Revenues

Construction and land costs

Selling, general and administrative expenses

Loss on loan guaranty

 

 

Operating loss

 

Interest income

Interest expense

Equity in loss of unconsolidated joint ventures

 

 

Homebuilding pretax loss

 

 

Revenues

Expenses

Equity in income (loss) of unconsolidated joint venture

 

 

Financial services pretax income

 

 

Income tax expense

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

Restricted cash

Receivables

Inventories

Investments in unconsolidated joint ventures

Other assets

 

 

 

 

 

 

 

 

 

Accounts payable

Accrued expenses and other liabilities

Mortgages and notes payable

 

 

 

 

 

 

Common stock

Paid-in capital

Retained earnings

Accumulated other comprehensive loss

Grantor stock ownership trust, at cost

Treasury stock, at cost

 

 

 

 

 

Net loss

Adjustments to reconcile net loss to net cash provided (used) by operating activities:

Equity in (income) loss of unconsolidated joint ventures

Distributions of earnings from unconsolidated joint ventures

Loss on loan guaranty

Gain on sale of operating property

Amortization of discounts and issuance costs

Depreciation and amortization

Loss (gain) on early extinguishment of debt/voluntary reduction of revolving credit facility

Tax benefits from stock-based compensation

Stock-based compensation expense

Inventory impairments and land option contract abandonments

Change in assets and liabilities:

Receivables

Inventories

Accounts payable, accrued expenses and other liabilities

Other, net

 

 

 

 

Investments in unconsolidated joint ventures

Proceeds from sale of operating property

Purchases of property and equipment, net

 

 

 

 

Change in restricted cash

Payments on mortgages and land contracts due to land sellers and other loans

Issuance of common stock under employee stock plans

Payments of cash dividends

Repurchases of common stock

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

Cash and cash equivalents at end of period

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted.

In the opinion of KB Home (the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s consolidated financial position as of February 28, 2011, the results of its consolidated operations for the three months ended February 28, 2011 and 2010, and its consolidated cash flows for the three months ended February 28, 2011 and 2010. The results of consolidated operations for the three months ended February 28, 2011 are not necessarily indicative of the results to be expected for the full year, due to seasonal variations in operating results and other factors. The consolidated balance sheet at November 30, 2010 has been taken from the audited consolidated financial statements as of that date. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended November 30, 2010, which are contained in the Company’s Annual Report on Form 10-K for that period.

The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP and, therefore, include amounts based on informed estimates and judgments of management. Actual results could differ from these estimates.

The Company considers all highly liquid short-term debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company’s cash equivalents totaled $656.3 million at February 28, 2011 and $797.2 million at November 30, 2010. The majority of the Company’s cash and cash equivalents were invested in money market accounts and U.S. government securities.

Restricted cash of $121.2 million at February 28, 2011 consisted of $94.4 million of cash deposited with various financial institutions that is required as collateral for the Company’s cash-collateralized letter of credit facilities (the “LOC Facilities”), and $26.8 million of cash in an escrow account required as collateral for a surety bond. Restricted cash of $115.5 million at November 30, 2010 consisted of $88.7 million of cash collateral for the LOC Facilities, and $26.8 million of cash collateral for a surety bond.

Basic and diluted loss per share were calculated as follows (in thousands, except per share amounts):

Numerator:

Net loss

 

 

Denominator:

Basic and diluted average shares outstanding

 

 

Basic and diluted loss per share

 

All outstanding stock options were excluded from the diluted loss per share calculations for the three months ended February 28, 2011 and 2010 because the effect of their inclusion would be antidilutive, or would decrease the reported loss per share.

The Company’s comprehensive loss was $114.5 million for the three months ended February 28, 2011 and $54.7 million for the three months ended February 28, 2010. The accumulated balances of other comprehensive loss in the consolidated balance sheets as of February 28, 2011 and November 30, 2010 were comprised solely of adjustments recorded directly to accumulated other comprehensive loss in accordance with Accounting Standards Codification Topic No. 715, “Compensation — Retirement Benefits” (“ASC 715”). ASC 715 requires an employer to recognize the funded status of defined postretirement benefit plans as an asset or liability on the balance sheet and requires any unrecognized prior service costs and actuarial gains/losses to be recognized in accumulated other comprehensive income (loss).

The Company measures and recognizes compensation expense associated with its grant of equity-based awards in accordance with Accounting Standards Codification Topic No. 718, “Compensation — Stock Compensation” (“ASC 718”). ASC 718 requires that public companies measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements over the vesting period.

In accordance with ASC 718, the Company estimates the grant-date fair value of its stock options using the Black-Scholes option-pricing model, which takes into account assumptions regarding an expected dividend yield, a risk-free interest rate, an expected volatility factor for the market price of the Company’s common stock and an expected term of the stock options. The following table summarizes the stock options outstanding and stock options exercisable as of February 28, 2011, as well as stock options activity during the three months then ended:

 

Options outstanding at beginning of period

 

Granted

 

Exercised

 

Cancelled

 

 

Options outstanding at end of period

 

 

Options exercisable at end of period

 

As of February 28, 2011, the weighted average remaining contractual life of stock options outstanding and stock options exercisable was 7.6 years and 7.0 years, respectively. There was $6.3 million of total unrecognized compensation cost related to unvested stock option awards as of February 28, 2011. For the three months ended February 28, 2011 and 2010, stock-based compensation expense associated with stock options totaled $1.4 million and $1.5 million, respectively. The aggregate intrinsic value of stock options outstanding and stock options exercisable was $3.2 million and $.1 million, respectively, as of February 28, 2011. (The intrinsic value of a stock option is the amount by which the market value of a share of the underlying common stock exceeds the exercise price of the stock option.)

From time to time, the Company grants restricted stock, phantom shares and stock appreciation rights (“SARs”) to various employees. In some cases, the Company has granted phantom shares and stock appreciation rights that can be settled only in cash and are therefore accounted for as liability awards. The Company recognized total compensation expense of $1.0 million in the three months ended February 28, 2011 and $5.7 million in the three months ended February 28, 2010 related to restricted stock, phantom shares and SARs awards. Some of the stock-based awards outstanding at February 28, 2010 were SARs that could be settled only in cash. In each of the third and fourth quarters of 2010, the Company offered to eligible officers and employees the opportunity to replace cash-settled SARs previously granted to them with options to purchase shares of the Company’s common stock. Each stock option issued to replace a SAR had an exercise price equal to the replaced SAR’s exercise price, and the same number of underlying shares, vesting schedule and expiration date as each such SAR. The offers did not include a re-pricing or any other changes impacting the value of the awards to the participating officers and employees, and no additional grants or awards were made to the participants as part of the offers. All of the SARs the Company received through the offers were canceled, and with forfeitures due to employee departures, the Company has canceled virtually all of its previously granted cash-settled SARs.

As of February 28, 2011, the Company had identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within its consolidated operations in accordance with Accounting Standards Codification Topic No. 280, “Segment Reporting.” As of February 28, 2011, the Company’s homebuilding reporting segments conducted ongoing operations in the following states:

The Company’s homebuilding reporting segments are engaged in the acquisition and development of land primarily for residential purposes and offer a wide variety of homes that are designed to appeal to first-time, move-up and active adult homebuyers.

The Company’s homebuilding reporting segments were identified based primarily on similarities in economic and geographic characteristics, product types, regulatory environments, methods used to sell and construct homes and land acquisition characteristics. The Company evaluates segment performance primarily based on segment pretax results.

The Company’s financial services reporting segment provides title and insurance services to the Company’s homebuyers. This segment also provides mortgage banking services to the Company’s homebuyers through KBA Mortgage, LLC (“KBA Mortgage”), a joint venture with a subsidiary of Bank of America, N.A. The Company’s financial services reporting segment conducts operations in the same markets as the Company’s homebuilding reporting segments. Since its formation in 2005, the Company’s mortgage banking joint venture has provided mortgage banking services to a majority of the Company’s homebuyers. During the quarter ended February 28, 2011, the Company’s partner in the joint venture approached the Company about changing the parties’ relationship due to the desire of Bank of America, N.A. to cease participating in joint venture structures in its business. The parties are discussing how residential consumer mortgage loans and mortgage banking services might be offered to the Company’s homebuyers if the joint venture is not continued, and are negotiating to reach a mutually beneficial resolution. The Company is also evaluating a number of other possible strategies it could pursue to facilitate the offering of mortgage banking services to its homebuyers. While there are a number of possible outcomes, the mortgage banking joint venture continues to provide services to the Company’s homebuyers. The Company’s focus remains on ensuring that its homebuyers obtain reliable mortgage banking services to purchase a home.

The Company’s reporting segments follow the same accounting policies used for the Company’s consolidated financial statements. Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent, stand-alone entity during the periods presented, nor are they indicative of the results to be expected in future periods.

The following tables present financial information relating to the Company’s reporting segments (in thousands):

Revenues:

West Coast

Southwest

Central

Southeast

 

Total homebuilding revenues

Financial services

 

 

Total

 

 

Pretax income (loss):

West Coast

Southwest

Central

Southeast

Corporate and other (a)

 

Total homebuilding loss

Financial services

 

 

Total

 

 

Equity in income (loss) of unconsolidated joint ventures:

West Coast

Southwest

Central

Southeast

 

 

Total

 

 

Inventory impairments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

Corporate and other includes corporate general and administrative expenses.

Land option contract abandonments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

 

Joint venture impairments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

Assets:

West Coast

Southwest

Central

Southeast

Corporate and other

 

Total homebuilding assets

Financial services

 

 

Total

 

 

Investments in unconsolidated joint ventures:

West Coast

Southwest

Central

Southeast

 

 

Total

 

The following tables present financial information relating to the Company’s financial services reporting segment (in thousands):

Revenues

Interest income

Title services

Insurance commissions

 

Total

 

Expenses

General and administrative

 

Operating income

Equity in income (loss) of unconsolidated joint venture

 

 

Pretax income

 

Assets

Cash and cash equivalents

Receivables

Investment in unconsolidated joint venture

Other assets

 

 

Total assets

 

 

Liabilities

Accounts payable and accrued expenses

 

 

Total liabilities

 

Mortgages and notes receivable totaled $40.5 million at February 28, 2011 and November 30, 2010. Included in mortgages and notes receivable at February 28, 2011 and November 30, 2010 was a note receivable of $40.0 million on which the Company is in the process of foreclosing on the underlying real estate.

Inventories consisted of the following (in thousands):

 

Homes, lots and improvements in production

 

Land under development

 

 

Total

 

The Company’s interest costs are as follows (in thousands):

 

Capitalized interest at beginning of period

 

Capitalized interest related to consolidation of previously unconsolidated joint ventures

 

Interest incurred (a)

 

Interest expensed (a)

 

Interest amortized to construction and land costs

 

 

Capitalized interest at end of period (b)

 

Amounts for the three months ended February 28, 2011 include a $3.6 million gain on the early extinguishment of secured debt. Amounts for the three months ended February 28, 2010 include $1.4 million of debt issuance costs written off in connection with the Company’s voluntary reduction of the aggregate commitment under an unsecured revolving credit facility (the “Credit Facility”) from $650.0 million to $200.0 million. The Company voluntarily terminated the Credit Facility effective March 31, 2010.

Inventory impairment charges are recognized against all inventory costs of a community, such as land, land improvements, costs of home construction and capitalized interest. Capitalized interest amounts presented in the table reflect the gross amount of capitalized interest as impairment charges recognized are not generally allocated to specific components of inventory.

Each land parcel or community in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each land parcel or community on a quarterly basis and include, but are not limited to: significant decreases in sales rates, average selling prices, volume of homes delivered, gross margins on homes delivered or projected margins on homes in backlog or future housing sales; significant increases in budgeted land development and construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a land parcel or community, the identified inventory is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). The Company evaluated 31 communities or land parcels for recoverability during the three months ended February 28, 2011, and evaluated 27 communities or land parcels for recoverability during the three months ended February 28, 2010. When an indicator of potential impairment is identified, the Company tests the asset for recoverability by comparing the carrying value of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by trends and factors known to the Company at the time they are calculated and the Company’s expectations related to: market supply and demand, including estimates concerning average selling prices; sales and cancellation rates; and anticipated land development, construction and overhead costs to be incurred. These estimates, trends and expectations are specific to each land parcel or community and may vary among land parcels or communities.

Based on the results of its evaluations, the Company recognized pretax, noncash inventory impairment charges of $1.0 million associated with three communities or land parcels in the first quarter of 2011 and $6.8 million associated with four communities or land parcels in the first quarter of 2010. As of February 28, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $384.9 million, representing 64 communities and various other land parcels. As of November 30, 2010, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $418.5 million, representing 72 communities and various other land parcels.

The Company’s optioned inventory is assessed to determine whether it continues to meet the Company’s internal investment and marketing standards. Assessments are made separately for each optioned parcel on a quarterly basis and are affected by, among other factors: current and/or anticipated sales rates, average selling prices and home delivery volume; estimated land development and construction costs; and projected profitability on expected future housing or land sales. When a decision is made not to exercise certain land option and other similar contracts due to market conditions and/or changes in marketing strategy, the Company writes off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. Based on the results of its assessments, the Company recognized pretax, noncash land option contract abandonment charges of $.8 million in the first quarter of 2011 and $6.5 million in the first quarter of 2010.

Inventory impairment and land option contract abandonment charges are included in construction and land costs in the Company’s consolidated statements of operations.

Due to the judgment and assumptions applied in the estimation process with respect to inventory impairments and land option contract abandonments, it is possible that actual results could differ substantially from those estimated.

Accounting Standards Codification Topic No. 820, “Fair Value Measurements and Disclosures,” provides a framework for measuring the fair value of assets and liabilities under GAAP and establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy can be summarized as follows:

 

Fair value determined based on quoted prices in active markets for identical assets or liabilities.

 

 

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

 

 

Fair value determined using significant unobservable inputs, such as pricing models, discounted cash flows, or similar techniques.

Fair value measurements are used for inventories on a nonrecurring basis when events and circumstances indicate the carrying value may not be recoverable. The following table presents the Company’s assets measured at fair value on a nonrecurring basis (in thousands):

 

Long-lived assets held and used

 

Amount represents the aggregate fair values for communities where the Company recognized noncash inventory impairment charges during the period, as of the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.

In accordance with the provisions of ASC 360, long-lived assets held and used with a carrying value of $2.2 million were written down to their fair value of $1.2 million during the three months ended February 28, 2011, resulting in noncash inventory impairment charges of $1.0 million.

The fair values for long-lived assets held and used, determined using Level 2 inputs, were based on an executed contract. The fair values for long-lived assets held and used, determined using Level 3 inputs, were primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each land parcel or community and may vary among land parcels or communities.

The Company’s financial instruments consist of cash and cash equivalents, restricted cash, mortgages and notes receivable, senior notes, and mortgages and land contracts due to land sellers and other loans. Fair value measurements of financial instruments are determined by various market data and other valuation techniques as appropriate. When available, the Company uses quoted market prices in active markets to determine fair value. The following table presents the carrying values and estimated fair values of the Company’s financial instruments, except for those for which the carrying values approximate fair values (in thousands):

Financial Liabilities:

Senior notes due 2011 at 6 3/8%

Senior notes due 2014 at 5 3/4%

Senior notes due 2015 at 5 7/8%

Senior notes due 2015 at 6 1/4%

Senior notes due 2017 at 9.1%

Senior notes due 2018 at 7 1/4%

The fair values of the Company’s senior notes are estimated based on quoted market prices.

The carrying values reported for cash and cash equivalents, restricted cash, mortgages and notes receivable, and mortgages and land contracts due to land sellers and other loans approximate fair values.

The Company participates in joint ventures from time to time for the purpose of conducting land acquisition, development and/or other homebuilding activities. Its investments in these joint ventures may create a variable interest in a variable interest entity (“VIE”), depending on the contractual terms of the arrangement. The Company analyzes its joint ventures in accordance with Accounting Standards Codification Topic No. 810, “Consolidation,” (“ASC 810”) to determine whether they are VIEs and, if so, whether the Company is the primary beneficiary. All of the Company’s joint ventures at February 28, 2011 and November 30, 2010 were determined under the provisions of ASC 810 to be unconsolidated joint ventures, either because they were not VIEs or, if they were VIEs, the Company was not the primary beneficiary of the VIEs.

In the ordinary course of its business, the Company enters into land option and other similar contracts to procure land for the construction of homes. The use of such land option and other similar contracts generally allows the Company to reduce the market risks associated with direct land ownership and development, reduce the Company’s capital and financial commitments, including interest and other carrying costs, and minimize the amount of the Company’s land inventories in its consolidated balance sheets. Under such contracts, the Company will pay a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of ASC 810, certain of these contracts may create a variable interest for the Company, with the land seller being identified as a VIE.

In compliance with ASC 810, the Company analyzes its land option and other similar contracts to determine whether the corresponding land sellers are VIEs and, if so, whether the Company is the primary beneficiary. Although the Company does not have legal title to the optioned land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. As a result of its analyses, the Company determined that as of February 28, 2011 and November 30, 2010 it was not the primary beneficiary of any VIEs from which it is purchasing land under land option and other similar contracts. In determining whether it is the primary beneficiary, the Company considers, among other things, whether it has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance. Such activities would include, among other things, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. The Company also considers whether it has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE.

As of February 28, 2011, the Company had cash deposits totaling $3.1 million associated with land option and other similar contracts that it determined to be unconsolidated VIEs, having an aggregate purchase price of $91.2 million, and had cash deposits totaling $13.2 million associated with land option and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $273.9 million. As of November 30, 2010, the Company had cash deposits totaling $2.6 million associated with land option and other similar contracts that the Company determined to be unconsolidated VIEs, having an aggregate purchase price of $86.1 million, and had cash deposits totaling $12.2 million associated with land option and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $274.3 million.

The Company’s exposure to loss related to its land option and other similar contracts with third parties and unconsolidated entities consisted of its non-refundable deposits, which totaled $16.3 million at February 28, 2011 and $14.8 million at November 30, 2010 and are included in inventories in the Company’s consolidated balance sheets. In addition, the Company had outstanding letters of credit of $3.3 million at February 28, 2011 and $4.2 million at November 30, 2010 in lieu of cash deposits under certain land option or other similar contracts.

The Company also evaluates its land option and other similar contracts for financing arrangements in accordance with Accounting Standards Codification Topic No. 470, “Debt” (“ASC 470”), and, as a result of its evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, in its consolidated balance sheets by $30.0 million at February 28, 2011 and $15.5 million at November 30, 2010.

The Company has investments in unconsolidated joint ventures that conduct land acquisition, development and/or other homebuilding activities in various markets where the Company’s homebuilding operations are located. The Company’s partners in these unconsolidated joint ventures are unrelated homebuilders, and/or land developers and other real estate entities, or commercial enterprises. The Company entered into these unconsolidated joint ventures in previous years to reduce or share market and development risks and increase the number of its owned and controlled homesites. In some instances, participation in unconsolidated joint ventures has enabled the Company to acquire and develop land that it might not otherwise have had access to due to a project’s size, financing needs, duration of development or other circumstances. While the Company has viewed its participation in unconsolidated joint ventures as beneficial to its homebuilding activities, it does not view such participation as essential and has unwound its participation in a number of unconsolidated joint ventures in the past few years.

The Company typically has obtained rights to purchase portions of the land held by the unconsolidated joint ventures in which it currently participates. When an unconsolidated joint venture sells land to the Company’s homebuilding operations, the Company defers recognition of its share of such unconsolidated joint venture earnings until a home sale is closed and title passes to a homebuyer, at which time the Company accounts for those earnings as a reduction of the cost of purchasing the land from the unconsolidated joint venture.

The Company and its unconsolidated joint venture partners make initial and/or ongoing capital contributions to these unconsolidated joint ventures, typically on a pro rata basis. The obligations to make capital contributions are governed by each unconsolidated joint venture’s respective operating agreement and related documents.

Each unconsolidated joint venture is obligated to maintain financial statements in accordance with GAAP. The Company shares in profits and losses of its unconsolidated joint ventures generally in accordance with its respective equity interests. In some instances, the Company recognizes profits and losses related to its investment in an unconsolidated joint venture that differ from its respective equity share in the unconsolidated joint venture. This may arise from impairments recognized by the Company related to its investment that differ from the recognition of impairments by the unconsolidated joint venture with respect to the unconsolidated joint venture’s assets; differences between the Company’s basis in assets it has transferred to an unconsolidated joint venture and the unconsolidated joint venture’s basis in those assets; the deferral of unconsolidated joint venture profits from land sales to the Company; or other items.

With respect to the Company’s investment in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures included pretax, noncash impairment charges of $53.7 million for the three months ended February 28, 2011 to write off the Company’s remaining investment in South Edge, LLC (“South Edge”), an unconsolidated joint venture in the Company’s Southwest reporting segment. The Company determined that its investment in South Edge was no longer recoverable due to a court decision in the period, which is discussed further below. There were no such impairment charges for the three months ended February 28, 2010. Due to the Company’s write-off of its investment in South Edge, the information from the combined condensed statements of operations of the Company’s unconsolidated joint ventures for the three months ended February 28, 2011 and the combined condensed balance sheet information for the Company’s unconsolidated joint ventures as of February 28, 2011, in each case as presented in the tables below, do not include South Edge.

The following table presents information from the combined condensed statements of operations of the Company’s unconsolidated joint ventures (in thousands):

 

Revenues

Construction and land costs

Other expenses, net

 

 

Loss

 

The following table presents combined condensed balance sheet information for the Company’s unconsolidated joint ventures (in thousands):

 

Assets

Cash

Receivables

Inventories

Other assets

 

 

Total assets

 

 

Liabilities and equity

Accounts payable and other liabilities

Mortgages and notes payable

Equity

 

 

Total liabilities and equity

 

The following table presents information relating to the Company’s investments in unconsolidated joint ventures and the outstanding debt of unconsolidated joint ventures as of the dates specified (dollars in thousands):

 

Number of investments in unconsolidated joint ventures:

South Edge (a)

Other (b)

 

 

Total

 

 

Investments in unconsolidated joint ventures:

South Edge (a)

Other

 

 

Total

 

 

Outstanding debt of unconsolidated joint ventures:

South Edge (a)

 

The Company’s unconsolidated joint ventures finance land and inventory investments through a variety of arrangements. To finance their respective land acquisition and development activities, certain of the Company’s unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying

property and related project assets. Of the Company’s unconsolidated joint ventures at November 30, 2010, only South Edge had outstanding debt, which was secured by a lien on South Edge’s assets, of $327.9 million.

In certain instances, the Company and/or its partner(s) in an unconsolidated joint venture have provided completion and/or carve-out guarantees to the venture’s lenders. A completion guaranty refers to the physical completion of improvements for a project and/or the obligation to contribute equity to an unconsolidated joint venture to enable it to fund its completion obligations. The Company’s potential responsibility under its completion guarantees, if triggered, is highly dependent on the facts of a particular case. A carve-out guaranty refers to the payment of losses a lender suffers due to certain bad acts or omissions by an unconsolidated joint venture or its partners, such as fraud or misappropriation, or due to environmental liabilities arising with respect to the relevant project.

In addition to the above-described guarantees, the Company has also provided the Springing Guaranty to the administrative agent for the lenders to South Edge. By its terms, the Springing Guaranty’s obligations arise after the occurrence of (a) an involuntary bankruptcy proceeding or an involuntary bankruptcy petition filed against South Edge that is not dismissed within 60 days or for which an order or decree approving or ordering any such proceeding or petition is entered; or (b) a voluntary bankruptcy commenced by South Edge. The Springing Guaranty and certain legal proceedings regarding South Edge are discussed further below in Note 15. Legal Matters. On February 3, 2011, a court entered an order for relief on a Chapter 11 involuntary bankruptcy petition (the “Petition”) filed against South Edge and a trustee has been appointed. Absent a consensual resolution, the Company anticipates that a demand will be made at some point under the Springing Guaranty. Although the Company will contest any such demand, and although the Company believes there are potential offsets or defenses to prevent or minimize its enforcement, the Company considers its obligation under the Springing Guaranty to be probable. Therefore, the Company’s consolidated financial statements at February 28, 2011 reflect an obligation of $211.8 million, representing its estimate of the probable amount that it would pay to the administrative agent for the lenders to South Edge, including amounts relating to unpaid interest, if it cannot offset or defend against the enforcement of the Springing Guaranty. The Company estimates the amounts relating to unpaid interest to be between $25 million and $35 million. In paying this amount, the Company would expect to assume the lenders’ lien position with respect to the Company’s share of the South Edge land. Thus, in the Company’s consolidated financial statements, the Company’s obligation relating to the Springing Guaranty is partially offset by $75.2 million, the estimated fair value of this South Edge land, which estimate is discussed further below. As a result of recording its probable obligation related to the Springing Guaranty, and taking into account accruals the Company had previously established with respect to its investment in South Edge, the Company recognized a charge of $22.8 million in the first quarter of 2011 that is reflected as a loss on loan guaranty in its consolidated statements of operations. This charge is in addition to the joint venture impairment charge of $53.7 million the Company recognized in the first quarter of 2011 to write off its investment in South Edge.

The Company calculated the estimated fair value of its share of the South Edge land using a present value methodology and assuming that it would develop the land, build and sell homes on most of the land, and sell the remainder of the developed land. This fair value estimate at February 28, 2011 reflected judgments and key assumptions concerning (a) housing market supply and demand conditions, including estimates of average selling prices; (b) estimates of potential future home sales and cancellation rates; (c) anticipated entitlements and development plans for the land; (d) anticipated land development, construction and overhead costs to be incurred; and (e) a risk-free rate of return and an expected risk premium. Due to the judgment and assumptions applied in the estimation process with respect to the fair value of the South Edge land, it is possible that actual results could differ substantially from those estimated.

The South Edge bankruptcy is at an early stage and the ultimate outcome is uncertain. The Company believes, however, that it will realize the value of its share of the South Edge land in the bankruptcy proceeding either through payment on the Springing Guaranty and assumption of the lenders’ lien position, as noted above, and/or through a plan of reorganization for South Edge of which the Company is one of several proponents (a “Supported Plan”). If it assumes the lenders’ lien position, the Company would become a secured lender with respect to its share of the South Edge land and would expect to have first claim on the value generated from the

land. If the Company is one of the proponents of a Supported Plan, which the Company considers to be a likely outcome, the Company would likely acquire its share of the South Edge land as a result of a court-approved disposition of the South Edge land to a newly created entity in which the Company would expect to be a part owner. However, if the Company is not able to realize some or all of the value of its share of the South Edge land, it may be required to recognize an additional expense. Based on the Company’s current estimates, this additional expense could range from near zero to potentially as much as $75 million if the Company could not realize any value from its share of the South Edge land.

 

Operating properties, net

Cash surrender value of insurance contracts

Property and equipment, net

Debt issuance costs

Prepaid expenses

Deferred tax assets

 

 

Total

 

On December 16, 2010, the Company sold a multi-level residential building the Company operated as a rental property for net proceeds of $80.6 million and recognized a gain of $8.8 million on the sale.

Accrued expenses and other liabilities consisted of the following (in thousands):

 

South Edge debt guaranty obligation

Construction defect and other litigation liabilities

Warranty liability

Employee compensation and related benefits

Liabilities related to inventory not owned

Accrued interest payable

Real estate and business taxes

Other

 

 

Total

 

Mortgages and notes payable consisted of the following (in thousands):

 

Mortgages and land contracts due to land sellers and other loans

Senior notes due 2011 at 6 3/8%

Senior notes due 2014 at 5 3/4%

Senior notes due 2015 at 5 7/8%

Senior notes due 2015 at 6 1/4%

Senior notes due 2017 at 9.1%

Senior notes due 2018 at 7 1/4%

 

 

Total

 

In connection with its voluntary termination of the Credit Facility effective March 31, 2010, the Company proceeded to enter into the LOC Facilities to obtain letters of credit in the ordinary course of operating its business. As of February 28, 2011, $93.4 million of letters of credit were outstanding under the LOC Facilities. The LOC Facilities require the Company to deposit and maintain cash with the issuing financial institutions as collateral for its letters of credit outstanding. As of February 28, 2011, the amount of cash maintained for the LOC Facilities totaled $94.4 million and was included in restricted cash on the Company’s consolidated balance sheet as of that date. During 2011, the Company may maintain, revise or enter into additional or expanded letter of credit facilities with the same or other financial institutions.

The termination of the Credit Facility also released and discharged six of the Company’s subsidiaries from guaranteeing obligations with respect to the Company’s senior notes (the “Released Subsidiaries”). Each of the Released Subsidiaries is not a “significant subsidiary,” as defined under Rule 1-02(w) of Regulation S-X, and does not guaranty any other indebtedness of the Company. Each Released Subsidiary may be required to again provide a guaranty with respect to the Company’s senior notes if it becomes a “significant subsidiary.” Three of the Company’s subsidiaries (the “Guarantor Subsidiaries”) continue to provide a guaranty of the Company’s senior notes.

During the three months ended February 28, 2011, the Company repaid debt that was secured by a multi-level residential building, which the Company sold during the period. As the secured debt was repaid at a discount prior to its scheduled maturity, the Company recognized a gain of $3.6 million on the early extinguishment of secured debt during the three months ended February 28, 2011.

The indenture governing the Company’s senior notes does not contain any financial maintenance covenants. Subject to specified exceptions, the indenture contains certain restrictive covenants that, among other things, limit the Company’s ability to incur secured indebtedness, or engage in sale-leaseback transactions involving property or assets above a certain specified value. The terms governing the Company’s $265.0 million of 9.1% senior notes due 2017 (the “$265 Million Senior Notes”) contain certain limitations related to mergers, consolidations, and sales of assets.

As of February 28, 2011, the Company was in compliance with the applicable terms of its covenants under the Company’s senior notes, the indenture, and mortgages and land contracts due to land sellers and other loans. The Company’s ability to secure future debt financing may depend in part on its ability to remain in such compliance.

Commitments and contingencies include the usual obligations of homebuilders for the completion of contracts and those incurred in the ordinary course of business.

Warranty. The Company provides a limited warranty on all of its homes. The specific terms and conditions of warranties vary depending upon the market in which the Company does business. The Company generally provides 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 the home. The Company estimates the costs that may be incurred under each limited warranty and records a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect the Company’s warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. The Company’s primary assumption in estimating the amounts it accrues for warranty costs is that historical claims experience is a strong indicator of future claims experience. The Company periodically assesses the adequacy of its recorded warranty liabilities, which are included in accrued expenses and other liabilities in the consolidated balance sheets, and adjusts the amounts as necessary based on its assessment.

 

Balance at beginning of period

 

Warranties issued

 

Payments

 

Adjustments

 

Balance at end of period

 

The Company’s overall warranty liability of $87.1 million at February 28, 2011 included $9.6 million for estimated remaining repair costs associated with 246 homes that have been identified as containing or suspected of containing allegedly defective drywall manufactured in China. These homes are located in Florida and were primarily delivered in 2006 and 2007. The Company’s overall warranty liability of $94.0 million at November 30, 2010 included $11.3 million for the estimated remaining repair costs associated with 296 such identified affected homes. The decrease in the liability for estimated repair costs associated with identified affected homes during the three months ended February 28, 2011 reflected the lower number of identified affected homes with unresolved repairs at February 28, 2011 compared to November 30, 2010. During the three months ended February 28, 2011, repairs were resolved on 63 identified affected homes, and the Company identified 13 additional affected homes. For these purposes, the Company considers repairs for identified affected homes to be “resolved” when all repairs are complete and all repair costs are fully paid. Repairs for identified affected homes are considered “unresolved” if repairs are not complete and/or there are repair costs remaining to be paid.

The drywall used in the construction of the Company’s homes is purchased and installed by subcontractors. The Company’s subcontractors obtained drywall material from multiple domestic and foreign sources through late 2008. In many cases, the origin of the drywall material obtained before December 2008 cannot be determined. As a result, the Company is unable to readily identify the total number of homes that may contain the allegedly defective drywall material manufactured in China. The Company has identified homes that contain or may contain such drywall material primarily by responding to homeowner-initiated warranty claims or customer service questions regarding such material or regarding conditions or items in a home that may be affected by such material. Additionally, in certain communities where there has been a high number of affected homes identified through the warranty/customer service process, the Company has proactively undertaken community-wide reviews and identified more affected homes. The Company expects to complete all such identified community-wide reviews by the end of May 2011. The Company’s customer service personnel or, in some instances, third-party consultants handle these matters. While the Company continues to respond to individual

warranty/customer service requests as they are made, the number of additional affected homes newly identified each quarter has fallen significantly since the third quarter of 2009 to a nominal amount. As a result, and based on the Company’s experience to date with the nature of the problems caused by the allegedly defective drywall material and the steps the Company has taken since late 2008 to direct its subcontractors to obtain only domestically sourced drywall material, the Company anticipates that after completion of the review process it will have identified substantially all potentially affected homes.

During the three months ended February 28, 2011 and 2010, the Company paid $5.4 million and $3.4 million, respectively, to repair identified affected homes, and estimated its additional repair costs with respect to the identified affected homes to be $3.7 million and $7.6 million, respectively. Since first identifying affected homes in 2009, the Company has identified a total of 450 affected homes and has resolved repairs on 204 of those homes through February 28, 2011. As of February 28, 2011, the Company has paid $32.2 million of the total estimated repair costs of $41.8 million associated with the identified affected homes. Based on its analyses, the Company determined that its overall warranty liability at each reporting date was sufficient with respect to the Company’s then-estimated remaining repair costs associated with identified affected homes and its overall warranty obligations on homes delivered. As a result, the Company did not incur charges in its 2010 fiscal year or in the three months ended February 28, 2011 with respect to such repair costs.

Depending on the number of additional affected homes identified, if any, and the actual costs the Company incurs to complete the above-described review process and repair identified affected homes in future periods, including costs to provide affected homeowners with temporary housing, the Company may revise the estimated amount of its liability with respect to this issue, which could result in an increase or decrease in the Company’s overall warranty liability.

As of February 28, 2011, the Company has been named as a defendant in nine lawsuits relating to the allegedly defective drywall material, and it may in the future be subject to other similar litigation or claims that could cause the Company to incur significant costs. Given the preliminary stages of the proceedings, the Company has not concluded whether the outcome of any of these lawsuits, if unfavorable, is likely to be material to its consolidated financial position or results of operations.

The Company intends to seek and is undertaking efforts, including legal proceedings, to obtain reimbursement from various sources for the costs it has incurred or expects to incur to investigate and complete repairs and to defend itself in litigation associated with this drywall material. At this stage of its efforts, however, the Company has not recorded any amounts for potential recoveries as of February 28, 2011.

Guarantees. In the normal course of its business, the Company issues certain representations, warranties and guarantees related to its home sales and land sales that may be affected by Accounting Standards Codification Topic No. 460, “Guarantees.” Based on historical evidence, the Company does not believe any potential liability with respect to these representations, warranties or guarantees would result in a material effect on its consolidated financial position or results of operations.

Insurance. The Company has, and requires the majority of its subcontractors to have, general liability insurance (including construction defect and bodily injury coverage) and workers’ compensation insurance. These insurance policies protect the Company against a portion of its risk of loss from claims related to its homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. In Arizona, California, Colorado and Nevada, the Company’s general liability insurance takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insured on each project. The Company self-insures a portion of its overall risk through the use of a captive insurance subsidiary. The Company records expenses and liabilities based on the estimated costs required to cover its self-insured retention and deductible amounts under its insurance policies, and on the estimated costs of potential claims and claim adjustment expenses that are above its coverage limits or that are not covered by its policies. These estimated costs are based on an analysis of the Company’s historical claims and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $96.0 million at February 28, 2011 and $95.7 million at November 30, 2010. These amounts are included in accrued expenses and other liabilities in the

Company’s consolidated balance sheets. The Company’s expenses associated with self-insurance totaled $2.3 million for the three months ended February 28, 2011 and $1.8 million for the three months ended February 28, 2010.

Performance Bonds and Letters of Credit. The Company is often required to obtain performance bonds and letters of credit in support of its obligations to various municipalities and other government agencies in connection with community improvements such as roads, sewers and water, and to support similar development activities by certain of its unconsolidated joint ventures. At February 28, 2011, the Company had $440.6 million of performance bonds and $93.4 million of letters of credit outstanding. At November 30, 2010, the Company had $414.3 million of performance bonds and $87.5 million of letters of credit outstanding. If any such performance bonds or letters of credit are called, the Company would be obligated to reimburse the issuer of the performance bond or letter of credit. The Company does not believe that a material amount of any currently outstanding performance bonds or letters of credit will be called. Performance bonds do not have stated expiration dates. Rather, the Company is released from the performance bonds as the underlying performance is completed. The expiration dates of some letters of credit issued in connection with community improvements coincide with the expected completion dates of the related projects or obligations. Most letters of credit, however, are issued with an initial term of one year and are typically extended on a year-to-year basis until the related performance obligation is completed.

Land Option Contracts. In the ordinary course of its business, the Company enters into land option and other similar contracts to procure land for the construction of homes. At February 28, 2011, the Company had total deposits of $19.6 million, comprised of $16.3 million of cash deposits and $3.3 million of letters of credit, to purchase land having an aggregate purchase price of $365.1 million. The Company’s land option and other similar contracts generally do not contain provisions requiring the Company’s specific performance.

On December 9, 2010, certain lenders to South Edge filed the Petition against South Edge in the United States Bankruptcy Court, District of Nevada, titled JPMorgan Chase Bank, N.A. v. South Edge, LLC (Case No. 10-32968-bam). The petitioning lenders were JPMorgan Chase Bank, N.A., Wells Fargo Bank, N.A., and Crédit Agricole Corporate and Investment Bank. KB HOME Nevada Inc., the Company’s wholly-owned subsidiary, is a member of South Edge together with unrelated homebuilders and a third-party property development firm. KB HOME Nevada Inc. holds a 48.5% interest in South Edge.

The Petition alleged 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”), that the petitioning lenders were undersecured, and that South Edge was generally not paying its debts as they became due. The Loans were used by South Edge to partially finance both the purchase of certain real property located near Las Vegas, Nevada and the development of a residential community on that property. The Loans are secured by the underlying property. As of February 28, 2011, the outstanding principal balance of the Loans was $327.9 million.

The petitioning lenders also filed a motion to appoint a Chapter 11 trustee for South Edge, and asserted that, among other actions, the trustee can enforce alleged obligations of the South Edge members to purchase land parcels from South Edge, which would likely result in repayment of the Loans, or enforce alleged obligations of the South Edge members to make capital contributions to the South edge bankruptcy estate. On January 6, 2011, South Edge filed a motion requesting that the court dismiss or abstain from the Petition. The court held a trial that commenced on January 24, 2011, and, on February 3, 2011, the court denied South Edge’s motion, entered an order for relief and appointed a trustee. The trustee may or may not pursue remedies proposed by the petitioning lenders, including attempted enforcement of alleged obligations of the South Edge members as described above.

As a result of the February 3, 2011 order for relief on the Petition, the Company considers it probable that it became responsible to pay certain amounts to the administrative agent for the lenders to South Edge under the Springing Guaranty that the Company provided in connection with the Loans. Each of KB HOME Nevada Inc., the other members of South Edge and their parent companies provided a similar repayment guaranty to the administrative agent for the lenders. If properly triggered, the Springing Guaranty is a partial several guaranty of the Loans according to which an amount of principal and unpaid interest is owed to the administrative agent for the lenders based on a formula. The Loans bear variable rates of base and default interest. Any payments made on the Springing Guaranty, if enforced, would also reduce the debt encumbering the property owned by South Edge.

Absent a consensual resolution, the Company anticipates that a demand will be made at some point under the Springing Guaranty, which the Company will contest. The Company believes it has several grounds to defend against a demand made under the Springing Guaranty. For instance, South Edge has appealed the court’s February 3, 2011 decision on several grounds; if that appeal is successful, the order for relief would be vacated, which, the Company believes, would provide a defense against enforcement of the Springing Guaranty. The Company also believes that the administrative agent and the lenders used the Petition primarily as a way to trigger the Springing Guaranty’s obligations, and that this provides a defense to its enforcement. In addition, the Company believes that there are or could be grounds to reduce or offset amounts potentially due under the Springing Guaranty based on, among other things, the lenders’ use of infrastructure development funds that have been pledged to them, or future sales of land by or on behalf of South Edge, including a potential sale or sales of land by the trustee in the bankruptcy case, either as part of a plan of reorganization or otherwise. While the Company believes it has reasonable grounds to assert them, if necessary, it can make no assurances that its potential offsets or defenses will successfully prevent or meaningfully reduce the impact of an attempt by the administrative agent for the lenders to enforce the Springing Guaranty, and as of February 28, 2011, it considers its potential Springing Guaranty obligation to be probable.

As of February 28, 2011, the Company estimates that its maximum potential payment with respect to the Springing Guaranty would have been $211.8 million, including unpaid interest. The Company estimates the amounts relating to unpaid interest to be between $25 million and $35 million. The Company, KB HOME Nevada Inc., the other members of South Edge, and their parent companies, are involved in discussions with the administrative agent for the lenders regarding the Loans and the South Edge project.

The administrative agent for the lenders had previously filed lawsuits in December 2008 against the South Edge members and their respective parent companies (including the Company 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) and consolidated and related actions) (the “Lender Litigation”). The Lender Litigation seeks to enforce completion guarantees provided to the administrative agent for the lenders in connection with the Loans, seeks to compel the South Edge members (including KB HOME Nevada Inc.) to purchase land parcels from South Edge, seeks to compel the South Edge members to provide certain financial support to South Edge, and also seeks various damages based on other guarantees and claims. The Lender Litigation has been stayed in light of the South Edge bankruptcy.

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 to purchase land parcels from and to make certain capital contributions to South Edge or, in the alternative, damages. On July 6, 2010, the arbitration panel issued a decision denying the specific performance and damages claim asserted on behalf of South Edge, but the panel awarded the claimant damages of $36.8 million against all of the respondents. Motions to partially vacate the award were denied and judgment was entered on the award, which the respondents have appealed to the United States Courts of Appeal for the Ninth Circuit, titled Focus South Group, LLC, et al. v. KB HOME Nevada Inc, et al., (Case No. 10-17562). The appeal 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. Although the appeal remains pending, the Company previously accrued for its proportionate share of the potential damages. This accrual is separate from the accrual the Company established with respect to its probable obligation under the Springing Guaranty.

The ultimate resolution of the South Edge bankruptcy, the Lender Litigation and the appeal of the arbitration panel decision, and the time at which any resolution is reached with respect to each matter, are uncertain and involve multiple factors. These factors include, but are not limited to, a demand made under the Springing Guaranty; the actions of the trustee appointed for South Edge; the outcome of discussions among the administrative agent for the lenders, the South Edge members (including KB HOME Nevada Inc.) and their respective parent companies (including the Company) regarding the Loans and the South Edge project; and decisions by various trial and appellate courts. As stated above in Note 10. Investments in Unconsolidated Joint Ventures, in light of the February 3, 2011 order for relief on the Petition, the Company recorded a liability for the probable obligation under the Springing Guaranty in its consolidated financial statements as of February 28, 2011, and it believes that if it is unable to recover some or all of the value of its share of the South Edge land in the resolution of the South Edge bankruptcy, the Company could recognize an additional expense ranging from near zero to potentially as much as $75 million, based on the Company’s current estimates, in excess of the amounts accrued. Further, the ultimate resolution of the South Edge bankruptcy (including with respect to the Company’s probable obligation under the Springing Guaranty), the Lender Litigation and the appeal of the arbitration panel decision could have a material adverse effect on the Company’s liquidity, as further discussed in this report.

The Company is also involved in other litigation and government proceedings incidental to its business. These other proceedings are in various procedural stages and, based on reports of counsel, the Company believes 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 material adverse effect on its consolidated financial position or results of operations. The outcome of any of these other proceedings, however, is inherently uncertain, and if unfavorable outcomes were to occur, there is a possibility that they could have a material adverse effect on the Company’s consolidated financial position or results of operations.

At February 28, 2011, the Company was authorized to repurchase 4,000,000 shares of its common stock under a board-approved share repurchase program. The Company did not repurchase any of its common stock under this program in the first quarter of 2011. The Company has not repurchased common shares pursuant to a common stock repurchase plan for the past several years and any resumption of such stock repurchases will be at the discretion of the Company’s board of directors.

During the three months ended February 28, 2011, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 17, 2011 to stockholders of record on February 3, 2011. A cash dividend of $.0625 per share of common stock was also declared and paid during the three months ended February 28, 2010.

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-06”), which provides amendments to Accounting Standards Codification Subtopic No. 820-10, “Fair Value Measurements and Disclosures — Overall.” ASU 2010-06 requires additional disclosures and clarifications of existing disclosures for recurring and nonrecurring fair value measurements. The revised guidance was effective for the Company in the second quarter of 2010, except for the Level 3 activity disclosures, which are effective for fiscal years beginning after December 15, 2010. ASU 2010-06 concerns disclosure only and will not have an impact on the Company’s consolidated financial position or results of operations.

In December 2010, the FASB issued Accounting Standards Update No. 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010-29”), which addresses diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in ASU 2010-29 also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in ASU 2010-29 are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company believes the adoption of this guidance concerns disclosure only and will not have a material impact on its consolidated financial position or results of operations.

The Company’s income tax expense totaled $.4 million for the three months ended February 28, 2011 and $.2 million for the three months ended February 28, 2010. Due to the effects of its deferred tax asset valuation allowance, carrybacks of its net operating losses (“NOLs”), and changes in its unrecognized tax benefits, the Company’s effective tax rates for the first quarters of 2011 and 2010 are not meaningful items as the Company’s income tax amounts are not directly correlated to the amount of its pretax losses for those periods.

In accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”), the Company evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During the three months ended February 28, 2011, the Company recorded a valuation allowance of $45.1 million against net deferred tax assets generated from the loss for the period. During the three months ended February 28, 2010, the Company recorded a similar valuation allowance of $21.2 million against net deferred tax assets. The Company’s net deferred tax assets totaled $1.1 million at both February 28, 2011 and November 30, 2010. The deferred tax asset valuation allowance increased to $816.2 million at February 28, 2011 from $771.1 million at November 30, 2010. This increase primarily reflected the impact of the $45.1 million valuation allowance recorded during the first quarter of 2011.

During the three months ended February 28, 2011, the Company had no additions to its total gross unrecognized tax benefits as a result of the current status of federal and state audits. The total amount of unrecognized tax benefits, including interest and penalties, was $6.9 million as of February 28, 2011. The Company anticipates that total unrecognized tax benefits will decrease by an amount ranging from $2.0 million to $3.0 million during the 12 months from this reporting date due to various state filings associated with the resolution of the federal audit.

The benefits of the Company’s NOLs, built-in losses and tax credits would be reduced or potentially eliminated if the Company experienced an “ownership change” under Internal Revenue Code Section 382 (“Section 382”). Based on the Company’s analysis performed as of February 28, 2011, the Company does not believe it has experienced an ownership change as defined by Section 382, and, therefore, the NOLs, built-in losses and tax credits the Company has generated should not be subject to a Section 382 limitation as of this reporting date.

The following are supplemental disclosures to the consolidated statements of cash flows (in thousands):

Summary of cash and cash equivalents at end of period:

Homebuilding

Financial services

 

Total

 

 

Supplemental disclosures of cash flow information:

Interest paid, net of amounts capitalized

Income taxes paid

Income taxes refunded

 

 

Supplemental disclosure of noncash activities:

Increase in inventories in connection with consolidation of joint ventures

Increase in accounts payable, accrued expenses and other liabilities in connection with consolidation of joint ventures

Cost of inventories acquired through seller financing

Increase (decrease) in consolidated inventories not owned

 

The Company’s obligations to pay principal, premium, if any, and interest under its senior notes are guaranteed on a joint and several basis by the Guarantor Subsidiaries. The guarantees are full and unconditional and the Guarantor Subsidiaries are 100% owned by the Company. The Company has determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor Subsidiaries is presented.

In connection with the Company’s voluntary termination of the Credit Facility effective March 31, 2010, the Released Subsidiaries were released and discharged from guaranteeing obligations with respect to the Company’s senior notes. Accordingly, the supplemental financial information presented below reflects the relevant subsidiaries that were Guarantor Subsidiaries as of the respective periods then ended.

 

Revenues

 

 

Homebuilding:

Revenues

Construction and land costs

Selling, general and administrative expenses

Loss on loan guaranty

 

 

Operating income (loss)

Interest income

Interest expense

Equity in loss of unconsolidated joint ventures

 

 

Homebuilding pretax loss

 

Financial services pretax income