Item 1. Business
Avatar Holdings Inc. (a Delaware corporation incorporated in 1970) and its subsidiaries (collectively, "Avatar" or the "Company") are engaged in two principal business activities: real estate and water and wastewater utilities operations. Avatar's real estate operations, which are located in the states of Florida, Arizona, California, and Tennessee, include: development, construction and sale of single family and multifamily housing communities; development, sale and management of vacation ownership intervals; development and sale of improved homesites and improved and unimproved commercial/industrial land tracts; operations of amenities and resorts; cable television operations and property management services. Avatar's utility operations consist of water and wastewater treatment plants which serve communities in Florida and Arizona, as well as contract management services to various utility companies. During 1996, approximately 78% and 22% of the total revenues were generated through real estate and utility operations, respectively.
Avatar's business strategy emphasizes housing sales, sales of vacation ownership intervals, retail and industrial real estate development, and resort operations. Certain of Avatar's properties are being developed and such developments are at various stages of completion.
Information regarding revenues, results of operations and assets of the business segments noted above are included in Item 8 under the caption "Notes to Consolidated Financial Statements".
Real Estate
Avatar's assets include real estate inventory in the states of Florida, Arizona, California and Tennessee. In its Florida communities of Harbor Islands, Poinciana, Cape Coral, Golden Gate and Leisure Lakes, as well as in its previously-owned Florida community of Barefoot Bay and its Arizona community of Rio Rico and its property in Tennessee, Avatar's activities include the construction and sale of single family and multifamily housing, the construction, sale and management of vacation ownership units and homesite and industrial/commercial land sales, with the types of activities varying from community to community. Avatar owns other sites including Banyan Bay in Martin County, Florida; Ocala Springs in Marion County, Florida; and Woodland Hills in Los Angeles County, California.
The Harbor Islands Project encompasses 192 acres, including 30 acres conveyed to the City of Hollywood for future parks, adjoining the Intracoastal Waterway in Hollywood, Florida. The Company may build up to 2,400 residential units, including single family homes, townhomes, villas and mid and high-rise condominium units in this water-oriented community. Additionally, this community will include a 196-boat slip marina. In 1996, Avatar closed 70 single family homes and received deposits on sales for another 41 single family homes. These sales have a combined sales value of approximately $17,917,000.
Poinciana, located in central Florida approximately 21 miles south of Orlando and 10 miles from Walt Disney World, encompasses 47,000 acres of land, approximately 16,000 of which are owned by Avatar. This planned community development includes subdivisions for single family, multifamily and
Item 1. Business -- continued
manufactured housing, and commercial/industrial areas. Since 1971, 21,850 homesites have been sold and approximately 5,256 housing units, primarily single family houses and townhouses, have been constructed by Avatar and other non-affiliated builders. As of December 31, 1996, approximately 14,200 developed and undeveloped single family homesites remained in inventory at Poinciana. Additionally, approximately 4,800 acres of land zoned for industrial/commercial/institutional and multifamily use also remained in inventory. Avatar's housing programs in Poinciana include its communities of Regency Pointe, Crescent Lakes, Cypress Woods and the Estates of Deerwood, as well as scattered lot housing programs. Regency Pointe, a 96 home community, was virtually sold out during 1996. The grand opening of Heatherstone, the first phase of Crescent Lakes, a 904 home community, and The Oaks at Cypress Woods occurred during 1995. Additionally, platting, design, and engineering of 121 and 70 homes began for Orchid Edge and Astor Cove, respectively; and sales and construction began for Laurel Run at Crescent Lakes. Platting, design and engineering for 84 and 70 homes also commenced at Peppertree and Pinehurst, respectively, at Cypress Woods. At December 31, 1996, Avatar had contracts at Poinciana to construct 175 single family units with a related sales value of approximately $16,292,000. Avatar also owns and operates a 31,100 square foot shopping center at Poinciana that was 100% occupied at December 31, 1996. Recreational facilities owned and operated by Avatar at the Poinciana development include an 18-hole Devlin Von-Hagge championship golf course, tennis courts, a golf and racquet club with a swimming pool, a community center and a series of nature walks and trails.
Barefoot Bay is located on Florida's east coast, midway between Vero Beach and Melbourne. Avatar's operations at Barefoot Bay include the sale of homesites. Since operations commenced in 1970, approximately 96% of the 5,020 available homesites have been sold. Avatar also owns 58 acres of land held for future development, sale or other use, adjacent to Barefoot Bay. Avatar's goal of divesting non- strategic assets resulted in the 1996 sale of an 18-hole executive golf course, a community center, swimming pools, tennis courts, a private beach, a fishing pier and a 13,420 square foot shopping center in Barefoot Bay.
Cape Coral, located on Florida's west coast seven miles west of Fort Myers, is a 60,700-acre community, of which approximately 3,600 acres are owned by Avatar. Its population has increased from 11,470 in 1970 to approximately 89,300 in 1996. Remaining inventory, at December 31, 1996, included approximately 7,700 developed and undeveloped single family homesites and approximately 730 acres of land zoned for commercial, industrial and multifamily use. Avatar's housing programs in Cape Coral include Emerald Cove, a 101 home community; The Hermitage, an upscale gated waterfront community consisting of 19 oversized homesites; Cape Harbour, a 232 home community, and scattered lot programs. At December 31, 1996, Avatar had contracts at Cape Coral to construct 72 single family units with a related sales value of approximately $9,472,464. Avatar owns and operates the Camelot Isles Shopping Center, a 70,000 square foot retail center. At December 31, 1996, the shopping center was 98% occupied. Avatar's Tarpon Point Marina, which is 100% occupied, is located in Cape Coral, accommodates 175 vessels and features dockmaster facilities, a ship's store and fueling facilities. The Camelot Marina, for which the initial phase of construction was completed in 1991, will accommodate 76 vessels and will feature 3,500 feet of boardwalk upon completion. Other amenities available to the residents of Cape Coral include Avatar's recently renovated Cape Coral Golf and Tennis Resort featuring a 18-hole championship golf course, a 9-hole executive golf course, eight tennis courts and a 100-room motel.
Golden Gate City, located east of Naples in southwest Florida, had remaining inventory at December 31, 1996 of 36 single family and duplex homesites, 48 acres of land zoned for multifamily use and 12 acres zoned for commercial use.
Item 1. Business -- continued
Remaining inventory, at Golden Gate Estates as of December 31, 1996, includes 150 homesites of varying size, the majority of which are approximately 1 and 1-1/4 acre homesites, and 7,500 acres of land held for future use.
Avatar's land holdings in Leisure Lakes, located near the city of Lake Placid in South Central Florida, consists of approximately 885 homesites in inventory at December 31, 1996. Amenities at Leisure Lakes include a 9-hole executive golf course, a small lakefront motel, tennis courts, shuffleboard courts, a swimming pool, a club house with pro shop, a coffee shop, a private beach, a boat ramp, a card room and various lakes available for water sports.
Avatar's real estate activities at Poinciana also include the construction, sale and management of vacation ownership intervals. As of December 31, 1996, 2,061 unit weeks had been sold and 851 unit weeks remained in inventory.
In 1995, Avatar began the development, construction and sale of vacation ownership intervals at its Sunrise Ridge property in Pigeon Forge, Tennessee. As of December 31, 1996, 2,165 unit weeks had been sold and 365 unit weeks remained in inventory, and 1,023 unit weeks remained available for sale for the units currently under construction.
During 1996, an Avatar subsidiary and Stanco Partners, Ltd. entered into a joint venture agreement and acquired Casa Del Mar, an Ormond Beach, Florida beachfront hotel. Avatar's plans include a phased conversion of the 151-room hotel into a timesharing resort as part of the Company's Vacation Club network.
Rio Rico, a 55,000-acre community development in southern Arizona, is located 57 miles south of Tucson. This community, with a population of approximately 3,500 residents, consists of single family homes and townhouses and includes several areas zoned for commercial and industrial development. Avatar owns and operates a 180-room hotel complex, an 18-hole Robert Trent Jones designed championship golf course and a 36,800 square foot shopping center, which was 92% occupied as of December 31, 1996. Remaining inventory, at Rio Rico at December 31, 1996, included approximately 5,600 single family homesites, approximately 1,000 acres of land zoned for commercial, industrial and multifamily use, 7,300 acres of land held for future development, sale or other use and 2,838 acres of undeveloped mountain range reserved for open space.
Banyan Bay, located in Martin County, Florida, comprises 251 acres of land. Future plans contemplate a bulk sale, or development of a medium-density residential development of two and four story condominiums.
Ocala Springs, located five miles northeast of Ocala in Marion County, Florida, is comprised of approximately 4,600 acres of land. The concept plan for this project provides for 700 single family ranchettes on 1-1/4 to 1-1/2 acre lots, 4,500 single family homesites on 1/4 to 1/2 acre lots, 400 homesites for manufactured housing and 1,000 multifamily condominium units. The plan also provides for construction of an 18-hole golf course, and development of more than 130 acres which will be used for commercial, industrial and service facilities. These plans have been reviewed by all appropriate state, regional and local governmental agencies and the plat for Phase I has been filed with and accepted by Marion County.
Item 1. Business -- continued
Woodland Hills, located in northwest Los Angeles County, California, consists of the Natoma tract that encompasses approximately 350 acres of land. Conceptual planning for this tract has been completed for 59 luxury homesites. An environmental impact report has been filed and has been accepted by the City of Los Angeles and documents are pending for Tentative Tract Map approval with the City.
In addition to the real estate holdings described above, Avatar owns approximately 3,500 acres of land in Florida that is being held for future development or bulk sales.
Utilities
Avatar's water and wastewater treatment facilities include 17 water treatment facilities and 12 wastewater treatment facilities serving 6 communities in Florida (including Poinciana, Barefoot Bay, and Golden Gate) and Rio Rico in Arizona. These facilities provide for the treatment, distribution and sale of water for public and private use, and the treatment and disposal of wastewater. At December 31, 1996, Avatar's utility operations had approximately 41,000 water customers and 32,000 wastewater customers.
An Avatar subsidiary provides consulting, data processing, customer billing and other related services to all Avatar utility operating subsidiaries. In addition, it provides these services and others, including plant operations and maintenance, meter reading, customer service, and payment remittance services, to 26 non-affiliated utilities, both public and private. Notable contracts include a five year contract for water/wastewater system operation and maintenance for Celebration, the project under construction by Disney Development Company, and contract meter reading for Fort Pierce Utilities Authority and the City of Sunrise, Florida.
Employees
As of December 31, 1996, Avatar employed approximately 1,108 individuals on a full-time or part-time basis. In addition, Avatar utilizes on a daily basis such additional personnel as may be required to perform various land development activities. Avatar's relations with its employees are satisfactory and there have been no work stoppages.
Item 1. Business -- continued
Regulation
Avatar's real estate operations, including matters such as planning, zoning, design, construction of improvements, environmental considerations and sales activities are regulated by various local, regional, state and federal agencies, including the Federal Trade Commission (FTC). For its community developments in Florida, Tennessee and Arizona, state laws and regulations may require the filing of registration statements, copies of promotional materials and numerous supporting documents, and the delivery of an approved disclosure report to purchasers, prior to the execution of a sales contract. In addition to Florida, Tennessee and Arizona, certain states impose requirements relating to the inspection of properties, approval of sales literature, disclosures to purchasers of specified information, assurances of future improvements, approval of terms of sale and delivery to purchasers of a report describing the property. Federal regulations adopted pursuant to the Interstate Land Sales Full Disclosure Act provide for the filing or certification of a registration statement with the Office of Interstate Land Sales Regulation of the Department of Housing and Urban Development. Avatar's homesite installment sales and timeshare sales activities are required to comply with the Federal Consumer Credit Protection ("Truth- in-Lending") Act.
Avatar's utility operations and rate structures are regulated by various federal, state and county agencies and must comply with federal and state treatment standards. All sources of water and wastewater effluent are required to be tested on a regular basis and purified in order to comply with governmental standards.
The Company believes it is in compliance with applicable laws and regulations in all material respects.
Competition
Avatar's real estate operations, particularly in the state of Florida, are highly competitive. In its sales of housing units, Avatar competes, as to price and product, with several homebuilding companies for the discretionary income of individuals who desire eventually to relocate or establish a second home in Florida or Arizona. In recent years, there have been extensive housing projects in the geographical areas in which Avatar operates. The vacation ownership sales business is also highly competitive with companies which are larger and better capitalized throughout the United States and abroad selling vacation ownership intervals on terms similar to those offered by Avatar.
Item 2.

Item 2. Properties
Avatar's real estate operations are described in Item 1 above. Land developed and in the process of being developed, or held for investment and/or future development, has an aggregate cost of approximately $137,008,000 at December 31, 1996.
Avatar's utility operations include water and wastewater plants and equipment located in Florida and Arizona. Such properties have a net book value of $181,745,000 at December 31, 1996.
Item 2. Properties -- continued
Avatar's corporate headquarters are located at 255 Alhambra Circle, Coral Gables, Florida, in 27,915 square feet of leased office space. For additional information concerning properties leased by Avatar, see Item 8, "Notes to Consolidated Financial Statements."
Item 3.

Item 3. Legal Proceedings
Avatar is involved in various pending litigation matters primarily arising in the normal course of its business. Although the outcome of these and the following matter cannot be determined, management believes that the resolution of these matters will not have a material effect on Avatar's business or financial position.
On October 1, 1993, the United States, on behalf of the U.S. Environmental Protection Agency, filed a civil action against Florida Cities Water Company ("Florida Cities"), a utility subsidiary of Avatar Holdings Inc. ("Avatar"), in the U.S. District Court for the Middle District of Florida, United States v. Florida Cities Water Company, Civil Action No. 93-281-CIV-FTM-21, alleging that Florida Cities' Waterway Estates treatment plant, located in Lee County, Florida operated in violation of the Federal Clean Water Act ("Act"), 33 U.S.C. S1251 et seq. On May 5 and June 26, 1995, the United States amended its complaint to include allegations against Florida Cities for violations of the Act at two other Florida wastewater treatment plants, Barefoot Bay, located in Brevard County, and Carrollwood, located in Hillsborough County. In addition, the government amended the complaint to include Avatar, the parent corporation, as a defendant. A trial was held in March and April 1996. On August 20, 1996, the Court issued its final judgment, incorporating earlier rulings. The Court found Avatar not liable on any of the government's claims and entered judgment in Avatar's favor. The Court found Florida Cities not liable on certain of the government's claims, but liable on other claims, and awarded the government $310,000 in civil penalties against Florida Cities. On October 18, 1996, the government filed a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit. Avatar and Florida Cities believe that there are strong arguments to support the affirmation of the judgment of the District Court on appeal.
Item 4.

Item 4. Submission of Matters to a Vote Security Holders
None
Executive Officers of the Registrant
Pursuant to General Instruction G (3) to Form 10-K, the following list is included as an unnumbered item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 29, 1997.
The following is a list of names and ages of all of the executive officers of Avatar, indicating all positions and offices with Avatar held by each such person and each such person's principal occupation(s) or employment during the past five years unless otherwise indicated. All such persons have been elected to serve until the next annual election of officers which is expected to occur on May 29, 1997, when they are reappointed or their successors are elected, or until their earlier resignation or removal.
Name Age Office and Business Experience - ---- --- ------------------------------
Leon Levy 71 Chairman of the Board since January 1981; General Partner, Odyssey Partners, L.P., a private partnership engaged in investment, trading and related activities; Chairman of the Board of Oppenheimer Funds; former Chairman of the Board (1974-1985) of Oppenheimer Management Corp.; Director of S.G. Warburg & Co., Ltd. (Jersey Funds).
Edwin Jacobson 67 Chief Executive Officer since February 1994; Chairman of the Executive Committee since June 1992; President from February 1994 to February 1997; President and Chief Executive Officer of Chicago Milwaukee Corporation since June 1985; President and Chief Executive Officer of CMC Heartland Partners since September 1990; and President and Chief Executive Officer, since June 1985, of Milwaukee Land Company, a non- diversified, closed-end management investment company, publicly traded since July 1993.
Executive Officers of the Registrant -- continued
Gerald D. Kelfer 51 President since February 1997, Vice Chairman of the Board since December 1996, and a member of the Board of Directors since October 1996. Formerly a principal of Odyssey Partners, L.P. from July 1994 to February 1997, Executive Vice President, Senior General Counsel and Director of Olympia & York Companies (U.S.) from 1985 to 1994.
Dennis J. Getman 52 Executive Vice President since March 1984. Senior Vice President from September 1981 to March 1984 and General Counsel since September 1981.
Charles L. McNairy 50 Executive Vice President since September 1993 and Treasurer and Chief Financial Officer since September 1992. Senior Vice President from September 1992 to September 1993. Vice President - Finance from January 1985 to September 1992, except from April 1987 to September 1988.
Juanita I. Kerrigan 50 Vice President and Secretary since September 1980.
G. Patrick Settles 48 Vice President since November 1986 and Assistant General Counsel since September 1983.
Lawrence L. Colditz 32 Controller since September 1995. Assistant Controller from October 1992 to September 1995. Director of Financial Accounting from October 1991 to October 1992. Accounting Manager from October 1990 to October 1991.
The above executive officers have held their present positions with Avatar for more than five years, except as otherwise noted.
No director or executive officer of Avatar has any family relationship with any other director or executive officer of Avatar.
PART II
Item 5.

Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The Common Stock of Avatar Holdings Inc. is traded through the National Market System of the National Association of Securities Dealers Automated Quotation System ("NASDAQ") under the symbol AVTR. There were 8,100 record holders of Common Stock at February 28, 1997.
High and low quotations, as reported, for the last two years were:
Avatar has not declared any cash dividends on Common Stock since its issuance and has no present intention to pay cash dividends. Avatar is subject to certain restrictions on the payment of dividends as set forth in Item 8, "Notes to Consolidated Financial Statements".
Item 6.

Item 6. Selected Financial Data
FIVE YEAR COMPARISON OF SELECTED FINANCIAL DATA Dollars in thousands (except per-share data)
(1) During 1993, the sale of the Midwest Water Utilities was completed.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands)
RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant factors that have affected Avatar during the periods included in the accompanying consolidated statements of operations.
A summary of the period to period changes in the items included in the consolidated statements of income is shown below.
Operations for the years ended December 31, 1996, 1995 and 1994 resulted in pre-tax income (loss) of $1,040, ($10,339), and ($14,621), respectively. The improvement in pre-tax income for 1996 compared to 1995 is primarily attributable to an increase in real estate contribution margin, recognition of deferred gross profit on homesite sales, and improved utility contribution margins which was partially mitigated by a decrease in net trading account profits. The decrease in pre-tax loss during 1995 compared to 1994 is primarily attributable to an increase in the pre-tax gain from net trading account profits of $6,570 which was partially mitigated by increased selling expenses and start up costs attributable to housing programs.
The financial statements for the year ended December 31, 1995 include the following amounts recorded in the fourth quarter: a decline due to an adjustment to the market value of investments of $1,315 and a provision of $1,250 due to an increase in the accrual relating to pending litigation.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RESULTS OF OPERATIONS -- continued
The financial statements for the year ended December 31, 1994 include the following amounts recorded in the fourth quarter: a loss of $1,402 due to the decline in market value of investments, a loss of $1,500 due to the write down of a certain inventory tract to net realizable value and a provision of $1,000 due to an increase in the accrual related to pending litigation.
Avatar uses the installment method of profit recognition for homesite sales. Under the installment method the gross profit on recorded homesite sales is deferred and recognized in income of future periods, as principal payments on contracts are received. Fluctuations in deferred gross profit result from deferred gross profit on current homesite sales less recognized deferred gross profit on prior years' homesite sales.
The Company continued to develop a diversified mix of products and services by introducing additional housing products, expanding vacation ownership operations, developing amenities and support facilities, expanding property contract management services and converting land holdings into income producing operations.
Gross real estate revenues increased $47,540 or 84.9% during 1996 when compared to 1995 and $12,118 or 27.6% during 1995 when compared to 1994. The increase in real estate revenues for 1996 when compared to 1995 is primarily a result of increased homebuilding, vacation ownership sales volume, the sale of the recreation facilities and other assets at the company's former Barefoot Bay Community and a bulk land sale at Leisure Lakes. Homebuilding revenues increased $36,787 or 277.4% in 1996 when compared to 1995, while vacation ownership revenues increased $2,161 or 29.2.% in 1996 when compared to 1995. The improvement in homebuilding revenues is primarily due to closings at the company's Harbor Islands project, as well as the other sites. Harbor Islands closed 70 units with a sales volume of $27,301 during 1996 compared to no closings in 1995. Housing units closed, excluding Harbor Islands totaled 223 units with a sales volume of $22,593 compared to 150 units with a sales volume of $12,989 in 1995. The improvement in vacation ownership revenues is due to increased sales at the company's Sunrise Ridge Resort. Sales for 1996 at Sunrise Ridge Resort totaled $9,031 compared to $5,742 for 1995. This increase was mitigated in part by a decrease in sales at the company's Alhambra at Poinciana Resort. The increase in real estate revenues for 1995 when compared to 1994 is primarily a result of increased housing and vacation ownership sales volume. Housing revenues increased $5,860 or 79% in 1995 when compared to 1994, while vacation ownership revenues increased $6,069 or 401% in 1995 when compared to 1994. Real estate expenses increased $37,723 or 57.2% in 1996 when compared to 1995 and $15,319 or 30.3% in 1995 when compared to 1994. The increase in real estate expenses for 1996 is primarily a result of increased real estate revenues and an inventory write down of the company's Banyan Bay property. The increase in real estate expenses for 1995 when compared to 1994 is primarily a result of increased selling expenses and start up costs attributable to increased housing programs. Margins for 1996 are comparable with those of 1995 for housing and vacation ownership.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RESULTS OF OPERATIONS -- continued
The average selling price of housing units closed for 1996 was $170, an increase of 95.0% when compared to 1995. This increase is due to closings at Harbor Islands, which had an average selling price on closed units of $390 for 1996 compared to no closings in 1995. The 1995 average selling prices of housing units closed were consistent with 1994 levels. The average selling price of housing units in backlog of $135 at December 31, 1996 decreased by 34.0% from 1995 prices due to the reduced number of sales in backlog at Harbor Islands. The average selling price of housing units in backlog of $210 at December 31, 1995 increased by 144% over 1994 prices due to sales at Harbor Islands, which has an average sales price of $412.
Data from home-building operations for the years ended 1996, 1995 and 1994 is summarized as follows:
Utility revenues increased $3,080 or 10.4% during 1996 when compared to 1995 and $1,005 or 3.5% during 1995 when compared to 1994. Utility expenses increased $582 or 2.3% during 1996 when compared to 1995 and $272 or 1.1% during 1995 when compared to 1994. Utility revenues increased as a result of rate increases, customer growth and increased contract management operations. Utility expenses increased correspondingly to the customer growth.
Interest income decreased $835 or 8.7% during 1996 when compared to 1995 and $1,472 or 13.2% during 1995 when compared to 1994. The declines in interest income are primarily attributable to lower average aggregate balances of the Company's contract and mortgage notes receivable portfolio, caused by collections, cancellations and reductions in new land sales. The average balance of Avatar's receivable portfolio was $81,673, $95,299, and $109,265 for 1996, 1995 and 1994, respectively.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RESULTS OF OPERATIONS -- continued
Trading account profit, net decreased $4,702 for 1996 when compared to 1995 and increased $6,570 in 1995 when compared to 1994. Trading account profit, net represents interest income and realized and unrealized gains and losses related to the trading investment portfolio, net of commissions payable to investment advisors.
Other revenues for 1996 includes a sale of water rights at Rio Rico for $1,585.
General and administrative expenses decreased $464 or 5.0% in 1996 compared to 1995 and $976 or 9.5% in 1995 compared to 1994. The decrease for 1996 compared to 1995 results primarily from a reduction in the accrual for incentive compensation recorded for executive officers. The decrease for 1995 compared to 1994 results from reductions in the accrual for incentive compensation recorded for executive officers and expenses related to a legal settlement in 1994.
Interest expense increased $1,310 or 11.3% in 1996 when compared to 1995 and $420 or 3.7% in 1995 when compared to 1994. The increase in 1996 when compared to 1995 is primarily due to an increase in interest expense in the homebuilding and vacation ownership operations, mitigated in part by a decrease in the outstanding balance of notes, mortgage notes and other debt, as well as an increase in capitalization of interest which totaled $4,003 in 1996. The increase in 1995 is primarily due to the increase in the outstanding balance of notes, mortgage notes and other debt, which was partially offset by capitalization of interest associated with the development and construction costs of approximately $3,234 for 1995 and $1,625 for 1994.
LIQUIDITY AND CAPITAL RESOURCES
Avatar's primary business activities, which include homebuilding, vacation ownership, land development, resort operations and utility services are capital intensive in nature. Avatar expects to fund its operations and capital requirements through a combination of cash and investment securities on hand, operating cash flows, proceeds from the sale of certain non-core assets and external borrowings. There is no assurance that the sale of certain non-core assets will be achieved.
In 1996, net cash provided by operating activities amounted to $40,246 as a result of withdrawals from the investment portfolio of $45,554 and principal payments on contracts receivable of $17,550 partially offset by an increase in inventories, which included expenditures from land development, housing, and vacation ownership operations of $28,935. Net cash used in investing activities of $11,537 in 1996 resulted primarily from investments in property, plant and equipment. Net cash used in financing activities of $23,609 resulted primarily from principal payments on revolving lines of credit and long-term borrowings of $115,147, less net proceeds from revolving lines of credit and long-term borrowings of $91,538.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
LIQUIDITY AND CAPITAL RESOURCES -- continued
In 1995, net cash used in operating activities amounted to $20,180 as a result of an increase in inventories, which included expenditures from land development, housing, and vacation ownership operations of $37,843, partially offset by principal payments on contracts receivable of $19,475 and $11,000 in withdrawals from the investment portfolio. Net cash used in investing activities of $13,753 in 1995 resulted primarily from investments in property, plant and equipment. Net cash provided by financing activities of $31,635 resulted primarily from net proceeds from revolving lines of credit and long-term borrowings of $76,035 less principal payments on revolving lines of credit and long-term borrowings of $44,013.
Avatar's secured lines of credit were $60,374 and $57,513 at December 31, 1996 and 1995, respectively. Avatar's unsecured credit lines were $15,000 at December 31, 1996 and 1995, respectively.
The unused portions of the secured and unsecured credit lines were $20,000 and $10,650, respectively, at December 31, 1996. Included in these lines of credit is a line of credit secured by investments, which had an outstanding balance at December 31, 1996 of $3,350 and will mature May 31, 1998. Also included are three lines of credit with balances outstanding at December 31, 1996 of $6,449, $7,840 and $15,000 due May 31, 1998; and two additional lines of credit with balances outstanding of $995 and $6,741 due October 31, 2002 and April 30, 2001, respectively. These lines are collateralized by certain contracts receivable.
Avatar has planned utility construction for 1997 totaling approximately $15,775. Additionally, the Company has planned development expenditures of $17,753 during 1997, of which $13,904 is related to housing, which will result in additional homesite inventory and preservation of development permits. It is anticipated that land development and utility construction expenditures for 1997 will be funded by operating cash flow and borrowings from external sources.
As of December 31, 1996, Avatar has approximately $4,535 in investments which are all classified as trading. The Company intends to continue to actively trade such securities in an effort to generate profits and will reinvest such profits until such time as the Company's cash requirements necessitate the use or partial use of the portfolio proceeds. During 1996, the Company's cash requirements necessitated the use of $45,554 from its portfolio proceeds, of which $32,650 was used to reduce related debt. As of December 31, 1996, $3,964 of the investments serve as collateral for a secured line of credit with an outstanding balance of $3,350.
As of December 31, 1995, Avatar had approximately $48,258 in investments which were classified as trading. During 1995, the Company's cash requirements necessitated the use of $11,000 from its portfolio proceeds. As of December 31, 1995, $46,729 of the investments served as collateral for a secured line of credit with an outstanding balance of $36,000.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
LIQUIDITY AND CAPITAL RESOURCES -- continued
Avatar's Board of Directors has authorized expenditures for the purchase of Avatar's common stock and 8% and 9% senior debentures. As of December 31, 1996, the remaining authorization for such expenditures was $2,942.
Management does not anticipate a significant change in interest rates for 1997, and accordingly, does not expect Avatar's primary business activities to be adversely affected by interest rates. Avatar's vacation ownership sales are not dependent upon the customer obtaining third party financing. Vacation ownership sales are substantially funded under credit facility agreements. A high interest rate environment would be likely to adversely affect Avatar's real estate results of operations and liquidity because of its negative impact on the housing industry and because certain of Avatar's debt obligations are tied to prevailing interest rates. Increases in interest rates affecting the Company's utility operations generally are passed on to the consumer through the regulatory process.
EFFECTS OF INFLATION AND ECONOMIC CONDITIONS
Inflation has had a minimal impact on Avatar's operations over the past several years, and management believes its effect has been neither significant nor greater than its effect to the industry as a whole. It is anticipated that the impact of inflation on Avatar's operations for 1997 will not be significant.
IMPACT OF TAX INSTALLMENT METHOD
In years 1988 through 1995, the Company elected the installment method for recording a substantial amount of its homesite and vacation ownership sales in its federal income tax return, which deferred taxable income into future fiscal periods. As a result of this election, the Company may be required to pay compound interest on certain federal income taxes in future fiscal periods attributable to the taxable income deferred under the installment method. The Company believes that the potential interest amount, if any, will not be material to its financial position and results of operations of the affected future periods.
Item 8.

Item 8. Financial Statements and Supplementary Data
Report of Independent Certified Public Accountants.................. 20
Consolidated Balance Sheets -- December 31, 1996 and 1995........... 21
Consolidated Statements of Operations -- For the years ended December 31, 1996, 1995 and 1994.................................. 22
Consolidated Statements of Stockholders' Equity -- For the years ended December 31, 1996, 1995 and 1994............................ 23
Consolidated Statements of Cash Flows -- For the years ended December 31, 1996, 1995 and 1994.................................. 24
Notes to Consolidated Financial Statements.......................... 26
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Stockholders and Board of Directors Avatar Holdings Inc.
We have audited the accompanying consolidated balance sheets of Avatar Holdings Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the index at Item 14. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and related schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avatar Holdings Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
ERNST & YOUNG LLP
Miami, Florida February 28, 1997, except for Note H, as to which the date is March 18, 1997.
AVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands)
AVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Operations (Dollars in thousands except per-share amounts)
See notes to consolidated financial statements.
AVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity (Dollars in thousands)
There are 5,000,000 authorized shares of preferred stock, none of which are issued.
See notes to consolidated financial statements.
AVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands)
AVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows -- continued (Dollars in thousands)
See notes to consolidated financial statements.
AVATAR HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996 (Dollars in thousands except per-share data)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: ----------------------------
The consolidated financia l statements include Avatar Holdings Inc. and its subsidiaries ("Avatar"). All significant intercompany accounts and transactions have been eliminated in consolidation.
General: --------
Avatar is principally engaged in the business of developing and selling single and multifamily residential housing, vacation ownership intervals, improved and unimproved real estate, and providing water and wastewater utility services.
Restricted Cash: ----------------
Restricted cash represents housing deposits of $684 and utility deposits of $46. The housing deposits will become available to the Company when the housing contracts close.
Land Inventories: -----------------
Land inventories are stated at the lower of cost or estimated net realizable value. Cost includes expenditures for acquisition, construction, development and carrying charges. Interest costs incurred during the period of land development, when applicable, are capitalized as part of the cost of such projects. Land acquisition costs are allocated to individual land parcels based upon the relationship that the estimated sales prices of specific parcels bear to the total sales price of the entire community. Construction and development costs are added to the value of the specific parcels for which the costs are incurred.
In March 1995, the FASB issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company adopted Statement 121 in the first quarter of 1996, and there was no material impact on the company's operations or financial position.
Revenues: ---------
Sales of housing units are recognized in full upon the transfer of title to a purchaser. Revenues from commercial land and bulk land sales are recognized in full at closing, provided the purchaser's initial investment is adequate, all financing is considered collectible and Avatar is not obligated to perform significant future activities.
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- continued
Revenues -- continued: ----------------------
The Company uses the installment method of profit recognition for sales of homesites, the accrual method of profit recognition for sales of completed vacation ownership intervals, and the percentage of completion method for sales of those vacation ownership intervals which are under construction. Under the installment method, the gross profit on recorded sales is deferred and recognized in income of future periods as principal payments on related contracts are received, and deferred profit is included in the balance sheet, as a reduction of contracts receivable, until recognized. Under the percentage of completion method, the gross profit on recorded sales is recognized based upon the percentage of construction completed.
Utility revenues are recorded as the service is provided.
Property, Plant and Equipment: ------------------------------
Property, plant and equipment are stated at cost and depreciation is computed principally by the straight line method over the estimated useful lives of the assets. Depreciation, maintenance and operating expenses of equipment utilized in the development of land are capitalized as land inventory cost.
Income Taxes: -------------
Income taxes have been provided using the liability method in accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Under Statement No. 109, 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.
The cumulative effect of adopting Statement No. 109 for Avatar's utility subsidiaries was not credited or charged to net income, but was recorded as a regulatory liability or regulatory asset in accordance with accounting procedures applicable to regulated enterprises. The regulatory liabilities and regulatory assets will generally be amortized to income or expense over the useful lives of the utility systems and reflect probable future revenue reductions or increases from ratepayers.
Deferred Customer Betterment Fees: ----------------------------------
Amounts collected from customers for utility improvements are classified as "Deferred Customer Betterment Fees". These fees will be reclassified to "Contributions in Aid of Construction" when service to the customer begins.
Contributions in Aid of Construction: -------------------------------------
Advances from real estate developers and other direct contributions to utility subsidiaries for plant construction are recorded as "Contributions in Aid of Construction". To the extent required by regulatory agencies, the account balance is amortized over the depreciable life of the utility plant as an offset to depreciation expense.
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- continued
Investments: ------------
The Company classifies all of its investment portfolio as trading. This category is defined as including debt and marketable equity securities held for resale in anticipation of earning profits from short-term movements in market prices. Trading account securities are carried at fair value which was $4,535 at December 31, 1996 and $48,258 at December 31, 1995.
Postretirement Benefits: ------------------------
The Company ac crues postretirement benefits (such as health care benefits) during the years an employee provides services. These benefits for retirees are currently provided only to the employees of the Company's utility subsidiaries.
Advertising Costs: ------------------
Advertising costs are expensed as incurred. For the years ended December 31, 1996, 1995 and 1994, advertising costs totaled $3,758, $3,265 and $1,304, respectively.
Net Income/Loss Per Common Share: ---------------------------------
For 1996, 1995 and 1994, net income/loss per common share is computed on the basis of the weighted average number of shares outstanding of 9,095,102.
Use of Estimates: -----------------
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results, however, could differ from those estimates.
Reclassifications: ------------------
Certain 1995 and 1994 financial statement items have been reclassified to conform with 1996 presentations.
NOTE B - REAL ESTATE SALES
The components of real estate sales are as follows:
* 1996 includes $3,714 of land sales generated by the Homebuilding Division and $4,276 for bulk land sales.
NOTE C - INVESTMENTS
The Company classifies all of its investment portfolio as trading. This category is defined as including debt and marketable equity securities held for resale in anticipation of earning profits from short-term movements in market prices. Trading account securities are carried at fair market value and both realized and unrealized gains and losses are included in net trading account profit. Fair values for actively traded debt securities and equity securities are based on quoted market prices on national markets. Fair values for thinly traded investment securities are generally based on prices quoted by investment brokerage companies.
Avatar's investment portfolio at December 31, 1996 and 1995 included corporate bonds and other bonds rated B- or above by Moody's and/or Standard and Poor's, non-rated bonds of companies which are in bankruptcy and have defaulted as to payments of principal and interest on such bonds, equity securities, money market accounts and U.S. Government and Agency securities. The portfolio at December 31, 1995, also included obligations for securities which had been sold that the Company does not own and was, therefore, obligated to purchase at a future date. Such obligations were recorded at the fair market value of the securities.
The following table sets forth the fair values of investments (including securities sold short which are valued at the cost to purchase as of December 31) :
NOTE D - CONTRACTS, MORTGAGE NOTES AND OTHER RECEIVABLES
Contracts, mortgage notes and other receivables are summarized as follows:
Contracts and mortgage notes receivable were generated through the sale of homesites at various sales offices located throughout the northeast, midwest and west coast of the United States. A significant portion of the contracts and mortgage notes receivable at December 31, 1996, resulted from sales made to customers in the northeast.
Contracts receivable are collectible primarily over a ten year period and bear interest at rates primarily ranging from 7 1/2% to 12% per annum (weighted average rate 9.9%). The Company generally requires that customers pledge the homesites as collateral for contracts and mortgages receivable and such collateral can be repossessed by the Company in the event of a default. A contract receivable is considered delinquent if the scheduled installment payment remains unpaid 30 days after its due date. Delinquent principal amounts of contracts and mortgage notes receivable at December 31, 1996 and 1995 were $7,099 or 9.6% and $11,619 or 13.0%, respectively. Estimated maturities for the five years subsequent to 1996 are: 1997 - $17,142; 1998 - $14,862; 1999 - $10,822; 2000 - $7,786 and 2001 - $6,501.
NOTE E - LAND AND OTHER INVENTORIES
Inventories consist of the following:
In 1996, the Company recorded an impairment loss of $1,464 on a certain tract of land located at the Company's Banyan Bay site. Fair value was determined based on a purchase offer received for the land.
NOTE F - ESTIMATED DEVELOPMENT LIABILITY FOR SOLD LAND
The estimated cost to complete consists of required land and utility improvements in all areas designated for homesite sales and is summarized as follows:
These estimates are based on engineering studies of quantities of work to be performed based on current estimated costs. These estimates are reevaluated annually and adjusted accordingly.
A major portion of the estimated development liability for sold land relates to utility extensions for homesites at Avatar's Arizona community (Rio Rico) which were sold prior to 1980.
At Rio Rico, Avatar entered into various service and construction agreements with Citizens Utilities Company (Citizens), a non-related company, generally providing for Avatar to construct certain utility facilities and deed them to Citizens. Avatar's expenditures, related to the construction of some of these facilities, are expected to be reimbursed from Citizens' present and future customers. Some of these reimbursable amounts are determined by specific formulas. The recovery of these expenditures is dependent upon the community attaining an occupancy and/or usage level sufficient to allow reimbursement prior to the expiration of the agreements. During 1993, Avatar purchased Citizens Utilities water and wastewater treatment division therefore voiding the portion of the existing agreement relating to water and wastewater extensions, leaving only the electrical portion.
Avatar may be obligated to expend approximately $8,394 (current costs) to complete water and wastewater utility facilities at its Poinciana subdivision. These possible future obligations are based on internal engineering studies and are not included in the estimated development liability discussed above. As such, past and future expenditures are expected to be recovered from customers' fees and future revenues.
Expenditures, net of recoveries, for homesite improvement costs totaling $11,685 are estimated as follows: 1997-$3,849 and thereafter-$7,836. Because the timing of the expenditures after 1997 is dependent upon certain future occurrences beyond Avatar's control, projection by year after 1997 is not presently practicable.
NOTE G - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and accumulated depreciation consist of the following:
Depreciation charged to operations during 1996, 1995 and 1994 was $6,380, $5,883 and $5,655, respectively, net of amortization of contributions and advances in aid of construction of $4,289, $4,051 and $2,798 during 1996, 1995 and 1994, respectively.
NOTE H - NOTES, MORTGAGE NOTES AND OTHER DEBT
Notes, mortgage notes and other debt are summarized as follows:
At December 31, 1996, Avatar had secured bank credit lines of $60,374 and unsecured bank credit lines of $15,000. The unused portions of secured and unsecured credit lines were $20,000 and $10,650 respectively, at December 31, 1996. The weighted average interest rate on short term borrowing at December 31, 1996 was 9.1% Interest rates for borrowings under these lines range from 6.43% to 8.25% on the unsecured bank credit lines and from 8% to 10.5% on the secured bank credit lines at December 31, 1996. Additionally, certain credit lines provide for fixed rate borrowing pursuant to Eurodollar interest rates. Under the terms of these agreements, Avatar is restricted from paying dividends and is required to maintain a minimum net worth as defined. The secured lines are collateralized by certain real property, and contracts and mortgage notes receivable of $57,436 and investments of $3,964 at December 31, 1996.
NOTE H - NOTES, MORTGAGE NOTES AND OTHER DEBT -- continued
In connection with the acquisition of Casa Del Mar, the Joint Venture entered into a loan agreement with $5,674 outstanding at December 31, 1996. The debt is guaranteed by a subsidiary of Avatar as well as the Joint Venture Partners.
In 1992, Avatar issued $51,160 of 7% Mortgage Trust Notes, rated "A" by Standard & Poor's Corporation, pursuant to the securitization of a portion of its homesite receivables. These notes were paid in full during the third quarter of 1996.
During 1996, an Avatar subsidiary and Stanco Partners, Ltd. entered into a joint venture agreement (the Joint Venture) and acquired Casa Del Mar (CDM), an Ormand Beach, Florida beachfront hotel. In connection with the acquisition of Casa Del Mar, the Joint Venture entered into a loan agreement with $5,674 outstanding at 31, 1996. The debt is guaranteed by a subsidiary of Avatar as well as the Joint Venture Partner. Maturities of notes, mortgage notes and other debt at December 31, 1996, are as follows:
Maturities for 1997 include approximately $4,350 related to the Company's bank credit lines. Interest capitalized during 1996, 1995 and 1994 amounted to $4,003, $3,234 and $1,625, respectively.
Property, plant and equipment and inventory pledged as collateral for notes, mortgage notes and other indebtedness had a net book value of approximately $159,000 at December 31, 1996.
NOTE I - MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES
As of December 31, 1996 and 1995, preferred stock outstanding is as follows:
Avatar's utility subsidiary's 9% cumulative preferred stock issue provides for redemption to occur no earlier than March 1, 1997, in whole or in part; however, a minimum of $1,800 of the preferred stock must be redeemed per annum beginning in 1997. A redemption of all outstanding shares shall occur no later than March 1, 2001.
Charges to operations recorded as "Other Expenses" relating to preferred stock dividends of subsidiaries amounted to $814 in 1996, $811 in 1995, and $811 in 1994.
NOTE J - RETIREMENT PLANS
Avatar has two defined contribution savings plans that cover substantially all employees. Under one of the savings plans, Avatar contributes to the plan based upon specified percentages of employees' voluntary contributions. The other savings plan does not provide for contributions by Avatar.
Avatar's non-contributory defined benefit pension plan covers substantially all employees of its subsidiary, Avatar Utilities Inc. The benefits are based on years of service and the employees' compensation during the five highest years of earnings. Avatar's funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974.
The following table sets forth the defined benefit plan's funded status as of December 31, 1996, 1995 and 1994 and the retirement expense recognized in the consolidated statements of income for the years then ended.
The actuarial assumptions used in determining the present value of the projected benefit obligation were: weighted average discount rate of 7.5% in 1996, 1995 and 1994, rate of increase in future compensation levels of 5% in 1996, 1995 and 1994, and expected long-term rate of return on plan assets of 8% in 1996, 1995 and 1994.
NOTE J - RETIREMENT PLANS -- continued
Plan assets are invested in the general asset fund of a major insurance company, which is composed primarily of fixed income securities, and a separate account, which is composed of equity securities, public bonds or cash equivalents.
NOTE K - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
A utility subsidiary of Avatar sponsors a defined non- contributory benefit postretirement plan that provides medical and life insurance benefits to both salaried and nonsalaried employees after retirement. Participants contribute a portion of such benefits. The utility's funding policy for its postretirement plan is to fund on a pay-as-you-go basis.
The following table sets forth the plan's status as of December 31, 1996 , 1995 and 1994:
For measurement purposes', the annual rate of increase in the per capita cost of covered health care benefits assumed for 1996, 1995 and 1994 was 10%, 11% and 12%, respectively; the rate of increase was assumed to decrease gradually to 6% by the year 2000 and remain at that level thereafter; termination rates calculations, except those at December 31, 1996, used the Crocker- Sarason Straight T-6 tables less 51GAM deaths; the T-8 tables were used for the December 31, 1996 calculation. This change in termination rates will decrease the net periodic benefit cost in future years. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1 percentage point each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by $516 and the aggregate of the service and interest cost components of net periodic postretirement benefit for the year then ended by $113.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation for 1996, 1995 and 1994 was 7.5%, 7.5% and 8.0%, respectively.
NOTE L - LEASE COMMITMENTS
Avatar leases the majority of its administration and sales offices under operating leases that expire at varying times through 2001. Rental expenses for the years 1996, 1995 and 1994 were $1,838, $1,562, and $1,235, respectively. Minimum rental commitments under noncancelable operating leases as of December 31, 1996 were as follows: 1997 - $2,199; 1998 - $1,837; 1999-$1,478; 2000 - $575; 2001 -$280.
NOTE M - ACCRUED AND OTHER LIABILITIES
Accrued and other liabilities are summarized as follows:
As of December 31, 1996, the Company had certain incentive compensation agreements providing for a cash payment (to the extent vested), within ten days following the respective fifth anniversary date (payment terms are subject to renewal agreements) of the respective agreement (or the termination date, if earlier), in an amount equal to the excess of a formula amount based upon the closing prices of Avatar common stock during a specified period prior to the respective fifth anniversary date (or termination date, if earlier) over the closing price of Avatar common stock on the date of the respective agreement. Each eligible employee will vest in the rights to this incentive compensation with respect to one- fifth thereof in each of the first through fifth anniversaries, subject to certain terms and conditions of the contracts should their employment status change prior to the fifth anniversary. For the years ended December 31, 1996, 1995 and 1994, the Company recorded incentive compensation of ($213), $39 and $763, respectively, associated with these agreements. The liability for incentive compensation included in other liabilities at December 31, 1996 and 1995 is $822 and $1,035, respectively.
NOTE N - INCOME TAXES
Under the installment method of tax reporting for homesite and vacation ownership sales, Avatar anticipates that its 1996 consolidated federal income tax return will reflect a net operating loss carryforward of approximately $40,000, which expires in years 2003 through 2010. In addition, investment tax credits and alternative minimum tax credit carryforwards of approximately $5,000 are available, a portion of which expires in years 1997 to 2001. These carryforwards have not been examined by the Internal Revenue Service.
The Company has recorded a valuation allowance of $41,000 with respect to the deferred income tax assets which remain after offset by the deferred income tax liabilities. Included in the valuation allowance for deferred income tax assets is approximately $9,000 which, if utilized, will be credited to additional paid-in capital.
NOTE N - INCOME TAXES -- continued
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liabilities as of December 31, 1996 and 1995 are as follows:
A reconciliation of income tax expense (credit) to the expected income tax expense (credit) at the federal statutory rate of 34% for the year ended December 31 is as follows:
In years 1988 through 1995, the Company elected the installment method for recording a substantial amount of its homesite and vacation ownership sales in its federal income tax return, which deferred taxable income into future fiscal periods. As a result of such election, the Company may be required to pay compound interest on certain federal income taxes in future fiscal periods attributable to the taxable income deferred under the installment method. The Company believes that the potential interest amount, if any, will not be material to its financial position and results of operations of the affected future periods.
NOTE O - CONTINGENCIES
Avatar is involved in various pending litigation matters primarily arising in the normal course of its business. Although the outcome of these and the following matter cannot be determined, management believes that the resolution of these matters will not have a material effect on Avatar's business or financial position.
On October 1, 1993, the United States, on behalf of the U.S. Environmental Protection Agency, filed a civil action against Florida Cities Water Company ("Florida Cities"), a utility subsidiary of Avatar Holdings Inc. ("Avatar"), in the U.S. District Court for the Middle District of Florida, United States v. Florida Cities Water Company, Civil Action No. 93-281-CIV-FTM-21, alleging that Florida Cities' Waterway Estates treatment plant, located in Lee County, Florida operated in violation of the Federal Clean Water Act ("Act"), 33 U.S.C. S1251 et seq. On May 5 and June 26, 1995, the United States amended its complaint to include allegations against Florida Cities for violations of the Act at two other Florida wastewater treatment plants, Barefoot Bay, located in Brevard County, and Carrollwood, located in Hillsborough County. In addition, the government amended the complaint to include Avatar, the parent corporation, as a defendant. A trial was held in March and April 1996. On August 20, 1996, the Court issued its final judgment, incorporating earlier rulings. The Court found Avatar not liable on any of the government's claims and entered judgment in Avatar's favor. The Court found Florida Cities not liable on certain of the government's claims, but liable on other claims, and awarded the government $310 in civil penalties against Florida Cities. On October 18, 1996, the government filed a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit. Avatar and Florida Cities believe that there are strong arguments to support the affirmance of the judgment of the District Court on appeal.
NOTE P - FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS
NOTE P - FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS -- continued
(a) Avatar's businesses are primarily conducted in the United States. (b) In computing operating profit, interest has been reflected separately. (c) Intersegment revenues contain primarily intercompany interest and management fees charged to affiliates. (d) Identifiable assets by segment are those assets that are used in the operations of each segment. General corporate assets are principally cash, receivables and investments. (e) No significant part of the business is dependent upon a single customer or group of customers. (f) Cable TV, mortgage and hotel and recreational operations which primarily serve Avatar communities do not qualify individually as separate reportable segments and are included in the real estate segment. (g) General corporate expenses are included in the real estate segment.
NOTE Q- FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial instruments, all of which are held for purposes other than trading except for investments - trading at December 31, 1996 and 1995, are as follows:
NOTE Q- FAIR VALUE OF FINANCIAL INSTRUMENTS - continued
The following methods and assumptions were used by the Company in estimating the fair value of financial instruments:
Cash and restricted cash: The carrying amount reported in the balance sheet for cash approximates its fair value.
Investments - trading: The carrying amount in the balance sheet for investments is at fair market value (See Note A).
Contracts, mortgage notes and other receivables: The fair value amounts of the Company's contracts, mortgage notes and other receivables are estimated based on a discounted cash flow analysis.
Notes, mortgage notes and other debt: The carrying amounts of the Company's borrowings under its short term bank credit lines and short term development and construction loans approximate their fair value. The fair values of the Company's mortgage obligations, mortgage bonds and promissory notes are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
Senior and subordinated debentures: The fair values of the Company's senior and subordinated debentures are estimated based on quoted market prices.
Mortgage trust notes: The fair value amount of the Company's mortgage trust notes are estimated using discounted cash flow analysis based on the Company's current incremental borrowing rate.
NOTE R - QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 1996 and 1995 is as follows:
The financial statements for the year ended December 31, 1995 include the following amounts recorded in the fourth quarter: (a) a decline due to an adjustment to the market value of investments of $1,315 ( or $.14 per share).
(b) a provision of $1,250 (or $.14 per share) due to an increase in the accrual related to pending litigation
Item 9.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.
Not applicable.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
A. Identification of Directors
The information called for in this item is incorporated by reference to Avatar's 1997 definitive proxy statement (under "Election of Directors") to be filed with the Securities and Exchange Commission on or before April 30, 1997.
B. Identification of Executive Officers
For information with respect to the executive officers of Avatar, see "Executive Officers of the Registrant" at the end of Part I of this report.
C. Compliance with Section 16(a) of the Exchange Act
The information required by this item is incorporated by reference from Avatar's 1997 definitive proxy statement (under the caption "Section 16(a) Beneficial Ownership Reporting Compliance"), to be filed with the Securities and Exchange Commission on or before April 30, 1997.
Item 11.

Item 11. Executive Compensation
The information called for by this item is incorporated by reference to Avatar's 1997 definitive proxy statement (under the caption "Executive Compensation and Other Information") to be filed with the Securities and Exchange Commission on or before April 30, 1997.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by this item is incorporated by reference to Avatar's 1997 definitive proxy statement (under the captions "Principal Stockholders" and "Security Ownership of Management") to be filed with the Securities and Exchange Commission on or before April 30, 1997.
Item 13.

Item 13. Certain Relationships and Related Transactions
None
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Financial Statements and Schedules: ----------------------------------
See Item 8 "Financial Statements and Supplementary Data" on Page 19 of this report.
Schedules: ---------
II - Valuation and Qualifying Accounts
Schedules other than those listed above are omitted, since the information required is not applicable or is included in the financial statements or notes thereto.
Exhibits: --------
3(a) * Certificate of Incorporation, as amended (previously filed as an exhibit to the Form 10-K for the year ended December 31, 1986).
3(b) By-laws, as amended and reinstated February 13, 1997, (filed herewith).
4(a) * Instruments defining the rights of security holders, including indenture for 8% senior debentures (previously filed as an exhibit to the Form 8-K dated as of September 12, 1980).
4(b) * Supplemental Indenture for 8% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
4(c) * Indenture for 9% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
10(a) *1 Employment Agreement, dated as of June 15, 1992, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
10(d) *1 Amendment to Employment Agreement, dated as of March 1, 1994, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993)
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K -- continued
10(b) *1 Incentive Compensation Agreement, dated as of January 18, 1993 by and between Avatar Holdings Inc. and Dennis Getman (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993).
10(c) *1 Incentive Compensation Agreement, dated as of September 9, 1993 by and between Avatar Holdings Inc. and Charles McNairy (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993).
10(d) * Revolving Credit Agreement between Avatar Properties Inc. and BHF Bank dated November 30, 1993 (previously filed as an exhibit to the Form 10-K for the year ended December 31, 1993).
10(e) *1 Employment Agreement, dated as of July 27, 1995, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-Q for the quarter ended September 30, 1995).
10(f) 1 Amendment to Employment Agreement, dated as of February 13, 1997, to Employment Agreement, dated as of June 15, 1992 (as amended as of March 1, 1994) and Employment Agreement, dated as of July 27, 1995, by and between Avatar Holdings Inc. and Edwin Jacobson (filed herewith).
10(g) 1 Employment Agreement, dated as of February 13, 1997, by and between Avatar Holdings Inc. and Gerald D. Kelfer (filed herewith).
10(h) 1 Nonqualified Stock Option Agreement, dated as of February 13, 1997, by and between Avatar Holdings Inc. and Gerald D. Kelfer (filed herewith).
11 Computations of earnings per share (filed herewith)
27 Financial Data Schedule (filed herewith)
* These exhibits are incorporated by reference and are on file with the Securities and Exchange Commission.
1 Employment and Compensation agreements.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)
(1) (Credit) Charge to operations as an (increase) decrease to revenues.
(2) Uncollectible accounts written off.
(3) Credited principally to interest income or allowance for doubtful open accounts upon write-off of uncollectible accounts.
(4) Valuation allowance for deferred tax assets recorded in conjunction with the adoption of FASB Statement No. 109.
SIGNATURES ----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AVATAR HOLDINGS INC.
Dated: March 20, 1997 By: /s/ Charles L. McNairy ------------------------------ Charles L. McNairy, Executive Vice President, Treasurer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Dated: March 20, 1997 By: /s/ Lawrence L. Colditz -------------------------------- Lawrence L. Colditz, Controller
Dated: March 20, 1997 By: /s/ Milton Dresner -------------------------------- Milton Dresner, Director and Audit Committee Member
Dated: March 20, 1997 By: /s/ Leon T. Kendall -------------------------------- Leon T. Kendall, Director, Chairman of the Audit Committee and Executive Committee Member
Dated: March 20, 1997 By: /s/ Edwin Jacobson -------------------------------- Edwin Jacobson, Director, Chairman of the Executive Committee and Chief Executive Officer
Dated March 20, 1997 By: /s/ Gerald D. Kelfer -------------------------------- Gerald D. Kelfer, Director, President, Vice Chairman of the Board of Directors and Executive Committee Member
Dated: March 20, 1997 By: /s/ Leon Levy -------------------------------- Leon Levy, Chairman of the Board of Directors and Executive Committee Member
Dated: March 20, 1997 By: /s/ Martin Meyerson ------------------------------- Martin Meyerson, Director and Audit Committee Member
Dated: March 20, 1997 By: /s/ Kenneth T. Rosen -------------------------------- Kenneth T. Rosen, Director
Dated: March 20, 1997 By: /s/ Fred Stanton Smith ------------------------------- Fred Stanton Smith, Director, Executive Committee Member and Audit Committee Member
Dated: March 20, 1997 By: /s/ Henry King Stanford -------------------------------- Henry King Stanford, Director
Exhibit Index -------------
* These exhibits are incorporated by reference and are on file with the Securities and Exchange Commission. 1 Employment and Compensation agreements.
3(a) * Certificate of Incorporation, as amended previously (filed as an exhibit to the Form 10-K for the year ended December 31, 1986)
3(b) By-laws, as amended and reinstated February 13, 1997, (filed herewith.)......................................... 52
4(a) * Instruments defining the rights of security holders, including indenture for 8% senior debentures (previously) (previously filed as an exhibit to the Form 8-K dated as of September 12, 1980).
4(b) * Supplemental Indenture for 8% senior debentures dated as of December 19, 1992 ( previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
4(c) * Indenture for 9% senior debentures dated as of December 19, 1992 ( previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
10(a) *1 Employment Agreement, dated as of June 15, 1992, by and between Avatar Holdings Inc. and Edwin Jacobson Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).
10(d) *1 Amendment to Employment Agreement, dated as of March 1, 1994, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993)
10(b) *1 Incentive Compensation Agreement, dated as of January 18, 1993 by and between Avatar Holdings Inc. and Dennis Getman (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993).
10(c) *1 Incentive Compensation Agreement, dated as of September 9, 1993 by and between Avatar Holdings Inc. and Charles McNairy (previously filed as an exhibit to Form 10-K for the year ended December 31, 1993).
10(d) * Revolving Credit Agreement between Avatar Properties Inc. and BHF Bank dated November 30, 1993 (previously filed as an exhibit to the Form 10-K for the year ended December 31, 1993)
Exhibit Index -- continued -------------
10(e) *1 Employment Agreement, dated as of July 27, 1995, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-Q for the quarter ended September 30, 1995).
10(f) 1 Amendment to Employment Agreement, dated as of February 13, 1997, to Employment Agreement, dated as of June 15, 1992 (as amended as of March 1, 1994) and Employment Agreement, dated as of July 27, 1995, by and between Avatar Holdings Inc. and Edwin Jacobson (filed herewith)............................................... 69
10(g) 1 Employment Agreement, dated as of February 13, 1997, by and between Avatar Holdings Inc. and Gerald D. Kelfer (filed herewith)........................................ 73
10(h) 1 Nonqualified Stock Option Agreement, dated as of February 1997, by and between Avatar Holdings Inc. and Gerald D. Kelfer (filed herewith).................................. 85
11 Computations of earnings per share (filed herewith)...... 90
27 Financial Data Schedule (filed herewith)................. 93