UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ  Annual Report Pursuant to Section 13 or 15(d) of     

the Securities Exchange Act of 1934

For the fiscal year ended November 30, 2009

or

o  Transition Report Pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

For the transition period from ­ ­ to ­ ­.

Commission File No. 001-09195

KB HOME

(Exact name of registrant as specified in its charter)

 

10990 Wilshire Boulevard, Los Angeles, California 90024

(Address of principal executive offices)

Registrant’s telephone number, including area code:  (310) 231-4000

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Securities Registered Pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ  No o  

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ   No o  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o   No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No þ

 

The aggregate market value of voting stock held by non-affiliates of the registrant on May 31, 2009 was $1,321,039,890, including 11,762,882 shares held by the registrant’s grantor stock ownership trust and excluding 27,047,379 shares held in treasury.

 

The number of shares outstanding of each of the registrant’s classes of common stock on December 31, 2009 was as follows: Common Stock (par value $1.00 per share) 88,072,926 shares, including 11,222,651 shares held by the registrant’s grantor stock ownership trust and excluding 27,047,379 shares held in treasury.

 

Documents Incorporated by Reference

 

Portions of the registrant’s definitive Proxy Statement for the 2010 Annual Meeting of Stockholders (incorporated into Part III).

 

 

 

KB HOME

FORM 10-K

FOR THE YEAR ENDED NOVEMBER 30, 2009

 

TABLE OF CONTENTS

 

 

PART I

 

Item 1. BUSINESS

 

General

 

KB Home is one of the nation’s largest homebuilders and has been building quality homes for families for more than 50 years. We construct and sell homes through our operating divisions across the United States under the name KB Home. Unless the context indicates otherwise, the terms “the Company,” “we,” “our” and “us” used in this report refer to KB Home, a Delaware corporation, and its predecessors and subsidiaries.

 

Beginning in 1957 and continuing until 1986, our business was conducted by various subsidiaries of Kaufman and Broad, Inc. (“KBI”) and its predecessors. In 1986, KBI transferred all of its homebuilding and mortgage banking operations to us. Shortly after the transfer, we completed an initial public offering of 8% of our common stock and began operating under the name Kaufman and Broad Home Corporation. In 1989, we were spun-off from KBI, which then changed its name to Broad Inc., and we became an independent company, operating primarily in California and France. In 2001, we changed our name to KB Home. Today, we operate a homebuilding and financial services business serving homebuyers in markets nationwide.

 

Our homebuilding operations, which are divided into four geographically defined segments for reporting purposes, offer a variety of homes designed primarily for first-time, first move-up and active adult buyers, including attached and detached single-family homes, townhomes and condominiums. We offer homes in development communities, at urban in-fill locations and as part of mixed-use projects. We use the term “home” to refer to a single-family residence, whether it is a single-family home or other type of residential property, and we use the term “community” to refer to a single development in which homes are constructed as part of an integrated plan.

 

Through our homebuilding segments, we delivered 8,488 homes at an average selling price of $207,100 during the year ended November 30, 2009, compared to 12,438 homes delivered at an average selling price of $236,400 during the year ended November 30, 2008. Our homebuilding operations represent most of our business, accounting for 99.5% of our total revenues in 2009 and 99.6% of our total revenues in 2008.

 

Our financial services operations offer mortgage banking, title and insurance services to our homebuyers. Mortgage banking services are offered to our homebuyers indirectly through KB Home Mortgage, LLC (“KB Home Mortgage”), a joint venture between us and CWB Venture Management Corporation, a subsidiary of Bank of America, N.A. Our financial services operations accounted for .5% of our total revenues in 2009 and .4% of our total revenues in 2008.

 

In 2009, we generated total revenues of $1.82 billion and a net loss of $101.8 million, compared to total revenues of $3.03 billion and a net loss of $976.1 million in 2008. Our financial results for 2009 and 2008 reflect challenging operating conditions that have persisted in the homebuilding industry to varying degrees since a general housing market downturn began in 2006, as well as our strategic actions in response to these conditions to align our operations with diminished home sales activity and to maintain a strong balance sheet.

 

Our principal executive offices are located at 10990 Wilshire Boulevard, Los Angeles, California 90024. The telephone number of our corporate headquarters is (310) 231-4000 and our website address is http://kbhome.com. Our Spanish-language website is http://kbcasa.com. In addition, location and community information is available at (888) KB-HOMES.

Markets

 

Reflecting the wide geographic reach of our homebuilding business, as of the date of this report, we operate in the 10 states and 30 major markets shown below. For reporting purposes, we organize our homebuilding operations into four segments — West Coast, Southwest, Central and Southeast.

 

 

Segment Operating Information.  The following table presents specific operating information for our homebuilding reporting segments for the years ended November 30, 2009, 2008 and 2007:

 

 

 

 

Unconsolidated Joint Ventures.  The above table does not include homes delivered from unconsolidated joint ventures in which we participate. These unconsolidated joint ventures acquire and develop land and, in some cases, build and deliver homes on developed land. Our unconsolidated joint ventures delivered 141 homes in 2009, 262 homes in 2008 and 127 homes in 2007.

 

Strategy

 

Generally since mid-2006, many housing markets across the United States, including those we serve, have experienced a severe and extended downturn. To varying degrees, these markets have suffered from a persistent oversupply of new, resale and foreclosed homes available for sale, driving selling prices steadily lower and intensifying competition among homebuilders, individual home sellers, investors and lenders vying for buyers. At the same time, housing demand has fallen sharply due to general economic weakness, rising unemployment, declining consumer confidence, reduced credit availability and tightened mortgage lending standards. Although housing affordability has improved recently due to lower selling prices, relatively low interest rates and homebuyer tax credit incentives, the negative supply and demand factors described above continue to constrain overall home sales activity.

 

We believe that there may be further volatility in housing markets in 2010 and that the homebuilding industry is likely to experience a prolonged and uneven transition before a sustained recovery takes hold. Based on this view, we intend to continue to execute on strategic initiatives that have allowed us to weather nearly four years of challenging market conditions, stabilize and strengthen our financial condition, and position our business to return to profitability and to capitalize on potential future growth opportunities. These initiatives are founded on the principles of our core operational business model, KBnxt.

 

KBnxt Operational Business Model.  Our KBnxt operational business model, first implemented in 1997, seeks to generate greater operating efficiencies and return on investment through a disciplined, fact-based and process-driven approach to homebuilding that is founded on a constant and systematic assessment of consumer preferences and market opportunities. The key principles of our KBnxt operational business model include:

 

 

Our KBnxt operational business model is designed to help us build and maintain a leading position in our existing markets; opportunistically expand our business into attractive new markets; exit investments that no longer meet our return standards or marketing strategy; calibrate our product designs to consumer preferences; and achieve lower costs and economies of scale in acquiring and developing land, purchasing building materials, subcontracting trade labor, and providing options to customers.

 

Our expansion into a new market depends on our assessment of the market’s viability and our ability to develop sustainable operations. Similar considerations apply to potential asset acquisitions in our existing markets.

 

Strategic Objectives.  Guided by the disciplines of our KBnxt operational business model, our primary strategic objectives include:

 

 

 

A tangible reflection of how we have implemented our strategic objectives is the ongoing nationwide rollout of The Open Series^TM product designs, which began in late 2008. In addition to meeting homebuyer design sensibilities and affordability needs, The Open Series product line has been value-engineered to reduce production costs and cycle times, while adhering to our quality standards and using materials and construction methods that reflect our commitment to environmentally sustainable homebuilding practices. Value-engineering encompasses measures such as simplifying the location and installation of internal plumbing and electrical systems, using prefabricated wall panels, flooring systems, roof trusses and other building components, and employing cost-minimizing and efficiency maximizing construction techniques. It also includes working continuously with our trade partners and materials suppliers to reduce direct construction costs. All of these actions have allowed us to achieve faster returns and higher gross margins from our inventory compared to our previous product designs, supporting strong cash flow generation and progress toward our profitability goal.

 

Marketing Strategy.  Our marketing activity is focused on differentiating the KB Home brand from resale homes and from homes sold through foreclosures, short sales and by other builders. We believe that our Built to Order^TM message and approach generate a high perceived value for our products and our company among consumers and are unique among large-production homebuilders. Built to Order emphasizes that we partner with our homebuyers to create a home built to their individual preferences in home design, layout, square footage and homesite location, and to personalize their home’s interior with features and amenities that meet their needs and interests. Built to Order serves as the consumer face of core elements of our KBnxt operational business model and ensures that our marketing strategy and advertising campaigns are closely aligned with our overall operational focus.

 

Our KB Home Studios are integral to the Built to Order experience we provide. These showrooms allow our homebuyers to select from thousands of product and design options that are available for purchase as part of the original construction of their homes. The coordinated efforts of our sales representatives and KB Home Studio consultants are intended to provide high levels of customer satisfaction and lead to enhanced customer retention and referrals.

 

We further differentiate the KB Home brand with our My Home. My Earth.^TM environmental initiative, publicly launched in 2008. My Home. My Earth. embodies our commitment to become a leading environmentally friendly national company. We were the first national homebuilder to commit to installing exclusively ENERGY STAR^TM appliances in all of our new homes, and in 2009, we committed to build all new communities we open to ENERGY STAR guidelines. We also offer our homebuyers an extensive line of high-value, low-cost products through our KB Home Studios that can help minimize the environmental impact of the homes they purchase.

 

During 2009, we continued to focus our marketing initiatives on first-time, first move-up and active adult homebuyers. These historically have been our core customers and it is among these groups that we see the greatest

potential for future home sales. In 2010, we plan to continue to focus on this homebuyer demographic and to roll out new home designs and environmental sustainability initiatives.

 

Sales Strategy.  To ensure the consistency of our message and adherence to our Built to Order approach, sales of our homes are carried out by in-house teams of sales representatives and other personnel who work personally with each homebuyer to create a home that meets the homebuyer’s preferences and budget.

 

Customer Service and Quality Control

 

Customer satisfaction is a high priority for us. We are committed to building and delivering quality homes. Our on-site construction supervisors perform regular pre-closing quality checks during the construction process to ensure our homes meet our quality standards and our homebuyers’ expectations. We have employees who are responsible for responding to homebuyers’ post-closing needs, including warranty claims. We believe prompt and courteous responses to homebuyers’ needs throughout the homebuying process reduces post-closing repair costs, enhances our reputation for quality and service, and helps encourage repeat and referral business from homebuyers and the real estate community. Our goal is for our customers to be 100% satisfied with their new homes.

 

We provide a limited warranty on all of our homes. The specific terms and conditions vary depending on the market where we do business. We generally provide a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of a home.

 

Local Expertise

 

To maximize our KBnxt operational business model’s effectiveness and help ensure its consistent execution, our employees are continuously trained on KBnxt principles and evaluated based on their achievement of relevant KBnxt operational objectives. We also believe that our business requires in-depth knowledge of local markets in order to acquire land in desirable locations and on favorable terms, to engage subcontractors, to plan communities that meet local demand, to anticipate consumer tastes in specific markets, and to assess local regulatory environments. Accordingly, we operate our business through divisions with trained personnel who have local market expertise. We have experienced management teams in each of our divisions. Though we centralize certain functions (such as marketing, advertising, legal, materials purchasing, purchasing administration, product development, architecture and accounting) to benefit from economies of scale, our local management exercises considerable autonomy in identifying land acquisition opportunities, developing product and sales strategies, and controlling costs.

 

Community Development and Land Inventory Management

 

Our community development process generally consists of four phases: land acquisition, land development, home construction and sale. Historically, the completion time of our community development process has ranged from six to 24 months in our West Coast segment to a somewhat shorter duration in our other homebuilding segments. The length of the community development process varies based on, among other things, the extent of government approvals required, the overall size of the community, necessary site preparation activities, weather conditions and marketing results.

 

Although they vary significantly, our communities typically consist of 50 to 250 lots ranging in size from 1,000 to 13,500 square feet. In our communities, we typically offer from three to 15 home designs for homebuyers to choose from. We also build an average of two to four model homes at each community so that prospective buyers can preview various home designs. Depending on the community, we may offer premium lots containing more square footage, better views or location benefits.

 

Land Acquisition and Land Development.  We continuously evaluate land acquisition opportunities, as they arise, against our internal investment standards and marketing strategy, balancing competing needs for financial strength and land inventory for future growth. When we acquire and develop land, we do so consistent with our KBnxt operational business model, which focuses on land parcels containing fewer than 250 lots that are entitled for residential construction and either physically developed to start home construction (referred to as “finished lots”) or partially finished. Acquiring finished or partially finished lots enables us to construct and deliver homes shortly after the land is acquired with minimal additional development expenditures. This is a more efficient way to use our working capital and reduces the operating

risks associated with having to develop and/or entitle land, such as unforeseen improvement costs and/or changes in market conditions. However, depending on market conditions, we may acquire undeveloped and/or unentitled land. We expect that the overall balance of undeveloped, unentitled, entitled and finished lots in our inventory will vary over time.

 

Consistent with our KBnxt operational business model, we target geographic areas for potential land acquisitions and assess the viability of our current inventory based on the results of periodic surveys of both new and resale homebuyers in particular markets. Local, in-house land acquisition specialists conduct site selection research and analysis in targeted geographic areas to identify desirable land or to evaluate whether an existing interest we hold is consistent with our marketing strategy. We also use studies performed by third-party marketing specialists. Some of the factors we consider in evaluating land acquisition targets and assessing current inventory are: consumer preferences; general economic conditions; specific market conditions, with an emphasis on the prices of comparable new and resale homes in the market; expected sales rates; proximity to metropolitan areas and employment centers; population and commercial growth patterns; estimated costs of completing lot development; and environmental matters.

 

We generally structure our land purchases and development activities to minimize or to defer the timing of cash and capital expenditures, which enhances returns associated with new land investments. While we use a variety of techniques to accomplish this, as further described below, we typically use agreements that give us an option right to purchase land at a future date, at a fixed price and for a small initial deposit payment. Our decision to exercise a particular option right is based on the results of due diligence and continued market viability analysis we conduct after entering into an agreement. In some cases, our decision to exercise an option may be conditioned on the land seller obtaining necessary entitlements, such as zoning rights and environmental approvals, and/or physically developing the land by a pre-determined date to allow us to build homes relatively quickly. Depending on the circumstances, our initial deposit payment for an option right may or may not be refundable to us if we do not purchase the underlying land.

 

In addition to acquiring land under option agreements, we may acquire land under agreements that condition our purchase obligation on our satisfaction with the feasibility of developing the land and selling homes on the land by a certain future date, consistent with our investment standards. Our option and other purchase agreements may also allow us to phase our land purchases and/or lot development over a period of time and/or upon the satisfaction of certain conditions. We may also acquire land with seller financing that is non-recourse to us, or by working in conjunction with third-party land developers. Our land option contracts generally do not contain provisions requiring our specific performance.

 

Under our KBnxt operational business model, we generally attempt to minimize our land development costs by focusing on acquiring finished or partially finished lots. Where we purchase unentitled and unimproved land, we typically use option agreements as described above and during the option period perform technical, environmental, engineering and entitlement feasibility studies, while we seek to obtain necessary governmental approvals and permits. These activities are sometimes done with the seller’s assistance and/or at the seller’s cost. The use of option arrangements in this context allows us to conduct these development-related activities while minimizing our inventory levels and overall financial commitments, including interest and other carrying costs. It also improves our ability to estimate development costs accurately prior to incurring them, an important element in planning communities and pricing homes.

 

Before we commit to any land purchase or dispose of any interest in land we hold, our senior corporate management carefully evaluates each asset based on the results of our local specialists’ due diligence and a set of strict financial measures, including, but not limited to, gross margin analyses and specific discounted, after-tax cash flow internal rate of return requirements. Potential land acquisition or disposal transactions are subject to review and approval by our corporate land committee, which is composed of senior corporate and regional management. The stringent criteria guiding our land acquisition and disposition decisions have resulted in our maintaining inventory in areas that we believe generally offer better returns for lower risk, and lower cash and capital investment.

 

In recent years, in light of difficult market conditions, we have sold some of our land and interests in land and have abandoned a portion of our options to acquire land. Consistent with our KBnxt operational business model, we determined that these properties no longer met our strategic needs or our internal investment standards. If market conditions remain challenging, we may sell more of our land and interests in land, and we may abandon or try to sell more of our options to acquire land.

 

The following table presents the number of inventory lots we owned, in various stages of development, or controlled under option contracts in our homebuilding segments as of November 30, 2009 and 2008. The table does not include approximately 316 acres optioned as of November 30, 2009 and 2008 that had not yet been approved for subdivision into lots.

 

 

Reflecting our geographic diversity, as of November 30, 2009, 21% of the lots we owned or controlled were located in the West Coast reporting segment, 24% were in the Southwest reporting segment, 27% were in the Central reporting segment, and 28% were in the Southeast reporting segment.

 

The following table presents the dollar value of inventory we owned, in various stages of development, or controlled under option contracts in our homebuilding segments as of November 30, 2009 and 2008 (in thousands):

 

 

Home Construction and Sale.  Following the purchase of land and, if necessary, the completion of the entitlement process, we typically begin marketing homes for sale and constructing model homes. The time required for construction of our homes depends on the weather, time of year, local labor supply, availability of materials and supplies and other factors. To minimize the costs and risks of standing inventory, we generally begin construction of a home only when we have signed a purchase contract with a homebuyer. However, cancellations of home purchase contracts prior to the delivery of the underlying homes, or strategic considerations, may cause us to have standing inventory of completed or partially completed homes.

 

We act as the general contractor for the majority of our communities and hire experienced subcontractors for all production activities. Our contracts with our subcontractors require that they comply with all laws applicable to their work, including labor laws, meet performance standards and follow local building codes and permits. Where practical, we use mass production techniques and pre-fabricated, standardized components and materials to streamline the on-site production process. We have also developed programs for national and regional purchasing of certain building materials, appliances and other items to take advantage of economies of scale and to reduce costs through improved pricing and, where available, participation in manufacturers’ or suppliers’ rebate programs. As part of our My Home. My Earth. environmental initiative, we have integrated products, materials and construction practices into our home building process to reduce the environmental impact of our operations and the homes we build. At all stages of production, our administrative and on-site supervisory personnel coordinate the activities of subcontractors and subject their work to quality and cost controls. As part of our KBnxt operational business model, we also emphasize even-flow production methods to enhance the quality of our homes and minimize production costs.

Backlog

 

We sell our homes under standard purchase contracts, which generally require a customer deposit at the time of signing. The amount of the deposit required varies among markets and communities. Homebuyers are also generally required to pay additional deposits when they select options or upgrades for their homes. Most of our home purchase contracts stipulate that if a homebuyer cancels a contract with us, we have the right to retain the homebuyer’s deposits. However, we generally permit homebuyers to cancel their obligations and obtain refunds of all or a portion of their deposits in the event mortgage financing cannot be obtained within a period of time, as specified in their contract.

 

“Backlog” consists of homes that are under contract but have not yet been delivered. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) generated during the current period minus the number of homes delivered during the current period. The backlog at any given time will be affected by cancellations. The number of homes delivered has historically increased from the first to the fourth quarter in any year.

 

Our backlog at November 30, 2009, excluding backlog of unconsolidated joint ventures, consisted of 2,126 homes, a decrease of 6% from the 2,269 homes in backlog at year-end 2008. The decrease in our backlog levels in 2009 primarily reflected our strategic decisions to reduce inventory and active community counts to align our operations with reduced housing market activity. Our backlog at November 30, 2009 represented potential future housing revenues of approximately $422.5 million, a 19% decrease from potential future housing revenues of $521.4 million at November 30, 2008, reflecting the impact of the lower number of homes in backlog and a lower average selling price. Our backlog ratio, defined as homes delivered as a percentage of beginning backlog in the quarter, was 82% for the quarters ended November 30, 2009 and 2008.

 

Our net orders increased slightly to 8,341 in 2009 from 8,274 in 2008. Our average cancellation rate based on net orders was 25% in 2009, compared to an average of 41% in 2008. During the fourth quarter of 2009, our net orders increased 12% from the fourth quarter of 2008. The increase in our net orders primarily reflected a reduction in our cancellation rate, which, as a percentage of gross orders, was 31% in the fourth quarter of 2009, compared to 46% in the fourth quarter of 2008.

The following table presents homes delivered, net orders and cancellation rates (based on gross orders) by reporting segment and with respect to our unconsolidated joint ventures for each quarter during the years ended November 30, 2009 and 2008, and our ending backlog at the end of each quarter within those years:

 

 

 

 

Land and Raw Materials

 

We currently own or control enough land to meet our forecasted production goals for approximately the next three to four years. As discussed above, we have recently sold some of our land and abandoned options to purchase land in order to balance our holdings with current and forecasted market conditions and we may sell additional land or land interests in 2010. In 2009, our land sales generated $58.3 million of revenues and $47.9 million of losses, including $10.5 million of impairments. In 2008, our land sales generated $82.9 million of revenues and $82.8 million of losses, including $86.2 million of impairments. Our land option contract abandonments resulted in pretax, noncash charges of $47.3 million in 2009 and $40.9 million in 2008.

 

The principal raw materials used in the construction of our homes are concrete and forest products. In addition, we use a variety of other construction materials in the homebuilding process, including sheetrock and plumbing and electrical items. We attempt to enhance the efficiency of our operations by using pre-made, standardized materials that are commercially available on competitive terms from a variety of sources. In addition, our centralized or regionalized purchasing of certain building materials, appliances and fixtures allows us to benefit from large quantity purchase discounts and, in some cases, manufacturer or supplier rebates. When possible, we arrange for bulk purchases of these products at favorable prices from manufacturers and suppliers.

 

Customer Financing

 

Our homebuyers may obtain mortgage financing from any qualified lender. KB Home Mortgage representatives on site at our communities offer to arrange mortgage financing for prospective homebuyers through the joint venture. We believe that the ability of KB Home Mortgage to offer customers an extensive variety of financing options on competitive terms as a part of the on-site sales process helps to complete sales. KB Home Mortgage originated loans for 84% of our customers who obtained mortgage financing in 2009 and 80% in 2008.

 

Discontinued Operations

 

In July 2007, we sold our 49% interest in our publicly traded French subsidiary, Kaufman and Broad, S.A. (“KBSA”). The disposition of the French operations enabled us to invest additional resources in our domestic homebuilding operations and we have since operated exclusively in the United States. The sale generated total gross proceeds of $807.2 million and a pretax gain of $706.7 million ($438.1 million net of income taxes). As a result of the sale, the French operations are presented as discontinued operations in our consolidated financial statements in 2007.

 

Employees

 

We employ a trained staff of land acquisition specialists, architects, planners, engineers, construction supervisors, marketing and sales personnel, and finance and accounting personnel, supplemented as necessary by outside consultants, who guide the development of our communities from their conception through the marketing and delivery of completed homes.

 

At December 31, 2009, we had approximately 1,400 full-time employees, compared to approximately 1,600 at December 31, 2008. None of our employees are represented by a collective bargaining agreement.

Competition and Other Factors

 

We believe our KBnxt operational business model, particularly the aspects that involve gaining a deeper understanding of customer interests and needs and offering a wide range of choices to homebuyers, provides us with long-term competitive advantages. The housing industry is highly competitive, and we compete with numerous homebuilders ranging from regional and national firms to small local builders primarily on the basis of price, location, financing, design, reputation, quality and amenities. In addition, we compete with housing alternatives other than new homes, including resale homes, foreclosed and short sale homes, and rental housing. In certain markets and at times when housing demand is high, we also compete with other builders to hire subcontractors.

 

During 2009, operating conditions in most U.S. housing markets remained difficult, reflecting the impact of the housing market downturn that began in 2006 and the weak economy as discussed above under the heading “Strategy.” We believe the heightened competition for homebuyers stemming from these conditions will continue in 2010, if not intensify.

 

Financing

 

We do not generally finance the development of our communities with project financing. By “project financing,” we mean proceeds of loans specifically obtained for, or secured by, particular communities. Instead, our operations have historically been funded by results of operations, public debt and equity financing, and borrowings under our unsecured revolving credit facility with various banks (the “Credit Facility”). In 2009, however, we did not borrow any funds under the Credit Facility and we do not anticipate doing so in 2010.

 

Environmental Matters

 

As part of our due diligence process for all land acquisitions, we often use third-party environmental consultants to investigate potential environmental risks and we require disclosures and representations and warranties from land sellers of environmental risks. Despite these precautions, there can be no assurance that we will avoid material liabilities relating to the existence or removal of toxic wastes, site restoration, monitoring or other environmental matters affecting properties currently or previously owned by us. No estimate of any potential liabilities can be made although we may, from time to time, purchase property that requires us to incur environmental clean-up costs after appropriate due diligence, including, but not limited to, using detailed investigations performed by environmental consultants. In such instances, we take steps prior to acquisition to gain reasonable assurance as to the precise scope of work required and the costs associated with removal, site restoration and/or monitoring. To the extent contamination or other environmental issues have occurred in the past, we will attempt to recover restoration costs from third parties, such as the generators of hazardous waste, land sellers or others in the prior chain of title and/or their insurers. Based on these practices, we anticipate that it is unlikely that environmental clean-up costs will have a material effect on our future consolidated financial position or results of operations. We have not been notified by any governmental agency of any claim that any of the properties owned or formerly owned by us are identified by the U.S. Environmental Protection Agency (“EPA”) as being a “Superfund” clean-up site requiring remediation, which could have a material effect on our future consolidated financial position or results of operations. Costs associated with the use of environmental consultants are not material to our consolidated financial position or results of operations.

 

Access to Our Information

 

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). We make our public SEC filings available, at no cost, through our website http://kbhome.com, as soon as reasonably practicable after the report is electronically filed with, or furnished to, the SEC. We will also provide these reports in electronic or paper format free of charge upon request made to our investor relations department at investorrelations@kbhome.com or at our principal executive offices. Our SEC filings are also available to the public over the Internet at the SEC’s website at http://sec.gov. The public may also read and copy any document we file at the SEC’s public reference room located at 100 F Street N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room.

 

 

The following important factors could adversely impact our business. These factors could cause our actual results to differ materially from the forward-looking and other statements (i) we make in registration statements, periodic reports and other filings with the SEC and from time to time in our news releases, annual reports and other written reports or communications, and (ii) made orally from time to time by our personnel and representatives.

 

The homebuilding industry is experiencing a prolonged and severe downturn that may continue for an indefinite period and adversely affect our business and results of operations compared to prior periods.

 

In recent years, many of our served markets and the U.S. homebuilding industry as a whole have experienced a significant and sustained decrease in demand for new homes and an oversupply of new and existing homes available for sale, conditions that generally began in 2006. In many markets, a rapid increase in new and existing home prices in the years leading up to and including 2006 reduced housing affordability relative to consumer incomes and tempered buyer demand. At the same time, investors and speculators reduced their purchasing activity and instead stepped up their efforts to sell residential property they had earlier acquired. These trends, which have been more pronounced in markets that had experienced the greatest levels of price appreciation, have resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions and other marketing efforts to close home sales since 2006, compared to the several years leading up to and including 2006. These negative supply and demand trends have been exacerbated since 2008 by increasing sales of lender-owned homes, a severe downturn in general economic conditions, rising unemployment, turmoil in credit and consumer lending markets and tighter lending standards.

 

Reflecting the impact of this difficult environment, we, like many other homebuilders, have experienced to varying degrees since the housing market downturn began, declines in net orders, decreases in the average selling price of new homes we have sold and delivered and reduced margins relative to prior years, and we have generated operating losses. Though we have seen some improvement in net orders and margins in 2009, we can provide no assurances that the homebuilding market or our business will improve substantially in the near future. If economic conditions and employment remain weak and mortgage foreclosures, delinquencies and short sales continue rising in 2010, there would likely be a corresponding adverse effect on our business and our results of operations, including, but not limited to, the number of homes delivered and the amount of revenues we generate.

 

Further tightening of mortgage lending or mortgage financing requirements or further turmoil in credit and mortgage lending markets could adversely affect the availability of credit for some potential purchasers of our homes and thereby reduce our sales.

 

In recent years, the mortgage lending and mortgage finance industries have experienced significant instability due to, among other things, delinquencies, defaults and foreclosures on home loans and a resulting decline in their market value, particularly subprime and adjustable-rate loans. A number of providers, purchasers and insurers of mortgage loans have gone out of business or exited the market. In light of these developments, lenders, investors, regulators and others have questioned the adequacy of lending standards and other credit requirements for several loan programs made available to borrowers in recent years. This has led to reduced investor demand for mortgage loans and mortgage-backed securities, tightened credit requirements, reduced liquidity, increased credit risk premiums and regulatory actions, including greater government purchases or insurance of mortgage loans and mortgage-backed securities. Deterioration in credit quality among subprime, adjustable-rate and other nonconforming loans has caused most lenders to stop offering such loan products. Fewer loan products and providers and tighter loan qualifications, in turn, make it more difficult for some categories of borrowers to finance the purchase of our homes or the purchase of existing homes from potential move-up buyers who wish to purchase one of our homes. In general, these developments have resulted in reduced demand for our homes and slowed any general improvement in the housing market. Furthermore, they have resulted in reduced demand for mortgage loans originated through our KB Home Mortgage joint venture and a corresponding decline in origination-related fee income. These reductions in demand have had a materially adverse effect on our business and results of operations in 2009 that is expected to continue in 2010.

 

Many of our homebuyers obtain financing for their home purchases from KB Home Mortgage. Our partner, a Bank of America, N.A. subsidiary, provides the loan products that the joint venture offers to our homebuyers. If our partner refuses or is unable to make loan products available to the joint venture to provide to our homebuyers, our home sales and results of operations may be adversely affected.

Our strategies in responding to the adverse conditions in the homebuilding industry have had limited success, and the continued implementation of these and other strategies may not be successful.

 

While we have been successful in generating positive operating cash flow and reducing our inventories in recent years, we have done so at significantly reduced gross profit levels and have incurred significant asset impairment charges compared to prior periods. Moreover, many of our strategic initiatives to generate cash and reduce our inventories have involved lowering overhead through workforce reductions, for which we incurred significant costs, and reducing our active community counts through strategic wind downs or market exits, curbs in development and sales of land interests. These strategic steps have resulted in our generating to varying degrees fewer net orders, homes delivered and revenues compared to prior periods, and have contributed to the net losses we have recognized in recent years. Though we have seen some improvement in our net orders for 2009, there can be no assurance that positive net order trends will continue and, notwithstanding our sales strategies, we have experienced volatility in cancellations of home purchase contracts in recent years. We believe that the volatile cancellation rates have largely reflected weak homebuyer confidence based on sustained home price declines, increased offerings of sales incentives in the marketplace for both new and existing homes and generally poor economic and employment conditions, all of which have prompted homebuyers to forgo or delay home purchases. The more restrictive mortgage lending environment and the inability of some buyers to sell their existing homes have also led to lower demand for new homes and cancellations. Many of these factors affecting new orders and cancellation rates are beyond our control. It is uncertain how long and to what degree these factors, and the reduced sales levels and volatility in cancellations we have experienced, will continue. To the extent that they do, we expect that they will have a negative effect on our business and our results of operations.

 

Our business is cyclical and is significantly affected by changes in general and local economic conditions.

 

Our business can be substantially affected by adverse changes in general economic or business conditions that are outside of our control, including changes in:

 

 

Adverse changes in these conditions may affect our business nationally or may be more prevalent or concentrated in particular regions or localities in which we operate. In recent years, unfavorable changes in many of these factors negatively affected all of our served markets, and we expect the widespread nature of the downturn in the housing market to continue into 2010. A continued downturn in the economy and employment levels would likely worsen the unfavorable trends the housing market has experienced since 2006.

 

Weather conditions and natural disasters, such as earthquakes, hurricanes, tornadoes, floods, droughts, fires and other environmental conditions, can also impair our homebuilding business on a local or regional basis. Civil unrest or acts of terrorism can also have a negative effect on our business.

 

Fluctuating lumber prices and shortages, as well as shortages or price fluctuations in other building materials or commodities, can have an adverse effect on our business. Similarly, labor shortages or disruptions among key trades, such as carpenters, roofers, electricians and plumbers, can delay the delivery of our homes and increase our costs.

 

The potential difficulties described above can cause demand and prices for our homes to diminish or cause us to take longer and incur more costs to build our homes. We may not be able to recover these increased costs by raising prices

because of market conditions and because the price of each home we sell is usually set several months before the home is delivered, as our customers typically sign their home purchase contracts before construction begins. The potential difficulties described above could cause some homebuyers to cancel or refuse to honor their home purchase contracts altogether. In fact, reflecting the difficult conditions in our served markets, we have experienced volatile home purchase contract cancellation rates in recent years and we may experience similar volatility in 2010.

 

Supply shortages and other risks related to demand for building materials and/or skilled labor could increase costs and delay deliveries.

 

There is a high level of competition in the homebuilding industry for skilled labor and building materials. Increased costs or shortages in building materials or skilled labor could cause increases in construction costs and construction delays. We generally are unable to pass on increases in construction costs to customers who have already entered into home purchase contracts, as the purchase contracts generally fix the price of the home at the time the contract is signed, and may be signed well in advance of when construction commences. Further, we may not be able to pass on increases in construction costs because of market conditions. Sustained increases in construction costs due, among other things, to pricing competition for materials and skilled labor may, over time, decrease our margins.

 

Inflation may adversely affect us by increasing costs that we may not be able to recover, particularly if sales prices decrease.

 

Inflation can have an adverse impact on our consolidated results of operations because increasing costs for land, materials and skilled labor may call for us to increase home sales prices to maintain satisfactory margins. However, if the current challenging and highly competitive conditions in the housing market persist, we may need to decrease our selling prices in an attempt to stimulate sales. Our lowering of selling prices, in addition to impacting our margins, may also reduce the value of our land inventory and make it more difficult for us to recover the full cost of previously purchased land with selling prices or, if we choose, in disposing of land assets. In addition, depressed land values may cause us to forfeit deposits on land option contracts if we cannot satisfactorily renegotiate the purchase price of the optioned land. We may incur noncash charges for inventory impairments if the value of our owned inventory is reduced or for land option contract abandonments if we choose not to exercise land option contracts.

 

Reduced home sales may impair our ability to recoup development costs or force us to absorb additional costs.

 

We incur many costs even before we begin to build homes in a community. Depending on the stage of development, these include costs of preparing land, finishing and entitling lots, and installing roads, sewage and other utilities, as well as taxes and other costs related to ownership of the land on which we plan to build homes. If the rate at which we sell and deliver homes slows or falls, which has occurred throughout the present housing market downturn, we may incur additional costs and it will take a longer period of time for us to recover our costs. Also, we frequently acquire options to purchase land and make deposits that may be forfeited if we do not exercise the options within specified periods. Because of current market conditions, we have strategically terminated some of these options, resulting in the forfeiture of deposits and unrecoverable due diligence and development costs.

 

The value of the land and housing inventory we own or control may fall significantly and our profits may decrease.

 

The value of the land and housing inventory we currently own or control depends on market conditions, including estimates of future demand for, and the revenues that can be generated from, such inventory. The market value of our land inventory can vary considerably because there is often a significant amount of time between our initial acquisition or optioning of land and the delivery of homes on that land. The downturn in the housing market, which has significantly depressed home sales and selling prices, has caused the fair value of certain of our owned or controlled inventory to fall, in some cases well below the estimated fair value at the time we acquired it. Because of our assessments of fair value, we have been required to write down the carrying value of certain of our inventory, including inventory that we have previously written down, and take corresponding noncash charges against our earnings to reflect the impaired value. We have also abandoned our interests in certain land inventory that no longer meets our internal investment standards, which also required us to take noncash charges. If the current downturn in the housing market continues, we may need to take additional charges against our earnings for inventory impairments or land option contract abandonments, or both. Any such noncash charges would have an adverse effect on our consolidated results of operations.

Some homebuyers may cancel their home purchases because the required deposits are small and generally refundable.

 

Our backlog information reflects the number of homes for which we have entered into a purchase contract with a customer, but not yet delivered the home. Our home purchase contracts typically require only a small deposit, and in many states, the deposit is fully refundable at any time prior to closing. If the prices for new homes decline, competitors increase their use of sales incentives, interest rates increase, the availability of mortgage financing diminishes or there is continued weakness or a further downturn in local or regional economies or the national economy, homebuyers may terminate their existing home purchase contracts with us in order to negotiate for a lower price, explore other options or because they cannot, or become reluctant to, complete the purchase. In recent years, we have experienced elevated and volatile cancellation rates, in part because of these reasons. Elevated and volatile cancellation rates due to these conditions, or otherwise, could have an adverse effect on our business and our results of operations.

 

Our long-term success depends on the availability of improved lots and undeveloped land that meet our land investment criteria.

 

The availability of finished and partially developed lots, and undeveloped land for purchase that meet our internal investment standards depends on a number of factors outside of our control, including land availability in general, competition with other homebuilders and land buyers for desirable property, inflation in land prices, zoning, allowable housing density and other regulatory requirements. Should suitable lots or land become less available, the number of homes we may be able to build and sell could be reduced, and the cost of attractive land could increase, perhaps substantially, which could adversely impact our results of operations including, but not limited to, our margins, and our ability to maintain ownership or control of a three-to-four year supply of developable land inventory.

 

Home prices and sales activity in the particular markets and regions in which we do business affect our results of operations because our business is concentrated in these markets.

 

Home prices and sales activity in some of our key served markets have declined from time to time for market-specific reasons, including adverse weather, lack of affordability or economic contraction due to, among other things, the failure or decline of key industries and employers. If home prices or sales activity decline in one or more of our key served markets, particularly in Arizona, California, Florida, Nevada or Texas, our costs may not decline at all or at the same rate and, as a result, our overall results of operations may be adversely affected.

 

Interest rate increases or changes in federal lending programs or regulation could lower demand for our homes.

 

Nearly all of our customers finance the purchase of their homes. Prior to 2006, historically low interest rates and the increased availability of specialized mortgage products, including mortgage products requiring no or low down payments, and interest-only and adjustable-rate mortgages, made homebuying more affordable for a number of customers and more available to customers with lower credit scores. Increases in interest rates or decreases in the availability of mortgage financing or of certain mortgage programs, as discussed above, may lead to fewer mortgage loans being provided, higher down payment requirements or monthly mortgage costs, or a combination of the foregoing, and, as a result, reduce demand for our homes.

 

Increased interest rates can also hinder our ability to realize our backlog because our home purchase contracts provide our customers with a financing contingency. Financing contingencies allow customers to cancel their home purchase contracts in the event they cannot arrange for adequate financing.

 

As a result of the turbulence in the credit markets and mortgage finance industry in 2008, the federal government has taken on a significant role in supporting mortgage lending through its conservatorship of the Federal National Mortgage Association (also known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (also known as Freddie Mac), both of which purchase home mortgages and mortgage-backed securities originated by mortgage lenders, and its insurance of mortgages originated by lenders through the Federal Housing Administration (“FHA”) and the Veterans Administration (“VA”). FHA-backing of mortgages has recently been particularly important to the mortgage finance industry and to our business. In 2009, 63% of our homebuyers that chose to finance with KB Home Mortgage purchased a home using a FHA-backed loan. In addition, the Federal Reserve has purchased a sizeable amount of mortgage-backed securities in part to stabilize mortgage interest rates and to support the market for mortgage-backed securities. The availability and affordability of mortgage loans, including the consumer interest rates for such loans, could be adversely affected by a curtailment or ceasing of the federal government’s mortgage-related programs or policies. The Federal Reserve, for example, has announced that it expects to end its purchases of mortgage-backed securities in early

2010. The FHA recently reported that its cash reserves have fallen below legal requirements due primarily to defaults on mortgages it has insured and, as a result, it has and may continue to impose stricter loan qualification standards, raise minimum down payment requirements, impose higher mortgage insurance premiums and other costs and/or limit the number of mortgages it insures. Due to growing federal budget deficits, the U.S. Treasury may not be able to continue supporting the mortgage-related activities of Fannie Mae, Freddie Mac, the FHA and the VA at present levels.

 

Because the availability of Fannie Mae, Freddie Mac, FHA- and VA-backed mortgage financing is an important factor in marketing and selling many of our homes, any limitations or restrictions in the availability of such government-backed financing could reduce our home sales and adversely affect our results of operations, including the income we earn from KB Home Mortgage.

 

Tax law changes could make home ownership more expensive or less attractive.

 

Significant expenses of owning a home, including mortgage interest expense and real estate taxes, generally are deductible expenses for the purpose of calculating an individual’s federal, and in some cases state, taxable income, subject to various limitations, under current tax law and policy. If the federal government or a state government changes income tax laws, as some policy makers have discussed, by eliminating or substantially reducing these income tax benefits, the after-tax cost of owning a new home would increase substantially. This could adversely impact demand for and/or sales prices of new homes.

 

Moreover, in 2009, our home sales increased in part because of federal and state tax credits made available to certain qualifying homebuyers. These tax credits are expected to be eliminated or curtailed in 2010,which could adversely affect our net orders, cancellation rates and results of operations in 2010.

 

We are subject to substantial legal and regulatory requirements regarding the development of land, the homebuilding process and protection of the environment, which can cause us to suffer delays and incur costs associated with compliance and which can prohibit or restrict homebuilding activity in some regions or areas.

 

Our homebuilding business is heavily regulated and subject to an increasing amount of local, state and federal regulation concerning zoning, resource protection and other environmental impacts, building design, construction and similar matters. These regulations often provide broad discretion to governmental authorities that oversee these matters, which can result in unanticipated delays or increases in the cost of a specified project or a number of projects in particular markets. We may also experience periodic delays in homebuilding projects due to building moratoria and permitting requirements in any of the areas in which we operate.

 

We are also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the environment, and in 2008 we entered into a consent decree with the EPA and certain states concerning our storm water pollution prevention practices. These laws and regulations, the enactment or implementation of new environmental laws or regulations, and the consent decree may cause delays in our construction and delivery of new homes, may cause us to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in certain regions or areas.

 

In addition, environmental laws may impose liability for the costs of removal or remediation of hazardous or toxic substances whether or not the developer or owner of the property knew of, or was responsible for, the presence of those substances. The presence of those substances on our properties may prevent us from selling our homes and we may also be liable, under applicable laws and regulations or lawsuits brought by private parties, for hazardous or toxic substances on properties and lots that we have sold in the past.

 

Further, a significant portion of our business is conducted in California, one of the most highly regulated and litigious states in the country. Therefore, our potential exposure to losses and expenses due to new laws, regulations or litigation may be greater than other homebuilders with a less significant California presence.

 

The mortgage banking operations of KB Home Mortgage are heavily regulated and subject to the rules and regulations promulgated by a number of governmental and quasi-governmental agencies. There are a number of federal and state statutes and regulations which, among other things, prohibit discrimination, impose various disclosure obligations, establish underwriting guidelines that include obtaining inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. A finding that KB Home Mortgage materially violated any of the foregoing laws could have an adverse effect on our results of operations to the extent it impacts the income we earn from our equity interest in the joint venture.

 

We are subject to a consent order that we entered into with the Federal Trade Commission in 1979 and related consent decrees that were entered into in 1991 and 2005. Pursuant to the consent order and the related consent decrees,

we provide explicit warranties on the quality of our homes, follow certain guidelines in advertising and provide certain disclosures to prospective purchasers of our homes. A finding that we have significantly violated the consent order and/or the related consent decrees could result in substantial liabilities or penalties and could limit our ability to sell homes in certain markets.

 

Homebuilding and financial services are very competitive, and competitive conditions could adversely affect our business or our financial results.

 

The homebuilding industry is highly competitive. Homebuilders compete not only for homebuyers, but also for desirable land, financing, building materials, skilled management and trade labor. We compete in each of our served markets with other local, regional and national homebuilders, often within larger subdivisions containing portions designed, planned and developed by such homebuilders. These homebuilders may also have long-standing relationships with local labor, materials suppliers or land sellers, which may provide an advantage in their respective regions or local markets. We also compete with other housing alternatives, such as existing home sales (including lender-owned homes acquired through foreclosure or short sales) and rental housing. The competitive conditions in the homebuilding industry can result in:

 

 

These competitive conditions may adversely affect our business and financial results by decreasing our revenues, increasing our costs and/or diminishing growth in our local or regional homebuilding business. In the current downturn in the homebuilding industry, actions taken by our new home and housing alternative competitors are reducing the effectiveness of our efforts to achieve pricing stability, generate home sales, and reduce our inventory levels.

 

Homebuilding is subject to warranty and liability claims in the ordinary course of business that can be significant.

 

In the ordinary course of our homebuilding business, we are subject to home warranty and construction defect claims. We record warranty and other liabilities for the homes we sell based on historical experience in our served markets and our judgment of the risks associated with the types of homes we build. We have, and require the majority of our subcontractors to have, general liability, property, errors and omissions, workers’ compensation and other business insurance. These insurance policies protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles and other coverage limits. Through our captive insurance subsidiary, we record expenses and liabilities for estimated costs required to cover our self-insured retention and deductible amounts under these policies, and for any costs of claims and lawsuits, based on an analysis of our historical claims, which includes an estimate of claims incurred but not yet reported. Because of the uncertainties inherent to these matters, we cannot provide assurance that our insurance coverage, our subcontractor arrangements and our liabilities will be adequate to address all our warranty and construction defect claims in the future, or that any potential inadequacies will not have an adverse affect on our results of operations. Additionally, the coverage offered by and the availability of general liability insurance for construction defects are currently limited and costly. There can be no assurance that coverage will not be further restricted, increasing our risks, and become more costly.

 

In 2009, we incurred additional warranty-related charges associated with the repair of approximately 230 homes primarily delivered in 2006 and 2007 and located in Florida and Louisiana that were identified as containing or suspected of containing allegedly defective drywall manufactured in China. We are continuing to review whether there are additional homes delivered in Florida, Louisiana or other locations that contain or may contain this drywall material. Based on the results of our review, we have not identified any homes outside of Florida and Louisiana that contain this drywall material. Depending on the outcome of our review and our actual claims experience, we may incur additional

warranty-related costs and further increase our warranty liability in future periods. In addition, we have been named as a defendant in one lawsuit relating to this drywall material, and we may in the future be subject to other similar litigation or claims that could cause us to incur significant costs.

 

Because of the seasonal nature of our business, our quarterly operating results fluctuate.

 

We have experienced seasonal fluctuations in our quarterly operating results. We typically do not commence significant construction on a home before a home purchase contract has been signed with a homebuyer. Historically, a significant percentage of our home purchase contracts are entered into in the spring and summer months, and a corresponding significant percentage of our homes delivered occur in the fall and winter months. Construction of our homes typically requires approximately four months and weather delays that often occur in late winter and early spring may extend this period. As a result of these combined factors, we historically have experienced uneven quarterly results, with lower revenues and operating income generally during the first and second quarters of the year. During the present housing market downturn, however, we have experienced lower sales in the spring and summer months and correspondingly fewer homes delivered in the fall and winter months as compared to earlier periods. With the current difficult market conditions expected to continue into 2010, we can make no assurances that our normal seasonal patterns will occur in the near future.

 

Failure to comply with the covenants and conditions imposed by the agreements governing our indebtedness could restrict future borrowing or cause our debt to become immediately due and payable.

 

The Credit Facility and, to a lesser degree, the indenture governing our outstanding senior notes impose restrictions on our operations and activities. The restrictions in the Credit Facility primarily relate to cash dividends, stock repurchases, incurrence of indebtedness, creation of liens and asset dispositions, defaults with respect to other debt obligations and require maintenance of a maximum debt to equity (or leverage) ratio, a minimum interest coverage ratio, and a minimum level of tangible net worth. The indenture governing our senior notes does not contain any financial maintenance covenants, but does contain certain restrictive covenants that, among other things, limit our ability to incur secured indebtedness; engage in sale-leaseback transactions involving property or assets above a specified value; or engage in mergers, consolidations or sales of assets. If we fail to comply with these restrictions or covenants, the holders of those debt instruments or the banks, as applicable, could cause our debt to become due and payable prior to maturity or could demand that we compensate them for waiving instances of noncompliance. In addition, a default under any series of our senior notes or the Credit Facility could cause a default with respect to our other notes or the Credit Facility, as the case may be, and result in the acceleration of the maturity of all such defaulted indebtedness and our inability to borrow under the Credit Facility. Moreover, we may curtail our investment activities and other uses of cash to maintain compliance with these restrictions and covenants.

 

We participate in certain unconsolidated joint ventures where we may be adversely impacted by the failure of the unconsolidated joint venture or the other partners in the unconsolidated joint venture to fulfill their obligations.

 

We have investments in and commitments to certain unconsolidated joint ventures with unrelated strategic partners to acquire and develop land and, in some cases, build and deliver homes. To finance these activities, our unconsolidated joint ventures often obtain loans from third-party lenders that are secured by the unconsolidated joint venture’s assets. In certain instances, we and the other partners in an unconsolidated joint venture provide guarantees and indemnities to lenders with respect to the unconsolidated joint venture’s debt, which may be triggered under certain conditions when the unconsolidated joint venture fails to fulfill its obligations under its loan agreements. Because we do not have a controlling interest in these unconsolidated joint ventures, we depend heavily on the other partners in each unconsolidated joint venture to both (i) cooperate and make mutually acceptable decisions regarding the conduct of the business and affairs of the unconsolidated joint venture and (ii) ensure that they, and the unconsolidated joint venture, fulfill their respective obligations to us and to third parties. If the other partners in our unconsolidated joint ventures do not provide such cooperation or fulfill these obligations due to their financial condition, strategic business interests (which may be contrary to ours), or otherwise, we may be required to spend additional resources (including payments under the guarantees we have provided to the unconsolidated joint ventures’ lenders) and suffer losses, each of which could be significant. Moreover, our ability to recoup such expenditures and losses by exercising remedies against such partners may be limited due to potential legal defenses they may have, their respective financial condition and other circumstances.

The downturn in the housing market and the continuation of the disruptions in the credit markets could limit our ability to access capital and increase our costs of capital or stockholder dilution.

 

We have historically funded our homebuilding and financial services operations with internally generated cash flows and external sources of debt and equity financing. However, during this downturn in the housing market, we have relied primarily on the positive operating cash flow we have generated to meet our working capital needs and repay outstanding indebtedness. While we generated positive operating cash flow in 2009, principally through the receipt of federal income tax refunds and from home and land sales, the persistent weakness in the housing markets and the disruption in the credit markets since 2008 have reduced the availability and increased the costs to us of other sources of liquidity.

 

Market conditions may significantly limit our ability to replace or refinance indebtedness, particularly due to the lowering of our senior debt ratings in 2009 by three rating agencies. Pricing in the public debt markets has increased substantially, and the terms of future issuances of indebtedness by us may be more restrictive than the terms governing our current indebtedness. Moreover, due to the deterioration in the credit markets and the uncertainties that exist in the general economy and for homebuilders in particular, we cannot be certain that we would be able to replace existing financing or secure additional sources of financing, if necessary, on terms satisfactory to us or at all. In addition, the significant decline in our stock price since 2006, the ongoing volatility in the stock markets and the reduction in our stockholders’ equity relative to our debt could also impede our access to the equity markets or increase the amount of dilution our stockholders would experience should we seek or need to raise capital through issuance of equity.

 

While we believe we can meet our forecasted capital requirements from our cash resources, expected future cash flow and the sources of financing that we anticipate will be available to us, we can provide no assurance that we will be able to do so, particularly if current difficult housing or credit market or economic conditions continue or deteriorate further. The effects on our business, liquidity and financial results of these conditions could be material and adverse to us.

 

Our net operating loss carryforwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

 

Since the end of our 2007 fiscal year, we have generated significant net operating losses (“NOLs”), and we may generate additional NOLs in 2010. Under federal tax laws, we can use our NOLs (and certain related tax credits) to reduce our future taxable income for up to 20 years, after which they expire for such purposes. Until they expire, we can carry forward our NOLs (and certain related tax credits) that we do not use in any particular year to reduce our taxable income in future years.

 

The benefits of our NOLs would be reduced or eliminated if we experience an “ownership change,” as determined under Internal Revenue Code Section 382 (“Section 382”). A Section 382 ownership change occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an ownership change occurs, Section 382 would impose an annual limit on the amount of NOLs we can use to reduce our taxable income equal to the product of the total value of our outstanding equity immediately prior to the ownership change (reduced by certain items specified in Section 382) and the federal long-term tax-exempt interest rate in effect for the month of the ownership change. A number of special rules apply to calculating this annual limit.

 

While the complexity of Section 382’s provisions and the limited knowledge any public company has about the ownership of its publicly-traded stock make it difficult to determine whether an ownership change has occurred, we currently believe that an ownership change has not occurred. However, if an ownership change were to occur, the annual limit Section 382 may impose could result in a material amount of our NOLs expiring unused. This would significantly impair the value of our NOL asset and, as a result, have a negative impact on our financial position and results of operations.

 

During 2009, our stockholders approved an amendment to our restated certificate of incorporation that is designed to block transfers of our common stock that could result in an ownership change, and a rights agreement pursuant to which we have issued certain stock purchase rights with terms designed to deter transfers of our common stock that could result in an ownership change. However, these measures cannot guarantee complete protection against an ownership change and it remains possible that one may occur.

A decline in our tangible net worth and the resulting increase in our leverage ratio may place burdens on our ability to comply with the terms of our indebtedness, may restrict our ability to operate and may prevent us from fulfilling our obligations.

 

The amount of our debt could have important consequences. For example, it could:

 

 

Our ability to meet our debt service and other obligations will depend upon our future performance. Our business is substantially affected by changes in economic cycles. Our revenues, earnings and cash flows vary with the level of general economic activity and competition in the markets in which we operate. Our business could also be affected by financial, political, regulatory and other factors, many of which are beyond our control. A higher interest rate on our debt could adversely affect our operating results.

 

Our business may not generate sufficient cash flow from operations and external financing may not be available to us in an amount sufficient to meet our debt service obligations, fulfill the financial or operational obligations we may have under certain unconsolidated joint venture transactions, or to fund our other liquidity needs. Should we not generate sufficient cash flow from operations or have external financing available to us, we may need to refinance all or a portion of our debt obligations on or before maturity, which we may not be able to do on favorable terms or at all, or raise capital through equity issuances that would dilute existing stockholders’ interests.

 

Our ability to obtain external financing could be adversely affected by a negative change in our credit rating by a third party rating agency.

 

Our ability to access external sources of financing on favorable terms is a key factor in our ability to fund our operations and to grow our business. As of the date of this report, our credit rating by both Fitch Ratings and Standard and Poor’s Financial Services is BB-, with both maintaining a negative outlook. On June 22, 2009, Moody’s Investor Services lowered our credit rating to B1 from Ba3 and also maintained a negative outlook. Further downgrades of our credit rating by any of these principal credit rating agencies may make it more difficult and costly for us to access external financing.

 

We may have difficulty in continuing to obtain the additional financing required to operate and develop our business.

 

Our homebuilding operations require significant amounts of cash and/or available credit. It is not possible to predict the future terms or availability of additional capital. Moreover, our outstanding senior notes and the Credit Facility contain provisions that may restrict the amount and nature of debt we may incur in the future. The Credit Facility limits our ability to borrow additional funds by placing a maximum cap on our leverage ratio. Under the most restrictive of these provisions, at November 30, 2009, we would have been permitted to incur up to $1.42 billion of consolidated total indebtedness, as defined in the Credit Facility. This maximum amount exceeded our actual consolidated total indebtedness at November 30, 2009 by $873.5 million. In addition, the Credit Facility limits our ability to borrow senior indebtedness, as defined in the Credit Facility, subject to a specified borrowing base. At November 30, 2009, we would have been permitted to incur up to $2.13 billion of senior indebtedness under the Credit Facility. This maximum amount exceeded our actual total senior indebtedness at November 30, 2009 by $474.7 million. There can be no assurance that we can actually borrow up to these maximum amounts of total consolidated indebtedness or senior indebtedness at any time, as our ability to borrow additional funds, and to raise additional capital through other means, also depends on conditions in the capital markets and our perceived credit worthiness, as discussed above. If conditions in the capital markets change significantly, it could reduce our ability to generate sales and may hinder our future growth and results of operations. Potential federal and state regulations limiting the investment activities of financial institutions could also impact our ability to obtain additional financing on a reasonable basis.

 

Our results of operations could be adversely affected if we are unable to obtain performance bonds.

 

In the course of developing our communities, we are often required to provide to various municipalities and other government agencies performance bonds to secure the completion of our projects. Our ability to obtain such bonds and

the cost to do so depend on our credit rating, overall market capitalization, available capital, past operational and financial performance, management expertise and other factors, including prevailing surety market conditions and the underwriting practices and resources of performance bond issuers. If we are unable to obtain performance bonds when required or the cost to obtain them increases significantly, we may be unable or significantly delayed in developing a community or communities, and, as a result, our consolidated financial position, results of operations, consolidated cash flows and/or liquidity could be adversely affected.

 

 

None.

 

We lease our corporate headquarters in Los Angeles, California. Our homebuilding division offices (except for our San Antonio, Texas office) and our KB Home Studios are located in leased space in the markets where we conduct business. We own the premises for our San Antonio office.

 

We believe that such properties, including the equipment located therein, are suitable and adequate to meet the needs of our businesses.

 

 

ERISA Litigation

 

On March 16, 2007, plaintiffs Reba Bagley and Scott Silver filed an action brought under Section 502 of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al., in the United States District Court for the Central District of California. The action was brought against us, our directors, certain of our current and former officers, and the board of directors committee that oversees the KB Home 401(k) Savings Plan (the “401(k) Plan”). After the court allowed leave to file an amended complaint, plaintiffs filed an amended complaint adding Tolan Beck and Rod Hughes as additional plaintiffs and dismissing certain individuals as defendants. All four plaintiffs claim to be former employees of KB Home who participated in the 401(k) Plan. Plaintiffs allege on behalf of themselves and on behalf of all others similarly situated that all defendants breached fiduciary duties owed to plaintiffs and purported class members under ERISA by failing to disclose information to and providing misleading information to participants in the 401(k) Plan about our alleged prior stock option backdating practices and by failing to remove our stock as an investment option under the 401(k) Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their 401(k) Plan accounts than they would have earned but for defendants’ alleged breach of duties.

 

The parties to the litigation have reached a settlement in principle, and the court was informed of this development on December 1, 2009. A scheduled hearing on our motion for summary judgment was taken off calendar, and we expect the final settlement to be submitted to the court for approval during the month of February 2010.

 

Other Matters

 

On October 2, 2009, the staff of the SEC notified us that a formal order of investigation had been issued regarding possible accounting and disclosure issues. The staff has stated that its investigation should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. We are cooperating with the staff of the SEC in connection with the investigation. We cannot predict the outcome of, or the timeframe for, the conclusion of this matter.

 

In addition to those described in this report, we are involved in litigation and government proceedings incidental to our business. These proceedings are in various procedural stages and, based on reports of counsel, we believe as of the date of this report that provisions or accruals made for any potential losses (to the extent estimable) are adequate and that any liabilities or costs arising out of these proceedings are not likely to have a materially adverse effect on our consolidated financial position or results of operations. The outcome of any of these proceedings, however, is inherently uncertain, and if unfavorable outcomes were to occur, there is a possibility that they would, individually or in the aggregate, have a materially adverse effect on our consolidated financial position or results of operations.

 

 

No matters were submitted to a vote of security holders during the fourth quarter of 2009 through the solicitation of proxies or otherwise.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following table presents certain information regarding our executive officers as of January 21, 2010:  

 

 

 

There is no family relationship between any of our executive officers or between any of our executive officers and any of our directors.

 

 

As of December 31, 2009, there were 923 holders of record of our common stock. Our common stock is traded on the New York Stock Exchange under the ticker symbol “KBH.” The following table presents, for the periods indicated, the price ranges of our common stock, and cash dividends declared and paid per share:

 

 

 

The declaration and payment of cash dividends on shares of our common stock, whether at current levels or at all, are at the discretion of our board of directors, and depend upon, among other things, our expected future earnings, cash flows, capital requirements, operational investment strategy, general financial condition and compliance with covenants contained in our Credit Facility, as well as general business conditions. In November 2008, our board of directors reduced the quarterly cash dividend on our common stock to $.0625 per share from $.25 per share.

 

The description of our equity compensation plans required by Item 201(d) of Regulation S-K is incorporated herein by reference to Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this report.

 

We did not repurchase any of our equity securities during the fourth quarter of 2009.

Stock Performance Graph

 

The graph below compares the cumulative total return of KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index for the last five year-end periods ended November 30.

 

Comparison of Five-Year Cumulative Total Return
Among KB Home, S&P 500 Index, S&P Homebuilding
Index and Dow Jones Home Construction Index

 

 

The above graph is based on the KB Home common stock and index prices calculated as of the last trading day before December 1 of the year-end periods presented. As of November 30, 2009, the closing price of KB Home common stock on the New York Stock Exchange was $13.55 per share. On December 31, 2009, our common stock closed at $13.68 per share. The performance of our common stock depicted in the graphs above represents past performance only and is not indicative of future performance. Total return assumes $100 invested at market close on November 30, 2004 in KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index including reinvestment of dividends.

 

The data in this table should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and the Notes thereto. Both are included later in this report.

 

KB HOME

SELECTED FINANCIAL INFORMATION

(In Thousands, Except Per Share Amounts)

 

 

 

RESULTS OF OPERATIONS

 

Overview.  Revenues are generated from our homebuilding operations and our financial services operations. On July 10, 2007, we sold our 49% equity interest in KBSA. Accordingly, our former French operations are presented as discontinued operations in this report. The following table presents a summary of our consolidated results of operations for the years ended November 30, 2009, 2008 and 2007 (in thousands, except per share amounts):

 

 

During the year ended November 30, 2009, operating conditions in the homebuilding industry remained challenging, reflecting the housing market’s prolonged and severe downturn since 2006 and the weak U.S. economy. Among the negative conditions impacting the homebuilding industry was a persistent oversupply of homes available for sale (including an increasing number of lender-owned homes acquired through foreclosures and short sales), which pushed down home selling prices and intensified competition. Housing markets were also negatively impacted by rising unemployment, tightened mortgage lending standards and weak consumer confidence, all of which depressed demand for housing. These negative factors were offset to varying degrees in some markets by continued improvement in housing affordability, stemming from lower selling prices, relatively low mortgage interest rates and government homebuyer tax credit incentives.

 

Although we delivered fewer homes and generated lower revenues in 2009 compared to 2008, we succeeded in reducing our pretax loss by 68% and generated higher net orders on a year-over-year basis. We believe the improvements in our pretax loss and net orders are largely the result of strategies we have put into action over the past several quarters to achieve three primary goals: generate cash and maintain a strong balance sheet; restore the profitability of our homebuilding operations; and position our business to capitalize on a housing market recovery when it occurs. To advance these goals during 2009, we pursued various initiatives to enhance our operational productivity and rolled out nationwide redesigned and value-engineered products. This included our The Open Series product line, which is tailored to meet the affordability needs of our core first-time, first move-up and active adult homebuyers. Largely through these initiatives, we improved our housing gross margins and reduced our pretax losses in each quarter of 2009, as measured against the corresponding prior year periods, even though our average selling prices decreased in each period.

Our total revenues of $1.82 billion for the year ended November 30, 2009 decreased 40% from $3.03 billion in 2008, which had decreased 53% from $6.42 billion in 2007. Revenues declined in 2009 and 2008 primarily due to decreases in our housing revenues, reflecting fewer homes delivered and lower average selling prices. The decreases in homes delivered in 2009 and 2008 were mainly due to our strategic reduction in the number of active communities we operated each year to align our business operations with the significantly reduced home sales activity we have experienced relative to the peak levels of a few years ago. “Active communities” are those that deliver five or more homes in a particular reporting period. Average selling prices declined in 2009 and 2008 due to the challenging housing market conditions and the resulting intense competition. In 2009, the lower average selling price was also due to our rollout of new product, including The Open Series, at lower price points compared to our previous product.

 

Included in our total revenues were financial services revenues of $8.4 million in 2009, $10.8 million in 2008 and $15.9 million in 2007. Financial services revenues decreased in both 2009 and 2008 mainly due to our delivering fewer homes.

 

We generated a net loss of $101.8 million, or $1.33 per diluted share, in 2009, largely due to pretax, noncash charges of $206.7 million for inventory and joint venture impairments and the abandonment of land option contracts we no longer planned to pursue. These charges reflected the continued weakness in housing market conditions, which depressed asset values. The majority of these charges were associated with our West Coast and Southeast reporting segments. The net loss in 2009 also included an income tax benefit of $209.4 million, which was primarily associated with federal tax legislation enacted in the fourth quarter of 2009. The new legislation extended the permitted carryback period for offsetting certain NOLs against earnings to up to five years, which allowed us to carry back and offset our 2009 NOL against earnings from 2005 and 2004. As a result, we expect to receive a federal tax refund of $190.7 million in the first quarter of 2010.

 

Reflecting reduced inventory impairment and land option contract abandonment charges and the favorable impact of our strategies to reduce direct construction costs and increase operational efficiencies, our housing gross margin in 2009 increased to positive 6.5% from negative 7.1% in 2008 and negative 5.7% in 2007. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, increased to 15.5% in 2009, compared to 10.6% in 2008 and 13.3% in 2007.

 

In 2008, we incurred a net loss of $976.1 million, or $12.59 per diluted share, largely due to pretax, noncash charges of $748.6 million for inventory and joint venture impairments and the abandonment of land option contracts, and $68.0 million for goodwill impairments. The bulk of the inventory-related charges were associated with our West Coast, Southwest and Southeast reporting segments. The goodwill impairment charges in 2008 related to our Central and Southeast reporting segments, and resulted in our having no remaining goodwill at November 30, 2008. The net loss in 2008 also reflected a $355.9 million valuation allowance charge taken against net deferred tax assets to fully provide for the tax benefits generated from our pretax loss for the year in accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”). In 2007, our continuing operations generated an after-tax loss of $1.41 billion, or $18.33 per diluted share, due to pretax, noncash charges of $1.41 billion for inventory and joint venture impairments and the abandonment of land option contracts, and $107.9 million for goodwill impairments recognized during the year. The majority of the inventory-related charges in 2007 related to our West Coast and Southwest reporting segments, and the goodwill impairments related solely to our Southwest reporting segment. Our 2007 loss from continuing operations also reflected a noncash charge of $514.2 million to establish a valuation allowance for our net deferred tax assets.

 

Overall, we posted a net loss of $929.4 million, or $12.04 per diluted share (including the discontinued operations) in 2007. Income from our French discontinued operations, net of income taxes, totaled $485.4 million in 2007, including a $438.1 million after-tax gain on the sale of these operations.

 

Our backlog at November 30, 2009 was comprised of 2,126 homes, representing projected future housing revenues of $422.5 million, compared to a backlog at November 30, 2008 of 2,269 homes, representing projected future housing revenues of $521.4 million. The number of homes in backlog decreased 6% year over year primarily due to the lower inventory levels we maintained and the reduced number of active communities we operated in 2009. The potential future housing revenues in backlog declined 19% year over year, reflecting fewer homes in backlog and lower average selling prices. Net orders from our homebuilding operations increased to 8,341 in 2009 from 8,274 in 2008, largely due to a decrease in our cancellation rate. As a percentage of gross orders, our cancellation rate decreased to 25% in 2009, compared to 41% in 2008, with each of our homebuilding segments experiencing year-over-year improvement.

Consistent with our goal of generating cash and maintaining a strong balance sheet, we generated $349.9 million of cash flow from operating activities during 2009 and ended the year with $1.29 billion of cash and cash equivalents and restricted cash. Restricted cash consists of an interest reserve account established with the Credit Facility’s administrative agent (the “Interest Reserve Account”), as discussed further below under the heading “Liquidity and Capital Resources”. Our debt balance at November 30, 2009 was $1.82 billion, down $121.2 million from $1.94 billion at November 30, 2008, mainly due to the redemption of public debt during the year, partly offset by the issuance of new public debt and the addition of debt associated with previously unconsolidated joint ventures that were consolidated during 2009. We ended 2009 with no cash borrowings outstanding under our Credit Facility. Effective December 28, 2009, we voluntarily reduced the aggregate commitment of the Credit Facility from $650.0 million to $200.0 million to lower costs associated with maintaining the Credit Facility. At November 30, 2009, our ratio of debt to total capital was 72.0%, compared to 70.0% at November 30, 2008. Our ratio of net debt to total capital was 42.9% at November 30, 2009 and 45.4% as of November 30, 2008.

 

Our inventory balance of $1.50 billion at November 30, 2009 was 29% lower than the $2.11 billion balance at November 30, 2008. This decrease reflected our actions to reduce inventory levels and limit land purchases to improve our liquidity, as well as inventory impairment and land option contract abandonment charges incurred during 2009. We ended 2009 with a geographically diverse land portfolio comprised of approximately 37,500 lots owned or controlled, compared to approximately 47,000 lots owned or controlled at the end of 2008. We believe our strong balance sheet and streamlined land positions leave us well-positioned to capitalize on future growth opportunities as they arise.

 

HOMEBUILDING

 

We have grouped our homebuilding activities into four reportable segments, which we refer to as West Coast, Southwest, Central and Southeast. As of November 30, 2009, our reportable homebuilding segments consisted of ongoing operations located in the following states: West Coast — California; Southwest — Arizona and Nevada; Central — Colorado and Texas; and Southeast — Florida, Maryland, North Carolina, South Carolina and Virginia.

 

The following table presents a summary of certain financial and operational data for our homebuilding operations (dollars in thousands, except average selling price):

 

Revenues.  Homebuilding revenues totaled $1.82 billion in 2009, decreasing 40% from $3.02 billion in 2008, which had decreased 53% from $6.40 billion in 2007. The year-over-year decreases in both 2009 and 2008 primarily reflected declines in housing revenues as a result of fewer homes delivered and lower average selling prices.

 

Housing revenues decreased to $1.76 billion in 2009 from $2.94 billion in 2008 and $6.21 billion in 2007. In 2009, housing revenues fell 40% from the previous year due to a 32% decrease in homes delivered and a 12% decline in the average selling price. In 2008, housing revenues fell 53% from 2007 due to a 48% decrease in homes delivered and a 10% decline in the average selling price.

 

We delivered 8,488 homes in 2009, down from 12,438 homes in 2008, largely due to a 38% year-over-year reduction in the number of active communities we operated. Over the past several quarters, we have strategically reduced the number of active communities we operate to align our business with the significantly reduced home sales activity we have experienced relative to the peak levels of a few years ago. Each of our reporting segments delivered fewer homes in 2009 compared to 2008, with decreases ranging from 17% to 50%.

 

In 2008, we delivered 12,438 homes, down from 23,743 homes delivered in 2007, with year-over-year decreases in each of our reporting segments. The lower delivery volume in 2008 compared to 2007 was mainly due to a 38% reduction in the number of active communities we operated and lower demand for new homes.

 

The average selling price of our homes decreased to $207,100 in 2009 from $236,400 in 2008, reflecting lower average selling prices in each of our geographic segments. Year-over-year, average selling prices declined 11% in our West Coast segment, 25% in our Southwest segment, 11% in our Central segment and 16% in our Southeast segment. Selling price declines, which varied depending on local market circumstances, occurred because of difficult economic and job market conditions, intense competition from homebuilders and sellers of existing homes (including lender-owned homes acquired through foreclosures and short sales), and our rollout of new product at price points lower than those of our previous product to meet consumer demand for more affordable homes.

 

Our 2008 average new home selling price decreased 10% from $261,600 in 2007. Year-over-year, average selling prices declined 18% in our West Coast segment, 11% in our Southwest segment and 12% in our Southeast segment due to the same pressures described above with respect to 2009 price decreases. The average selling price in our Central segment increased 4% in 2008 from 2007, reflecting changes in product mix.

 

Land sale revenues totaled $58.3 million in 2009, $82.9 million in 2008 and $189.0 million in 2007. Generally, land sale revenues fluctuate with our decisions to maintain or decrease our land ownership positions in certain markets based upon the volume of our holdings, our marketing strategy, the strength and number of competing developers entering particular markets at given points in time, the availability of land in markets we serve, and prevailing market conditions. Land sale revenues were more significant in 2007 compared to 2008 and 2009 because we sold a higher volume of land that year, rather than hold it for future development, as the housing market downturn intensified and the land no longer fit our marketing strategy or met our investment standards.

 

Operating Loss.  Our homebuilding operations generated operating losses of $236.5 million in 2009, $860.6 million in 2008 and $1.36 billion in 2007 due to losses from both housing operations and land sales. Our homebuilding operating loss as a percentage of homebuilding revenues was negative 13.0% in 2009, negative 28.5% in 2008 and negative 21.2% in 2007. The loss decreased on a percentage basis in 2009 mainly due to the increase in our housing gross margin. In 2008, the loss increased on a percentage basis due to a decrease in our housing gross margin and an increase in our selling, general and administrative expenses as a percentage of housing revenues.

 

Within our housing operations, the 2009 operating loss was primarily due to pretax, noncash charges of $157.6 million for inventory impairments and land option contract abandonments. The 2008 operating loss was largely due to pretax, noncash charges of $520.5 million for inventory impairments and land option contract abandonments and $68.0 million for goodwill impairments, as well as lower margins stemming from fiercely competitive market conditions and higher overhead costs relative to the volume of homes delivered. Inventory impairment charges in 2009 and 2008 were incurred as a result of persistent increases in housing supply and decreases in demand, both of which reduced achievable sales prices and, in turn, asset values. In 2007, the operating loss within housing operations was driven by pretax, noncash charges of $1.18 billion for inventory impairments and land option contract abandonments and $107.9 million for goodwill impairments. The inventory-related charges in 2007 resulted from declining market conditions, which depressed new home values and sales rates in certain housing markets across the

country. In 2009, 2008 and 2007, poor market conditions also depressed land values and led us to terminate our land option contracts on several projects that no longer met our investment standards.

 

Our housing gross margin improved to positive 6.5% in 2009 from negative 7.1% in 2008. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, was 15.5% in 2009 and 10.6% in 2008. The year-over-year improvement in our housing gross margin reflects the impact of our delivering more of our value-engineered, affordable new product, such as The Open Series, reducing direct construction costs and increasing operating efficiencies, consistent with the principles of our KBnxt operational business model. Our margins were also favorably impacted by inventory-related charges incurred in prior periods.

 

In 2008, the homebuilding operating loss was $860.6 million compared to $1.36 billion in 2007. The operating loss in 2008 represented negative 28.5% of homebuilding revenues. In 2007, the operating loss as a percentage of homebuilding revenues was negative 21.2%. The 2008 operating loss resulted from a decrease in our housing gross margin, which fell to negative 7.1% from negative 5.7% in 2007. Our housing gross margin in 2008 was adversely impacted by pretax, noncash charges for inventory impairments and land option contract abandonments, lower average selling prices and our implementation of targeted price reductions and sales incentives in response to competitive conditions or to facilitate strategic exits from certain projects or products. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, would have been 10.6% in 2008 and 13.3% in 2007.

 

In 2009, our land sales generated losses of $47.9 million, including impairment charges of $10.5 million relating to future land sales. Our land sales generated losses of $82.8 million in 2008 and $74.3 million in 2007, including impairment charges relating to future land sales of $86.2 million in 2008 and $74.8 million in 2007.

 

We evaluate our land and housing inventory for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”), whenever indicators of potential impairment exist. Based on our evaluations, we recognized pretax, noncash charges for inventory impairments of $120.8 million in 2009, $565.9 million in 2008 and $1.11 billion in 2007.

 

The inventory impairment charges in all three years reflected declining asset values due to difficult economic and housing market conditions. Further deterioration in housing market supply and demand factors, whether due to rising foreclosures, heightened competition, poor economic or employment conditions, tightened mortgage lending standards or restricted credit availability, may lead to additional impairment charges or cause us to reevaluate our strategy concerning certain assets that could result in future charges associated with land sales or the abandonment of land option contracts.

 

When we decide not to exercise certain land option contracts due to market conditions and/or changes in our market strategy, we write off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. We recognized abandonment charges associated with land option contracts of $47.3 million in 2009, $40.9 million in 2008 and $144.0 million in 2007. Inventory impairment and land option contract abandonment charges are included in construction and land costs in our consolidated statements of operations.

 

Selling, general and administrative expenses totaled $303.0 million in 2009, down from $501.0 million in 2008, which had decreased from $824.6 million in 2007. The year-over-year decrease in each period was driven by actions we have taken to streamline our organizational structure by consolidating certain homebuilding operations, strategically exiting or winding down activity in certain markets, and reducing our workforce to adjust the size of our operations to the significantly reduced home sales activity we have experienced during the present housing market downturn. Most of the cost reductions in 2009 were related to lower salary and other payroll-related expenses stemming from a 24% decrease in our personnel count from 2008. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses increased slightly to 17.2% in 2009 from 17.0% in 2008, which had increased from 13.3% in 2007. The percentages increased in 2009 and 2008 because our expense reductions have been outpaced by the significant year-over-year declines in our housing revenues and the costs incurred to implement these reductions.

 

Goodwill Impairment.  We recorded goodwill in connection with various acquisitions in prior years. Goodwill represented the excess of the purchase price over the fair value of net assets acquired. We tested goodwill for potential impairment annually as of November 30 and between annual tests if an event occurred or circumstances changed that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During 2008 and 2007, we

determined that it was necessary to evaluate goodwill for impairment between annual tests due to deteriorating conditions in certain housing markets and the significant inventory impairments we identified and recognized in those years.

 

Based on the results of our impairment evaluation performed in the second quarter of 2008, we recorded an impairment charge of $24.6 million in that quarter related to our Central reporting segment, where we determined all of the goodwill previously recorded was impaired. The annual goodwill impairment test we performed as of November 30, 2008 resulted in an impairment charge of $43.4 million in the fourth quarter of 2008 related to our Southeast reporting segment, where we determined all of the goodwill previously recorded was impaired. Based on the results of our impairment evaluation performed in the third quarter of 2007, we recorded an impairment charge of $107.9 million in that quarter related to our Southwest reporting segment, where we determined all of the goodwill previously recorded was impaired. The annual goodwill impairment test we performed as of November 30, 2007 indicated no additional impairment. The goodwill impairment charges in 2008 and 2007 were recorded at our corporate level because all goodwill was carried at that level. As a result of those impairment charges, we had no remaining goodwill at November 30, 2008 or November 30, 2009.

 

Interest Income.  Interest income, which is generated from short-term investments and mortgages receivable, totaled $7.5 million in 2009, $34.6 million in 2008 and $28.6 million in 2007. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of short-term investments and mortgages receivable, as well as fluctuations in interest rates. Mortgages receivable are primarily related to land sales. The year-over-year decrease in interest income in 2009 compared to 2008 reflected a decrease in the average balance of cash and cash equivalents we maintained and lower interest rates.

 

Loss on Early Redemption/Interest Expense, Net of Amounts Capitalized.  In 2009, our loss on early redemption of debt totaled $1.0 million. This amount represented a $3.7 million loss associated with our early redemption, in August, of $250.0 million in aggregate principal amount of our $350.0 million of 63/8% senior notes due 2011 (the “$350 Million Senior Notes”), partly offset by a gain of $2.7 million associated with our early extinguishment of mortgages and land contracts due to land sellers and other loans. In 2008, our loss on early redemption of debt of $10.4 million was comprised of $7.1 million associated with our redemption of $300.0 million of our 73/4% senior subordinated notes due 2010 (the “$300 Million Senior Subordinated Notes”) and $3.3 million associated with an amendment of the Credit Facility, which reduced our aggregate commitment under the Credit Facility. In 2007, our loss on early redemption of debt of $13.0 million was associated with the redemption of $250.0 million of our 91/2% senior subordinated notes due in 2011 (the “$250 Million Senior Subordinated Notes”), and the repayment of an unsecured $400.0 million term loan due 2011 (the “$400 Million Term Loan”).

 

Interest expense results principally from borrowings to finance land purchases, housing inventory and other operating and capital needs. Our interest expense, net of amounts capitalized, totaled $50.8 million in 2009 and $2.6 million in 2008. In 2007, all of our interest was capitalized and, consequently, we had no interest expense, net of amounts capitalized. The percentage of interest capitalized was 57% in 2009 and 98% in 2008. These percentages decreased from the corresponding year-earlier periods because, beginning in the fourth quarter of 2008, the amount of inventory qualifying for interest capitalization was below our debt level, reflecting the inventory reduction strategy we have implemented over the past several quarters, and our suspending land development in certain communities. Gross interest incurred during 2009 decreased by $36.8 million to $119.6 million, from $156.4 million in 2008 due to our overall lower debt levels in 2009. Gross interest incurred during 2008 decreased by $43.2 million from $199.6 million incurred in 2007, reflecting comparatively lower debt levels in 2008.

 

Equity in Loss of Unconsolidated Joint Ventures.  Our unconsolidated joint ventures operate in various markets, typically where our consolidated homebuilding operations are located. These unconsolidated joint ventures posted combined revenues of $60.8 million in 2009, $112.8 million in 2008 and $662.7 million in 2007. The year-over-year decrease in unconsolidated joint venture revenues in 2009 was primarily due to a decline in the number of unconsolidated joint ventures that delivered homes. The year-over-year decrease in unconsolidated joint venture revenues in 2008 primarily reflected fewer land sales by the unconsolidated joint ventures than in 2007. Activities performed by our unconsolidated joint ventures generally include buying, developing and selling land, and, in some cases, constructing and delivering homes. Our unconsolidated joint ventures delivered 141 homes in 2009, 262 homes in 2008 and 127 homes in 2007. Our unconsolidated joint ventures generated combined losses of $102.9 million in 2009, $383.6 million in 2008 and $51.6 million in 2007. Our equity in loss of unconsolidated joint ventures of $49.6 million in 2009 included charges of

$38.5 million to recognize the impairment of certain unconsolidated joint ventures primarily in our West Coast, Southwest and Southeast reporting segments. In 2008 and 2007, our equity in loss of unconsolidated joint ventures of $152.8 million and $151.9, respectively, included similar charges of $141.9 million and $156.4 million, respectively, also mainly related to our West Coast, Southwest and Southeast reporting segments.

 

Non-GAAP Financial Measures

 

This report contains information about our housing gross margin, excluding inventory impairment and land option contract abandonment charges, and our ratio of net debt to total capital, both of which are not calculated in accordance with generally accepted accounting principles (“GAAP”). We believe these non-GAAP financial measures are relevant and useful to investors in understanding our operations and the leverage employed in our operations, and may be helpful in comparing us with other companies in the homebuilding industry to the extent they provide similar information. However, because the housing gross margin, excluding inventory impairment and land option contract abandonment charges, and the ratio of net debt to total capital are not calculated in accordance with GAAP, these measures may not be completely comparable to other companies in the homebuilding industry and thus, should not be considered in isolation or as an alternative to operating performance measures prescribed by GAAP. Rather, these non-GAAP financial measures should be used to supplement their respective most directly comparable GAAP measures in order to provide a greater understanding of the factors and trends affecting our operations.

 

Housing Gross Margin, Excluding Inventory Impairment and Land Option Contract Abandonment Charges.  The following table reconciles our housing gross margin to our housing gross margin, excluding inventory impairment and land option contract abandonment charges (dollars in thousands):