NOBILITY HOMES INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

Nobility focuses on home buyers who generally purchase their manufactured homes from retail sales centers to locate on property they own. Nobility has aggressively pursued this market through its Prestige retail sales centers. While Nobility actively seeks to make wholesale sales to independent retail dealers, its presence as a competitor limits potential sales to dealers located in the same geographic areas serviced by its Prestige retail sales centers.

Nobility has aggressively targeted the retirement community market, which is made up of retirees moving to Florida and typically purchasing or renting homes to be located on sites leased from park communities offering a variety of amenities. Sales are not limited by the presence of the Company's Prestige retail sales centers in this type of arrangement, as the retirement community sells homes only within their community. Sales to these retirement communities increased significantly in 2012 from 2011.

Nobility has a product line of approximately 100 active models. Although market demand can fluctuate on a fairly short-term basis, the manufacturing process is such that Nobility can alter its product mix relatively quickly in response to changes in the market. During fiscal years 2012 and 2011, Nobility's product mix was affected by the number of "Special Edition" homes marketed by Prestige and by consumer demand for smaller, less expensive homes. Beginning in 2011, two publicly traded REIT'S (Real Estate Investment Trusts) and other companies which own multiple retirement communities increased their purchase of lower price homes, which helped to improve the slower sales in their communities. Our three, four and five bedroom manufactured homes are favored by families, compared with the one, two and three-bedroom homes that typically appeal to the retirement buyers who reside in the manufactured housing communities.

Nobility's joint venture and finance revenue sharing agreement with 21st Mortgage Corporation provides mortgage financing to retail customers who purchase Nobility's manufactured homes at Prestige retail sales centers. These agreements, under which loans are originated and serviced, have given Prestige more control over the financing aspect of the retail home sales process and allowed it to offer better services to its retail customers. Management believes that these agreements give Prestige an additional potential for profit by providing finance products to retail customers. In addition, management believes that Prestige has more input in the design of unique finance programs for prospective homebuyers, and that the joint venture has resulted in more profitable sales at its Prestige retail sales centers. In an effort to make manufactured homes more competitive with site-built housing, financing packages are available to provide (1) 30-year financing, (2) an interest rate reduction program, (3) combination land/manufactured home loans, and (4) a 5% down payment program for qualified buyers.

In December 2008, 21st Mortgage Corporation advised the Company that 21st Mortgage Corporation's parent company had decided not to provide any additional funding for loan originations at that time. The Company owns a 50% interest in Majestic 21, a joint venture with 21st Mortgage Corporation. The decision by the parent company of 21st Mortgage Corporation to not provide additional capital to support the lending operation required us to consider seeking capital from alternative sources. The Company has been able to sign dealer agreements with additional lenders who provide financing for our homes. In the third quarter of fiscal year 2009, Majestic 21 secured $5,000,000 in financing from a commercial bank. The Company guarantees 50% of this financing. These sources of funding have been sufficient to fund our loan originations to date allowing us to fund loans without interruption. Subsequent to our 2009 fiscal year end, 21stMortgage Corporation announced that their parent company had agreed to provide additional capital to fund loan originations, which became available when Majestic 21 fully utilized the proceeds from the $5,000,000 commercial loan. As of November 3, 2012, the outstanding principal balance of the note was $2,484,600 and the amount of collateral held by our joint venture partner for the Majestic 21 note payable was $3,367,869.

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Prestige also maintains several other outside financing sources that provide financing to retail homebuyers for its manufactured homes and the Company is in the process of developing relationships with new lenders. In the future, Nobility may explore the possibility of underwriting its own mortgage loans for non-21st Mortgage financed buyers.

Prestige's wholly-owned subsidiary, Mountain Financial, Inc., is an independent insurance agent and licensed loan originator. Mountain Financial provides construction loans, mortgage brokerage services, automobile insurance, extended warranty coverage and property and casualty insurance to Prestige customers in connection with their purchase and financing of manufactured homes.

The Company's fiscal year ends on the first Saturday on or after October 31. The years ended November 3, 2012 and November 5, 2011 consisted of fifty-two week periods.

Results of Operations

The Company reported net income of approximately $50,000 in fiscal year 2012, compared to a net loss of approximately $5.5 million during fiscal year 2011. The loss in 2011 resulted from a combination of losses on our limited partnerships and the execution of the Seventh Amendment of the FRSA, which resulted in net non-cash losses of approximately $4.1 million.

The following table summarizes certain key sales statistics and percent of gross profit as of and for fiscal years ended November 3, 2012 and November 5, 2011.

                                                                   2012             2011  New homes sold through Company owned sales centers                 60               85 Pre-owned homes sold through Company owned sales centers                                                            40               37 Homes sold to independent dealers                                 268              156 Total new factory built homes produced                            312              220 Average new manufactured home price - retail                 $ 64,598$ 66,353 Average new manufactured home price - wholesale              $ 26,990$ 29,576  As a percent of net sales: Gross profit from the Company owned retail sales centers excluding the adjustments for the amendment to the FRSA                                                           12 %             14 % 

Gross profit (loss) from the Company owned retail sales centers including the adjustments for the amendment to the FRSA

                                                           12 %            (30 %) Gross profit from the manufacturing facilities - including intercompany sales                                       19 %             14 %   

Total net sales in fiscal year 2012 were $15,834,971 compared to $13,428,699 in fiscal year 2011.Sales to two publicly traded REIT'S (Real Estate Investment Trusts) and other companies which own multiple retirement communities in our market area accounted for approximately 38% and 23% of our sales for the twelve months ended November 3, 2012 and November 5, 2011, respectively. Accounts receivable due from these customers were approximately $2,769,361 at November 3, 2012.

According to the Florida Manufactured Housing Association, shipments in Florida for the period from November 2011 through October 2012 were up approximately 13% from the same period last year. Our unit sales of homes increased 36% in fiscal 2012 from fiscal 2011. Our sales and operations continue to be impacted by our country's economic conditions and those in the state of Florida. Although the overall housing picture, credit market and economy have not improved measurably during the past year and the immediate outlook for the manufactured housing industry in Florida and the nation is uncertain, the long-term demographic trends still favor future growth in the Florida market area we serve. We believe job formation, immigration growth and migration trends, plus consumers returning to more affordable housing indicate a positive future for manufactured housing in Florida. The Baby Boomer generation began to turn 65 in January 2011 and by 2030 the

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number of Americans age 65 and over is predicted to almost double. This trend coupled with the end of the free spending credit-driven years, our 45 years of experience in the Florida market, and consumers' increased need for more affordable housing should serve us well in the coming years. We remain convinced that our specific geographic market is one of the best long-term growth areas in the country. The country must experience a better economy with less uncertainty, improved sales in the existing home market, declining unemployment, continued low interest rates, improving credit markets, increased consumer confidence and more retail financing for the sales of our affordable homes to improve significantly.

We understand that during this very complex economic environment, maintaining our strong financial position is vital for future growth and success. Because of the recent historical poor business conditions in our market area and the lack of any clarity as to when today's economic challenges will improve measurably, we will continue to evaluate Prestige's retail model centers in Florida, along with all other expenses and react in a manner consistent with maintaining our financial position.

We have specialized for 45 years in the design and production of quality, affordable manufactured homes at our plant located in central Florida. With our multiple retail sales centers, a finance company joint venture, an insurance subsidiary, and investments in retirement manufactured home communities, we are the only vertically integrated manufactured home company headquartered in Florida.

Insurance agent commissions in fiscal year 2012 were $211,076 compared to $234,034 in fiscal year 2011. The decline in insurance agent commissions resulted from a decline in new policies written and renewals. The Company establishes appropriate reserves for policy cancellations based on numerous factors, including past transaction history with customers, historical experience and other information, which is periodically evaluated and adjusted as deemed necessary. In the opinion of management, no reserve is deemed necessary for policy cancellations at November 3, 2012 and November 5, 2011.

The revenues from the construction lending operations in fiscal year 2012 were $31,907 compared to $51,839 in fiscal year 2011. The decrease in revenues was due to fewer homes sales in fiscal year 2012 financed with a construction loan.

Cost of goods sold at our manufacturing facilities include: materials, direct and indirect labor and manufacturing expenses (which consists of factory occupancy, salary and salary related, delivery costs, mobile home service costs and other manufacturing expenses). Cost of goods sold at our retail sales centers include: appliances, air conditioners, electrical and plumbing hook-ups, furniture, insurance, impact and permit fees, land and home fees, manufactured home, service warranty, setup contractor, interior drywall finish, setup display, skirting, steps, well and septic tank and other expenses.

Our gross profit of $2,859,493 for 2012 increased to 18.1% compared to 3.5% for 2011. Our 2011 gross profit was reduced due to the write down of the repossessed inventory by $3,548,056 and the reversal of the guarantee liability of $1,707,230, for a net charge to cost of goods sold of $1,840,826. The Company no longer has any continuing involvement with repossessed homes that are bundled with land sales. The Company is no longer required to recognize profit under the installment method and recognizes revenue and profit associated with sales of repossessed homes bundled with land under the full accrual method. The deferred revenue for repossessed homes bundled with land treated under the installment method was recognized in the fourth quarter of 2011 as a result of the FRSA amendment. This resulted in the recognition of $733,467 in sales and $54,869 in gross profit in the fourth quarter of 2011.

Selling, general and administrative expenses at our manufacturing facility include salaries, professional services, advertising and promotions, corporate expense, employee benefits, office equipment and supplies and utilities. Selling, general and administrative expenses at our retail sales center include: advertising, retail sales centers expenses, salary and salary related, professional fees, corporate expense, employee benefit, office equipment and supplies, utilities and travel. Selling, general and administrative expenses at the insurance company include: advertising, professional fees and office supplies.

Selling, general and administrative expenses decreased approximately $1,214,000 from 2011 to 2012. As a percent of net sales, selling, general and administrative expenses was 17.1% in fiscal year 2012 compared to 29.2% in fiscal year 2011. The decrease in selling, general and administrative expenses in 2012 resulted primarily from a decrease in legal and accounting expenses.

The Company earned $95,035 from its joint venture, Majestic 21, in fiscal year 2012 compared to $37,707 in fiscal year 2011. The earnings from Majestic 21 represent the allocation of profit and losses which are owned 50% by 21st Mortgage Corporation and 50% by the Company. The increase in earnings was due to a higher amount of loans being financed with Majestic 21 internal capital which results in lower costs of funds.

In accordance with the Company's FRSA with 21st Mortgage Corporation, the Company refers its customers to 21st Mortgage Corporation for financing on manufactured homes sold through the Company's retail sales centers. Prior to the Seventh

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Amendment (discussed below), the Company had agreed to repurchase from 21st Mortgage Corporation any repossessed homes and related collateral that was financed under the finance revenue sharing agreement. The repurchase price was the remaining loan balance (plus 21st Mortgage Corporation's legal fees). If the loan included a mortgage on the land, the Company received the land in addition to the home. If the loan only had the home as collateral, the Company only received the home and was required to move it off the location where it was previously sited. After the Company re-sold the homes, the Company received the full proceeds from the sale of the home, plus a reimbursement from 21st Mortgage Corporation for liquidation expenses. The reimbursement covered the Company's cost of transporting homes, repairing homes to resale condition, remarketing homes and other liquidation expenses. The Company and 21st Mortgage Corporation agreed that the reimbursement for: (a) a home only repurchase would not exceed 60% of the Company's purchase price nor would it be less than 40% of the Company's repurchase price; and (b) a home and land repurchase would not exceed 45% of the Company's purchase price nor would it be less than 25% of the Company's purchase price. Due to the number of repurchased homes the Company experienced in fiscal year 2011 under the FRSA, the Company increased the reserve $147,774 to $550,768 in 2011 for potential losses associated with the refurbishing and reselling of the repurchased homes. The Company was repurchasing the collateral consisting of either the home or the home and the land for the amount of the loan receivable (not including accrued interest) carried by 21st Mortgage Corporation. The impact upon results of operations from the re-sale of the collateral for defaulted loans was a $76,754 gain in fiscal year 2011. There were 20 re-sales during fiscal year 2011.

Effective October 25, 2011, the parties entered into a Seventh Amendment to the FRSA with 21st Mortgage Corporation. The following changes were made:

           •    The Company's obligation to buyback contracts on repossessed homes              ceased as of the effective date of the agreement.             •    Any homes repurchased as of the effective date of the agreement that              have not yet been re-sold are to be liquidated by the Company and              there will be no reimbursement from the FRSA escrow for any expenses              or losses upon the sale of such homes.             •    In consideration for the Company waiving its right to any              reimbursement for expenses or losses on the repurchased homes in              inventory, 21st Mortgage Corporation contributed $3,000,000 to the              escrow account in the FRSA.             •    As future loans in the FRSA become repossessions, 21st Mortgage              Corporation will have sole responsibility for the sale of such              repossessions and all expenses will be charged to the FRSA escrow              account.             •    There will be no distributions from the escrow account until              December 31, 2015.             •    In no event shall the Company be required to make up any shortfall in              the escrow account.  

As a result of these changes, on October 25, 2011, the Company recorded an impairment charge of $4,098,824 to reduce the value of the repossessed inventory to its estimated realizable value, without consideration to future reimbursement which would be no longer available to the Company. The Company had been recording a reserve for losses for disposition of the repossessed homes to facilitate the potential accelerated sales; this balance had accumulated to $550,768 at November 5, 2011. Consequently, the remaining impairment charge recorded in the fourth quarter of 2011 related to the execution of the Seventh Amendment was $3,548,056 (included in cost of goods sold).

With the Seventh Amendment to the FRSA, 21st Mortgage Corporation eliminated the obligation to buyback any more defaulted loans, thereby eliminating the guarantee liability of $1,707,230 that existed as of the date of the execution. Therefore, the guarantee liability was reversed in the fourth quarter of 2011. Additionally, the amendment to the FRSA provided for no more reimbursements from the escrow reserve account, for losses incurred upon liquidating the defaulted loans that we had already bought back.

In 2011, the Company assessed the fair value of its investment in two manufactured home communities, using projected financial information. The analysis for Walden Woods revealed that the value for Walden Woods was less than the value at which the Company was carrying the investment on the balance sheet. Consequently, the Company fully impaired its investment in Walden Woods, resulting in a noncash charge to losses from investments in retirement community limited partnerships of $791,355. The fair value analysis for Cypress Creek also resulted in impairment. The Company took a noncash $1.3 million charge to reduce the carrying value of this investment in third quarter of 2011. In 2012, no impairment in the carrying value of Cypress Creek was necessary.

The Company earned interest on cash, cash equivalents and short- and long-term investments in the amount of $59,834 in fiscal year 2012 compared to $169,521 in fiscal year 2011. The decreased interest income was primarily due to a decrease in the amount of cash, cash equivalents and short-term investments and in the lower variable rate earned on our cash and cash equivalents balances.

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The Company realized pre-tax income of approximately $50,000 in 2012 compared to a pre-tax loss of approximately $5.5 million in fiscal 2011. In fiscal 2012, the Company reduced by approximately $10,000 the allowance against the net deferred tax asset which offset the income tax benefit. In fiscal 2011, the Company was not able to provide a tax benefit to its pre-tax loss due to its assessment that it could not support the recording of additional deferred tax assets on the basis of a more-likely than not realization criteria.

As a result of the factors discussed above, net income in fiscal year 2012 was $49,759 or $0.01 per share and net loss in fiscal year 2011 was $5,511,475 or $1.36 per share.

Liquidity and Capital Resources

Cash and cash equivalents were $7,352,480 at November 3, 2012 compared to $6,206,218 at November 5, 2011. Short-term investments were $320,946 at November 3, 2012 compared to $799,297 at November 5, 2011. The increase in cash was due primarily to a reduction in inventory. The decrease in short-term investments was primarily due to the maturity of the bonds in the investment portfolio. Working capital was $18,589,914 at November 3, 2012 as compared to $16,366,829 at November 5, 2011. Nobility owns the entire inventory for its Prestige retail sales centers which includes new, pre-owned and repossessed or foreclosed homes and does not incur any third party floor plan financing expenses. The Company has no material commitments for capital expenditures.

The Company views its liquidity as the total of its cash and cash equivalents and short-term investments in securities. The Company currently has no line of credit facility and does not believe that such a facility is currently necessary to its operations. The Company has no debt. The Company also has approximately $2.5 million of cash surrender value of life insurance which it may be able to access as an additional source of liquidity though the Company has not currently viewed this to be necessary. Total liquidity, as defined by the Company, at November 3, 2012 was approximately $7.7 million as compared to approximately $7.0 million at November 5, 2011. The 2012 increase of $.7 million in liquidity was primarily generated from reduced inventory levels offset by an increase in accounts receivable. Additionally, as of November 3, 2012 the Company continued to report a strong balance sheet which included total assets of approximately $36 million which was funded primarily by stockholders' equity of approximately $34 million.

The Company reported net income of approximately $50,000 in fiscal year 2012, compared to a net loss of approximately $5.5 million during fiscal year 2011 of which $4.1 million was related to non-cash charges. These primarily included equity losses and impairment charges related to the Company's investment in limited partnerships in mobile home parks which amounted to approximately $2.3 million.

In fiscal year 2011, a significant non-cash charge also included the impacts of the execution of the Seventh Amendment to the FRSA which resulted in a charge of approximately $3.5 million to value pre-owned homes under the revised terms of the FRSA. The impact of this was partially offset by the reversal of the guarantee liability related to the FRSA that was established under ASC 460 guidance. This reversal resulted in the recognition in fiscal year 2011 of non-cash income of approximately $1.7 million, as the guarantee liability was no longer required after execution of the Seventh Amendment due to the elimination of further repurchase obligations by the Company.

The combination of the losses on the limited partnerships and the execution of the Seventh Amendment of the FRSA resulted in net non-cash losses of approximately $4.1 million in fiscal 2011. With these matters considered, loss of liquidity resulting from the Company's net loss approximated $1.4 million.

The most significant item that contributed to the reduction in the Company's liquidity in fiscal 2011 was the requirement under the repurchase provisions of the FRSA to repurchase repossessed pre-owned homes. In fiscal 2011, the Company's net cash outlays related to its investment in pre-owned homes approximated $3.3 million of which approximately $2.8 million related to repurchase of pre-owned homes related to the FRSA arrangement. Certain other repurchases of Majestic 21 foreclosed homes and trade in activities with respect to new home sales amounted to approximately $.5 million.

The combination of the above outlined cash costs of the Company's loss and its net cash outlay related to pre-owned homes resulted in a reduction of approximately $4.7 million in liquidity in fiscal 2011. Other items such as changes in the levels of various working capital items and non-cash operating items such as depreciation, amortization and goodwill impairment added to liquidity in fiscal 2011 to result in an overall reduction in liquidity of approximately $3.7 million.

Certain matters related to the Company's potential ability to access capital markets have occurred up to the date of this filing largely as a result of its inability to timely file periodic financial reports required by the Securities Exchange Act of 1934. These late filings are due in large part to changes in accounting and operation of the FRSA. These matters are described below.

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On September 17, 2012, the Company received a letter from The NASDAQ Stock Market LLC ("NASDAQ") informing the Company that it has not regained compliance with NASDAQ Listing Rule 5250(c) (1) within the 180 day extension period previously granted by NASDAQ and, on September 19, 2012, NASDAQ removed the Company's securities from listing and registration on the NASDAQ Stock Market.

The Company's common stock currently trades under the symbol NOBH on the OTC Markets Group, Inc. (the "Pink Sheets"). The Company's common stock will be eligible for trading only on the Pink Sheets unless and until it is eligible for trading on the OTC Bulletin Board ("OTCBB"). OTCBB trading may occur only if a market maker applies to quote the Company's common stock; however, a potential market maker's application to quote the Company's common stock on the OTCBB will not be cleared until the Company is current in its reporting obligations under the Securities Act of 1934. There is no assurance that the Company will become current in its reporting obligations, that any market maker will apply to quote the Company's common stock or that the Company's common stock will become eligible to trade on the OTCBB.

As indicated previously, we have become delinquent in the periodic filings required under the Securities and Exchange Act of 1934. The Securities and Exchange Commission (SEC) has issued the Company a letter of notification that inaction to bring our filings current may result in de-registration of the Company with the SEC. Loss of this status may limit our ability to access capital markets. The Company has filed and is continuing to file the delinquent reports.

The Company's latest internal financial statements as of the date of this filing include cash and cash equivalents of $9.9 million and investments in marketable securities of $.4 million for total liquidity, as defined above of $10.3 million. The Company continues to have no debt and has taken no action to utilize the cash surrender value of its life insurance as a source of liquidity.

Looking ahead, the Company's strong balance sheet and significant cash reserves accumulated in profitable years has allowed the Company to remain sufficiently liquid so as to allow continuation of operations and should enable the Company to take advantage of market opportunities when presented by an expected improvement in the overall and the industry specific economy in fiscal 2014 and beyond. The Company believes that the execution of the Seventh Amendment should significantly improve the Company's ability to manage its liquidity and will result in positive cash flows as pre-owned homes repossessed under the repurchase provisions of the FRSA are sold. Management believes it has sufficient levels of liquidity as of the date of the filing of this Form 10-K to allow the Company to operate into the foreseeable future.

Critical Accounting Policies and Estimates

The Company applies judgment and estimates, which may have a material effect in the eventual outcome of assets, liabilities, revenues and expenses, accounts receivable, inventory and goodwill. The following explains the basis and the procedure where judgment and estimates are applied.

Revenue Recognition

The Company recognizes revenue from its retail sales upon the occurrence of the following:

     •   Its receipt of a down payment,       •   Construction of the home is complete,          •   Home has been delivered and set up at the retail home buyer's site and          title has been transferred to the retail home buyer,          •   Remaining funds have been released by the finance company (financed sales          transaction), remaining funds have been committed by the finance company          by an agreement with respect to financing obtained by the customer,          usually in the form of a written approval for permanent home financing          received from a lending institution, (financed construction sales          transaction) or cash has been received from the home buyer (cash sales          transaction), and       •   Completion of any other significant obligations.  

As more fully described in Note 5 to the financial statements included in Item 8, prior to 2012, the Company recognized certain revenue and gross profit by use of the installment method related to sales of pre-owned homes bundled with land that were financed under the FRSA. This policy was adopted under concepts of "continuing involvement" in real estate transactions due to the repurchase obligation the Company undertakes related to financings offered under the FRSA. With the execution of the Seventh Amendment to the FRSA, continuing involvement related to these transactions has ceased and the deferred revenue and related gross profit on such transactions were recognized in sales and gross profit in the amounts of $733,467 and $54,869 respectively in the fourth quarter of fiscal 2011.

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The Company recognizes revenues from its independent dealers upon receiving wholesale floor plan financing or establishing retail credit approval for terms, shipping of the home and transferring title and risk of loss to the independent dealer. For wholesale shipments to independent dealers, the Company has no obligation to setup the home or to complete any other significant obligations.

The Company recognizes revenues from its wholly-owned subsidiary, Mountain Financial, Inc., as follows: commission income (and fees in lieu of commissions) is recorded as of the effective date of insurance coverage or the billing date, whichever is later. Commissions on premiums billed and collected directly by insurance companies are recorded as revenue when received which, in many cases, is the Company's first notification of amounts earned due to the lack of policy and renewal information. Contingent commissions are recorded as revenue when received. Contingent commissions are commissions paid by insurance underwriters and are based on the estimated profit and/or overall volume of business placed with the underwriter. The data necessary for the calculation of contingent commissions cannot be reasonably obtained prior to the receipt of the commission which, in many cases, is the Company's first notification of amounts earned. The Company provides appropriate reserves for policy cancellations based on numerous factors, including past transaction history with customers, historical experience and other information, which is periodically evaluated and adjusted as deemed necessary. In the opinion of management, no reserve was deemed necessary for policy cancellations at November 3, 2012 or November 5, 2011.

Investments in Retirement Communities

During 2008, the Company formed a limited liability company called Nobility Parks I, LLC to invest in a new Florida retirement manufactured home community, Walden Woods, III Ltd. (Walden Woods) located in Homosassa, Florida. The investment of $2,360,000 provided the Company with 49% of the earnings/losses of the 236 residential lots. The investment amount was equivalent to $10,000 per residential lot. The investment is included in Other Investments in the accompanying consolidated balance sheets. Nobility Parks I, LLC has the right to assign some of its ownership to partners other than Nobility Homes. During fiscal year 2008, Nobility Parks I, LLC sold $825,250 of its ownership at cost, which reduced the Company's investment, and percentage of earning/losses by the same amount to 31.9%.

During 2008, the Company formed a limited liability company called Nobility Parks II, LLC to invest in a new Florida retirement manufactured home community, CRF III, Ltd. (Cypress Creek) located in Winter Haven, Florida. The investment of $4,030,000 provided the Company with 49% of the earnings/losses of the 403 residential lots. The investment amount was equivalent to $10,000 per residential lot. The investment is included in Other Investments in the accompanying consolidated balance sheets. Nobility Parks II, LLC has the right to assign some of its ownership to partners other than Nobility Homes. During fiscal year 2009, Nobility Parks II, LLC sold $40,000 of its ownership at cost, which reduced the Company's investment, and percentage of earning/losses to 48.5%. In 2011 Walden Woods Park was acquired out of bankruptcy by a newly formed entity owned by the Company's principal shareholder, Walden Woods South LLC ("South"). The Company's principal shareholder then contributed a 31.9% interest in South to the Company.

These investments are accounted for under the equity method of accounting and are reviewed quarterly for impairment. The Company holds a 31.9% interest in South and a 48.5% interest in Cypress Creek and all allocations of profit and loss are on a pro-rata basis. Since all allocations are to be made on a pro-rata basis and the Company's maximum exposure is limited to its investment in South and Cypress Creek, management has concluded that the Company would not absorb a majority of South's, Walden Woods' and Cypress Creek's expected losses nor receive a majority of South's, Walden Woods' and Cypress Creek's expected residual returns; therefore, the Company is not required to consolidate South, Walden Woods and Cypress Creek with the accounts of Nobility Homes in accordance with ASC No. 810-10.

As more fully discussed in Note 5 of Item 8 - Financial Statements, the Company's analysis indicated that significant impairments occurred related to these investments in fiscal 2011 and the Company recorded impairment losses of approximately $2.1 million. In 2012, no impairment in the carrying value of Cypress Creek was necessary.

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Investment in Majestic 21

On May 20, 2009, the Company became a 50% guarantor on a $5 million note payable entered into by Majestic 21, a joint venture in which the Company owns a 50% interest. This guarantee was a requirement of the bank that provided the $5 million loan to Majestic 21. The $5 million guarantee of Majestic 21's debt is for the life of the note which matures on the earlier of May 31, 2019 or when the principal balance is less than $750,000. The amount of the guarantee declines with the amortization and repayment of the loan. As collateral for the loan, 21st Mortgage Corporation (our joint venture partner) has granted the lender a security interest in a pool of loans encumbering homes sold by Prestige Homes Centers, Inc. If the pool of loans securing this note should decrease in value so that the notes outstanding principal balance is in excess of 80% of the principal balance of the pool of loans, then Majestic 21 would have to pay down the note's principal balance to an amount that is no more than 80% of the principal balance of the pool of loans. The Company and 21st Mortgage Corporation are obligated jointly to contribute the amount necessary to bring the loan balance back down to 80% of the collateral provided. We do not anticipate any required contributions as the pool of loans securing the note have historically been in excess of 100% of the collateral value. As of November 3, 2012, the outstanding principal balance of the note was $2,484,600 and the amount of collateral held by our joint venture partner for the Majestic 21 note payable was $3,367,869. Based upon management's analysis, the fair value of the guarantee is not material and as a result, no liability for the guarantee has been recorded in the accompanying balance sheets of the Company.

At November 3, 2012, there was approximately $256,073 in loan loss reserves or 1.23% of the portfolio in Majestic 21. The Majestic 21 joint venture partnership is monitoring loan loss reserves on a monthly basis and is adjusting the loan loss reserves as necessary. The Majestic 21 joint venture is reflected on 21st Mortgage Corporation's financial statements which are included in the financial statements of its ultimate parent which is a public company. Management believes the loan loss reserves are adequate based upon its review of the Majestic 21 joint venture partnership's financial statements.

Income Taxes

The Company accounts for income taxes utilizing the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The Company has determined that, due to significant negative evidence as a result of losses in numerous consecutive years, a valuation reserve is required to reduce the Company's net deferred taxes to a level supportable by certain tax planning strategies that could be enacted to realize deferred tax assets, if necessary.

The primary tax planning strategy is the potential sale of real estate, primarily land not currently used in the operations of the Company, to generate taxable gains. The Company has assessed that these strategies could result in the realization of approximately $1.9 million of deferred tax assets. The amount of deferred tax assets above this amount are reserved with a valuation allowance. The valuation allowance was approximately $2.1 million at November 3, 2012 and November 5, 2011.

The Company's tax planning strategies include estimates and as to the amount of gains on sales of properties that could be realized. The Company believes its estimates are reasonable and supportable but if circumstances change, these amounts could be affected which would impact the amount of net deferred taxes which would be supportable. The Company will continue to monitor these matters at each future reporting period.

Finance Revenue Sharing Agreement

As more fully described in Note 5 to Item 8 - Financial Statements, the Company entered into a FRSA with 21st Mortgage Corporation during 2004. Under this arrangement, the Company had agreed to repurchase and remarket financed homes that are in default. The Company was subject to loss on such repurchases if a loss on a closed transaction exceeded reimbursement provisions available to the Company under the FRSA from an escrow account funded by collections of interest on the financed portfolio. The FRSA also allowed for revenue sharing distributions of excess reserves that accumulated under the escrow arrangement to the Company and 21st Mortgage Corporation. On a cumulative basis, the Company has reported approximately $1.75 million in revenue from distributions under the FRSA arrangement during fiscal years 2007 through 2009. The Company has determined that escrow balances should be sufficient to cover losses on repurchases in the normal course of business and has recognized revenue under the arrangement on an as-received basis and has not incurred losses on a cumulative basis on repurchased transactions throughout the term of the arrangement.

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On October 25, 2011, the parties executed the Seventh Amendment to the FRSA which eliminated its repurchase obligation under the FRSA. Under this Amendment, the Company agreed to forego further reimbursements from the escrow account related to losses resulting from the liquidation of repossessed pre-owned homes as of the Amendment date which resulted in the Company recording a net reserve of approximately $3.5 million relating to its assessment of realizable value of the pre-owned homes under the revised arrangement. Since the Company's repurchase obligation ceased with the execution of the Seventh Amendment, the guarantee liability that had been recorded under provisions of ASC 460 was reversed. This guarantee liability approximated $1.7 million.

The Company will continue to participate in revenue sharing under the FRSA and will continue to recognize distributions on an as received basis. Under provisions of the Seventh Amendment, no such distributions are likely to occur before December 31, 2015.

The Company will continue to monitor the value of its pre-owned inventory which is separately identified in the Company's balance and will adjust the valuation, as circumstances warrant. Any adjustments to the valuation of this inventory will impact future income.

Rebate Program

The Company has a rebate program for some dealers, based upon the number and type of homes purchased, which pays rebates based upon sales volume to the dealers. Volume rebates are recorded as a reduction of sales in the accompanying consolidated financial statements. The rebate liability is calculated and recognized as eligible homes are sold based upon factors surrounding the activity and prior experience of specific dealers and is included in accrued expenses in the accompanying consolidated balance sheets.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or variable interest entities ("VIE's"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of November 3, 2012, we are not involved in any material unconsolidated entities (other than the Company's investments in Majestic 21, the FRSA and retirement community limited partnerships).

Forward Looking Statements

Certain statements in this report are forward-looking statements within the meaning of the federal securities laws, including our statement that working capital requirements will be met with internal sources. Although Nobility believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, there are risks and uncertainties that may cause actual results to differ materially from expectations. These risks and uncertainties include, but are not limited to, competitive pricing pressures at both the wholesale and retail levels, increasing material costs, continued excess retail inventory, increase in repossessions, changes in market demand, changes in interest rates, availability of financing for retail and wholesale purchasers, consumer confidence, adverse weather conditions that reduce sales at retail centers, the risk of manufacturing plant shutdowns due to storms or other factors, the impact of marketing and cost-management programs, reliance on the Florida economy, impact of labor shortage, impact of materials shortage, increasing labor cost, cyclical nature of the manufactured housing industry, impact of rising fuel costs, catastrophic events impacting insurance costs, availability of insurance coverage for various risks to Nobility, market demographics, management's ability to attract and retain executive officers and key personnel, increased global tensions, market disruptions resulting from terrorist or other attack and any armed conflict involving the United States and the impact of inflation.