frequency and severity of natural disasters.  An increased frequency or duration of extreme weather conditions and environmental events could limit, delay and/or increase the costs to develop land and build new homes and reduce the value of our land and housing inventory in locations that become less desirable to consumers or blocked to development.  Projected climate change, if it occurs, may exacerbate the scarcity of water and other natural resources in affected regions, which could limit, prevent or increase the costs of residential development in certain areas.  In addition, government mandates, standards or regulations intended to mitigate or reduce greenhouse gas emissions or projected climate change impacts could result in prohibitions or severe restrictions on land development in certain areas, increased energy, transportation and raw material costs that make building materials less available or more expensive, or cause us to incur compliance expenses and other financial obligations to meet permitting or land development- or home construction-related requirements that we may be unable to fully recover (due to market conditions or other factors), and may reduce our housing gross profit margins and may adversely impact our consolidated financial statements, potentially to a material degree.  As a result, climate change impacts, and laws and land development and home construction standards, and/or the manner in which they are interpreted or implemented, to address potential climate change impacts, could increase our costs and have a long-term adverse impact on our business and our consolidated financial statements.
 
As we continue to increase our dependence on digital technologies to conduct operations, our risks associated with cyber security have also increased, leaving us subject to possible frequent and severe cyber incidents.
 
For a number of years, we have been increasing our reliance on computers and digital technology. Many of our files have been digitized and more of our employees are working in almost paperless environments. We have also made changes, some significant, to our hardware and software environments and some of these transitions have not been successful, taken longer than anticipated and/or are still in progress. All of these activities may give rise to material cyber security risks and potential costs and consequences that cannot be estimated or predicted with any certainty. We have outsourced a number of our IT functions including IT support of our infrastructure and software. We are continuing to take steps to secure our confidential information from our vendors as well as third parties who may be seeking to infiltrate our systems. At this time we do not have any specific insurance for cyber security events. Management will continue to monitor our IT environment and determine whether our business operations merit further insurance coverage. Although we have not experienced any cyber attacks to date, we consider a future cyber attack a material concern that could have severe financial and other business implications.
 
Increased regulation of the mortgage industry could harm our future sales and earnings.
 
The mortgage industry is under intense scrutiny and is facing increasing regulation at the federal, state and local level. Changes in regulation have the potential to negatively impact the full spectrum of mortgage related activity. Potential changes to federal laws and regulations could have the effect of limiting the activities of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, the entities that provide liquidity to the secondary mortgage market, which could lead to increases in mortgage interest rates. At the same time, changes to the Federal Housing Administration’s rules to require increased Borrower FICO scores, increased down payment amounts, and potentially limiting the amount of permitted seller concessions, lessen the number of buyers able to finance a new home. All of these regulatory activities reduce the number of potential buyers who qualify for the financing necessary to purchase our homes, which could harm our future sales and earnings.
 
There may be future sales or other dilution of our equity, which may adversely affect the market price of our common stock.
 
Issuances of shares of common stock upon conversion of our 7.50% Notes, 7.50% Exchange Notes and 4.50% Notes, as well as the issuance of a substantial number of shares of our common stock or other equity-related securities either for new consideration or in connection with restructuring existing indebtedness, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities. Any such future issuances could dilute the ownership interests of stockholders, and we cannot predict the effect that future issuances of our common stock or other equity-related securities would have on the market price of our common stock nor can we predict our future needs to fund our operations or balance sheet with future equity issuances.
 
 
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Item 6.
 
 
3.1
Certificate of Incorporation, as amended and restated May 28, 1998 (filed as Exhibit 3(a) to Form 10-Q for the quarter ended June 30, 1998 (File No. 0-7616), and incorporated herein by reference).
 
 
3.2
Certificate of Amendment of Restated Certificate of Incorporation, dated May 26, 2000 (filed as Exhibit 3(a) to Form 10-Q for the quarter ended June 30, 2000 (File No. 0-7616), and incorporated herein by reference).
 
 
3.3
Amended and Restated By-laws (filed as Exhibit 3.2 to the Form 8-K filed on February 15, 2012, and incorporated herein by reference).
 
 
10.1
Form of performance-based Stock Award Agreement for executive officers. +
 
 
First Amendment to Amended and Restated Employment Agreement with Joseph Carl Mulac (filed herewith).
   
First Amendment to Amended and Restated Employment Agreement with Tina M. Johnston (filed herewith).
   
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
 
Certification of Chief Executive Officer required by 18 U.S.C. Section 1350 (as adopted by Section 906 of the Sarbanes-Oxley Act of 2002) (furnished herewith).
 
 
Certification of Chief Financial Officer required by 18 U.S.C. Section 1350 (as adopted by Section 906 of the Sarbanes-Oxley Act of 2002) (furnished herewith).
 
 
101.INS
XBRL Instance Document.*
 
 
101.SCH
XBRL Taxonomy Extension Schema.*
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase.*
 
 
101.DEF