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, 2010

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 þ   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, 2010 was $1,274,932,694, including 11,174,633 shares held by the registrant’s grantor stock ownership trust and excluding 27,095,467 shares held in treasury.

 

There were 76,973,096 shares of the registrant’s common stock, par value $1.00 per share, outstanding on December 31, 2010. The registrant’s grantor stock ownership trust held an additional 11,080,023 shares of the registrant’s common stock on that date.

 

Documents Incorporated by Reference

 

Portions of the registrant’s definitive Proxy Statement for the 2011 Annual Meeting of Stockholders (incorporated into Part III).

 

 

 

KB HOME

FORM 10-K

FOR THE YEAR ENDED NOVEMBER 30, 2010

 

TABLE OF CONTENTS

 

 

PART I

 

Item 1. BUSINESS

 

General

 

KB Home is one of the nation’s largest homebuilders and has been building homes 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 public company, operating primarily in California and France. In 2001, we changed our name to KB Home. Today, having sold our French operations in 2007, 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, move-up and active adult homebuyers, 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 7,346 homes at an average selling price of $214,500 during the year ended November 30, 2010, compared to 8,488 homes delivered at an average selling price of $207,100 during the year ended November 30, 2009. Our homebuilding operations represent most of our business, accounting for 99.5% of our total revenues in 2010 and 2009.

 

Our financial services operations offer title and insurance services to our homebuyers. They also offer mortgage banking services to our homebuyers through KBA Mortgage, LLC (“KBA Mortgage”), a joint venture with a subsidiary of Bank of America, N.A. Our financial services operations accounted for .5% of our total revenues in 2010 and 2009.

 

In 2010, we generated total revenues of $1.59 billion and a net loss of $69.4 million, compared to total revenues of $1.82 billion and a net loss of $101.8 million in 2009. Our financial results for 2010 and 2009 reflect challenging operating conditions that have persisted in the homebuilding industry to varying degrees since a general housing market downturn began in mid-2006, as well as our strategic actions since the downturn began to align our operations with these conditions and to maintain a strong financial position.

 

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 geographic reach of our homebuilding business, as of the date of this report, our principal operations are in the nine states and 30 major markets presented 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 certain operating information for our homebuilding reporting segments for the years ended November 30, 2010, 2009 and 2008:

 

 

 

 

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 102 homes in 2010, 141 homes in 2009 and 262 homes in 2008.

 

Strategy

 

To varying degrees since mid-2006, many housing markets across the United States, including those we serve, have experienced a prolonged downturn compared to the period from 2000 through 2005 due to a persistent oversupply of homes available for sale and weak consumer demand for housing. Since 2008, a generally poor economic and employment environment as well as turbulence in financial and credit markets have worsened these conditions. Although housing affordability has been at historically high levels in the past few years due to lower selling prices and relatively low residential consumer mortgage interest rates, the negative supply and demand dynamics for the homebuilding industry during the present housing downturn have severely constrained our net orders, revenues and profitability.

 

We believe housing markets will likely remain weak in 2011 and that our business and the homebuilding industry will experience uneven results before a sustained recovery takes hold. At this time, we cannot predict when such a recovery might occur. Based on this view, we intend to continue to focus on achieving three primary integrated strategic goals:

 

 

In pursuing these goals during the period from mid-2006 through 2009, we reduced our overhead, inventory and active community count levels to better align our operations with diminished home sales activity compared to the peak levels reached in the period from 2000 through 2005. Consequently, we exited or reduced our investments in certain markets, sold land positions and interests, unwound our participation in certain unconsolidated joint ventures, and experienced a sharp decline in our backlog and homes delivered compared to our peak period performance primarily due to decreased demand and because we had fewer community locations from which we sold homes. During this period, we also focused on improving our operating efficiencies, investing selectively in a few markets with perceived strong growth prospects, and, as discussed further below, redesigning and re-engineering our product line to meet consumer demand for more affordable homes and to lower our direct construction costs and generate higher margins compared to our previous product.

 

In 2010, building on the sound financial position and the operational re-positioning we achieved over the prior four years and seeing a number of attractive opportunities becoming available, we implemented a targeted land acquisition initiative to further our primary strategic goals. Under this initiative, we concentrated on acquiring ownership or control of well-priced developed land parcels that met our investment and marketing standards and were located within or near our existing markets. This tactical shift was designed to help us restore and maintain our homebuilding operations’ profitability — currently, our highest priority — by increasing our future revenues through a larger inventory base from which we can sell our higher-margin and well-received new product. It was also designed to help us maintain a three-to-four year supply of developed or developable land. While the inventory and active community count reductions and other land portfolio and operational adjustments we made in prior years and into 2010 have had a negative effect on our backlog and homes delivered on a year-over-year basis, we anticipate that our land investment activities in 2010 and recent and planned new community openings will improve such comparisons in 2011. As a result, we believe that our land acquisition initiative and the other actions we have taken in pursuing our primary strategic goals in the present housing downturn have established a solid foundation for us to eventually achieve long-term future growth and profitability as and to the extent housing markets improve.

 

While market conditions in 2011 will determine the degree to which we acquire or dispose of land assets in managing our inventory, the pace with which we open new home communities, and the manner in which we pursue and refine the execution of our primary integrated strategic goals, we will continue to operate in accordance with 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. We believe our KBnxt operational business model sets us apart from other homebuilders. The key principles of our KBnxt operational business model include:

 

 

Through its disciplines and standards, 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 near our existing operations; exit investments that no longer meet our return or marketing standards; 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 home design and product options to customers.

 

Our expansion into a new market and our withdrawal from an existing market or submarket depends in each instance on our assessment of the market’s viability and our ability to develop and/or sustain operations at a level that meets our investment standards. Similar considerations apply to potential asset acquisitions or dispositions in our existing markets.

 

Operational Objectives.  Guided by the disciplines of our KBnxt operational business model, our principal operational objectives during the present housing downturn include:

 

 

 

Exemplifying how we have implemented our strategic and operational objectives is our 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 construction cycle times, while adhering to our quality standards and using materials and construction techniques that reflect our commitment to more environmentally conscious homebuilding methods. 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 generally employing construction techniques that minimize costs and maximize efficiencies. It also includes working continuously with our trade partners and materials suppliers to reduce direct construction costs and construction cycle times. 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.  During 2010, we continued to focus our marketing efforts on first-time, move-up and active adult homebuyers. These homebuyers historically have been our core customers and it is among these groups that we see the greatest potential for future home sales. Our marketing efforts are directed at differentiating the KB Home brand from resale homes and from homes sold through foreclosures, short sales and by other homebuilders. 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 design, layout, square footage and homesite location, and to personalize their home 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, which are generally located close to our communities, 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.

 

My Home. My Earth.^TM  We have made a dedicated effort to further differentiate ourselves from other homebuilders and sellers of existing homes through our ongoing commitment to become a leading national company in environmental sustainability. This commitment, organized under our My Home. My Earth. initiative, stems from growing sensitivities regarding and regulatory attention to the potential impact the construction and use of our homes can have on the environment, including on global average temperatures and associated climate change, and from our homebuyers’ interest in reducing this impact in the most cost-effective way possible. This commitment also stems from our primary strategic goal to maintain a strong balance sheet by minimizing expenses, waste and inefficiencies in our operations. Through our My Home. My Earth. programs:

 

 

 

In many instances, we have been able to implement our My Home. My Earth. programs at minimal or no additional cost to us and to our homebuyers. Along with the standard home designs and amenities we offer pursuant to our My Home. My Earth. programs, we also offer our homebuyers several options through our KB Home Studios that can help them to further lower their consumption of energy and water resources and reduce their utility bills. As we see environmental issues related to housing becoming increasingly important to consumers and government authorities at all levels, we intend to continue to research, evaluate and utilize new or improved products and construction and business practices consistent with the goals of our My Home. My Earth. programs. In addition to making good business sense, we believe our My Home. My Earth. programs can help put us in a better position, compared to homebuilders with less-developed programs, to comply with evolving local, state and federal rules and regulations intended to protect natural resources and to address climate change and similar environmental concerns.

 

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 standards and our homebuyers’ expectations. 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 also have employees who are responsible for responding to homebuyers’ post-closing needs, including warranty claims.

 

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 and implementing 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 duration 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 13,000 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 investment and marketing standards, balancing competing needs for financial strength and land inventory for future growth. When we acquire land, we focus on land parcels containing fewer than 250 lots that are fully entitled for residential construction and are 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. We believe 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 and available opportunities, 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 and other research activities. Local, in-house land acquisition specialists conduct site selection analysis in targeted geographic areas to identify desirable land acquisition targets or to evaluate whether to dispose of an existing interest. We also use studies performed by third-party marketing specialists. Some of the factors we consider in evaluating land acquisition targets and assessing the viability of 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, household formation and commercial growth patterns; estimated costs of completing land development; and environmental compliance 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 analyses 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 and development 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 abandon the land option contract and 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 and marketing standards. Our option and other purchase agreements may also allow us to phase our land purchases and/or land 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.

 

Before we commit to any land purchase or dispose of any interest in land, our senior corporate and regional management evaluates each asset based on the results of our local specialists’ due diligence and a set of defined financial measures, including, but not limited to, gross margin analyses and specific discounted, after-tax cash flow internal rate of return requirements. The 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. We determined that these properties no longer met our investment or marketing standards. Although we shifted our strategic focus in 2010 to acquiring land assets in order to open more new home communities and increase our revenues, as discussed above under “Strategy,” 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 or other agreements to acquire land.

 

The following table presents the number of inventory lots we owned, in various stages of development, or controlled under land option contracts or other agreements in our homebuilding segments as of November 30, 2010 and 2009. The table does not include approximately 316 acres owned and 64 acres optioned as of November 30, 2010 and approximately 316 acres owned as of November 30, 2009 that had not yet been approved for subdivision into lots.

 

 

Reflecting our geographic diversity and relatively balanced operational footprint, as of November 30, 2010, 24% of the inventory lots we owned or controlled were located in the West Coast reporting segment, 23% were in the Southwest reporting segment, 28% were in the Central reporting segment and 25% 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 land option contracts or other agreements in our homebuilding segments as of November 30, 2010 and 2009 (in thousands):

 

 

Home Construction and Sale.  Following the purchase of land and, if necessary, the finishing of lots, 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 a signed purchase contract with a homebuyer. However, cancellations of home purchase contracts prior to the delivery of the underlying homes, or specific strategic considerations, may cause us to have standing inventory of completed or partially completed homes. During the present housing downturn, we have experienced more volatility in our cancellation rates than in the years immediately before the downturn began. In 2010, we built unsold homes in some communities to help increase sales before the expiration of a federal homebuyer tax credit in April. As a result, at times during the year we had slightly more standing inventory than we have had historically. Market conditions and strategic considerations will determine our standing inventory levels in 2011.

 

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. We have 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. 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.

 

Backlog

 

We sell our homes under standard purchase contracts, which generally require a homebuyer 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 our 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. Since 2008, tightened residential consumer mortgage lending standards have led to higher cancellation rates than those experienced before then, and we expect these standards to continue to have a negative impact on our cancellation rates in 2011.

 

“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, 2010, excluding backlog of unconsolidated joint ventures, consisted of 1,336 homes, a decrease of 37% from the 2,126 homes in backlog at November 30, 2009. The decrease in our backlog levels in 2010 primarily reflected our strategic decisions in the mid-2006 through 2009 time period to reduce our inventory and active community counts to align our operations with diminished housing market activity and overall lower net orders. Our backlog at November 30, 2010 represented potential future housing revenues of approximately $263.8 million, a 38% decrease from potential future housing revenues of $422.5 million at November 30, 2009, resulting primarily from the lower number of homes in backlog. Our backlog ratio, defined as homes delivered in the quarter as a percentage of backlog at the beginning of the quarter, was 88% for the quarter ended November 30, 2010 and 82% for the quarter ended November 30, 2009.

 

Our net orders totaled 6,556 in 2010, a decrease of 21% from 8,341 net orders in 2009. Our average cancellation rate based on gross orders was 28% in 2010, compared to an average of 25% in 2009. During the fourth quarter of 2010, our net orders declined 25% from the corresponding quarter of 2009, primarily due to a 24% decrease in our overall average active community count, generally weak economic and housing market conditions, and tightened residential consumer mortgage lending standards. As a percentage of gross orders, our cancellation rate was 37% in the fourth quarter of 2010, compared to 31% in the fourth quarter of 2009.

The following tables present homes delivered, net orders and cancellation rates (based on gross orders) by homebuilding reporting segment and with respect to our unconsolidated joint ventures for each quarter during the years ended November 30, 2010 and 2009, 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. As discussed above, however, depending on market conditions we may continue to acquire land assets in 2011 or we may sell certain land or land interests. In 2010, our land sales generated $6.3 million of revenues and $.3 million of losses, including $.3 million of impairments. In 2009, our land sales generated $58.3 million of revenues and $47.9 million of losses, including $10.5 million of impairments. Our land option contract abandonments resulted in pretax, noncash charges of $10.1 million in 2010 and $47.3 million in 2009.

 

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 and/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 lending institution of their choice. KBA 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 KBA Mortgage to offer customers a variety of financing options on competitive terms as a part of the on-site sales process helps to complete sales. KBA Mortgage originated loans for 82% of our customers who obtained mortgage financing in 2010 and 84% in 2009.

 

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, 2010, we had approximately 1,300 full-time employees, compared to approximately 1,400 at December 31, 2009. 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 homebuilding industry and housing market are 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 2010, operating conditions in most U.S. housing markets remained difficult, reflecting the impact of the housing downturn and the weak economy as discussed above under “Strategy.” We believe the heightened competition for homebuyers stemming from these conditions will continue in 2011, 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 an unsecured revolving credit facility with various financial institutions (the “Credit Facility”). In 2010, however, anticipating that we would not need to borrow any funds under the Credit Facility before its scheduled maturity in November 2010, we voluntarily terminated the Credit Facility effective March 31, 2010 to eliminate the costs of maintaining it.

 

Environmental Compliance 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 efforts, 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 or controlled 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 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) that 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, (ii) that we post on or make available through our website, and (iii) 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.

 

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 mid-2006. As a result, since mid-2006, compared to the period from 2000 through 2005, we and other homebuilders have generally experienced fewer home sales and greater volatility in the cancellations of home purchase contracts by homebuyers, and faced higher inventories of unsold homes and the increased use of discounts, incentives, price concessions and other marketing efforts by sellers of new and existing homes to close sales, putting downward pressure on home selling prices, revenues and profitability. These negative supply and demand trends have been exacerbated since 2008 by a number of factors, including (a) a severe and persistent downturn in general economic and employment conditions that, among other things, has further tempered consumer demand and confidence for buying homes; (b) increasing residential consumer mortgage loan foreclosure and short sales activity and sales of lender-owned homes; (c) volatility and uncertainty in credit and consumer lending markets, including from voluntary and involuntary delays by financial institutions in finalizing residential consumer mortgage loan foreclosures and increasing demands from investors for lenders, residential consumer mortgage loan brokers and other institutions, or their agents, to repurchase the residential consumer mortgage loans or securities backed by residential consumer mortgage loans that they originated, issued or administer; (d) generally tighter lending standards for residential consumer mortgage loans; and (e) the termination, expiration or scaling back of homebuyer tax credits and other government programs supportive of home sales. It is uncertain when, and to what extent, these housing industry trends and factors might reverse or improve.

 

Reflecting this difficult operating environment, we, like many other homebuilders, have experienced to varying degrees since the housing downturn began, declines in net orders, decreases in the average selling price of new homes we have sold and delivered and reduced revenues and margins relative to the period from 2000 through 2005, and we have generated operating losses. Though we improved our operating margins and narrowed our net loss in 2010 compared to 2009, and housing affordability is currently at historically high levels overall, we can provide no assurances that the homebuilding industry or our business will improve substantially or at all in 2011. If economic conditions, employment, personal income growth and consumer confidence remain weak and residential consumer mortgage loan foreclosures, delinquencies and short sales continue rising in future periods, 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 we deliver, the amount of revenues we generate and our ability to achieve or maintain profitability.

 

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

 

Since 2008, the residential consumer mortgage lending and mortgage finance industries have experienced significant instability due to, among other things, relatively high rates of delinquencies, defaults and foreclosures on residential consumer mortgage loans and a resulting decline in their market value and the market value of securities backed by such loans. The delinquencies, defaults and foreclosures have been driven in part by persistent poor economic and employment conditions, which have negatively affected borrowers’ incomes, and by a decline in the values of many existing homes in various markets below the principal balance of the residential consumer mortgage loans secured by such homes. A number of providers, purchasers and insurers of residential consumer mortgage loans and residential consumer mortgage-backed securities have gone out of business or exited the market, and lenders, investors, regulators and others have questioned the oversight and the adequacy of lending standards for several residential consumer mortgage loan programs made available to borrowers in recent years, including programs offered or supported by the Federal Housing Administration (“FHA”), the Veterans Administration (“VA”) and the federal government sponsored enterprises, the Federal National Mortgage Association (also known as “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”). Compared to prior periods, this has led to reduced investor demand for residential consumer mortgage loans and residential consumer mortgage-backed securities, tightened credit requirements, reduced liquidity and availability of residential consumer mortgage loan products (particularly subprime and nonconforming loans), and increased down payment requirements and credit risk premiums related to home purchases. It has also led to enhanced regulatory and legislative actions, and government programs focused on modifying the principal balances, interest rates and/or payment terms of existing residential consumer mortgage loans and preventing residential consumer mortgage loan foreclosures, which have achieved somewhat mixed results.

 

The reduction in the availability of residential consumer mortgage loan products and providers and tighter residential consumer mortgage loan qualifications and down payment requirements have made 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. Overall, these factors have slowed any general improvement in the housing market, and they have resulted in volatile home purchase cancellation rates and reduced demand for our homes and for residential consumer mortgage loans originated through our KBA Mortgage joint venture. These reductions in demand have had a materially adverse effect on our business and results of operations in 2010 that is expected to continue in 2011.

 

Potentially exacerbating the foregoing trends, in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law and established several new standards and requirements (including risk retention obligations) relating to the origination, securitizing and servicing of, and consumer disclosures for, residential consumer mortgage loans. These new standards and requirements are expected to further reduce the availability of and/or increase the costs to borrowers to obtain such loans. Federal regulators and legislators are also discussing steps that may significantly reduce the ability or authority of the FHA, Fannie Mae and Freddie Mac to purchase or insure residential consumer mortgage loans. In the last few years, the FHA, Fannie Mae and Freddie Mac have purchased or insured substantially all new residential consumer mortgage loans originated by lenders, including KBA Mortgage. Also in 2010, and as noted above, investors in residential consumer mortgage-backed securities, as well as Fannie Mae and Freddie Mac, increasingly demanded that lenders, brokers and other institutions, or their agents, repurchase the loans underlying the securities based on alleged breaches of underwriting standards or of representations and warranties made in connection with transferring the loans. These “put-back” demands are expected to continue into 2011 and, to the extent successful, could cause lenders and brokers to further curtail their residential consumer mortgage loan origination activities due to reduced liquidity. Concerns about the soundness of the residential consumer mortgage lending and mortgage finance industries have also been heightened recently due to allegedly widespread errors by lenders or brokers, or their agents, in the processing of residential consumer mortgage loan foreclosures and sales of foreclosed homes, leading to voluntary or involuntary delays and higher costs to finalize foreclosures and foreclosed home sales, and greater court and regulatory scrutiny. In addition to having a potential negative impact on the origination of new residential consumer mortgage loans, these disruptions in residential consumer mortgage loan foreclosures and lender-owned home sales may make it more difficult for us to accurately assess the supply of and prevailing prices for unsold homes and/or the overall stability of particular housing markets.

 

Many of our homebuyers obtain financing for their home purchases from our KBA Mortgage joint venture. Our partner, a Bank of America, N.A. subsidiary, provides the loan products that the joint venture offers to our homebuyers. If, due to higher costs, reduced liquidity, heightened risk retention obligations and/or new operating restrictions or regulatory reforms related to or arising from compliance with the Dodd-Frank Act, residential consumer mortgage loan put-back demands or internal or external reviews of its residential consumer mortgage loan foreclosure processes, or other factors or business decisions, our partner refuses or is unable to make loan products available to the joint venture to provide to our homebuyers, our home sales and our homebuilding and financial services results of operations may be adversely affected. For instance, in the fourth quarter of 2010, stricter lending standards led to an increase in our cancellation rate compared to the fourth quarter of 2009. The degree to which this more cautious approach to providing loans to our homebuyers continues into 2011 is unclear, and we can provide no assurance that the trend of tighter residential consumer mortgage lending standards will slow or reverse in the foreseeable future.

 

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 since the housing downturn began, we have done so at reduced gross profit levels and, until 2010, have incurred significant asset impairment charges compared to the period from 2000 through 2005. Moreover, many of our strategic initiatives during the housing downturn to generate cash and improve our operating efficiency have involved lowering overhead through workforce reductions, for which we incurred significant costs, and reducing our active community count through strategic wind downs, reduced investments 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 periods before the housing downturn began, and have contributed to the net losses we have recognized in recent years.

 

In an effort to generate higher revenues and restore and maintain our homebuilding operations’ profitability, beginning in late 2008 and continuing through 2010, we rolled out new, more flexible product designs, including The

Open Series, and we continued to take steps to reduce our selling, general and administrative expenses, and to redeploy our capital into housing markets with perceived higher future growth prospects.

 

These integrated strategic steps helped us narrow our net losses and improve our operating margins in each quarter of 2010 compared to the corresponding year-earlier periods. However, there can be no assurance that these trends will continue in 2011 or at all, that we will successfully increase our average active community count and inventory base with desirable land assets at a reasonable cost, or that we will achieve or maintain profitability in the near future. In addition, notwithstanding our sales strategies, we have experienced volatility in our net orders and in cancellations of home purchase contracts by buyers throughout the present housing downturn, including in 2010. We believe that our volatile net order and cancellation levels have largely reflected weak homebuyer confidence due to sustained home sales price declines, increased offerings of sales incentives in the marketplace for both new and existing homes, tightened residential consumer mortgage lending standards, and generally poor economic and employment conditions, all of which have prompted homebuyers to forgo or delay home purchases. Additional volatility arose in 2010 with the April 30 expiration of the federal homebuyer tax credit, which likely pulled demand forward to the first two quarters of the year and led to a drop in net orders and customer traffic in the periods that followed. The relatively tight consumer mortgage lending environment and the inability of some homebuyers to sell their existing homes have also led to lower demand for new homes and to volatility in home purchase contract cancellations for us and the homebuilding industry. Many of these factors affecting our net orders and cancellation rates, and the related market dynamics that put downward pressure on our average selling prices, are beyond our control. It is uncertain how long and to what degree these factors, and the volatility in net orders and home purchase contract cancellations we have experienced, will continue. To the extent that they do, and to the extent that they depress our average selling prices, 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 results of operations 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 present housing downturn to

continue into 2011. Continued weakness in the economy, employment levels and consumer confidence would likely exacerbate the unfavorable trends the housing market has experienced since mid-2006.

 

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. Inclement weather, natural disasters, such as earthquakes, hurricanes, tornadoes, floods, droughts, fires and other environmental conditions, and labor shortages or disruptions among key trades, such as carpenters, roofers, electricians and plumbers, can delay the delivery of our homes and/or increase our costs. Civil unrest or acts of terrorism can also have a negative effect on our business.

 

The potential difficulties described above can cause demand and prices for our homes to fall 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 could also lead some homebuyers to cancel or refuse to honor their home purchase contracts altogether. Reflecting the difficult conditions in our served markets and the impact of the termination, expiration or scaling back of homebuyer tax credits and other government programs supportive of home sales, we have experienced volatility in our net orders and in home purchase contract cancellations in recent years, and we may experience similar or increased volatility in 2011.

 

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 homebuyers 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 to competition for materials and skilled labor and higher commodity prices (including prices for lumber, metals and other building material inputs), among other things, may, over time, decrease our margins.

 

Changes in global or regional environmental conditions and governmental actions in response to such changes may adversely affect us by increasing the costs of or restricting our planned or future residential development activities.

 

There is growing concern from the scientific community and the general public that an increase in global average temperatures due to emissions of greenhouse gases and other human activities will cause significant changes in weather patterns and increase the frequency and severity of natural disasters. An increased frequency or duration of extreme weather conditions and environmental events could limit, delay and/or increase the costs to build new homes and reduce the value of our land and housing inventory in locations that become less desirable to consumers or blocked to development. Projected climate change, if it occurs, may exacerbate the scarcity of water and other natural resources in affected regions, which could limit, prevent or increase the costs of residential development in certain areas. In addition, government mandates, standards and/or regulations intended to mitigate or reduce greenhouse gas emissions and/or projected climate change impacts could result in increased energy, transportation and raw material costs that make building materials less available or more expensive, or cause us to incur compliance expenses and other financial obligations to meet permitting or development- or construction-related requirements that we will be unable to fully recover (due to market conditions or other factors), and reduce our margins. As a result, climate change impacts, and laws and construction standards, and/or the manner in which they are interpreted or implemented, to address potential climate change impacts, could increase our costs and have a long-term adverse impact on our business and results of operations. This is a particular concern with respect to our West Coast reporting segment as California has instituted some of the most extensive and stringent environmental laws and residential building construction standards in the country.

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 results of operations because increasing costs for land, building materials and skilled labor may raise a need for us to increase home selling prices to maintain satisfactory margins. In 2010, worldwide demand for certain commodities and monetary policy actions have led to price increases for raw materials that are used in construction, including lumber and metals. These pricing trends are expected to continue into 2011 and, in combination with Federal Reserve policies and programs designed to boost economic growth, may lead to a general increase in inflation. However, if the current challenging and highly competitive conditions in the housing market persist, we may not be able to increase, and may need to decrease, our home selling prices to help stimulate sales. If determined necessary, our lowering of home selling prices, in addition to impacting our margins, may also reduce the value of our land inventory, including the assets we purchased in 2010 pursuant to our strategic land acquisition initiative, and make it more difficult for us to recover the full cost of previously purchased land with home selling prices or, if we choose, in disposing of land assets. In addition, depressed land values may cause us to abandon and forfeit deposits on land option contracts if we cannot satisfactorily renegotiate the purchase price of the optioned land. We may incur noncash charges against our earnings 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, and these charges may be substantial as has occurred in certain periods during the present housing downturn.

 

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 a land parcel’s stage of development when acquired, 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. In addition, local municipalities may impose requirements resulting in additional costs. If the rate at which we sell and deliver homes slows or falls, which has occurred throughout the present housing downturn, we may incur additional costs and it will take a longer period of time for us to recover our costs, including the costs we incurred in 2010 to purchase assets pursuant to our strategic land acquisition initiative. Furthermore, due to market conditions during the current housing downturn, we have abandoned some options to purchase land, 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 profitability may decrease.

 

The value of the inventory we currently own or control depends on market conditions, including estimates of future demand for, and the revenues that can be generated from, this inventory. The market value of our 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 housing downturn, which has generally 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. Through our periodic 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 record corresponding noncash charges against our earnings to reflect the impaired value. We have also taken noncash charges in connection with abandoning our interests in certain optioned inventory that no longer meets our investment or marketing standards. Although the magnitude of such noncash charges diminished significantly in 2010 compared to prior periods, if the current housing downturn 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 results of operations, including our ability to achieve or maintain profitability.

 

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 homebuyer, but not yet delivered the home. Our home purchase contracts typically require only a small deposit, and in some circumstances, the deposit is refundable prior to closing. If the prices for new homes decline, competitors increase their use of sales incentives, interest rates increase, the availability of residential consumer mortgage financing diminishes or there is continued weakness or a further downturn in local or regional economies or the national economy and in consumer confidence, customers may terminate their existing home purchase contracts with us because they have been unable to

finalize their mortgage financing for the purchase, or in order to attempt to negotiate for a lower price, explore other options or for other reasons they are unable or unwilling to complete the purchase. In recent years, we have experienced volatile home purchase contract cancellations, in part because of these reasons and, as discussed above, in part due to the April 30, 2010 expiration of the federal homebuyer tax credit. To the extent they continue, volatile home purchase contract cancellations 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 finished lots and undeveloped land that meet our land investment criteria.

 

The availability of finished and partially finished lots and undeveloped land assets that meet our investment and marketing standards depends on a number of factors outside of our control, including land availability in general, climate conditions, competition with other homebuilders and land buyers for desirable property, credit market conditions, legal or government agency processes (particularly for land assets that are part of bankruptcy estates or are held by financial institutions taken over by government agencies), inflation in land prices, zoning, allowable housing density, our ability and the costs to obtain building permits, the amount of environmental impact fees, property tax rates 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 sufficient supply of developed or developable land inventory. The availability of suitable land assets will also affect the success of the land acquisition strategy we initiated in 2010, and if we decide to reduce our acquisition of new land due to a lack of available assets that meet our standards, our ability to increase our average community count and revenues and to achieve or maintain profitability would likely be constrained.

 

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 selling prices and sales activity in some of our key served markets have declined from time to time for market-specific reasons, including adverse weather, high levels of foreclosures, and lack of affordability or economic contraction due to, among other things, the failure or decline of key industries and employers. If home selling 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 regulations could lower demand for our homes.

 

Nearly all of our customers finance the purchase of their homes. Before the housing downturn began, historically low interest rates and the increased availability of specialized residential consumer mortgage loan products, including products requiring no or low down payments, and interest-only and adjustable-rate residential consumer mortgage loans, made purchasing a home 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 residential consumer mortgage loan financing or of certain residential consumer mortgage loan products or programs may, as discussed above, lead to fewer residential consumer mortgage loans being provided, higher down payment requirements or borrower costs, or a combination of the foregoing, and, as a result, reduce demand for our homes and increase our home purchase contract cancellation rates.

 

As a result of the volatility and uncertainty in the credit markets and in the residential consumer mortgage lending and mortgage finance industries since 2008, the federal government has taken on a significant role in supporting residential consumer mortgage lending through its conservatorship of Fannie Mae and Freddie Mac, both of which purchase or insure residential consumer mortgage loans and residential consumer mortgage-backed securities, and its insurance of residential consumer mortgage loans through the FHA and the VA. FHA-backing of residential consumer mortgage loans has been particularly important to the residential consumer mortgage finance industry and to our business. In 2010, approximately 62% of our homebuyers (compared to approximately 63% in 2009) that chose to finance with our KBA Mortgage joint venture purchased a home using an FHA-backed loan. The availability and affordability of residential consumer mortgage loans, including interest rates for such loans, could be adversely affected by a scaling back or termination of the federal government’s mortgage-related programs or policies. For example, in October 2010, the FHA instituted higher mortgage insurance premiums to help address its low cash reserves and imposed new minimum credit scores and higher down payment requirements for borrowers with lower credit scores for

the residential consumer mortgage loans it insures. In addition, due to growing federal budget deficits, the U.S. Treasury may not be able to continue supporting the residential consumer mortgage-related activities of Fannie Mae, Freddie Mac, the FHA and the VA at present levels.

 

Because Fannie Mae-, Freddie Mac-, FHA- and VA-backed residential consumer mortgage loan 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 our equity interest in our KBA Mortgage joint venture due to lower levels of residential consumer mortgage loan originations.

 

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

 

Under current tax law and policy, significant expenses of owning a home, including residential consumer mortgage loan interest costs 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. If the federal government or a state government changes income tax laws, as some policy makers and a presidential commission have proposed, by eliminating or substantially reducing these income tax benefits, the after-tax cost of owning a home could increase substantially. This could adversely impact demand for and/or sales prices of new homes, as could increases in personal income tax rates.

 

Moreover, in early 2010, our home sales increased in part because of a federal homebuyer tax credit made available to certain qualifying homebuyers until April 30. The expiration of this homebuyer tax credit adversely affected our net orders, home purchase contract cancellation rates, customer traffic levels and results of operations in subsequent periods of 2010, as weak consumer confidence and unfavorable economic and employment conditions caused many potential homebuyers to delay or forgo the purchase of a home. It is uncertain whether and to what degree the higher demand driven by the federal homebuyer tax credit might return, if at all.

 

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, natural and other resource protection, building designs, construction methods and similar matters. These regulations often provide broad discretion to government authorities that oversee these matters, which can result in unanticipated delays or increases in the cost of a specified development 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 locations in which we operate.

 

In addition, we are 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. As noted above with respect to potential climate change impacts, these laws and regulations, and/or evolving interpretations thereof, and the EPA 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 restrict homebuilding activity in certain regions or areas.

 

Environmental laws may also 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 residential consumer mortgage banking operations of our KBA Mortgage joint venture are heavily regulated and subject to the rules and regulations issued by a number of government and quasi-government 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 verifying prospective borrowers’ incomes and obtaining property inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. As discussed above, the recently enacted Dodd-Frank Act imposed additional standards and obligations with respect to the origination, securitizing and servicing of residential consumer mortgage loans. A finding that KBA Mortgage materially violated any of the foregoing laws and/or the additional costs it may incur in complying with such laws or to address any violations thereof could have an adverse effect on our results of operations to the extent it impacts the income we earn from our equity interest in KBA Mortgage.

 

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 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.

 

The homebuilding industry and housing market 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 assets, financing, building materials, and skilled management talent and trade labor. We compete in each of our served markets with other local, regional and national homebuilders, including within larger subdivisions containing sections designed, planned and developed by such homebuilders. Other homebuilders may also have long-standing relationships with local labor, materials suppliers or land sellers in certain areas, 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, impairing our ability to successfully execute our land acquisition and land asset management strategies, increasing our costs and/or diminishing growth in our local or regional homebuilding businesses. In the present housing downturn, actions taken by our new home and housing alternative competitors are reducing the effectiveness of our efforts to achieve stability in home selling prices, to generate higher home sales, revenues and margins, and to achieve and maintain profitability.

Our ability to attract and retain talent is critical to the success of our business and a failure to do so may materially adversely affect our performance.

 

Our officers and employees are an important resource, and we see attracting and retaining a dedicated and talented team to execute our KBnxt operational business model as crucial to our ability to achieve and maintain an advantage over other homebuilders. We face intense competition for qualified personnel, particularly at senior management levels, from other homebuilders, from other companies in the housing and real estate industries, and from companies in various other industries with respect to certain roles or functions. Moreover, the prolonged housing downturn and the decline in the market value of our common stock during the downturn have made it relatively more difficult for us to attract and retain talent compared to the 2000 to 2005 period. In addition, we currently have a limited number of shares of our common stock available for grant as incentive compensation awards, and an inability to grant equity compensation to the same degree as other companies may adversely affect our talent recruitment and retention efforts. If we are unable to continue to retain and attract qualified employees, our performance and our ability to achieve and maintain a competitive advantage could be materially adversely affected.

 

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 primarily 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 maintain, general liability insurance (including construction defect and bodily injury coverage) and workers’ compensation insurance. These insurance policies protect us against a portion of our risk of loss from claims related to our homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. Through our captive insurance subsidiary, we record expenses and liabilities based on the estimated costs required to cover our self-insured retention and deductible amounts under our insurance policies, and on the estimated costs of potential claims and claim adjustment expenses above our coverage limits or that are not covered by our policies. These estimated costs are based on an analysis of our historical claims and include an estimate of construction defect 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/or become more costly.

 

In 2009, we incurred warranty-related charges associated with the repair of homes primarily delivered in 2006 and 2007 and located in Florida 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 or other locations that contain or may contain this drywall material. Based on the results of our review, we have not identified homes outside of Florida 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 increase our warranty liability in future periods. In addition, we have been named as a defendant in lawsuits 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 we deliver a corresponding significant percentage of our homes in the fall and winter months. Construction of our homes typically requires approximately three to 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 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 the period from 2000 through 2005. Moreover, our normal selling patterns were disrupted to a significant extent in 2010 by the federal homebuyer tax credit that was made

available to qualifying homebuyers until April 30. The increased demand driven by the federal tax homebuyer credit in early 2010 resulted in our delivering more homes in the third quarter of 2010 and experiencing lower net orders and higher home purchase contract cancellations in our third and fourth quarters, in each case compared to a more typical seasonal pattern. With the current difficult market conditions expected to continue into 2011, and the expiration of the federal homebuyer tax credit, we can make no assurances that our historical seasonal patterns will return in the near future if at all.

 

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 indenture governing our outstanding senior notes imposes restrictions on our business operations and activities. Though it does not contain any financial maintenance covenants, the indenture contains certain restrictive covenants that, among other things, limit our ability to incur secured indebtedness, to engage in sale-leaseback transactions involving property or assets above a specified value, and, as in the case of one of our outstanding senior notes, to engage in mergers, consolidations, and sales of assets. If we fail to comply with these restrictions, the holders of our senior notes 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 could cause a default with respect to our other senior notes and result in the acceleration of the maturity of all such defaulted indebtedness.

 

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 (a) cooperate and make mutually acceptable decisions regarding the conduct of the business and affairs of the unconsolidated joint venture and (b) 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.

 

As discussed below under “Part I — Item 3. Legal Proceedings,” we are currently a party to an involuntary bankruptcy case initiated by the lenders to one of these unconsolidated joint ventures, which includes seeking to enforce a guarantee. An unfavorable outcome in this case could have a material adverse effect on our consolidated financial position and results of operations.

 

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 the present housing downturn, 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 recent years, principally through the receipt of federal income tax refunds, and from home and land sales and our efforts to reduce our overhead and operating expenses, 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 by the three principal nationally recognized registered credit rating agencies, as discussed further below. The terms of potential future issuances of indebtedness by us may be more restrictive than the terms governing our current indebtedness, and the issuance, interest and debt service expenses may be higher. 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.

 

We may not realize our deferred income tax assets. In addition, our net operating loss carryforwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

 

Since the end of our 2007 fiscal year, we have generated significant net operating losses (“NOLs”), and we may generate additional NOLs in 2011. 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, and we have recorded a valuation allowance against net deferred tax assets representing the NOLs (and certain related tax credits) that we have generated but have not yet realized. At November 30, 2010, we had net deferred tax assets totaling $772.2 million against which we have provided a valuation allowance of $771.1 million. Our ability to realize our net deferred tax assets is based on the extent to which we generate profits and we cannot provide any assurances as to when and to what extent we will generate future taxable income to realize our net deferred tax assets, whether in whole or in part.

 

In addition, the benefits of our NOLs, built-in losses and tax credits would be reduced or eliminated if we experience an “ownership change,” as determined under Internal Revenue Code Section 382 (“Section 382”). A Section 382 ownership change occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an ownership change 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 complex 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 NOLs and, as a result, have a negative impact on our consolidated financial position and results of operations.

 

In 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.

We have a substantial amount of indebtedness in relation to our tangible net worth, which may restrict our ability to meet our operational and strategic goals.

 

As of November 30, 2010, we had total outstanding debt of approximately $1.78 billion and total stockholders’ equity of approximately $631.9 million. 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 on 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, environmental 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, support our letter of credit facilities (including our cash-collateralized letter of credit facilities with various financial institutions (the “LOC Facilities”)), or to fund our other liquidity or operational needs. Further, if a change of control occurs as defined in the indenture governing our $265.0 million of 9.1% senior notes due 2017 (the “$265 Million Senior Notes”), we would be required to offer to purchase these notes (but not our other outstanding senior notes) at 101% of their principal amount, together with all accrued and unpaid interest, if any. If we are unable to 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 Fitch Ratings is BB-, with a stable outlook, and our credit rating by Moody’s Investor Services is B1, with a negative outlook. On July 16, 2010, Standard and Poor’s Financial Services lowered our credit rating to B+ from BB-, though it upgraded its outlook from negative to stable. Further downgrades of our credit rating by any of these principal nationally recognized registered 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 the availability of external financing. While we terminated the Credit Facility in 2010, we established LOC Facilities in order to support certain aspects of our operations in the ordinary course of our business, including our acquisition of land assets and our development of communities. We anticipate that we will need to maintain these facilities in 2011, and, if necessary or desirable, we may in the future seek to expand their capacity or enter into additional such facilities. It is not possible to predict the future

terms or availability of additional external capital or for maintaining or, if necessary or desirable, expanding the capacity of the LOC Facilities or entering into additional such facilities. Moreover, our outstanding senior notes contain provisions that may restrict the amount and nature of debt we may incur in the future. There can be no assurance that we can actually borrow additional funds, raise additional capital through other means, or successfully maintain or, if necessary or desirable, expand the capacity of the LOC Facilities or enter into additional such facilities, each of which depends, among other factors, 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, including regulations that have been or may be issued under the recently enacted Dodd-Frank Act, could also impact our ability to obtain additional financing and to maintain or, if necessary or desirable, expand the LOC Facilities or enter into additional such facilities, in each case on favorable terms or at all.

 

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 and to support similar development activities by certain of our unconsolidated joint ventures. 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, which tightened in 2010 with certain providers exiting the market or substantially reducing their issuances of performance bonds, and the underwriting practices and resources of performance bond issuers. If we are unable to obtain performance bonds when required or the cost or operational restrictions or conditions imposed by issuers to obtain them increases significantly, we may not be able to develop or we may be significantly delayed in developing a community or communities and/or we may incur significant additional expenses, and, as a result, our consolidated financial position, results of operations, cash flows and/or liquidity could be adversely affected.

 

Changes in accounting standards could affect our reported financial results.

 

New accounting standards or interpretations of existing standards that may become applicable to us could have a significant effect on our reported results of operations, and may also cause us to incur significant additional expenses in order to comply with them.

 

 

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.

 

 

South Edge, LLC Litigation

 

On December 9, 2010, certain lenders to South Edge, LLC, a Nevada limited liability company (“South Edge”) filed a Chapter 11 involuntary bankruptcy petition in the United States Bankruptcy Court, District of Nevada, JPMorgan Chase Bank, N.A. v. South Edge, LLC (Case No. 10-32968-bam). KB HOME Nevada Inc., our wholly-owned subsidiary, is a member of South Edge together with other unrelated homebuilders and a third-party property development firm. KB HOME Nevada Inc. holds a 48.5% interest in South Edge. The involuntary bankruptcy petition alleges that South Edge failed to undertake certain development-related activities and to repay amounts due on secured loans that the petitioning lenders (as part of a lending syndicate) made to South Edge in 2004 and 2007, totaling $585.0 million in initial aggregate principal amount (the

“Loans”). At November 30, 2010, the outstanding principal balance of the Loans was approximately $328.0 million. The Loans were used by South Edge to partially finance the purchase and development of the underlying property for a residential community located near Las Vegas, Nevada. The petitioning lenders for the involuntary bankruptcy — JPMorgan Chase Bank, N.A., Wells Fargo Bank, N.A. and Crédit Agricole Corporate and Investment Bank — also filed motions to appoint a Chapter 11 trustee for South Edge, and have asserted that, among other actions, the trustee can enforce alleged obligations of the South Edge members to purchase land parcels from South Edge resulting in repayment of the Loans. On January 6, 2011, South Edge filed a motion for the court to dismiss or to abstain from the involuntary bankruptcy petition, and the court scheduled a trial that commenced on January 24, 2011 and is planned to continue until no later than February 4, 2011. The exact timing of the court’s decision on the motion is uncertain.

 

We, KB HOME Nevada Inc., and the other South Edge members and their respective parent companies each provided certain guaranties to the lenders in connection with the Loans, including a limited several guaranty that, by its terms, purports to guarantee the repayment to the lenders of the Loans certain amounts, including principal and interest, if an involuntary bankruptcy petition is filed against South Edge that is not dismissed within 60 days or for which an order approving relief under bankruptcy law is entered (the “Springing Repayment Guaranty”). If our Springing Repayment Guaranty were enforced, our maximum potential responsibility at November 30, 2010 would have been approximately $180.0 million in aggregate principal amount, plus a potentially significant amount for accrued and unpaid interest and attorneys’ fees in respect of the Loans. This potential Springing Repayment Guaranty obligation, however, does not account for any offsets or defenses that could be available to us to prevent or minimize the impact of its enforcement, or any reduction in the principal balance of the Loans arising from purchases of land parcels from South Edge under authority potentially given to a Chapter 11 trustee (as described above) or otherwise.

 

The petitioning lenders previously filed a lawsuit in December 2008 against the South Edge members and their respective parent companies (including us and KB HOME Nevada Inc.) (JP Morgan Chase Bank, N.A. v. KB HOME Nevada, et al., U.S. District Court, District of Nevada (Case No. 08-CV-01711 PMP)) (the “Lender Litigation”). The Lender Litigation, which, among other things, is seeking to enforce completion guaranties and also to force the South Edge members (including KB HOME Nevada Inc.) to purchase land parcels from and to provide certain financial and other support to South Edge, has been stayed pending the outcome of the involuntary bankruptcy petition. If the involuntary bankruptcy petition is dismissed, we expect the Lender Litigation to resume.

 

A separate arbitration proceeding was also commenced in May 2009 to address one South Edge member’s claims for specific performance by the other members and their respective parent companies to purchase land parcels from and to make certain capital contributions to South Edge and, in the alternative, damages. On July 6, 2010, the arbitration panel issued a decision denying the specific performance claims and awarding to the claimant total damages of approximately $37.0 million against all of the defendants. The parties involved have appealed the arbitration panel’s decision to the United States Courts of Appeal for the Ninth Circuit, Focus South Group, LLC, et al. v. KB HOME Nevada Inc, et al., (Case No. 10-17562), and the case is pending. If the appeal on the damages awarded by the arbitration panel is denied, KB HOME Nevada Inc. will be responsible for a share of those damages.

 

While there are defenses to the above legal proceedings, the ultimate resolution of these matters and the timing of such resolutions are uncertain and involve multiple factors. Therefore, a meaningful range of potential outcomes cannot be reasonably estimated at this time. If unfavorable outcomes were to occur, however, there is a possibility that we could incur significant losses in excess of amounts accrued for these matters that could have a material adverse effect on our consolidated financial position and results of operations.

 

Other Matters

 

We are also 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 could, individually or in the aggregate, have a materially adverse effect on our consolidated financial position or results of operations.

 

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following table presents certain information regarding our executive officers as of December 31, 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, 2010, there were 775 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, debt structure and adjustments thereto, operational and financial investment strategy and general financial condition, as well as general business conditions.

 

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 2010.

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, 2010, the closing price of KB Home common stock on the New York Stock Exchange was $11.30 per share. On December 31, 2010, our common stock closed at $13.49 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, 2005 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. The following table presents a summary of our consolidated results of operations for the years ended November 30, 2010, 2009 and 2008 (in thousands, except per share amounts):

 

 

During the year ended November 30, 2010, we and the homebuilding industry continued to face a difficult operating environment amid the ongoing housing downturn that began in mid-2006. This environment, in which there is a persistent oversupply of homes available for sale and soft demand for new homes, was prolonged throughout 2010 by rising sales of lender-owned homes acquired through foreclosures and short sales, generally weak economic conditions, high unemployment, tighter mortgage lending standards and reduced credit availability, muted consumer confidence, intense competition for home sales, and the expiration on April 30 of a federal homebuyer tax credit. These negative factors undermined progress toward broad-based market stabilization and stalled any meaningful recovery in the overall U.S. housing market, despite improved affordability in several markets stemming from lower home selling prices and relatively low residential consumer mortgage interest rates.

 

Although this environment resulted in our delivering fewer homes and, consequently, generating lower revenues in 2010 compared to 2009, we narrowed our net loss in 2010 by 32% due to a higher housing gross margin and lower overhead costs. In addition, we generated operating income from our homebuilding operations in each of the last two quarters of 2010; achieved year-over-year improvement in our pretax results in each quarter of 2010, extending a trend of such improvement to 11 consecutive quarters; and in the fourth quarter of 2010 generated pretax earnings for the first time in nearly four years. These improved results were largely due to the initiatives we have put into place over the past several quarters to achieve the following three primary integrated strategic goals: restore and maintain the profitability of our homebuilding operations; generate cash and maintain a strong balance sheet; and position our business to capitalize on future growth opportunities. This includes continuing to execute on our KBnxt operational business model; improving and refining our product offerings, including The Open Series, to compete with resale homes and to meet the affordability demands and environmental sustainability concerns of our core customers — first-time, move-up and active adult homebuyers; aligning our overhead to current market conditions while retaining a solid growth platform through a tight focus on controlling costs, improving our operating efficiencies and monitoring local market activity levels and demographic trends; maintaining a strong and liquid balance sheet to allow us to make opportunistic investments in our business; and acquiring attractively-priced new land interests meeting our investment standards in desirable markets with perceived favorable growth prospects. We believe these initiatives have helped position us operationally and financially to be able to generate higher future revenues and sustained profitability as and to the extent housing markets improve over time. Given the present operating environment and our outlook, however, the positive trends in our gross margin and earnings results may not continue in 2011 or to the same degree as in 2010.

In 2010, we continued to make progress toward achieving our highest priority of restoring and maintaining the profitability of our homebuilding operations, as we narrowed our net loss on a year-over-year basis. This result was largely driven by lower pretax, noncash charges for asset impairments and land option contract abandonments, as well as our success in expanding our housing gross margin and reducing our selling, general and administrative expenses.

 

Our total revenues of $1.59 billion for the year ended November 30, 2010 decreased 13% from $1.82 billion in 2009, which had declined 40% from $3.03 billion in 2008. Revenues decreased in 2010 and 2009 primarily due to lower housing and land sale revenues. The year-over-year decrease in housing revenues in 2010 reflected fewer homes delivered, partly offset by a higher average selling price. In 2009, the decline in housing revenues resulted from a decrease in homes delivered and a lower average selling price. Homes delivered decreased in 2010 and 2009 mainly due to our operating with a strategically lower overall average active community count in each year compared to the previous year, as discussed above under “Part I — Item 1. Business — Strategy.” “Active communities” are those that deliver five or more homes in a quarterly reporting period. The active community count for the year is based on the average of the quarterly reporting periods. Land sale revenues totaled $6.3 million in 2010 compared to $58.3 million in 2009, reflecting a significantly reduced volume of land sales activity.

 

Our overall average selling price increased in 2010 compared to 2009 primarily due to changes in community and product mix, as we delivered more homes from markets that supported higher selling prices. In 2009, our overall average selling price declined from 2008, reflecting the challenging housing market conditions and intense competition for sales as well as 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 $8.2 million in 2010, $8.4 million in 2009 and $10.8 million in 2008. Financial services revenues decreased in both 2010 and 2009, reflecting fewer homes delivered by our homebuilding operations.

 

We posted a net loss of $69.4 million, or $.90 per diluted share, in 2010, which narrowed from our net loss of $101.8 million, or $1.33 per diluted share, in 2009. In 2010, our net loss included pretax, noncash charges of $19.9 million for inventory impairments and the abandonment of land option contracts we no longer planned to pursue, an after-tax valuation allowance charge of $26.6 million against net deferred tax assets to fully reserve the tax benefits generated from our net loss for the period, and an income tax benefit of $7.0 million, primarily associated with an increase in the carryback of our 2009 NOLs to offset earnings we generated in 2004 and 2005. The majority of the inventory impairments and land option contract abandonments in 2010 occurred during the first quarter and affected our Central and Southeast reporting segments.

 

In 2009, our net loss of $101.8 million, or $1.33 per diluted share, was largely due to pretax, noncash charges of $206.7 million for inventory and joint venture impairments and the abandonment of land option contracts. These charges reflected the ongoing 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 primarily resulted from federal tax legislation enacted in the fourth quarter of 2009 that allowed us to carry back our 2009 NOLs to offset earnings we generated in 2004 and 2005. As a result, we received a federal tax refund of $190.7 million in the first quarter of 2010.

 

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. Most of these charges were associated with our West Coast, Southwest and Southeast reporting segments. The net loss in 2008 also reflected a $355.9 million valuation allowance charge against net deferred tax assets to fully reserve the tax benefits generated from our pretax loss for the period.

 

Our housing gross margin increased to 17.4% in 2010 from 6.5% in 2009 and negative 7.1% in 2008. We have improved our housing gross margin for the last nine consecutive quarters, as measured on a year-over-year basis. The improvement in our housing gross margin in 2010 compared to 2009 primarily reflected improved operating efficiencies, an increase in the number of homes delivered from our new products, such as The Open Series, which are designed to be built with lower direct construction costs, a decrease in inventory impairment and land option contract abandonment charges, and the impact of inventory impairment charges incurred in prior years, which lowered our land cost basis with respect to the relevant communities. In 2009, the year-over-year increase in our housing gross margin resulted from lower inventory impairment and land option contract abandonment charges and our strategies to reduce direct construction costs and increase our operational efficiencies. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges (as described below under “Non-GAAP Financial Measures”), improved to 18.6% in 2010, compared to 15.5% in 2009 and 10.6% in 2008.

 

Our backlog at November 30, 2010 was comprised of 1,336 homes, representing projected future housing revenues of approximately $263.8 million, compared to a backlog at November 30, 2009 of 2,126 homes, representing projected future housing revenues of $422.5 million. The number of homes in backlog declined 37% year over year, reflecting a decrease in net orders in the latter half of 2010 and an increase in the percentage of homes delivered from our backlog in the fourth quarter, partly due to improved construction cycle times. The potential future housing revenues in backlog decreased 38% year over year, reflecting the lower level of homes in backlog. Net orders from our homebuilding operations declined 21% to 6,556 in 2010 from 8,341 in 2009 due to a 12% decrease in our overall average active community count, generally weak economic and housing market conditions, a sharp reduction in demand following the April 30, 2010 expiration of the federal homebuyer tax credit, and an increase in our cancellation rate. As a percentage of gross orders, our cancellation rate increased to 28% in 2010, compared to 25% in 2009.

 

Our cash, cash equivalents and restricted cash totaled $1.02 billion at November 30, 2010, compared to $1.29 billion at November 30, 2009. Our debt balance at November 30, 2010 was $1.78 billion, down from $1.82 billion at November 30, 2009, mainly due to the repayment of mortgages and land contracts due to land sellers and other loans. At November 30, 2010, our ratio of debt to total capital was 73.8%, compared to 72.0% at November 30, 2009. Our ratio of net debt to total capital (as described below under “Non-GAAP Financial Measures”) was 54.5% at November 30, 2010 and 42.9% at November 30, 2009.

 

Our inventory balance of $1.70 billion at November 30, 2010 was 13% higher than the $1.50 billion balance at November 30, 2009. This increase primarily reflected the results of our land acquisition initiative in 2010, as discussed above under “Part I — Item 1. Business — Strategy.” Through this initiative, we ended our 2010 fiscal year with a geographically diverse land portfolio comprised of 39,540 lots owned or controlled, compared to 37,465 lots owned or controlled at November 30, 2009.

 

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, 2010, 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, 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 $1.58 billion in 2010, decreasing 13% from $1.82 billion in 2009, which had decreased 40% from $3.02 billion in 2008. The year-over-year decreases in 2010 and 2009 reflected lower housing and land sale revenues.

 

Housing revenues decreased to $1.58 billion in 2010 compared to $1.76 billion in 2009 and $2.94 billion in 2008. In 2010, housing revenues declined 10% from the previous year due to a 13% decrease in homes delivered, partly offset by a 4% increase in the average selling price. In 2009, housing revenues fell 40% from 2008 due to a 32% decrease in homes delivered and a 12% decline in the average selling price.

 

In 2010, we delivered 7,346 homes, down from 8,488 homes in 2009. Each of our homebuilding reporting segments delivered fewer homes in 2010 compared to 2009, with decreases ranging from 4% to 27%. The year-over-year decline in the total number of homes delivered in 2010 was principally due to a 12% decrease in the overall average number of active communities we operated and weak demand for new homes. This decline in our overall average active community count reflects the impact of the reduction in our community count that we undertook in prior years, although in 2010 we implemented a targeted land acquisition initiative that is designed to support future growth in our average active community count and our revenues. These actions are further discussed above under “Part I — Item 1. Business — Strategy.”

 

In 2009, we delivered 8,488 homes, down from 12,438 homes delivered in 2008, with year-over-year decreases in each of our homebuilding reporting segments. The lower delivery volume in 2009 compared to 2008 was mainly due to a 38% reduction in the overall average number of active communities we operated.

 

The average selling price of our homes rose to $214,500 in 2010 from $207,100 in 2009, reflecting higher average selling prices in three of our four homebuilding reporting segments. Year over year, average selling prices increased 10% in our West Coast segment, 5% in our Central segment and 1% in our Southeast segment. In our Southwest segment, the average selling price for 2010 decreased 8% from 2009. The increase in our overall average selling price was primarily due to changes in our community and product mix, as we delivered more homes from markets that supported higher selling prices.

 

Our 2009 overall average selling price decreased 12% from $236,400 in 2008 as 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. In 2009, 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.

 

Land sale revenues totaled $6.3 million in 2010, $58.3 million in 2009 and $82.9 million in 2008. Generally, land sale revenues fluctuate with our decisions to maintain or decrease our land ownership position 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 2009 and 2008 compared to 2010 because we sold a greater volume of land in those years, rather than hold it for future development, as the housing downturn continued and the land no longer fit our marketing strategy.

 

Operating Loss.  Our homebuilding business generated operating losses of $16.0 million in 2010, $236.5 million in 2009 and $860.6 million in 2008. Our homebuilding operating loss as a percentage of homebuilding revenues was negative 1.0% in 2010, negative 13.0% in 2009, and negative 28.5% in 2008. Homebuilding operating results improved on a percentage basis in 2010 and 2009, mainly due to the increase in our housing gross margin in each of those years.

 

Within our homebuilding operations, the 2010 operating loss was principally due to pretax, noncash charges of $19.9 million for inventory impairments and land option contract abandonments. In 2009, our homebuilding operating loss was largely due to pretax, noncash charges of $157.6 million for inventory impairments and land option contract abandonments. The 2008 homebuilding operating loss reflected 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 a lower housing gross margin. Inventory impairment charges in 2010, 2009 and 2008 were incurred as a result of persistent increases in housing supply and decreases in demand, both of which put downward pressure on sales prices and, in turn,

asset values. During these years, poor market conditions also depressed land values and led us to terminate our land option contracts on projects that no longer met our investment and/or marketing standards.

 

Our housing gross margin improved by 10.9 percentage points to 17.4% in 2010 from 6.5% in 2009. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, increased by 3.1 percentage points to 18.6% in 2010 from 15.5% in 2009. The year-over-year improvement in our housing gross margin, excluding inventory impairment and land option contract abandonment charges, reflected an increase in homes delivered from our new, value-engineered products, such as The Open Series, which are designed to be built with lower direct construction costs, and improved operating efficiencies. Our housing gross margin in 2010 was also favorably impacted by an increase in homes delivered from communities newly opened during the year, which had a relatively lower land cost basis compared to many of our older communities; an increase in homes delivered from markets that supported higher selling prices; and the impact of inventory impairment charges incurred in prior years, which lowered our land cost basis with respect to the relevant communities. In light of the soft demand and intense competition for sales in the present operating environment, however, we may not experience similar margin improvement in 2011.

 

In 2009, the homebuilding operating loss was $236.5 million compared to $860.6 million in 2008. As a percentage of homebuilding revenues, our homebuilding operating loss was negative 13.0% in 2009 and negative 28.5% in 2008. The 2009 homebuilding operating loss narrowed from 2008 mainly due to an increase in our housing gross margin, which improved by 13.6 percentage points to 6.5% in 2009 from negative 7.1% in 2008. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, increased by 4.9 percentage points to 15.5% in 2009 from 10.6% in 2008. The year-over-year improvement in our housing gross margin reflected the impact of our delivering more of our new value-engineered product, which helped lower direct construction costs, and increased operating efficiencies. Our margins were also favorably impacted by inventory-related charges incurred in prior periods.

 

Our land sales generated losses of $.3 million in 2010, $47.9 million in 2009 and $82.8 million in 2008. The land sale losses in 2010, 2009 and 2008 included impairment charges of $.3 million, $10.5 million and $86.2 million, respectively, related to planned future land sales.

 

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 $9.8 million in 2010, $120.8 million in 2009 and $565.9 million in 2008.

 

The inventory impairment charges in all three years reflected declining asset values in certain markets due to the challenging economic and housing market conditions. Further deterioration in housing market supply and demand factors 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 marketing 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 $10.1 million in 2010, $47.3 million in 2009 and $40.9 million in 2008. 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 $289.5 million in 2010, down from $303.0 million in 2009, which had decreased from $501.0 million in 2008. The year-over-year decrease in each period reflected 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 in line with market conditions. Our selling, general and administrative expenses also decreased in 2010 and 2009 based on the lower volume of homes delivered. A portion of the cost reductions in 2010 and 2009 were related to lower salary and other payroll-related expenses stemming from year-over-year decreases in our personnel count of 7% in 2010 and 24% in 2009. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses increased to 18.4% in 2010 from 17.2% in 2009, which had increased slightly from 17.0% in 2008. The percentages increased in 2010 and 2009 because our expense reductions have been outpaced by the corresponding year-over-year declines in our housing revenues.

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, 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 that year.

 

Based on the results of our goodwill impairment evaluations performed in 2008, we determined that all of the goodwill previously recorded was impaired. As a result, we recognized goodwill impairment charges of $24.6 million related to our Central reporting segment and $43.4 million related to our Southeast reporting segment during 2008. These charges were recorded at our corporate level because all goodwill was carried at that level. We had no goodwill balance as of November 30, 2010, November 30, 2009 or November 30, 2008.

 

Interest Income.  Interest income, which is generated from short-term investments and mortgages receivable, totaled $2.1 million in 2010, $7.5 million in 2009 and $34.6 million in 2008. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of our 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 2010 was mainly due to lower interest rates. In 2009, the year-over-year decline in interest income reflected a decrease in the average balance of cash and cash equivalents we maintained and lower interest rates.

 

Interest Expense, Net of Amounts Capitalized/Loss on Early Redemption of Debt.  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 $66.5 million in 2010, $50.8 million in 2009 and $2.6 million in 2008. Interest expense in 2010 included a total of $1.8 million of debt issuance costs written off in connection with our voluntary reduction of the aggregate commitment under the Credit Facility from $650.0 million to $200.0 million and our subsequent voluntary termination of the Credit Facility. The percentage of interest capitalized was 45% in 2010, 57% in 2009 and 98% in 2008. The percentages for 2010 and 2009 decreased from the corresponding year-earlier periods due to the lower amounts of inventory qualifying for interest capitalization. Gross interest incurred during 2010 increased by $2.6 million to $122.2 million, from $119.6 million in 2009 primarily due to the write-off of debt issuance costs and a higher overall average interest rate for borrowings in 2010. Gross interest incurred during 2009 decreased by $36.8 million from $156.4 million in 2008, reflecting comparatively lower overall debt levels in 2009.

 

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 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.

 

Equity in Loss of Unconsolidated Joint Ventures.  Our unconsolidated joint ventures operate in various markets, typically where our homebuilding operations are located. These unconsolidated joint ventures posted combined revenues of $122.2 million in 2010, $60.8 million in 2009 and $112.8 million in 2008. The year-over-year increase in unconsolidated joint venture revenues in 2010 was primarily related to the sale of land by an unconsolidated joint venture in our Southeast reporting segment. The year-over-year decrease in unconsolidated joint venture revenues in 2009 was primarily due to a decline in the number of homes delivered by the unconsolidated joint ventures. Activities performed by our unconsolidated joint ventures generally include acquiring, developing and selling land, and, in some cases, constructing and delivering homes. Our unconsolidated joint ventures delivered 102 homes in 2010, 141 homes in 2009 and 262 homes in 2008, reflecting in part the lower number of unconsolidated joint venture investments we had each year. Our unconsolidated joint ventures generated combined losses of $17.2 million in 2010, $102.9 million in 2009 and $383.6 million in 2008. Our equity in loss of unconsolidated joint ventures totaled $6.3 million in 2010, $49.6 million in 2009 and $152.8 million in 2008. In 2009 and 2008, our equity in loss of unconsolidated joint ventures included charges of $38.5 million and $141.9 million, respectively, to recognize the impairment of certain unconsolidated joint ventures primarily in our West Coast, Southwest and Southeast reporting segments. There were no such charges in 2010.

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 financial 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 calculated in accordance with GAAP to the non-GAAP financial measure of our housing gross margin, excluding inventory impairment and land option contract abandonment charges (dollars in thousands):