XNYS:KBH KB Home Quarterly Report 10-Q Filing - 5/31/2012

Effective Date 5/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended May 31, 2012.

or

 

¨ 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)

 

 

 

Delaware   95-3666267

(State of

incorporation)

 

(IRS employer

identification number)

10990 Wilshire Boulevard

Los Angeles, California 90024

(310) 231-4000

(Address and telephone number of principal executive offices)

 

 

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  x    No  ¨

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  x    No  ¨

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.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of May 31, 2012.

There were 77,117,168 shares of the registrant’s common stock, par value $1.00 per share, outstanding on May 31, 2012. The registrant’s grantor stock ownership trust held an additional 10,839,351 shares of the registrant’s common stock on that date.

 

 

 


Table of Contents

KB HOME

FORM 10-Q

INDEX

 

     Page

Number

 

PART I. FINANCIAL INFORMATION

  

Item 1. Financial Statements

  

Consolidated Statements of Operations — Six Months and Three Months Ended May 31, 2012 and 2011

     3   

Consolidated Balance Sheets — May 31, 2012 and November 30, 2011

     4   

Consolidated Statements of Cash Flows — Six Months Ended May 31, 2012 and 2011

     5   

Notes to Consolidated Financial Statements

     6   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     33   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     56   

Item 4. Controls and Procedures

     56   

PART II. OTHER INFORMATION

  

Item 1. Legal Proceedings

     57   

Item 1A. Risk Factors

     57   

Item 6. Exhibits

     58   

SIGNATURES

     59   

INDEX OF EXHIBITS

     60   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KB HOME

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts – Unaudited)

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Total revenues

   $ 557,410      $ 468,678      $ 302,852      $ 271,738   
  

 

 

   

 

 

   

 

 

   

 

 

 

Homebuilding:

        

Revenues

   $ 552,500      $ 465,284      $ 300,605      $ 269,983   

Construction and land costs

     (477,027     (421,177     (249,669     (250,381

Selling, general and administrative expenses

     (122,158     (112,125     (66,472     (62,520

Loss on loan guaranty

     —          (37,330     —          (14,572
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (46,685     (105,348     (15,536     (57,490

Interest income

     246        653        111        270   

Interest expense

     (30,755     (24,560     (14,469     (13,121

Equity in loss of unconsolidated joint ventures

     (315     (55,929     (243     (92
  

 

 

   

 

 

   

 

 

   

 

 

 

Homebuilding pretax loss

     (77,509     (185,184     (30,137     (70,433
  

 

 

   

 

 

   

 

 

   

 

 

 

Financial services:

        

Revenues

     4,910        3,394        2,247        1,755   

Expenses

     (1,528     (1,652     (693     (787

Equity in income (loss) of unconsolidated joint venture

     89        512        (53     661   
  

 

 

   

 

 

   

 

 

   

 

 

 

Financial services pretax income

     3,471        2,254        1,501        1,629   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total pretax loss

     (74,038     (182,930     (28,636     (68,804

Income tax benefit (expense)

     4,100        (100     4,500        300   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (69,938   $ (183,030   $ (24,136   $ (68,504
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per share

   $ (.91   $ (2.38   $ (.31   $ (.89
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted average shares outstanding

     77,097        76,983        77,105        76,991   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

   $ .0875      $ .1250      $ .0250      $ .0625   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

3


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KB HOME

CONSOLIDATED BALANCE SHEETS

(In Thousands – Unaudited)

 

     May 31,
2012
    November 30,
2011
 

Assets

    

Homebuilding:

    

Cash and cash equivalents

   $ 314,258      $ 415,050   

Restricted cash

     63,182        64,481   

Receivables

     74,028        66,179   

Inventories

     1,727,640        1,731,629   

Investments in unconsolidated joint ventures

     121,408        127,926   

Other assets

     85,197        75,104   
  

 

 

   

 

 

 
     2,385,713        2,480,369   

Financial services

     8,292        32,173   
  

 

 

   

 

 

 

Total assets

   $ 2,394,005      $ 2,512,542   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Homebuilding:

    

Accounts payable

   $ 91,805      $ 104,414   

Accrued expenses and other liabilities

     344,380        374,406   

Mortgages and notes payable

     1,582,788        1,583,571   
  

 

 

   

 

 

 
     2,018,973        2,062,391   
  

 

 

   

 

 

 

Financial services

     5,501        7,494   

Common stock

     115,171        115,171   

Paid-in capital

     887,262        884,190   

Retained earnings

     443,160        519,844   

Accumulated other comprehensive loss

     (26,152     (26,152

Grantor stock ownership trust, at cost

     (117,573     (118,059

Treasury stock, at cost

     (932,337     (932,337
  

 

 

   

 

 

 

Total stockholders’ equity

     369,531        442,657   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,394,005      $ 2,512,542   
  

 

 

   

 

 

 

See accompanying notes.

 

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KB HOME

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands – Unaudited)

 

     Six Months Ended May 31,  
     2012     2011  

Cash flows from operating activities:

    

Net loss

   $ (69,938   $ (183,030

Adjustments to reconcile net loss to net cash used in operating activities:

    

Equity in loss of unconsolidated joint ventures

     226        55,417   

Distributions of earnings from unconsolidated joint ventures

     —          6,313   

Loss on loan guaranty

     —          37,330   

Gain on sale of operating property

     —          (8,825

Amortization of discounts and issuance costs

     1,347        1,108   

Depreciation and amortization

     781        1,160   

Loss (gain) on early extinguishment of debt

     2,003        (3,612

Stock-based compensation expense

     3,205        3,775   

Inventory impairments and land option contract abandonments

     16,509        22,345   

Change in assets and liabilities:

    

Receivables

     16,795        (1,443

Inventories

     (16,131     (167,792

Accounts payable, accrued expenses and other liabilities

     (40,214     (28,080

Other, net

     (4,464     (5,990
  

 

 

   

 

 

 

Net cash used in operating activities

     (89,881     (271,324
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Return of investment in (contributions to) unconsolidated joint ventures

     4,550        (1,919

Proceeds from sale of operating property

     —          80,600   

Purchases of property and equipment, net

     (592     (108
  

 

 

   

 

 

 

Net cash provided by investing activities

     3,958        78,573   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Change in restricted cash

     1,299        1,514   

Proceeds from issuance of senior notes

     344,831        —     

Payment of senior notes issuance costs

     (6,751     —     

Repayment of senior notes

     (340,481     —     

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

     (6,695     (80,826

Issuance of common stock under employee stock plans

     353        442   

Payments of cash dividends

     (6,746     (9,613
  

 

 

   

 

 

 

Net cash used in financing activities

     (14,190     (88,483
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (100,113     (281,234

Cash and cash equivalents at beginning of period

     418,074        908,430   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 317,961      $ 627,196   
  

 

 

   

 

 

 

See accompanying notes.

 

5


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KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation and Significant Accounting Policies

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 May 31, 2012, the results of its consolidated operations for the six months and three months ended May 31, 2012 and 2011, and its consolidated cash flows for the six months ended May 31, 2012 and 2011. The results of consolidated operations for the six months and three months ended May 31, 2012 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, 2011 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, 2011, which are contained in the Company’s Annual Report on Form 10-K for that period.

Use of Estimates

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.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid short-term investments purchased with an original maturity of three months or less to be cash equivalents. The Company’s cash equivalents totaled $197.6 million at May 31, 2012 and $212.8 million at November 30, 2011. The majority of the Company’s cash and cash equivalents were invested in money market accounts and U.S. government securities.

Restricted cash of $63.2 million at May 31, 2012 and $64.5 million at November 30, 2011 consisted of cash deposited with various financial institutions that was required as collateral for the Company’s cash-collateralized letter of credit facilities (the “LOC Facilities”).

Loss Per Share

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

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Numerator:

        

Net loss

   $ (69,938   $ (183,030   $ (24,136   $ (68,504
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Basic and diluted average shares outstanding

     77,097        76,983        77,105        76,991   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per share

   $ (.91   $ (2.38   $ (.31   $ (.89
  

 

 

   

 

 

   

 

 

   

 

 

 

All outstanding stock options were excluded from the diluted loss per share calculations for the six months and three months ended May 31, 2012 and 2011 because the effect of their inclusion would be antidilutive, or would decrease the reported loss per share.

 

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Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation and Significant Accounting Policies (continued)

 

Comprehensive Loss

The Company’s comprehensive loss was $24.1 million for the three months ended May 31, 2012 and $68.5 million for the three months ended May 31, 2011. The Company’s comprehensive loss was $69.9 million for the six months ended May 31, 2012 and $183.0 million for the six months ended May 31, 2011. The accumulated balances of other comprehensive loss in the consolidated balance sheets as of May 31, 2012 and November 30, 2011 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).

 

2. Stock-Based Compensation

The Company measures and recognizes compensation expense associated with its grants 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.

Stock Options

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 May 31, 2012, as well as stock options activity during the six months then ended:

 

     Options     Weighted
Average Exercise
Price
 

Options outstanding at beginning of period

     10,160,396      $ 21.27   

Granted

     30,000        9.08   

Exercised

     —          —     

Cancelled

     (7,000     20.95   
  

 

 

   

Options outstanding at end of period

     10,183,396        21.24   
  

 

 

   

Options exercisable at end of period

     7,240,732        26.27   
  

 

 

   

As of May 31, 2012, the weighted average remaining contractual life of stock options outstanding and stock options exercisable was 6.8 years and 6.1 years, respectively. There was $3.5 million of total unrecognized compensation cost related to unvested stock option awards as of May 31, 2012. For the three months ended May 31, 2012 and 2011, stock-based compensation expense associated with stock options totaled $1.2 million and $1.3 million, respectively. For the six months ended May 31, 2012 and 2011, stock-based compensation expense associated with stock options totaled $2.4 million and $2.7 million, respectively. The aggregate intrinsic value of stock options outstanding was $1.5 million at May 31, 2012. Stock options exercisable had no aggregate intrinsic value at May 31, 2012. (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.)

 

7


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. Stock-Based Compensation (continued)

 

Other Stock-Based Awards

From time to time, the Company grants restricted common stock, phantom shares and stock appreciation rights (“SARs”) to various employees. In some cases, the Company has granted phantom shares and SARs that can be settled only in cash and are therefore accounted for as liability awards. The Company recognized total compensation expense of $.4 million in each of the three months ended May 31, 2012 and 2011 related to restricted common stock and phantom shares. The Company recognized total compensation expense of $.8 million in the six months ended May 31, 2012 and $1.4 million in the six months ended May 31, 2011 related to these stock-based awards.

 

3. Segment Information

As of May 31, 2012, 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 May 31, 2012, the Company’s homebuilding reporting segments conducted ongoing operations in the following states:

West Coast: California

Southwest: Arizona and Nevada

Central: Colorado and Texas

Southeast: Florida, Maryland, North Carolina and Virginia

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 in the same markets as the Company’s homebuilding reporting segments. In addition, since the third quarter of 2011, this segment has earned revenues pursuant to the terms of a marketing services agreement with a preferred mortgage lender that offers mortgage banking services, including residential consumer mortgage loan originations, to the Company’s homebuyers who elect to use the lender. The Company’s homebuyers are under no obligation to use the Company’s preferred mortgage lender and may select any lender of their choice to obtain mortgage financing for the purchase of a home. The Company makes available to its homebuyers marketing materials and other information regarding its preferred mortgage lender’s financing options and mortgage loan products, and is compensated solely for the fair market value of these services. Prior to late June 2011, this segment provided mortgage banking services to the Company’s homebuyers indirectly through KBA Mortgage, LLC (“KBA Mortgage”), a former unconsolidated joint venture of a subsidiary of the Company and a subsidiary of Bank of America, N.A., with each partner having had a 50% interest in the joint venture.

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):

 

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Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. Segment Information (continued)

 

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Revenues:

        

West Coast

   $ 237,884      $ 178,914      $ 132,651      $ 107,143   

Southwest

     59,493        51,932        27,909        28,632   

Central

     168,030        144,790        87,756        84,201   

Southeast

     87,093        89,648        52,289        50,007   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

     552,500        465,284        300,605        269,983   

Financial services

     4,910        3,394        2,247        1,755   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 557,410      $ 468,678      $ 302,852      $ 271,738   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pretax income (loss):

        

West Coast

   $ (33,454   $ 6,591      $ (14,694   $ (2,274

Southwest

     (7,182     (116,821     (2,139     (36,492

Central

     (4,138     (10,202     (631     (3,493

Southeast

     320        (23,021     4,579        (8,993

Corporate and other (a)

     (33,055     (41,731     (17,252     (19,181
  

 

 

   

 

 

   

 

 

   

 

 

 

Total homebuilding loss

     (77,509     (185,184     (30,137     (70,433

Financial services

     3,471        2,254        1,501        1,629   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (74,038   $ (182,930   $ (28,636   $ (68,804
  

 

 

   

 

 

   

 

 

   

 

 

 

Equity in loss of unconsolidated joint ventures:

        

West Coast

   $ (77   $ (17   $ (32   $ (80

Southwest

     (217     (55,902     (209     (2

Central

     —          —          —          —     

Southeast

     (21     (10     (2     (10
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (315   $ (55,929   $ (243   $ (92
  

 

 

   

 

 

   

 

 

   

 

 

 

Inventory impairments:

        

West Coast

   $ 13,107      $ 1,351      $ 6,535      $ 1,351   

Southwest

     2,135        18,715        2,135        18,324   

Central

     1,267        51        1,267        —     

Southeast

     —          969        —          419   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 16,509      $ 21,086      $ 9,937      $ 20,094   
  

 

 

   

 

 

   

 

 

   

 

 

 

Land option contract abandonments:

        

West Coast

   $ —        $ 112      $ —        $ —     

Southwest

     —          296        —          296   

Central

     —          240        —          —     

Southeast

     —          611        —          201   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ —        $ 1,259      $ —        $ 497   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Corporate and other includes corporate general and administrative expenses.

 

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KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. Segment Information (continued)

 

 

     Six Months Ended May 31,      Three Months Ended May 31,  
     2012      2011      2012      2011  

Joint venture impairments:

           

West Coast

   $ —         $ —         $ —         $ —     

Southwest

     —           53,727         —           —     

Central

     —           —           —           —     

Southeast

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $       —         $ 53,727       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     May 31,
2012
     November 30,
2011
 

Assets:

     

West Coast

   $ 968,793       $ 995,888   

Southwest

     311,475         338,586   

Central

     339,314         336,553   

Southeast

     333,548         317,308   

Corporate and other

     432,583         492,034   
  

 

 

    

 

 

 

Total homebuilding assets

     2,385,713         2,480,369   

Financial services

     8,292         32,173   
  

 

 

    

 

 

 

Total assets

   $ 2,394,005       $ 2,512,542   
  

 

 

    

 

 

 

Investments in unconsolidated joint ventures:

     

West Coast

   $ 38,328       $ 38,405   

Southwest

     73,439         80,194   

Central

     —           —     

Southeast

     9,641         9,327   
  

 

 

    

 

 

 

Total

   $ 121,408       $ 127,926   
  

 

 

    

 

 

 

 

4. Financial Services

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

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Revenues

        

Insurance commissions

   $ 2,754      $ 2,586      $ 1,154      $ 1,333   

Title services

     878        803        492        419   

Marketing services fees

     1,275        —          600        —     

Interest income

     3        5        1        3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     4,910        3,394        2,247        1,755   

Expenses

        

General and administrative

     (1,528     (1,652     (693     (787
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     3,382        1,742        1,554        968   

Equity in income (loss) of unconsolidated joint venture

     89        512        (53     661   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pretax income

   $ 3,471      $ 2,254      $ 1,501      $ 1,629   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

4. Financial Services (continued)

 

 

     May 31,
2012
     November 30,
2011
 

Assets

     

Cash and cash equivalents

   $ 3,703       $ 3,024   

Receivables (a)

     851         25,495   

Investment in unconsolidated joint venture

     3,728         3,639   

Other assets

     10         15   
  

 

 

    

 

 

 

Total assets

   $ 8,292       $ 32,173   
  

 

 

    

 

 

 

Liabilities

     

Accounts payable and accrued expenses

   $ 5,501       $ 7,494   
  

 

 

    

 

 

 

Total liabilities

   $ 5,501       $ 7,494   
  

 

 

    

 

 

 

 

(a) In December 2011, the Company collected a $23.5 million receivable it established in the fourth quarter of 2011 in connection with the wind down of KBA Mortgage’s business operations.

 

5. Inventories

Inventories consisted of the following (in thousands):

 

     May 31,
2012
     November 30,
2011
 

Homes under construction

   $ 469,880       $ 417,304   

Land under development

     532,520         587,582   

Land held for future development

     725,240         726,743   
  

 

 

    

 

 

 

Total

   $ 1,727,640       $ 1,731,629   
  

 

 

    

 

 

 

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

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Capitalized interest at beginning of period

   $ 233,461      $ 249,966      $ 234,917      $ 253,040   

Interest incurred (a)

     60,020        55,399        29,609        29,462   

Interest expensed (a)

     (30,755     (24,560     (14,469     (13,121

Interest amortized to construction and land costs

     (27,694     (31,013     (15,025     (19,589
  

 

 

   

 

 

   

 

 

   

 

 

 

Capitalized interest at end of period (b)

   $ 235,032      $ 249,792      $ 235,032      $ 249,792   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Amounts for the six months ended May 31, 2012 include a $2.0 million loss on early extinguishment of debt. Amounts for the six months ended May 31, 2011 include a $3.6 million gain on the early extinguishment of secured debt.
(b)

Inventory impairment charges are recognized against all inventory costs of a community, such as land, land development, cost of home construction and capitalized interest. Capitalized interest amounts presented

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

5. Inventories (continued)

 

in the table reflect the gross amount of capitalized interest as impairment charges recognized are not generally allocated to specific components of inventory.

 

6. Inventory Impairments and Land Option Contract Abandonments

Each community or land parcel in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each community or land parcel on a quarterly basis and include, but are not limited to: significant decreases in sales rates, average selling prices, volume of homes delivered, gross profit margins on homes delivered or projected gross profit 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 community or land parcel, the identified asset is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). The Company evaluated 39 and 33 communities or land parcels for recoverability during the three months ended May 31, 2012 and 2011, respectively. The Company evaluated 76 and 64 communities or land parcels for recoverability during the six months ended May 31, 2012 and 2011, respectively. Some of the communities or land parcels evaluated during the six months ended May 31, 2012 and 2011 were evaluated in more than one quarterly period.

When an indicator of potential impairment is identified for a community or land parcel, 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 then-current conditions and trends in the market in which the asset is located as well as factors known to the Company at the time the cash flows are calculated. The undiscounted future net cash flows consider recent trends in the Company’s sales, backlog and cancellation rates. Also taken into account are the Company’s future expectations related to the following: 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. With respect to the three months and six months ended May 31, 2012 and 2011, these expectations reflected the Company’s experience that market conditions for its assets in inventory where impairment indicators were identified have been generally stable in 2011 and into 2012, with no significant deterioration or improvement identified as to revenue and cost drivers. In the Company’s assessments during the first half of 2012, the Company determined that the year-over-year decrease in net orders in the first quarter of 2012 and modest increase in net orders in the second quarter of 2012 did not reflect a sustained change in market conditions preventing recoverability. Rather, the Company considered that the changes reflected period-specific residential consumer mortgage loan funding issues arising from a change in the nature of the Company’s relationships with mortgage lenders during the period. The Company believes such issues will be mitigated in future periods as a result of an operational transition to its new preferred mortgage lender, as well as the Company’s expected ability to continue to generate a consistent or higher average selling price. The Company’s year-over-year net order comparison for the first half of 2012 also reflected a lower number of new home communities open for sales. Based on this experience, and taking into account the signs of stability in many markets for new home sales, the Company’s inventory assessments as of May 31, 2012 considered an expected steady, if slightly improved, overall sales pace for the remainder of 2012 relative to the pace in the second half of 2011.

Given the inherent challenges and uncertainties in forecasting future results, the Company’s inventory assessments at the time they are made generally assume the continuation of then-current market conditions, subject to identifying information suggesting a significant sustained deterioration or improvement, or other changes, in such conditions. Therefore, the Company’s inventory assessments, at the time made, anticipate sales rates, average selling prices and costs to generally continue at or near then-current levels through the affected asset’s estimated remaining life. Inventory assessments for the Company’s land held for future development also incorporate highly subjective forecasts for future performance, including the timing and projected costs of development and construction, the product to be offered, and the sales rates and selling prices of the product when an associated community is anticipated to open for sales. The Company evaluates various factors to develop these forecasts, including the availability of and demand for homes and finished lots within the relevant marketplace; historical, current and future sales trends for the marketplace; and third-party data, if available.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

6. Inventory Impairments and Land Option Contract Abandonments (continued)

 

Based on these factors, the Company formulates assumptions for future performance that it believes are reasonable. These various estimates, trends, expectations and assumptions used in the Company’s inventory assessments are specific to each community or land parcel and may vary among communities or land parcels and over time.

The Company records an inventory impairment charge when the carrying value of a real estate asset is greater than the undiscounted future net cash flows the asset is expected to generate. These real estate assets are written down to fair value, which is primarily based on the estimated future net cash flows discounted for inherent risk associated with each such asset. Inputs used in the estimated discounted future net cash flows are specific to each affected community or land parcel and are based on expectations of the Company’s local management teams for each such asset as of the applicable measurement date, including, among others, expectations related to average selling prices and delivery rates. The discount rates used are impacted by the following: 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.

The following table summarizes ranges for significant quantitative unobservable inputs the Company utilized in its fair value measurements with respect to the impaired communities or land parcels written down to fair value during the six months and three months ended May 31, 2012:

 

Unobservable Input

  

Six Months Ended May 31, 2012

  

Three Months Ended May 31, 2012

Average selling price

   $115,200 - $498,000    $115,200 - $487,300

Deliveries per month

   1 - 6    1 - 6

Discount rate

   17% - 20%    17% - 20%

Based on the results of its evaluations, the Company recognized inventory impairment charges of $9.9 million in the three months ended May 31, 2012 associated with five communities with a post-impairment fair value of $15.2 million. In the three months ended May 31, 2011, the Company recognized $20.1 million of such charges associated with five communities with a post-impairment fair value of $27.6 million. These charges included an $18.1 million adjustment to the fair value of real estate collateral in the Company’s Southwest homebuilding reporting segment that the Company took back on a note receivable. In the six months ended May 31, 2012, the Company recognized inventory impairment charges of $16.5 million associated with seven communities with a post-impairment fair value of $27.4 million. In the six months ended May 31, 2011, the Company recognized $21.1 million of such charges associated with eight communities or land parcels with a post-impairment fair value of $28.8 million.

As of May 31, 2012, the aggregate carrying value of the Company’s inventory that had been impacted by inventory impairment charges was $351.2 million, representing 50 communities and various other land parcels. As of November 30, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by inventory impairment charges was $338.5 million, representing 53 communities and various other land parcels.

The Company’s inventory controlled under land option contracts and other similar contracts is assessed to determine whether it continues to meet the Company’s internal investment and marketing standards. Assessments are made separately for each optioned land parcel on a quarterly basis and are affected by the following factors, among others: 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 contracts and other similar contracts due to market conditions and/or changes in its marketing strategy, the Company writes off the related inventory costs, including non-refundable deposits and pre-acquisition costs. Based on the results of its assessments, the Company recognized no land option contract abandonment charges in the three months or six months ended May 31, 2012. In the three months ended May 31, 2011, the Company recognized $.5 million of land option contract abandonment charges corresponding to 117 lots. In the six months ended May 31, 2011, the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

6. Inventory Impairments and Land Option Contract Abandonments (continued)

 

Company recognized $1.3 million of such charges corresponding to 258 lots. Inventory impairment and land option contract abandonment charges are included in construction and land costs in the Company’s consolidated statements of operations.

The estimated remaining life of each community or land parcel in the Company’s inventory depends on various factors, such as the total number of lots remaining; the expected timeline to acquire and entitle land and develop lots to build homes; the anticipated future sales and cancellation rates; and the expected timeline to build and deliver homes sold. While it is difficult to determine a precise timeframe for any particular inventory asset, the Company estimates its inventory assets’ remaining operating lives under current and expected future market conditions to range generally from one year to in excess of 10 years. Based on current market conditions and expected delivery timelines, the Company expects to realize, on an overall basis, the majority of its current inventory balance within five years.

Due to the judgment and assumptions applied in the estimation process with respect to inventory impairments, land option contract abandonments, the remaining operating lives of the Company’s inventory assets and the realization of its inventory balances, it is possible that actual results could differ substantially from those estimated.

 

7. Fair Value Disclosures

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:

 

  Level 1

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

  Level 2

   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.

  Level 3

   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 is not recoverable. The following table presents the Company’s assets measured at fair value on a nonrecurring basis during the six months ended May 31, 2012 and the year ended November 30, 2011 (in thousands):

 

     Fair Value  

Description

   Hierarchy    May 31,
2012 (a)
     November 30,
2011 (a)
 

Long-lived assets held and used

   Level 2    $ —         $ 75   

Long-lived assets held and used

   Level 3      27,396         33,947   
     

 

 

    

 

 

 

Total

      $ 27,396       $ 34,022   
     

 

 

    

 

 

 

 

(a) Amounts represent the aggregate fair values for communities or land parcels for which the Company recognized inventory impairment charges during the period, as of the date that the fair value measurements were made. The carrying value for these communities or land parcels may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

7. Fair Value Disclosures (continued)

 

In accordance with the provisions of ASC 360, long-lived assets held and used with a carrying value of $43.9 million were written down to their fair value of $27.4 million during the six months ended May 31, 2012, resulting in inventory impairment charges of $16.5 million. Long-lived assets held and used with a carrying value of $56.7 million were written down to their fair value of $34.0 million during the year ended November 30, 2011, resulting in inventory impairment charges of $22.7 million.

The fair values for the Company’s long-lived assets held and used that were determined using Level 2 inputs were based on an executed contract. The fair values for long-lived assets held and used that were determined using Level 3 inputs were primarily based on the estimated future net cash flows discounted for inherent risk associated with each asset as described in Note 6. Inventory Impairments and Land Option Contract Abandonments. The discount rates used were impacted by the following: 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 was located at the time the assessment was made. These factors were specific to each affected community or land parcel and may have varied among communities or land parcels.

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 fair value hierarchy, carrying values and estimated fair values of the Company’s financial instruments, except those for which the carrying values approximate fair values (in thousands):

 

            May 31, 2012      November 30, 2011  
     Fair Value
Hierarchy
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 

Financial Liabilities:

              

Senior notes due 2014 at 5  3/4%

     Level 2       $ 193,482       $ 191,033       $ 249,647       $ 232,500   

Senior notes due 2015 at 5  7/8%

     Level 2         169,657         163,207         299,273         270,000   

Senior notes due 2015 at 6  1/4%

     Level 2         296,179         285,556         449,795         401,625   

Senior notes due 2017 at 9.10%

     Level 2         261,141         267,650         260,865         235,519   

Senior notes due 2018 at 7  1/4%

     Level 2         299,067         282,000         299,007         251,625   

Senior notes due 2020 at 8.00%

     Level 2         344,973         339,500         —           —     

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.

 

8. Variable Interest Entities

The Company participates in joint ventures from time to time that conduct 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 May 31, 2012 and November 30, 2011 were determined under the provisions of ASC 810 to be unconsolidated joint ventures and were accounted for under the equity method, either because they were not VIEs or, if they were VIEs, the Company was not the primary beneficiary of the VIEs.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. Variable Interest Entities (continued)

 

In the ordinary course of its business, the Company enters into land option contracts and other similar contracts to procure rights to land parcels for the construction of homes. The use of such land option contracts and other similar contracts generally allows the Company to reduce the market risks associated with direct land ownership and development, and to reduce the Company’s capital and financial commitments, including interest and other carrying costs. Under such contracts, the Company typically pays 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 contracts 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 underlying land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. 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 a result of its analyses, the Company determined that as of May 31, 2012 and November 30, 2011 it was not the primary beneficiary of any VIEs from which it is purchasing land under land option contracts and other similar contracts.

As of May 31, 2012, the Company had cash deposits totaling $2.9 million associated with land option contracts and other similar contracts that it determined were unconsolidated VIEs, having an aggregate purchase price of $267.3 million, and had cash deposits totaling $20.9 million associated with land option contracts and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $351.9 million. As of November 30, 2011, the Company had cash deposits totaling $8.1 million associated with land option contracts and other similar contracts that it determined were unconsolidated VIEs, having an aggregate purchase price of $122.1 million, and had cash deposits totaling $12.8 million associated with land option contracts and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $223.0 million.

The Company’s exposure to loss related to its land option contracts and other similar contracts with third parties and unconsolidated entities consisted of deposits and pre-acquisition costs, which totaled $23.8 million and $27.1 million, respectively, at May 31, 2012 and $20.9 million and $31.5 million, respectively, at November 30, 2011. These amounts are included in inventories in the Company’s consolidated balance sheets. In addition, the Company had outstanding letters of credit of $.5 million at May 31, 2012 and $1.7 million at November 30, 2011 in lieu of cash deposits under certain land option contracts or other similar contracts.

The Company also evaluates its land option contracts 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 $20.3 million at May 31, 2012 and $23.9 million at November 30, 2011.

 

9. Investments in Unconsolidated Joint Ventures

The Company has investments in unconsolidated joint ventures that conduct land acquisition, development and/or other homebuilding activities in various markets where its 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. These investments are designed primarily to reduce market and development risks and to increase the number of homesites owned and controlled by the Company. In some instances, participating in unconsolidated joint ventures has enabled the Company to acquire

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

9. Investments in Unconsolidated Joint Ventures (continued)

 

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 considers its participation in unconsolidated joint ventures as potentially 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’s 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 equal to their respective equity interests. The obligations to make capital contributions are governed by each such unconsolidated joint venture’s respective operating agreement and related governing documents.

Each unconsolidated joint venture is obligated to maintain financial statements in accordance with GAAP. The Company shares in the profits and losses of these 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 equity interest 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 the unconsolidated joint venture and the unconsolidated joint venture’s basis in those assets; the deferral of the unconsolidated joint venture profits from land sales to the Company; or other items.

With respect to the Company’s investments in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures included no impairment charges for the six months ended May 31, 2012 and $53.7 million of such charges for the six months ended May 31, 2011. The impairment charges for the six months ended May 31, 2011 reflected the write-off of the Company’s remaining investment in South Edge, LLC (“South Edge”). South Edge was a residential development joint venture in the Company’s Southwest homebuilding reporting segment. The Company wrote off its remaining investment in South Edge based on the Company’s determination that South Edge was no longer able to perform its activities as originally intended following a court decision in the first quarter of 2011 to enter an order for relief on a Chapter 11 involuntary bankruptcy petition filed against the joint venture.

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

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Revenues

   $ —        $ 230      $ —        $ —     

Construction and land costs

     6        (201     —          21   

Other expenses, net

     (749     (4,605     (288     (238
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss

   $ (743   $ (4,576   $ (288   $ (217
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

9. Investments in Unconsolidated Joint Ventures (continued)

 

 

     May  31,
2012
     November 30,
2011
 

Assets

     

Cash

   $ 24,060       $ 8,923   

Receivables

     12,009         19,503   

Inventories

     360,007         368,306   

Other assets

     150         151   
  

 

 

    

 

 

 

Total assets

   $ 396,226       $ 396,883   
  

 

 

    

 

 

 

Liabilities and equity

     

Accounts payable and other liabilities

   $ 93,990       $ 96,981   

Equity

     302,236         299,902   
  

 

 

    

 

 

 

Total liabilities and equity

   $ 396,226       $ 396,883   
  

 

 

    

 

 

 

The following table presents information relating to the Company’s investments in unconsolidated joint ventures (dollars in thousands):

 

     May 31,
2012
     November 30,
2011
 

Number of investments in unconsolidated joint ventures (a)

     8         8   
  

 

 

    

 

 

 

Investments in unconsolidated joint ventures (a)

   $ 121,408       $ 127,926   
  

 

 

    

 

 

 

 

(a) The Company’s investments in unconsolidated joint ventures as of May 31, 2012 and November 30, 2011 include Inspirada Builders, LLC, an unconsolidated joint venture that was formed in 2011 in connection with the South Edge Plan (as defined below) and in which a wholly owned subsidiary of the Company is a member. As part of the South Edge Plan, land previously owned by South Edge was transferred to Inspirada Builders, LLC in November 2011. The Company anticipates that it will acquire its share of the land from Inspirada Builders, LLC through a future distribution.

The Company’s unconsolidated joint ventures finance land and inventory investments for a project 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. However, none of the Company’s unconsolidated joint ventures had outstanding debt at May 31, 2012 or November 30, 2011.

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 unconsolidated joint venture’s lenders. A completion guaranty refers to the physical completion of improvements for a project and/or the obligation to contribute capital 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. The Company does not believe it currently has exposure with respect to any of its completion or carve-out guarantees.

In the first quarter of 2011, as a result of recording a probable obligation related to a limited several repayment guaranty (the “Springing Guaranty”) that the Company had provided to the administrative agent for the lenders

 

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9. Investments in Unconsolidated Joint Ventures (continued)

 

to South Edge, and taking into account accruals it had previously established with respect to its investment in South Edge, the Company recognized a charge of $22.8 million that was reflected as a loss on loan guaranty in its consolidated statements of operations. This charge was in addition to the joint venture impairment charge of $53.7 million to write off the Company’s remaining investment in South Edge. In the second quarter of 2011, in updating the estimate of its probable net payment obligation to reflect the terms of an agreement regarding a proposed consensual plan of reorganization for South Edge (the “South Edge Plan”), the Company recorded an additional loss on loan guaranty of $14.6 million. South Edge underwent and completed a bankruptcy reorganization under the South Edge Plan in 2011. In connection with a bankruptcy court’s confirmation of the South Edge Plan in November 2011 and the resolution of other matters concerning South Edge, the Company’s obligations under the Springing Guaranty were eliminated in the fourth quarter of 2011.

 

10. Other Assets

Other assets consisted of the following (in thousands):

 

     May 31,
2012
     November 30,
2011
 

Cash surrender value of insurance contracts

   $ 61,933       $ 59,718   

Debt issuance costs

     10,032         4,219   

Property and equipment, net

     7,617         7,801   

Prepaid expenses

     4,463         2,214   

Net deferred tax assets

     1,152         1,152   
  

 

 

    

 

 

 

Total

   $ 85,197       $ 75,104   
  

 

 

    

 

 

 

 

11. Accrued Expenses and Other Liabilities

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

 

     May 31,
2012
     November 30,
2011
 

Construction defect and other litigation liabilities

   $ 109,953       $ 101,017   

Employee compensation and related benefits

     75,550         76,960   

Warranty liability

     50,866         67,693   

Accrued interest payable

     45,172         43,129   

Liabilities related to inventory not owned

     20,293         23,903   

Real estate and business taxes

     3,340         10,770   

Other

     39,206         50,934   
  

 

 

    

 

 

 

Total

   $ 344,380       $ 374,406   
  

 

 

    

 

 

 

 

12. Mortgages and Notes Payable

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

 

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(Unaudited)

 

12. Mortgages and Notes Payable (continued)

 

 

     May 31,
2012
     November 30,
2011
 

Mortgages and land contracts due to land sellers and other loans

   $ 18,289       $ 24,984   

Senior notes due 2014 at 5  3/4%

     193,482         249,647   

Senior notes due 2015 at 5  7/8%

     169,657         299,273   

Senior notes due 2015 at 6  1/4%

     296,179         449,795   

Senior notes due 2017 at 9.10%

     261,141         260,865   

Senior notes due 2018 at 7  1/4%

     299,067         299,007   

Senior notes due 2020 at 8.00%

     344,973         —     
  

 

 

    

 

 

 

Total

   $ 1,582,788       $ 1,583,571   
  

 

 

    

 

 

 

The Company maintains the LOC Facilities to provide letters of credit in the ordinary course of operating its business. As of May 31, 2012 and November 30, 2011, $61.8 million and $63.8 million, respectively, 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. The Company may maintain, revise or, if necessary or desirable, enter into additional or expanded letter of credit facilities, or other similar facility arrangements, with the same or other financial institutions.

On February 7, 2012, pursuant to its universal shelf registration statement filed with the SEC on September 20, 2011 (the “2011 Shelf Registration”), the Company issued $350.0 million in aggregate principal amount of 8.00% senior notes due 2020 (the “$350 Million Senior Notes”). The $350 Million Senior Notes, which are due on March 15, 2020, with interest payable semi-annually, represent senior unsecured obligations of the Company and rank equally in right of payment with all of the Company’s existing and future senior unsecured indebtedness. The $350 Million Senior Notes may be redeemed, in whole at any time or from time to time in part, at a price equal to the greater of (a) 100% of their principal amount and (b) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the date of redemption at a defined rate, plus, in each case, accrued and unpaid interest to the applicable redemption date. If a change in control occurs as defined in the instruments governing the $350 Million Senior Notes, the Company would be required to offer to purchase the $350 Million Senior Notes at 101% of their principal amount, together with all accrued and unpaid interest, if any. The $350 Million Senior Notes are unconditionally guaranteed jointly and severally by certain of the Company’s subsidiaries (the “Guarantor Subsidiaries”) on a senior unsecured basis. The Company used substantially all of the net proceeds from the issuance of the $350 Million Senior Notes to purchase, pursuant to the terms of tender offers that were initially made on January 19, 2012 (the “Tender Offers”), $56.3 million in aggregate principal amount of its 5  3/4% senior notes due 2014, $130.0 million in aggregate principal amount of its 5  7/8 % senior notes due 2015, and $153.7 million in aggregate principal amount of its 6  1/4% senior notes due 2015. The applicable Tender Offers expired on February 15, 2012. The total amount paid to purchase these senior notes was $340.5 million. The Company incurred a loss of $2.0 million in the first quarter of 2012 related to the early redemption of debt due to a premium paid under the Tender Offers and the unamortized original issue discount.

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. Unlike the Company’s other senior notes, the terms governing both the Company’s $265.0 million in aggregate principal amount of 9.10% senior notes due 2017 (the “$265 Million Senior Notes”) and the $350 Million Senior Notes contain certain limitations related to mergers, consolidations, and sales of assets.

As of May 31, 2012, the Company was in compliance with the applicable terms of all 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.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

12. Mortgages and Notes Payable (continued)

 

Principal payments on senior notes, mortgages and land contracts due to land sellers and other loans are due as follows: 2012 –$15.9 million; 2013 – $2.4 million; 2014 – $193.5 million; 2015 – $465.8 million; 2016 – $0; and thereafter – $905.2 million.

 

13. Commitments and Contingencies

Commitments and contingencies include typical 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 these limited 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 accrued warranty liability, which is included in accrued expenses and other liabilities in the consolidated balance sheets, and adjusts the amount as necessary based on its assessment. The Company’s assessment includes the review of its actual warranty costs incurred to identify trends and changes in its warranty claims experience, and considers the Company’s construction quality and customer service initiatives and outside events. While the Company believes the warranty liability reflected in its consolidated balance sheets to be adequate, unanticipated changes in the legal environment, local weather, land or environmental conditions, quality of materials or methods used in the construction of homes, or customer service practices could have a significant impact on its actual warranty costs in the future and such amounts could differ from the Company’s current estimates.

The changes in the Company’s warranty liability are as follows (in thousands):

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Balance at beginning of period

   $ 67,693      $ 93,988      $ 64,607      $ 87,061   

Warranties issued

     2,973        1,981        1,656        1,133   

Payments

     (8,703     (14,471     (4,267     (6,662

Adjustments (a)

     (11,097     1,132        (11,130     1,098   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 50,866      $ 82,630      $ 50,866      $ 82,630   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) The Company’s warranty adjustments for the three months and six months ended May 31, 2012 include $11.2 million of adjustments that were recorded to reflect the Company’s assessment of trends in its overall warranty claims experience on homes previously delivered.

The Company’s overall warranty liability of $50.9 million at May 31, 2012 included $3.3 million for estimated remaining repair costs associated with 54 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 $67.7 million at November 30, 2011 included $4.8 million for the estimated remaining repair costs associated with 87 such identified affected homes. The decrease in the liability for estimated remaining repair costs associated with

 

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(Unaudited)

 

13. Commitments and Contingencies (continued)

 

identified affected homes during the six months ended May 31, 2012 reflected the lower number of identified affected homes with unresolved repairs at May 31, 2012 compared to November 30, 2011. During the six months ended May 31, 2012, the Company resolved repairs on 35 identified affected homes and identified two 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.

During the six months ended May 31, 2012 and 2011, the Company paid $2.4 million and $9.0 million, respectively, to repair identified affected homes, and estimated its additional repair costs with respect to the identified affected homes to be $.9 million and $4.7 million, respectively. Since first identifying affected homes in 2009, the Company has identified a total of 469 affected homes and has resolved repairs on 415 of those homes through May 31, 2012. As of May 31, 2012, the Company has paid $42.9 million of the total estimated repair costs of $46.2 million associated with the identified affected homes. The Company believes that it has identified substantially all potentially affected homes and anticipates it will receive only nominal additional claims in future periods.

As of May 31, 2012, the Company has been named as a defendant in 11 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 will be material to its consolidated financial statements.

The Company intends to seek and is undertaking efforts, including legal proceedings, to obtain reimbursement from various sources, including suppliers and insurers, for the costs it has incurred or expects to incur to investigate and complete repairs and to defend itself in litigation associated with this allegedly defective drywall material. Given uncertainties in the potential outcomes of these efforts, some of which may involve pursuing claims in international forums, the Company has not recorded any amounts for potential future recoveries as of May 31, 2012.

In assessing its overall warranty liability, the Company evaluates the costs related to identified homes affected by the allegedly defective drywall material and other home warranty-related items on a combined basis. Based on its assessments, 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. In light of these assessments, the Company did not incur charges in its consolidated statements of operations for the three months ended May 31, 2012 or May 31, 2011 with respect to repair costs associated with the identified affected homes. Additionally, based on the Company’s assessment of trends in its warranty claims experience, the Company recorded favorable warranty adjustments of $11.2 million as reductions to construction and land costs in its consolidated statements of operations during the three months ended May 31, 2012. The overall warranty liability has decreased in part because of the payments the Company has made to resolve repairs on identified affected homes and in part due to the decrease in the number of homes the Company has delivered over the past several years.

The Company has tendered claims with its liability insurance carriers, seeking reimbursement of costs the Company has incurred to repair construction defects on previously delivered homes, including homes affected by the allegedly defective drywall material described above. During the three months ended May 31, 2012, the Company recognized an insurance recovery of $10.0 million as a reduction to construction and land costs in its consolidated statements of operations, representing an amount the Company received from one of its insurance carriers for a portion of the claims the Company has tendered. While its discussions and negotiations with the insurance carriers are ongoing, the Company has not recorded any amounts for potential future recoveries from the carriers as of May 31, 2012.

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

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

13. Commitments and Contingencies (continued)

 

with respect to these representations, warranties or guarantees would be material to its consolidated financial statements.

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 insureds 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 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 experience and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $93.9 million at May 31, 2012 and $94.9 million at November 30, 2011. 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 each of the three-month periods ended May 31, 2012 and May 31, 2011. For each of the six-month periods ended May 31, 2012 and 2011, the Company’s expenses associated with self-insurance totaled $4.6 million. These expenses were largely offset by contributions from subcontractors participating in the wrap-up policy.

Performance Bonds and Letters of Credit. The Company is often required to provide to various municipalities and other government agencies performance bonds and/or letters of credit to secure the completion of its projects and/or in support of obligations to build community improvements such as roads, sewers, water systems and other utilities, and to support similar development activities by certain of its unconsolidated joint ventures. At May 31, 2012, the Company had $282.7 million of performance bonds and $61.8 million of letters of credit outstanding. At November 30, 2011, the Company had $361.6 million of performance bonds and $63.8 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 obligations are completed.

Land Option Contracts. In the ordinary course of its business, the Company enters into land option contracts and other similar contracts to procure rights to land parcels for the construction of homes. At May 31, 2012, the Company had total deposits of $24.3 million, comprised of $23.8 million of cash deposits and $.5 million of letters of credit, to purchase land having an aggregate purchase price of $619.2 million. The Company’s land option contracts and other similar contracts generally do not contain provisions requiring the Company’s specific performance.

 

14. Legal Matters

Nevada Development Contract Litigation

On November 4, 2011, the Eighth Judicial District Court, Clark County, Nevada set for trial a consolidated action against KB HOME Nevada Inc., a wholly owned subsidiary of the Company (“KB Nevada”), in a case entitled Las Vegas Development Associates, LLC, Essex Real Estate Partners, LLC, et al. v. KB HOME Nevada Inc. In 2007, Las Vegas Development Associates, LLC (“LVDA”) agreed to purchase from KB Nevada approximately 83 acres of land located near Las Vegas, Nevada. LVDA subsequently assigned its rights to Essex

 

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(Unaudited)

 

14. Legal Matters (continued)

 

Real Estate Partners, LLC (“Essex”). KB Nevada and Essex entered into a development agreement relating to certain major infrastructure improvements. LVDA’s and Essex’s complaint, initially filed in 2008, alleges that KB Nevada breached the development agreement, and also alleges that KB Nevada fraudulently induced them to enter into the purchase and development agreements. LVDA’s and Essex’s lenders subsequently filed related actions that were consolidated into the LVDA/Essex matter. The consolidated plaintiffs seek rescission of the agreements or a rescissory measure of damages or, in the alternative, compensatory damages of $55 million plus unspecified punitive damages and other damages, and interest charges in excess of $41 million (the “Claimed Damages”). KB Nevada denies the allegations and damages, and believes it has meritorious defenses to the consolidated plaintiffs’ claims. While the ultimate outcome is uncertain — the Company believes it is reasonably possible that the loss in this matter could range from zero to the amount of the Claimed Damages and could be material to the Company’s consolidated financial statements — KB Nevada believes it will be successful in defending against the plaintiffs’ claims and that the plaintiffs will not be awarded rescission or damages. The non-jury trial is currently set for September 2012.

Southern California Project Development Case

On December 27, 2011, the jury in a case entitled Estancia Coastal, LLC v. KB HOME Coastal Inc. et al. returned a verdict against KB HOME Coastal Inc., a wholly owned subsidiary, and the Company for $9.8 million, excluding legal fees and interest. The case related to a land option contract and a construction agreement between KB HOME Coastal Inc. and the plaintiff. Based on pre-trial analysis, the verdict was not expected, and KB HOME Coastal Inc. and the Company jointly filed a motion for judgment notwithstanding the verdict and a motion for a new trial, which were heard on May 18, 2012. On May 23, 2012, the trial court denied the motions and on June 4, 2012 entered a judgment in favor of the plaintiff in the amount of $9.2 million plus pre-judgment interest of approximately $.9 million. The judgment entered reflects an earlier payment by the Company to the plaintiff of a portion of the jury’s award and does not include legal fees and costs and post-judgment interest. KB HOME Coastal Inc. and the Company expect the trial court to award legal fees and costs to the plaintiff after a hearing in September 2012 in an amount less than $1.8 million. The Company had established an accrual for this matter based on its previous estimate of the probable loss. However, as a result of the trial court’s decision and probable attorney fees and costs award, the Company recorded a charge of $8.8 million in the second quarter of 2012 to increase the accrual for this matter to $11.7 million at May 31, 2012. The charge was included in selling, general and administrative expenses in the Company’s consolidated statement of operations. KB HOME Coastal Inc. and the Company have appealed the entry of judgment. While the ultimate outcome is uncertain, KB HOME Coastal Inc. and the Company believe they will be successful in resolving the matter for an amount less than the judgment.

Other Matters

In addition to the specific proceedings described above, the Company is involved in other litigation and regulatory proceedings incidental to its business that are in various procedural stages. The Company believes that the accruals it has recorded for probable and reasonably estimable losses with respect to these proceedings are adequate and that, as of May 31, 2012, it was not reasonably possible that an additional material loss had been incurred in an amount in excess of the estimated amounts already recognized on the Company’s consolidated financial statements. The Company evaluates its accruals for litigation and regulatory proceedings at least quarterly and, as appropriate, adjusts them to reflect (i) the facts and circumstances known to the Company at the time, including information regarding negotiations, settlements, rulings and other relevant events and developments; (ii) the advice and analyses of counsel; and (iii) the assumptions and judgment of management. Similar factors and considerations are used in establishing new accruals for proceedings as to which losses have become probable and reasonably estimable at the time an evaluation is made. Based on its experience, the Company believes that the amounts that may be claimed or alleged against it in these proceedings are not a meaningful indicator of its potential liability. The outcome of any of these proceedings, including the defense and other litigation-related costs and expenses the Company may incur, however, is inherently uncertain and could differ significantly from the estimate reflected in a related accrual, if made. Therefore, it is possible that the ultimate outcome of any proceeding, if in excess of a related accrual or if no accrual had been made, could be material to the Company’s consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

15. Stockholders’ Equity

As of May 31, 2012, the Company was authorized to repurchase four million 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 six months ended May 31, 2012. 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 May 31, 2012, the Company’s board of directors declared a cash dividend of $.025 per share of common stock, which was paid on May 17, 2012 to stockholders of record on May 3, 2012. During the three months ended February 29, 2012, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 16, 2012 to stockholders of record on February 7, 2012. A cash dividend of $.0625 per share of common stock was declared and paid during the three months ended February 28, 2011 and the three months ended May 31, 2011.

 

16. Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and IFRS” (“ASU 2011-04”), which changes the wording used to describe the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements in order to improve consistency in the application and description of fair value between GAAP and International Financial Reporting Standards. ASU 2011-04 clarifies how the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or liabilities. In addition, the guidance expanded the disclosures for the unobservable inputs for Level 3 fair value measurements, requiring quantitative information to be disclosed related to (1) the valuation processes used, (2) the sensitivity of recurring fair value measurements to changes in unobservable inputs and the interrelationships between those unobservable inputs, and (3) use of a nonfinancial asset in a way that differs from the asset’s highest and best use. The revised guidance was effective for interim and annual periods beginning after December 15, 2011. The Company’s adoption of this guidance as of March 1, 2012 did not have a material impact on its consolidated financial position or results of operations.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), which allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both instances, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. However, in December 2011, the FASB issued Accounting Standards Update No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”), which deferred the guidance on whether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for both interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of reclassifications that were in place prior to the issuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. For public entities, the amendments in ASU 2011-05 and ASU 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively. The adoption of this guidance concerns disclosure only and will not have an impact on the Company’s consolidated financial position or results of operations.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

17. Income Taxes

The Company’s income tax benefit totaled $4.5 million for the three months ended May 31, 2012 and $.3 million for the three months ended May 31, 2011. For the six months ended May 31, 2012, the Company’s income tax benefit totaled $4.1 million, compared to income tax expense of $.1 million for the six months ended May 31, 2011. The income tax benefits recognized for the three months and six months ended May 31, 2012 primarily resulted from a $4.1 million state income tax refund received in the second quarter in connection with the resolution of a state tax audit. Due to the effects of its deferred tax asset valuation allowance, and changes in its unrecognized tax benefits, the Company’s effective tax rates for the three months and six months ended May 31, 2012 and 2011 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 adjustments to the valuation allowance are required. ASC 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with respect to whether deferred tax assets will be realized. The realization of deferred tax assets depends primarily on the Company’s ability to generate sustained profitability. During the three months ended May 31, 2012, the Company recorded a valuation allowance of $9.7 million against net deferred tax assets generated from the loss for the period. During the three months ended May 31, 2011, the Company recorded a similar valuation allowance of $25.7 million. For the six months ended May 31, 2012 and 2011, the Company recorded valuation allowances of $28.0 million and $70.8 million, respectively, against the net deferred tax assets generated from the losses for those periods. The Company’s net deferred tax assets totaled $1.1 million at both May 31, 2012 and November 30, 2011. The deferred tax asset valuation allowance increased to $875.8 million at May 31, 2012 from $847.8 million at November 30, 2011, reflecting the $28.0 million valuation allowance recorded during the six months ended May 31, 2012.

During the three months and six months ended May 31, 2012, the Company had a net reduction to its total gross unrecognized tax benefits of $.5 million as a result of the current status of federal and state tax audits. The total amount of unrecognized tax benefits, including interest and penalties, that would affect the effective tax rate was $1.4 million as of May 31, 2012. The Company anticipates that total unrecognized tax benefits will decrease by approximately $.2 million during the 12 months from this reporting date due to various state tax filings associated with the resolution of the federal tax audit.

The benefits of the Company’s net operating losses (“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 May 31, 2012, 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.

 

18. Supplemental Disclosure to Consolidated Statements of Cash Flows

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

 

     Six Months Ended May 31,  
     2012      2011  

Summary of cash and cash equivalents at end of period:

     

Homebuilding

   $ 314,258       $ 621,304   

Financial services

     3,703         5,892   
  

 

 

    

 

 

 

Total

   $ 317,961       $ 627,196   
  

 

 

    

 

 

 

 

26


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

18. Supplemental Disclosure to Consolidated Statements of Cash Flows (continued)

 

     Six Months Ended May 31,  
     2012     2011  

Supplemental disclosures of cash flow information:

    

Interest paid, net of amounts capitalized

   $ 28,711      $ 22,544   

Income taxes paid

     647        226   

Income taxes refunded

     4,376        182   
  

 

 

   

 

 

 

Supplemental disclosures of noncash activities:

    

Increase (decrease) in consolidated inventories not owned

   $ (3,611   $ 12,813   

Acquired property securing note receivable

     —          40,000   
  

 

 

   

 

 

 

 

19. Supplemental Guarantor Information

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.

The supplemental financial information for the periods presented below reflects the relevant subsidiaries of the Company that were Guarantor Subsidiaries as of and for the respective periods then ended. Accordingly, information for any period presented does not reflect subsequent changes, if any, in the subsidiaries of the Company considered to be Guarantor Subsidiaries.

 

27


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KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

19. Supplemental Guarantor Information (continued)

 

Condensed Consolidated Statements of Operations

Six Months Ended May 31, 2012 (in thousands)

 

     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
     Total  

Revenues

   $ —        $ 322,432      $ 234,978      $ —         $ 557,410   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding:

           

Revenues

   $ —        $ 322,432      $ 230,068      $ —         $ 552,500   

Construction and land costs

     —          (278,469     (198,558     —           (477,027

Selling, general and administrative expenses

     (28,934     (51,428     (41,796     —           (122,158
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating loss

     (28,934     (7,465     (10,286     —           (46,685

Interest income

     225        4        17        —           246   

Interest expense

     30,930        (47,517     (14,168     —           (30,755

Equity in loss of unconsolidated joint ventures

     —          (292     (23     —           (315
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding pretax income (loss)

     2,221        (55,270     (24,460     —           (77,509

Financial services pretax income

     —          —          3,471        —           3,471   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total pretax income (loss)

     2,221        (55,270     (20,989     —           (74,038

Income tax benefit (expense)

     (100     3,100        1,100        —           4,100   

Equity in net loss of subsidiaries

     (72,059     —          —          72,059         —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net loss

   $ (69,938   $ (52,170   $ (19,889   $ 72,059       $ (69,938
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Six Months Ended May 31, 2011 (in thousands)

           
     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
     Total  

Revenues

   $ —        $ 131,894      $ 336,784      $ —         $ 468,678   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding:

           

Revenues

   $ —        $ 131,894      $ 333,390      $ —         $ 465,284   

Construction and land costs

     —          (114,128     (307,049     —           (421,177

Selling, general and administrative expenses

     (33,839     (9,935     (68,351     —           (112,125

Loss on loan guaranty

     —          —          (37,330     —           (37,330
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income (loss)

     (33,839     7,831        (79,340     —           (105,348

Interest income

     534        4        115        —           653   

Interest expense

     23,779        (21,392     (26,947     —           (24,560

Equity in loss of unconsolidated joint ventures

     —          (72     (55,857     —           (55,929
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding pretax loss

     (9,526     (13,629     (162,029     —           (185,184

Financial services pretax income

     —          —          2,254        —           2,254   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total pretax loss

     (9,526     (13,629     (159,775     —           (182,930

Income tax expense

     —          —          (100     —           (100

Equity in net loss of subsidiaries

     (173,504     —          —          173,504         —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net loss

   $ (183,030   $ (13,629   $ (159,875   $ 173,504       $ (183,030
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

28


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

19. Supplemental Guarantor Information (continued)

 

Condensed Consolidated Statements of Operations

Three Months Ended May 31, 2012 (in thousands)

 

     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
     Total  

Revenues

   $ —        $ 175,943      $ 126,909      $ —         $ 302,852   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding:

           

Revenues

   $ —        $ 175,943      $ 124,662      $ —         $ 300,605   

Construction and land costs

     —          (143,487     (106,182     —           (249,669

Selling, general and administrative expenses

     (14,934     (30,257     (21,281     —           (66,472
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income (loss)

     (14,934     2,199        (2,801     —           (15,536

Interest income

     100        3        8        —           111   

Interest expense

     16,810        (23,634     (7,645     —           (14,469

Equity in loss of unconsolidated joint ventures

     —          (241     (2     —           (243
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding pretax income (loss)

     1,976        (21,673     (10,440     —           (30,137

Financial services pretax income

     —          —          1,501        —           1,501   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total pretax income (loss)

     1,976        (21,673     (8,939     —           (28,636

Income tax benefit (expense)

     (200     3,400        1,300        —           4,500   

Equity in net loss of subsidiaries

     (25,912     —          —          25,912         —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net loss

   $ (24,136   $ (18,273   $ (7,639   $ 25,912       $ (24,136
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Three Months Ended May 31, 2011 (in thousands)

           
     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
     Total  

Revenues

   $ —        $ 82,687      $ 189,051      $ —         $ 271,738   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding:

           

Revenues

   $ —        $ 82,687      $ 187,296      $ —         $ 269,983   

Construction and land costs

     —          (67,551     (182,830     —           (250,381

Selling, general and administrative expenses

     (15,169     (11,060     (36,291     —           (62,520

Loss on loan guaranty

     —          —          (14,572     —           (14,572
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income (loss)

     (15,169     4,076        (46,397     —           (57,490

Interest income

     221        —          49        —           270   

Interest expense

     13,929        (13,085     (13,965     —           (13,121

Equity in loss of unconsolidated joint ventures

     —          (29     (63     —           (92
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Homebuilding pretax loss

     (1,019     (9,038     (60,376     —           (70,433

Financial services pretax income

     —          —          1,629        —           1,629   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total pretax loss

     (1,019     (9,038     (58,747     —           (68,804

Income tax expense

     —          100        200        —           300   

Equity in net loss of subsidiaries

     (67,485     —          —          67,485         —     
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net loss

   $ (68,504   $ (8,938   $ (58,547   $ 67,485       $ (68,504
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

29


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

19. Supplemental Guarantor Information (continued)

 

Condensed Consolidated Balance Sheets

May 31, 2012 (in thousands)

 

     KB Home
Corporate
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Consolidating
Adjustments
    Total  

Assets

            

Homebuilding:

            

Cash and cash equivalents

   $ 273,312      $ 17,847       $ 23,099       $ —        $ 314,258   

Restricted cash

     63,182        —           —           —          63,182   

Receivables

     899        29,891         43,238         —          74,028   

Inventories

     —          1,229,731         497,909         —          1,727,640   

Investments in unconsolidated joint ventures

     —          107,090         14,318         —          121,408   

Other assets

     76,609        846         7,742         —          85,197   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
     414,002        1,385,405         586,306         —          2,385,713   

Financial services

     —          —           8,292         —          8,292   

Investments in subsidiaries

     12,710        —           —           (12,710     —     
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 426,712      $ 1,385,405       $ 594,598       $ (12,710   $ 2,394,005   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and stockholders’ equity

            

Homebuilding:

            

Accounts payable, accrued expenses and other liabilities

   $ 118,224      $ 154,853       $ 163,108       $ —        $ 436,185   

Mortgages and notes payable

     1,539,389        39,348         4,051         —          1,582,788   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
     1,657,613        194,201         167,159         —          2,018,973   

Financial services

     —          —           5,501         —          5,501   

Intercompany

     (1,600,432     1,191,204         409,228         —          —     

Stockholders’ equity

     369,531        —           12,710         (12,710     369,531   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 426,712      $ 1,385,405       $ 594,598       $ (12,710   $ 2,394,005   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

November 30, 2011 (in thousands)

            
     KB Home
Corporate
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Consolidating
Adjustments
    Total  

Assets

            

Homebuilding:

            

Cash and cash equivalents

   $ 340,957      $ 32,876       $ 41,217       $ —        $ 415,050   

Restricted cash

     64,475        6         —           —          64,481   

Receivables

     801        29,250         36,128         —          66,179   

Inventories

     —          1,256,468         475,161         —          1,731,629   

Investments in unconsolidated joint ventures

     —          113,921         14,005         —          127,926   

Other assets

     67,059        730         7,315         —          75,104   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
     473,292        1,433,251         573,826         —          2,480,369   

Financial services

     —          —           32,173         —          32,173   

Investments in subsidiaries

     34,235        —           —           (34,235     —     
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 507,527      $ 1,433,251       $ 605,999       $ (34,235   $ 2,512,542   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and stockholders’ equity

            

Homebuilding:

            

Accounts payable, accrued expenses and other liabilities

   $ 121,572      $ 181,835       $ 175,413       $ —        $ 478,820   

Mortgages and notes payable

     1,533,477        45,925         4,169         —          1,583,571   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
     1,655,049        227,760         179,582         —          2,062,391   

Financial services

     —          —           7,494         —          7,494   

Intercompany

     (1,590,179     1,205,491         384,688         —          —     

Stockholders’ equity

     442,657        —           34,235         (34,235     442,657   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 507,527      $ 1,433,251       $ 605,999       $ (34,235   $ 2,512,542   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

30


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

19. Supplemental Guarantor Information (continued)

 

Condensed Consolidated Statements of Cash Flows

Six Months Ended May 31, 2012 (in thousands)

 

     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
    Total  

Cash flows from operating activities:

          

Net loss

   $ (69,938   $ (52,170   $ (19,889   $ 72,059      $ (69,938

Adjustments to reconcile net loss to net cash used in operating activities:

          

Equity in (income) loss of unconsolidated joint ventures

     —          292        (66     —          226   

Inventory impairments and land option contract abandonments

     —          8,362        8,147        —          16,509   

Changes in assets and liabilities:

          

Receivables

     (98     (641     17,534        —          16,795   

Inventories

     —          14,765        (30,896     —          (16,131

Accounts payable, accrued expenses and other liabilities

     (4,198     (21,719     (14,297     —          (40,214

Other, net

     (499     181        3,190        —          2,872   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in operating activities

     (74,733     (50,930     (36,277     72,059        (89,881
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Return of investment in (contributions to) unconsolidated joint ventures

     —          4,886        (336     —          4,550   

Purchases of property and equipment, net

     (53     (297     (242     —          (592
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (53     4,589        (578     —          3,958   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Change in restricted cash

     1,293        6        —          —          1,299   

Proceeds from issuance of senior notes

     344,831        —          —          —          344,831   

Payment of senior notes issuance costs

     (6,751     —          —          —          (6,751

Repayment of senior notes

     (340,481     —          —          —          (340,481

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

     —          (6,577     (118     —          (6,695

Issuance of common stock under employee stock plans

     353        —          —          —          353   

Payments of cash dividends

     (6,746     —          —          —          (6,746

Intercompany

     14,642        37,883        19,534        (72,059     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     7,141        31,312        19,416        (72,059     (14,190
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (67,645     (15,029     (17,439     —          (100,113

Cash and cash equivalents at beginning of period

     340,957        32,876        44,241        —          418,074   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 273,312      $ 17,847      $ 26,802      $ —        $ 317,961   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

31


Table of Contents

KB HOME

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

19. Supplemental Guarantor Information (continued)

 

Six Months Ended May 31, 2011 (in thousands)

 

     KB Home
Corporate
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Consolidating
Adjustments
    Total  

Cash flows from operating activities:

          

Net loss

   $ (183,030   $ (13,629   $ (159,875   $ 173,504      $ (183,030

Adjustments to reconcile net loss to net cash used in operating activities:

          

Equity in loss of unconsolidated joint ventures

     —          72        55,345        —          55,417   

Loss on loan guaranty

     —          —          37,330        —          37,330   

Gain on sale of operating property

     —          (8,825     —          —          (8,825

Inventory impairments and land option contract abandonments

     —          663        21,682        —          22,345   

Changes in assets and liabilities:

          

Receivables

     340        (3,740     1,957        —          (1,443

Inventories

     —          (60,612     (107,180     —          (167,792

Accounts payable, accrued expenses and other liabilities

     4,374        (13,431     (19,023     —          (28,080

Other, net

     (512     (3,007     6,273        —          2,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in operating activities

     (178,828     (102,509     (163,491     173,504        (271,324
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Contributions to unconsolidated joint ventures

     —          (1,388     (531     —          (1,919

Proceeds from sale of operating property

     —          80,600        —          —          80,600   

Sales (purchases) of property and equipment, net

     (289     (14     195        —          (108
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (289     79,198        (336     —          78,573   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Change in restricted cash

     1,514        —          —          —          1,514   

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

     —          (79,471     (1,355     —          (80,826

Issuance of common stock under employee stock plans

     442        —          —          —          442   

Payments of cash dividends

     (9,613     —          —          —          (9,613

Intercompany

     (92,445     106,687        159,262        (173,504     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (100,102     27,216        157,907        (173,504     (88,483
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (279,219     3,905        (5,920     —          (281,234

Cash and cash equivalents at beginning of period

     770,603        3,619        134,208        —          908,430   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 491,384      $ 7,524      $ 128,288      $ —        $ 627,196   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 six months and three months ended May 31, 2012 and 2011 (in thousands, except per share amounts):

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Revenues:

        

Homebuilding

   $ 552,500      $ 465,284      $ 300,605      $ 269,983   

Financial services

     4,910        3,394        2,247        1,755   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 557,410      $ 468,678      $ 302,852      $ 271,738   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pretax income (loss):

        

Homebuilding

   $ (77,509   $ (185,184   $ (30,137   $ (70,433

Financial services

     3,471        2,254        1,501        1,629   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total pretax loss

     (74,038     (182,930     (28,636     (68,804

Income tax benefit (expense)

     4,100        (100     4,500        300   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (69,938   $ (183,030   $ (24,136   $ (68,504
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per share

   $ (.91   $ (2.38   $ (.31   $ (.89
  

 

 

   

 

 

   

 

 

   

 

 

 

In the first six months of 2012, the overall housing market showed signs that it is stabilizing and moving into a period of recovery from the severe housing downturn that began in mid-2006. Historically high housing affordability, particularly compared to rising rental costs, with record-low interest rates for residential consumer mortgage loans helped to spur home sales activity. Meanwhile, relatively low inventories of homes available for sale in some markets helped to moderate prior downward trends in home prices and, in a few areas, push selling prices higher. Conditions are uneven, however, with local economic and employment dynamics strongly influencing the health or weakness of and within individual housing markets, and during the period there has generally been greater sales activity for existing homes than for new homes. In addition, and notwithstanding the somewhat healthier environment, the homebuilding industry still faces significant challenges from unbalanced inventories of homes available for sale in several markets; sales of distressed homes, including a sizeable number of lender-owned homes acquired through foreclosures and short sales that are currently or may soon be made available for sale; and restraints on consumer demand for housing. These restraints include variable macroeconomic conditions, uncertainty regarding job growth, tight residential consumer mortgage lending standards and reduced credit availability for residential consumer mortgage loans. Though the recent positive trends and more favorable buyer sentiment have been encouraging, continued improvement for the housing industry will depend substantially on the extent and pace of economic growth.

In the three months ended May 31, 2012, we continued to focus on our primary strategic goals — to achieve and maintain profitability at the scale of prevailing market conditions; to generate cash and strengthen our balance sheet; and to position our business to capitalize on future growth opportunities — and we generated year-over-year improvement in a number of financial and operational metrics. We ended the 2012 second quarter with the number of homes in backlog up 22% and potential future housing revenues up 38% from a year ago. In addition, while we generated only a 3% increase in net orders compared to the year-earlier quarter, reflecting in part a 4% year-over-year decrease in our number of new home communities open for sales, the value of our net orders increased 18%. We also produced year-over-year growth in homes delivered and revenues, and reduced our net loss significantly from the second quarter of 2011. Apart from our improved results in the current quarter, we believe that the actions we have taken since the beginning of 2012 have further strengthened our business and our ability to take advantage of any future improvements in housing markets as they occur. These actions included an operational transition to a new preferred mortgage lender, as further described below; investing in land and land development in desirable locations within our served markets; and extending our senior debt maturity schedule through the issuance of the $350 Million Senior Notes and the related completion of the Tender Offers.

 

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Our total revenues of $302.9 million for the three months ended May 31, 2012 increased 11% from $271.7 million for the three months ended May 31, 2011, primarily due to higher housing revenues. Housing revenues increased 11% to $300.6 million for the second quarter of 2012 from $270.0 million for the year-earlier quarter, reflecting a 2% increase in the number of homes delivered and a 9% increase in the average selling price. We use the term “home” in this discussion and analysis to refer to a single-family residence, whether it is a single-family home or other type of residential property. We delivered 1,290 homes at an average selling price of $233,000 in the second quarter of 2012, compared with 1,265 homes delivered at an average selling price of $213,400 in the year-earlier quarter.

The year-over-year increase in the number of homes delivered in the second quarter of 2012 was due to our relatively higher backlog level at the beginning of the quarter, which was up 30% from the prior year. Within our homebuilding reporting segments, the number of homes delivered in the three months ended May 31, 2012 increased by 13% and 5% in our Central and Southeast homebuilding reporting segments, respectively, and decreased by 7% and 14% in our West Coast and Southwest homebuilding reporting segments, respectively, compared to the year-earlier quarter.

Our overall average selling price for the three months ended May 31, 2012 increased from the corresponding period of 2011, primarily due to changes in community and product mix, as we delivered more homes from markets with economic and consumer demand dynamics that supported larger home sizes and higher selling prices, and our repositioning in stronger, highly desirable, land-constrained submarkets. Our higher average selling price in the 2012 second quarter reflected year-over-year increases of 33% and 14% in our West Coast and Southwest homebuilding reporting segments, respectively, partly offset by decreases of 8% and 1% in our Central and Southeast homebuilding reporting segments, respectively.

Included in our total revenues were financial services revenues of $2.2 million for the second quarter of 2012 and $1.8 million for the second quarter of 2011. Financial services revenues increased compared to the year-earlier period mainly due to revenues associated with a marketing services agreement with our preferred mortgage lender.

We generated a net loss of $24.1 million, or $.31 per diluted share, for the three months ended May 31, 2012, compared to a net loss of $68.5 million, or $.89 per diluted share, for the three months ended May 31, 2011. Our 2012 second quarter net loss included favorable warranty adjustments of $11.2 million that reflected trends in our overall warranty claims experience, and an insurance recovery of $10.0 million related to costs we have incurred to repair construction defects on previously delivered homes, including homes affected by allegedly defective drywall material. These items were largely offset by charges of $9.9 million for inventory impairments and a charge of $8.8 million recorded as a result of an unfavorable court decision that is being appealed, as discussed in Note 14. Legal Matters in the Notes to Consolidated Financial Statements in this report. In the 2012 second quarter, our net loss also included an income tax benefit of $4.5 million, which primarily resulted from a $4.1 million state income tax refund received in connection with the resolution of a state tax audit. Our net loss for the quarter ended May 31, 2011 included charges of $20.6 million for inventory impairments and land option contract abandonments, and a loss on loan guaranty of $14.6 million related to South Edge. South Edge was a residential development joint venture located near Las Vegas, Nevada in which one of our wholly owned subsidiaries participated along with other unrelated homebuilders and a third-party property development firm. South Edge underwent and completed a bankruptcy reorganization under the South Edge Plan in 2011, a process that commenced in the first quarter of that year. The loss on loan guaranty recorded in the 2011 second quarter resulted from our updated estimate of our probable net payment obligation to reflect the terms of the South Edge Plan.

Our homebuilding operations generated operating losses of $15.5 million for the three months ended May 31, 2012 and $57.5 million for the three months ended May 31, 2011. The homebuilding operating loss narrowed by $42.0 million in the second quarter of 2012 due to higher housing gross profits, partly offset by higher selling, general and administrative expenses in the current quarter, and the inclusion of the loss on loan guaranty in the year-earlier quarter.

Housing gross profits of $50.9 million for the three months ended May 31, 2012 increased by $31.3 million from $19.6 million for the year-earlier period. Our housing gross profit margin improved to 16.9% in the second quarter of 2012 from 7.3% in the second quarter of 2011. Our housing gross profits in the 2012 second quarter included the above-described favorable warranty adjustments and insurance recovery, which were partly offset by the current quarter inventory impairment charges. In the year-earlier quarter, our housing gross profits included the above-described inventory impairment and land option contract abandonment charges. Our housing

 

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gross profit margin, excluding inventory impairment charges, was 20.3% in the second quarter of 2012, compared to the housing gross profit margin, excluding inventory impairment and land option contract abandonment charges, of 14.9% in the year-earlier quarter. The calculation of this measure of housing gross profit margin is described below under “Non-GAAP Financial Measures.”

Our selling, general and administrative expenses of $66.5 million in the three months ended May 31, 2012 increased 6% from $62.5 million in the year-earlier period. The year-over-year increase was primarily due to the above-described court decision charge, and was partly offset by cost-saving initiatives. As a percentage of housing revenues, selling, general and administrative expenses were 22.1% for the three months ended May 31, 2012, compared to 23.2% for the year-earlier period, reflecting the impact of higher housing revenues in the current quarter.

Total revenues for the six months ended May 31, 2012 were $557.4 million, up 19% from $468.7 million for the six months ended May 31, 2011. Included in our total revenues were financial services revenues of $4.9 million for the first six months of 2012 and $3.4 million for the year-earlier period. Our net loss for the six months ended May 31, 2012 totaled $69.9 million, or $.91 per diluted share, including charges of $16.5 million for inventory impairments and the $8.8 million court decision charge, which were partly offset by the favorable warranty adjustments and insurance recovery recorded in the three months ended May 31, 2012. The net loss for the six months ended May 31, 2012 also included the income tax benefit of $4.1 million in the second quarter of 2012. In the year-earlier period, our net loss of $183.0 million, or $2.38 per diluted share, included inventory impairment and land option contract abandonment charges of $22.3 million, and a joint venture impairment charge of $53.7 million and a loss on loan guaranty of $37.3 million, both related to South Edge.

We ended the second quarter of 2012 with $377.4 million of cash and cash equivalents and restricted cash; our balance of unrestricted cash was $314.3 million. Our debt balance was $1.58 billion at May 31, 2012 and November 30, 2011. Our debt balance at May 31, 2012 included the issuance of the $350 Million Senior Notes, which was largely offset by the purchase of $340.0 million in aggregate principal amount of certain of our senior notes due 2014 and 2015 pursuant to the applicable Tender Offers. Our ratio of debt to total capital was 81.1% at May 31, 2012, compared to 78.2% at November 30, 2011. Our ratio of net debt to total capital (a calculation that is described below under “Non-GAAP Financial Measures”) was 76.5% at May 31, 2012, compared to 71.4% at November 30, 2011.

Our backlog at May 31, 2012 totaled 2,962 homes, representing potential future housing revenues of $693.4 million, compared to a backlog at May 31, 2011 of 2,422 homes, representing projected future housing revenues of $501.5 million. The number of homes in our backlog increased 22% year over year, due to a higher number of homes in our backlog at the beginning of the 2012 second quarter and an increase in our net orders in the quarter.

Net orders from our homebuilding operations rose 3% to 2,049 in the second quarter of 2012 from 1,998 in the second quarter of 2011, despite a 4% year-over-year decrease in our number of new home communities open for sales, and were 71% higher than our 1,197 net orders in the first quarter of 2012. Within our homebuilding reporting segments, second quarter net orders, on a year-over-year basis, increased by 11% and 7% in our West Coast and Central homebuilding reporting segments, respectively, and decreased by 15% and 8% in our Southwest and Southeast homebuilding reporting segments, respectively. The lower net orders from our Southwest and Southeast homebuilding reporting segments reflected a strategic reduction in our investments in certain underperforming locations in those segments. This strategic reduction, mainly exiting South Carolina in 2011 and significantly downsizing our business in Arizona and in Charlotte, North Carolina during 2011 and into 2012, is part of an ongoing repositioning of our operational footprint to better-performing markets. In addition, our net order results were a product of our focus in 2012 to prioritize gross profit margin improvement over sales pace. Reflecting this focus, the value of the net orders we generated in the second quarter of 2012 increased 18% to $503.1 million from $427.5 million in the year-earlier quarter. Three of our four homebuilding reporting segments generated year-over-year increases in net order value, with our West Coast homebuilding reporting segment up 31% to $235.3 million, our Central homebuilding reporting segment up 12% to $155.5 million, and our Southeast homebuilding reporting segment up 6% to $67.7 million.

The value of the net orders we generated in the first six months of 2012 increased 9% to $780.6 million from $716.3 million in the prior-year period. Our cancellation rate as a percentage of gross orders was 26% in the second quarter of 2012, compared to 25% in the year-earlier quarter and 36% in the first quarter of 2012. We believe our operational transition to our new preferred mortgage lender, Nationstar Mortgage LLC (“Nationstar”), will help moderate our cancellation rate by addressing the residential consumer mortgage loan

 

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funding issues experienced in the first half of 2012 with the wind down of a prior preferred mortgage lender relationship during that period. This wind down disrupted the ability of some of our customers to obtain mortgage financing to complete home purchases and contributed to an elevated level of cancellations, particularly in the first quarter of 2012. Nationstar began accepting new mortgage loan applications from our homebuyers on May 1, 2012.

HOMEBUILDING

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

 

     Six Months Ended May 31,     Three Months Ended May 31,  
     2012     2011     2012     2011  

Revenues:

        

Housing

   $ 552,500      $ 465,206      $ 300,605      $ 269,983   

Land

     —          78        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     552,500        465,284        300,605        269,983   
  

 

 

   

 

 

   

 

 

   

 

 

 

Costs and expenses:

        

Construction and land costs

        

Housing

     477,027        421,052        249,669        250,381   

Land

     —          125        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     477,027        421,177        249,669        250,381   

Selling, general and administrative expenses

     122,158        112,125        66,472        62,520   

Loss on loan guaranty

     —          37,330        —          14,572   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     599,185        570,632        316,141        327,473   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

   $ (46,685   $ (105,348   $ (15,536   $ (57,490
  

 

 

   

 

 

   

 

 

   

 

 

 

Homes delivered

     2,440        2,214        1,290        1,265   

Average selling price

   $ 226,400      $ 210,100      $ 233,000      $ 213,400   

Housing gross profit margin as a percentage of housing revenues

     13.7     9.5     16.9     7.3

Selling, general and administrative expenses as a percentage of housing revenues

     22.1     24.1     22.1     23.2

Operating loss as a percentage of homebuilding revenues

     -8.4     -22.6     -5.2     -21.3

We have grouped our homebuilding activities into four reporting segments, which we identify in this report as West Coast, Southwest, Central and Southeast. As of May 31, 2012, our homebuilding reporting 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 tables present homes delivered, net orders and cancellation rates (based on gross orders) by homebuilding reporting segment for the three months and six months ended May 31, 2012 and 2011, and our ending backlog at May 31, 2012 and 2011:

 

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     Three Months Ended May 31,  
     Homes Delivered      Net Orders      Cancellation Rates  

Segment

   2012      2011      2012      2011      2012     2011  

West Coast

     330         353         600         542         24     22

Southwest

     157         183         229         270         17        18   

Central

     536         475         900         838         28        29   

Southeast

     267         254         320         348         28        24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

     1,290         1,265         2,049         1,998         26     25
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

     Six Months Ended May 31,  
     Homes Delivered      Net Orders      Cancellation Rates  

Segment

   2012      2011      2012      2011      2012     2011  

West Coast

     639         577         889         946         27     19

Southwest

     327         341         369         476         20        18   

Central

     1,023         838         1,447         1,286         33        33   

Southeast

     451         458         541         592         32        28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

&nbs