KB HOME - Annual Report: 2007 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

the Securities Exchange Act of 1934

For the Fiscal Year Ended November 30, 2007

or

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

the Securities Exchange Act of 1934

For the transition period from ­ ­ to ­ ­.

Commission File No. 001-09195

KB HOME

(Exact name of registrant as specified in its charter)

 

10990 Wilshire Boulevard, Los Angeles, California 90024

(Address of principal executive offices)

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

Large accelerated filer  þ    Accelerated filer  o    Non-accelerated filer  o

 

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

 

The aggregate market value of voting stock held by non-affiliates of the registrant on May 31, 2007 was $4,107,806,638, including 12,314,882 shares held by the registrant’s grantor stock ownership trust and excluding 25,358,823 shares held in treasury.

 

The number of shares outstanding of each of the registrant’s classes of common stock on December 31, 2007 was as follows: Common Stock (par value $1.00 per share) 89,525,178 shares, including 12,192,182 shares held by the registrant’s grantor stock ownership trust and excluding 25,451,107 shares held in treasury.

 

Documents Incorporated by Reference

 

Portions of the registrant’s definitive Proxy Statement for the 2008 Annual Meeting of Stockholders (incorporated into Part III).

 

 

 

KB HOME

FORM 10-K

FOR THE YEAR ENDED NOVEMBER 30, 2007

 

TABLE OF CONTENTS

 

 

PART I

 

Item 1. BUSINESS

 

General

 

KB Home is a Fortune 500 company listed on the New York Stock Exchange under the ticker symbol “KBH.” We are one of the nation’s largest homebuilders and commemorated our 50th year in the homebuilding industry in 2007. We construct and sell homes through our operating divisions across the United States under the name KB Home. Unless the context indicates otherwise, the terms “the Company,” “we,” “our” and “us” used herein refer to KB Home, a Delaware corporation, and its predecessors and subsidiaries.

 

Beginning in 1957 and continuing until 1986, our business was operated through various subsidiaries of Kaufman and Broad, Inc. (“KBI”) and its predecessors. In 1986, KBI transferred to us the outstanding capital stock of its subsidiaries conducting KBI’s homebuilding and mortgage banking business. Shortly thereafter, we completed an initial public offering of 8% of our common stock and began operating under the name Kaufman and Broad Home Corporation. In 1989, we were spun-off from KBI, which then changed its name to Broad Inc., and operated as an independent company, primarily in California and France. In 2001, we changed our name to KB Home. Since 1989, we have expanded our business in both our existing markets and into new markets through capital investments and acquisitions of a number of other homebuilders. Today, we operate a geographically diverse homebuilding and financial services business serving homebuyers in markets across the United States. We believe our geographic diversity helps to mitigate the effects of local and regional economic cycles, enhancing our long-term growth potential.

 

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

 

We delivered 23,743 homes in 2007 compared to our record 32,124 homes delivered in 2006. In 2007, our average selling price of $261,600 decreased from $287,700 in 2006. We generated total revenues of $6.42 billion and a loss from continuing operations of $1.41 billion in 2007 compared to total revenues of $9.38 billion and income from continuing operations of $392.9 million in 2006. Our homebuilding revenues, which include revenues from land sales, accounted for 99.8% of our total revenues in both 2007 and 2006. Our results in 2007 reflected the significant market downturn the homebuilding industry experienced throughout the year, and our actions to align our operations with the diminished sales environment and to strengthen our balance sheet.

 

Our financial services segment derives income from mortgage banking, title and insurance services offered to our homebuyers. Mortgage banking services are provided through Countrywide KB Home Loans, a joint venture operated by Countrywide Financial Corporation (“Countrywide”) that offers a variety of loan programs to serve the needs of our homebuyers. Our financial services segment accounted for .2% of our total revenues in both 2007 and 2006.

 

On July 10, 2007, we sold our 49% equity interest in our publicly traded French subsidiary, Kaufman & Broad S. A. (“KBSA”). Accordingly, we now operate our homebuilding and financial services business solely in the United States.

 

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

Markets

 

Our homebuilding operations span the United States from coast to coast. Because of the geographic reach of our homebuilding business, we have four homebuilding segments based on the markets in which we construct homes — West Coast, Southwest, Central and Southeast. We operate in the 13 states and 35 major markets shown below:

 

 

Segment Operating Information.  The following table sets forth specific operating information for our homebuilding segments for the years ended November 30, 2007, 2006 and 2005:

 

 

 

 

Unconsolidated Joint Ventures.  The above tables do not include deliveries from unconsolidated joint ventures. From time to time, we participate in the acquisition, development, construction and sale of residential properties through

unconsolidated joint ventures. Our unconsolidated joint ventures delivered 127 homes in 2007, 4 homes in 2006 and 83 homes in 2005.

 

Strategy

 

We expect the difficult conditions we experienced in our served markets in 2007 to continue through 2008. Consistent with the general downturn in housing markets across the United States, most of our served markets have faced a persistent oversupply of new and resale homes available for sale, with some areas reaching historically high levels. In these markets, our business has encountered significant challenges from heightened builder and investor efforts to sell homes and land, increased foreclosure activity, consumer reluctance to purchase homes, tighter lending standards due to turmoil in the mortgage finance and credit markets, and reduced home affordability, particularly in areas that experienced rapid sales price increases in the years leading up to and including 2006. These conditions resulted in both lower overall sales in our homebuilding business compared to prior years and downward pressure on our selling prices and margins in 2007, as competition for sales drove marketing expenses higher and increased the need for sales incentives. We do not expect the present business environment in our served markets or these trends to improve in 2008.

 

We believe our continued adherence to the disciplines of our core built-to-order operational business model, KBnxt, will enable us to manage through the current and expected near-term business environment. We believe it will also position us to capitalize on long-term growth opportunities that we expect will arise as housing supply and demand conditions in our served markets begin to stabilize.

 

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

 

 

Our KBnxt operational business model is designed to help us achieve a leading position in our existing markets, expand our business into attractive new markets, exit investments that no longer meet our return standards or marketing strategy and calibrate our product lines to consumer preferences in both our existing and new markets. Historically, this focus has allowed us to achieve lower costs and economies of scale with respect to acquiring and developing land, purchasing building materials, subcontracting labor and providing options to customers.

 

Our expansion into new markets will depend on our assessment of a potential new market’s viability and our ability to develop operations in that new market. We will also continue to consider appropriate acquisitions, as market conditions may produce attractive opportunities. However, expansion into new markets and large acquisitions are not a priority for us in the near term.

Strategic Objectives.  Based on our KBnxt operational business model, and building on initiatives we implemented in 2006 and 2007 as conditions in our served markets became increasingly challenging, our primary strategic objectives include:

 

 

Marketing Strategy.  Our marketing strategy aims to generate traffic to our communities by promoting our distinct customized homebuying experience. We believe this approach, supported with unique marketing partnerships and consistently applied companywide under one brand, generates a high perceived value for our products and our company among our target customers nationwide.

 

Reflecting this approach, in 2007 we launched a “Built to Order” consumer brand messaging initiative to provide potential homebuyers with a clearer understanding of how our homebuying experience differs from that of other homebuilders and resale homes. The “Built to Order” campaign emphasizes the choices our homebuyers can make in community location, floor plan, exterior architectural style, and interior design options and amenities to create a home built to their individual preferences. In highlighting the choices we make available to our homebuyers and reinforcing our general approach to build homes only after we receive a qualified order, the “Built to Order” campaign serves as the consumer face to core elements of our KBnxt operational business model.

 

During 2007, we also saw the expansion of our successful partnership with Martha Stewart, a leading lifestyle expert. Under this partnership, we offer our homebuyers in selected communities an opportunity to build homes inspired by Martha Stewart’s own residences and to customize them using interior designs that reflect her style. We opened six additional Martha Stewart communities in 2007, bringing the total number to nine. The new Martha Stewart communities included the first in California, Texas, Colorado and Florida, as well as the second in North Carolina and Georgia. Our Martha Stewart communities have generated significant consumer and media interest and traffic, and we expect to open more of them in the future.

 

In September 2007, we announced a high-profile collaboration with The Walt Disney Company to develop exclusive Disney Home product options to be offered to our homebuyers. Options include elements that would normally be built into a home such as lighting fixtures and window coverings and feature some of Disney’s most recognized characters. The first options in the collaboration will be available to our homebuyers in 2008.

During 2007, we also maintained our focus on the Internet as a key vehicle for reaching homebuyers. We redesigned our primary consumer website, kbhome.com, to be easier to navigate, to better reflect current technologies, and to make “Built to Order” a central message throughout the site.

 

We renewed our emphasis on the first-time, first move-up and active adult homebuyer in 2007. These homebuyers historically have been our core customers and are the buyers we anticipate to have the greatest potential for future home sales. In the present mortgage financing environment, focusing on these types of homebuyers also allows us to offer more homes that fall within conforming loan limits for Fannie Mae, Federal Home Loan Mortgage Corporation (“Freddie Mac”), Federal Housing Administration (“FHA”) and Veterans Administration (“VA”) programs.

 

In 2008, we will continue to implement our “Built to Order” marketing strategy, building on our efforts in 2007.

 

Sales Strategy.  To ensure the consistency of our message and adherence to our KBnxt operational business model, sales of our homes are carried out by in-house teams of sales representatives. Our sales representatives are trained to provide prospective customers with floor plan and design choices, pricing information and tours of fully furnished and landscaped model homes that are decorated to emphasize the distinctive options we offer. We also have Countrywide KB Home Loans representatives available in many of our communities to assist prospective customers with financing questions.

 

To help our homebuyers customize their homes, we operate KB Home Studios in the vast majority of our markets. KB Home Studios are large showrooms where our customers may select from thousands of options to purchase conveniently as part of the original construction of their homes. The coordinated efforts of sales representatives, KB Home Studio consultants and other personnel involved in the customer’s homebuying experience are intended to provide high levels of customer satisfaction and lead to enhanced customer retention and referrals.

 

Customer Service and Quality Control

 

Customer satisfaction is a high priority for us and we are committed to building and delivering quality homes. Our on-site construction supervisors perform regular pre-closing quality checks during the construction process to ensure our homes meet our quality standards and our homebuyers’ expectations. We have customer service personnel who are responsible for responding to homebuyers’ post-closing needs, including warranty claims. We believe prompt and courteous responses to homebuyers’ needs throughout the homebuying process reduces post-closing repair costs, enhances our reputation for quality and service, and may help encourage repeat and referral business from homebuyers and the real estate community. Our goal is for our customers to be 100% satisfied with their new homes. We provide a limited warranty on all of our homes. The specific terms and conditions vary depending on the market where we do business. We generally provide a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home such as appliances.

 

Local Expertise

 

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

 

Community Development and Land Inventory Management

 

Our community development process generally consists of four phases: land acquisition, land development, home construction and sale. Historically, our community development process has ranged from six to 24 months in our

West Coast segment to a somewhat shorter duration in our other homebuilding segments. The length of the community development process varies based on, among other things, the extent of government approvals required, the overall size of the community, necessary site preparation activities, weather conditions and marketing results.

 

Although they vary significantly, our communities typically consist of 50 to 250 lots ranging in size from 2,000 to 20,000 square feet. Depending on the community, we offer from two to five model home designs with premium lots often containing more square footage, better views or location benefits. Our goal is to own or control enough lots to meet our forecasted production goals over the next three to four years.

 

Land Acquisition and Land Development.  Our current focus is on creating a strong balance sheet and positioning ourselves for future growth. Significant land acquisitions are not currently a priority, but we will consider attractive opportunities as they arise. When we do acquire and develop land, we do so consistent with our KBnxt operational business model, which focuses on obtaining land containing fewer than 250 lots that are entitled and either physically developed (referred to as “finished lots”) or partially finished. Acquiring finished or partially finished lots enables us to construct and deliver homes shortly after the land is acquired with minimal additional development expenditures. This is a more efficient way to use our working capital and reduces the operating risks associated with having to develop and/or entitle land, such as unforeseen improvement costs and/or changes in market conditions. However, depending on market conditions, we may acquire undeveloped and/or unentitled land. We expect that the overall balance of undeveloped, unentitled, entitled and finished lots in our inventory will vary over time.

 

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

 

We generally structure our land purchases and development activities to minimize, or to defer the timing of cash and capital expenditures, which enhances returns associated with new land investments. While we use a variety of techniques to accomplish this, as further described below, we typically use agreements that give us an option right to purchase land at a future date at a fixed price for a small or no initial deposit payment. Our decision to exercise a particular option right is based on the results of due diligence we conduct after entering into an agreement. In some cases our decision to exercise an option may be conditioned on the land seller obtaining necessary entitlements, such as zoning rights and environmental approvals, and/or physically developing the land by a pre-determined date to allow us to build homes relatively quickly. Depending on the circumstances, our initial deposit payment for an option right may or may not be refundable to us if we do not purchase the underlying land.

 

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

 

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

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

 

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

 

The following table shows the number of lots we owned in various stages of development and under option contracts in our homebuilding segments as of November 30, 2007 and 2006. The table does not include approximately 376 acres optioned as of November 30, 2007 and 393 acres optioned as of November 30, 2006 that have not yet been approved for subdivision into lots.

 

 

Reflecting our geographic diversity and balanced operations, as of November 30, 2007, 22% of the lots we owned or controlled were located in the West Coast reporting segment, 24% were in the Southwest reporting segment, 24% were in the Central reporting segment, and 30% were in the Southeast reporting segment.

 

The following table shows the dollar value of inventory we owned in various stages of development and under option contracts in our homebuilding segments as of November 30, 2007 and 2006 (in thousands):

 

 

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

 

We act as the general contractor for the majority of our communities and hire subcontractors for all production activities. The use of subcontractors enables us to reduce our investment in direct labor costs, equipment and facilities. Where practical, we use mass production techniques, and pre-made, standardized components and materials to

streamline the on-site production process. We have also developed systems for national and regional purchasing of certain building materials, appliances and other items to take advantage of economies of scale and to reduce costs through improved pricing and, where available, participation in manufacturers’ rebate programs. At all stages of production, our administrative and on-site supervisory personnel coordinate the activities of subcontractors and subject their work to quality and cost controls. As part of our KBnxt operational business model, we have also emphasized even-flow production methods to enhance the quality of our homes, minimize production costs and improve the predictability of our revenues and earnings.

 

Backlog

 

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

 

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

 

Our backlog at November 30, 2007, excluding unconsolidated joint ventures, consisted of 6,322 homes, down 40% from the 10,575 homes in backlog at year-end 2006. Our backlog ratio was 68% for the fourth quarter of 2007 and 60% for the fourth quarter of 2006. (Backlog ratio is defined as homes delivered as a percentage of beginning backlog in the quarter.)

 

The significant decrease in backlog levels in 2007 reflected an overall decrease in net orders and lower average selling prices compared to prior years, reflecting the persistently challenging conditions in the housing market that began in 2006. Our net orders declined 13% to 19,490 in 2007 from 22,459 in 2006. Our average cancellation rate in 2007 was 42%, improving from an average of 47% in 2006. During the fourth quarter of 2007, our net orders decreased 32% from the fourth quarter of 2006, reflecting decreases in each of our reporting segments. The fourth quarter 2007 cancellation rate of 58% was the same as the cancellation rate we experienced in the year-earlier quarter, and 8 percentage points higher than the 50% cancellation rate we experienced in the third quarter of 2007.

The following table sets forth homes delivered, net orders and ending backlog for each quarter during the years ended November 30, 2007 and 2006:

 

 

Land and Raw Materials

 

We currently own or control enough land to meet our forecasted production goals for approximately the next three to four years, and we believe that we will be able to acquire land on acceptable terms for future communities as needed. In

fact, as discussed above, we have recently sold some of our land and abandoned options to purchase land in order to balance our holdings with diminished current and forecasted market conditions. In 2007, our land sales generated $189.0 million of revenues and $74.3 million of pretax losses, including $74.8 million of impairments. Our land option contract abandonments resulted in pretax, non-cash charges of $144.0 million in 2007.

 

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

 

Customer Financing

 

On-site representatives at our communities facilitate sales by offering to arrange financing for prospective customers through Countrywide KB Home Loans. Countrywide KB Home Loans is a retail mortgage banking joint venture that we established with Countrywide in 2005. Although our customers have the choice of obtaining financing elsewhere, we believe that the ability of Countrywide KB Home Loans to offer customers a variety of financing options on competitive terms as a part of the on-site sales process is an important factor in completing sales.

 

Countrywide KB Home Loans provides mortgage banking services to our homebuyers. Leveraging the resources of Countrywide, the joint venture operates with decentralized teams of employees located in all of our markets. Through its relationship with Countrywide, the joint venture offers virtually every loan program in the industry, as well as some products not offered by other lenders. This includes fixed and adjustable rate, conventional, privately-insured mortgages, FHA-insured or VA-guaranteed mortgages and mortgages funded by revenue bond programs of states and municipalities. Countrywide KB Home Loans originated loans for 72% of our customers who obtained mortgage financing in 2007 and 57% in 2006.

 

Discontinued Operations

 

In July 2007, we sold our 49% interest in our French operations. The disposition of the French operations enables us to invest additional resources in our U.S. homebuilding operations. The sale generated total gross proceeds of $807.2 million and a pretax gain of $706.7 million ($438.1 million net of income taxes). As a result of the sale, the French operations, which had previously been presented as a separate reporting segment, are presented as discontinued operations in our consolidated financial statements. All prior period information has been reclassified to be consistent with the current period presentation.

 

Employees

 

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

 

At December 31, 2007, we had approximately 3,100 full-time employees in our operations, compared to approximately 5,100 at December 31, 2006. None of our employees are represented by a collective bargaining agreement.

 

Competition and Other Factors

 

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

including resale homes and rental housing. In certain markets and at times when housing demand is high, we also compete with other builders to hire subcontractors.

 

Financing

 

We do not generally finance the development of our communities with project financing. By “project financing,” we mean proceeds of loans specifically obtained for, or secured by, particular communities. Instead, our operations have been primarily funded by results of operations, public debt and equity financing, and borrowings under our unsecured revolving credit facility with various banks (the “Credit Facility”).

 

Regulation and Environmental Matters

 

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

 

Access to Our Information

 

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Our SEC filings are available to the public over the Internet at the SEC’s website at http://www.sec.gov. The public may also read and copy any document we file at the SEC’s public reference room located at 100 F Street N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room.

 

We encourage the public to read our periodic and current reports. Copies of these filings, as well as any future filings, may be obtained, at no cost, through our website http://www.kbhome.com or by writing to our investor relations department at investorrelations@kbhome.com or at our principal executive offices.

 

In addition to the risks and the challenging market conditions previously mentioned, the following important factors could adversely impact our business. These factors could cause our actual results to differ materially from the forward-looking and other statements that we make in registration statements, periodic reports and other filings with the SEC, and that we make from time to time in our news releases, annual reports and other written communications, as well as oral forward-looking and other statements made from time to time by our representatives.

 

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

 

In 2007, many of our served markets and the U.S. homebuilding industry as a whole continued to experience a significant and sustained decrease in demand for new homes and an oversupply of new and existing homes available for sale, conditions that generally began in 2006. In many markets, a rapid increase in new and existing home prices in the years leading up to and including 2006 reduced housing affordability relative to consumer incomes and tempered buyer

demand. At the same time, investors and speculators reduced their purchasing activity and instead stepped up their efforts to sell residential property they had earlier acquired. These trends, which were more pronounced in markets that had experienced the greatest levels of price appreciation, resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions and other marketing efforts to close home sales in 2007 compared to the past several years.

 

Reflecting these demand and supply trends, we, like many other homebuilders, experienced a large drop in net orders, a decline in the selling price of new homes sold and a reduction in our margins in 2007 relative to prior years. We can provide no assurances that the homebuilding market will improve in the near future. In fact, we expect the weakness to continue at least through 2008 and have an adverse effect on our business and our results of operations.

 

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

 

While we have been successful in generating positive operating cash flow and reducing our inventories in 2007, we have done so at significantly reduced gross profit levels and have incurred significant asset impairment charges. These contributed to the net loss we recognized in 2007. Also, in 2007, notwithstanding our sales strategies, we continued to experience an elevated rate of sales contract cancellations. We believe that the elevated cancellation rate largely reflects a decrease in homebuyer confidence, with continued price declines and increases in the level of sales incentives for both new and existing homes prompting homebuyers to forgo or delay home purchases. A more restrictive mortgage lending environment and the inability of some buyers to sell their existing homes have also led to cancellations. Many of the factors that affect new orders and cancellation rates are beyond our control. It is uncertain how long the reduced sales levels and the increased level of cancellations will continue.

 

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

 

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

 

 

Adverse changes in these conditions may affect our business nationally or may be more prevalent or concentrated in particular regions or localities in which we operate. In 2007, adverse changes in many of these factors affected all of our markets, and we expect the widespread nature of the downturn in the housing market to continue at least through 2008. A downturn in the economy would likely exacerbate the adverse trends the housing market experienced in 2007.

 

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

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

 

The potential difficulties described above can cause demand and prices for our homes to diminish or cause us to take longer and incur more costs to build our homes. We may not be able to recover these increased costs by raising prices because of market conditions and because the price of each home is usually set several months before the home is delivered, as our customers typically sign their home purchase contracts before construction begins. The potential difficulties described above could cause some homebuyers to cancel or refuse to honor their home purchase contracts altogether. In fact, reflecting the difficult conditions in our served markets, we continued to experience elevated cancellation rates in 2007 and we may experience similar cancellation rates in 2008.

 

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

 

The homebuilding industry is highly competitive for skilled labor and building materials. Increased costs or shortages in building materials or skilled labor could cause increases in construction costs and construction delays. We generally are unable to pass on increases in construction costs to customers who have already entered into sales contracts, as the sales contracts generally fix the price of the home at the time the contract is signed, and may be signed well in advance of when construction commences. Sustained increases in construction costs may, over time, erode our margins, and pricing competition for materials and labor may restrict our ability to pass on any additional costs, thereby decreasing our margins.

 

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

 

Inflation can have a long-term impact on us because increasing costs of land, materials and labor may call for us to increase sales prices of homes in order to maintain satisfactory margins. However, if the current challenging and highly competitive conditions in the homebuilding market persist, we may be required to decrease prices in an attempt to stimulate sales volume. This potential lowering of sales prices, in addition to impacting our margins on new homes, may also reduce the value of our land inventory and make it more difficult for us to recover the full cost of previously purchased land in new home sales prices or, if we choose, in the disposition of land assets. In addition, depressed land values may cause us to forfeit deposits on land option contracts if we cannot satisfactorily renegotiate the purchase price of the optioned land. We may incur non-cash charges for inventory impairments or land option contract abandonments if the value of our inventory is so reduced or if we choose not to exercise land option contracts.

 

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

 

We incur many costs even before we begin to build homes in a community. Depending on the stage of development, these include costs of preparing land and installing roads, sewage and other utilities, as well as taxes and other costs related to ownership of the land on which we plan to build homes. Reducing the rate at which we build homes extends the length of time it takes us to recover these costs. Also, we frequently acquire options to purchase land and make deposits that will be forfeited if we do not exercise the options within specified periods. Because of current market conditions, we have had to terminate some of these options, resulting in the forfeiture of deposits and unrecoverable development costs.

 

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

 

The value of the land and housing inventory we currently own or control depends on market conditions, including estimates of future demand for, and the revenues that can be generated from, such inventory. The market value of our land inventory can vary considerably because there is often a significant amount of time between our initial acquisition of land and the delivery of homes on that land. The downturn in the housing market has caused the fair market value of certain of our inventory to fall, in some cases well below the estimated fair market value at the time we acquired it. Depending on our assessment of fair market value, we may need to write down the carrying value of certain of our inventory and take corresponding non-cash charges against our earnings to reflect the impaired value. We may also abandon our interests in certain land inventory that no longer meets our internal investment standards, which would also require us to take non-cash charges. If the current downturn in the housing market continues, we may need to take additional charges against

our earnings for abandonments or inventory impairments, or both. Any such non-cash charges would have an adverse effect on our consolidated results of operations.

 

If new home prices decline, interest rates increase or there is a downturn in the economy, some homebuyers may cancel their home purchases because the required deposits are small and generally refundable.

 

Our backlog numbers reflect the number of homes for which we have entered into a purchase contract with a customer but not yet delivered the home. Our home purchase contracts typically require only a small deposit, and in many states, the deposit is fully refundable at any time prior to closing. If the prices for new homes decline, competitors increase their use of sales incentives, interest rates increase, the availability of mortgage financing diminishes or there is a downturn in local or regional economies or the national economy, homebuyers may terminate their existing home purchase contracts with us in order to negotiate for a lower price or to explore other options. In 2007 and 2006, we experienced elevated cancellation rates, in part because of these reasons. Additional cancellations could have an adverse effect on our business and our results of operations.

 

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

 

The availability of finished and partially developed lots and undeveloped land for purchase that meet our internal investment criteria depends on a number of factors outside our control, including land availability in general, competition with other homebuilders and land buyers for desirable property, inflation in land prices, zoning, allowable housing density and other regulatory requirements. Should suitable lots or land become less available, the number of homes we may be able to build and sell could be reduced, and the cost of land could increase, perhaps substantially, which could adversely impact our results of operations.

 

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

 

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

 

Market conditions in the mortgage lending and mortgage finance industries deteriorated significantly in 2007, which adversely affected the availability of credit for some purchasers of our homes, reduced the population of potential mortgage customers and reduced mortgage liquidity. Further tightening of mortgage lending or mortgage financing requirements or further reduced mortgage liquidity could adversely affect the availability of credit for some purchasers of our homes and thereby reduce our sales.

 

During 2007, the mortgage lending and mortgage finance industries experienced significant instability due to, among other things, defaults on subprime loans and a resulting decline in the market value of such loans. In light of these developments, lenders, investors, regulators and other third parties questioned the adequacy of lending standards and other credit requirements for several loan programs made available to borrowers in recent years. This has led to reduced investor demand for mortgage loans and mortgage-backed securities, tightened credit requirements, reduced liquidity, increased credit risk premiums and regulatory actions. Deterioration in credit quality among subprime and other nonconforming loans has caused most lenders to eliminate subprime mortgages and most other loan products that do not conform to Fannie Mae, Freddie Mac, FHA or VA standards. Fewer loan products and tighter loan qualifications in turn make it more difficult for some categories of borrowers to finance the purchase of our homes or the purchase of existing homes from potential move-up buyers who wish to purchase one of our homes. In general, these developments have resulted in a reduction in demand for the homes we sell and have delayed any general improvement in the housing market. Furthermore, they have resulted in a reduction in demand for the mortgage loans that we originate through Countrywide KB Home Loans, our joint venture with Countrywide. These reductions in demand have had, and are expected to continue to have, a materially adverse effect on our business and results of operations in 2008.

Many of our homebuyers obtain financing for their home purchases from Countrywide KB Home Loans. Countrywide provides the loan products that the joint venture offers to our homebuyers. If Countrywide refuses or is unable to make loan products available to the joint venture to provide to our homebuyers, our results of operations may be adversely affected.

 

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

 

Nearly all of our customers finance the purchase of their homes. In recent years, historically low interest rates and the increased availability of specialized mortgage products, including mortgage products requiring no or low down payments, and interest-only and adjustable rate mortgages, had made homebuying more affordable for a number of customers. Increases in interest rates or decreases in the availability of mortgage financing or of certain mortgage programs, as discussed above, may lead to higher down payment requirements or monthly mortgage costs, or both, and could therefore reduce demand for our homes.

 

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

 

Because the availability of Fannie Mae, Freddie Mac, FHA and VA mortgage financing is an important factor in marketing and selling many of our homes, any limitations or restrictions in the availability of such government-backed financing could reduce our home sales.

 

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

 

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

 

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

 

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

 

We are also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the environment. These laws and regulations may cause delays in construction and delivery of new homes, may cause us to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas. In addition, environmental laws may impose liability for the costs of removal or remediation of hazardous or toxic substances whether or not the developer or owner of the property knew of, or was responsible for, the presence of those substances. The presence of those substances on our properties may prevent us from selling our homes and we may also be liable, under applicable laws and regulations or lawsuits brought by private parties, for hazardous or toxic substances on properties and lots that we have sold in the past.

 

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

 

The mortgage banking operations of Countrywide KB Home Loans are heavily regulated and subject to the rules and regulations promulgated by a number of governmental and quasi-governmental agencies. There are a number of

federal and state statutes and regulations which, among other things, prohibit discrimination, establish underwriting guidelines that include obtaining inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. A finding that we or Countrywide KB Home Loans materially violated any of the foregoing laws could have an adverse effect on our results of operations.

 

We are subject to a Consent Order that we entered into with the Federal Trade Commission in 1979 and related Consent Decrees that were entered into in 1991 and 2005. Pursuant to the Consent Order and the related Consent Decrees, we provide explicit warranties on the quality of our homes, follow certain guidelines in advertising and provide certain disclosures to prospective purchasers of our homes. A finding that we have significantly violated the Consent Order and/or the related Consent Decrees could result in substantial liabilities or penalties and could limit our ability to sell homes in certain markets.

 

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

 

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

 

 

Our financial services business competes with other mortgage lenders, including national, regional and local mortgage banks and other financial institutions. Mortgage lenders with greater access to capital or different lending criteria may be able to offer more attractive financing to potential customers.

 

When we are affected by these competitive conditions, our business and financial results can be adversely affected by decreased revenues, increased costs and/or diminished growth in our local or regional homebuilding business. In the current downturn in the homebuilding industry, the reactions of our competitors may be reducing the effectiveness of our efforts to achieve pricing stability and reduce our inventory levels.

 

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

 

In the ordinary course of our homebuilding business, we are subject to home warranty and construction defect claims. We record warranty and other reserves for the homes we sell based on historical experience in our markets and our judgment of the qualitative risks associated with the types of homes we build. We have, and require the majority of our subcontractors to have, general liability, property, errors and omissions, workers compensation and other business insurance. These insurance policies protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles, and other coverage limits. Through our captive insurance subsidiary, we reserve for costs to cover our self-

insured and deductible amounts under these policies and for any costs of claims and lawsuits, based on an analysis of our historical claims, which includes an estimate of claims incurred but not yet reported. Because of the uncertainties inherent to these matters, we cannot provide assurance that our insurance coverage, our subcontractor arrangements and our reserves will be adequate to address all our warranty and construction defect claims in the future. Additionally, the coverage offered by and the availability of general liability insurance for construction defects are currently limited and costly. There can be no assurance that coverage will not be further restricted and become more costly.

 

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

 

We have experienced seasonal fluctuations in quarterly operating results. We typically do not commence significant construction on a home before a home purchase contract has been signed with a homebuyer. Historically, a significant percentage of our home purchase contracts are entered into in the spring and summer months, and a corresponding significant percentage of our deliveries occur in the fall and winter months. Construction of our homes typically requires approximately four months and weather delays that often occur in late winter and early spring may extend this period. As a result of these combined factors, we historically have experienced uneven quarterly results, with lower revenues and operating income generally during the first and second quarters of the year. However, the increasingly challenging market conditions we experienced in 2007 resulted in lower sales in the spring and summer months and correspondingly lower deliveries in the fall and winter months as compared to 2006. With the current difficult market conditions expected to continue through at least 2008, we can make no assurances that our normal seasonal patterns will occur in the near future.

 

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

 

Our Credit Facility and the indentures governing our outstanding senior and senior subordinated public notes impose restrictions on our operations and activities. The most significant restrictions relate to limits on investments, cash dividends, stock repurchases and other restricted payments, incurrence of indebtedness, creation of liens and asset dispositions, and require maintenance of a maximum debt to equity (or leverage) ratio, a minimum interest coverage ratio, and a minimum level of tangible net worth. If we fail to comply with these restrictions or covenants, the holders of those debt instruments or the banks, as appropriate, could cause our debt to become due and payable prior to maturity or could demand that we compensate them for waiving instances of noncompliance. In addition, a default under the indenture for any of our notes or our Credit Facility could cause a default with respect to our other notes or the Credit Facility, as the case may be, and result in the acceleration of the maturity of all such defaulted indebtedness and our inability to borrow under the Credit Facility. Moreover, we may curtail our investment activities and other uses of cash to maintain compliance with these restrictions and covenants.

 

Our leverage may place burdens on our ability to comply with the terms of our indebtedness, may restrict our ability to operate and may prevent us from fulfilling our obligations.

 

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

 

 

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

Our business may not generate sufficient cash flow from operations and borrowings may not be available to us under our Credit Facility in an amount sufficient to pay our debt service obligations, fulfill financial or operational guarantees we have provided for certain unconsolidated joint venture transactions, or to fund our other liquidity needs. Should this occur, we may need to refinance all or a portion of our debt on or before maturity, which we may not be able to do on favorable terms or at all.

 

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

 

Our homebuilding operations require significant amounts of cash and/or available credit. It is not possible to predict the future terms or availability of additional capital. Moreover, our outstanding public debt and the Credit Facility contain provisions that may restrict the amount and nature of debt we may incur in the future. The Credit Facility limits our ability to borrow additional funds by placing a maximum cap on our leverage ratio. Under the most restrictive of these provisions, at November 30, 2007, we would have been permitted to incur up to $3.56 billion of total consolidated indebtedness, as defined in the Credit Facility. This maximum amount exceeded our actual total consolidated indebtedness at November 30, 2007 by $2.68 billion. In addition, the Credit Facility limits our ability to borrow senior indebtedness, as defined in the Credit Facility, subject to a specified borrowing base. At November 30, 2007, we would have been permitted to incur up to $3.32 billion of senior indebtedness under the Credit Facility. This maximum amount exceeded our actual total senior indebtedness at November 30, 2007 by $1.66 billion. There can be no assurance that we can actually borrow up to these maximum amounts of total consolidated indebtedness or senior indebtedness at any time, as our ability to borrow additional funds, and to raise additional capital through other means, also depends on conditions in the capital markets and our credit worthiness. If conditions in the capital markets change significantly, it could reduce our ability to generate sales and may hinder our future growth and results of operations.

 

We are involved in government investigations and litigation relating to our past stock option grant practices.

 

The SEC and the U.S. Department of Justice (“DOJ”) are conducting investigations into our stock option grant practices. In addition, shareholder derivative lawsuits have been filed in California state and federal courts relating to our stock option grant practices. It is possible that additional lawsuits may be filed. The investigations and lawsuits have resulted in, and will continue to result in, substantial legal and professional fees, and will continue to occupy our time and attention. An adverse outcome to the investigations or one or more of the lawsuits may have a negative effect on our business and our results of operations.

 

None.

 

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

 

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

 

Derivative Litigation

 

On July 10, 2006, a shareholder derivative action, Wildt v. Karatz, et al., was filed in Los Angeles Superior Court. On August 8, 2006, a virtually identical shareholder derivative lawsuit, Davidson v. Karatz, et al., was also filed in Los Angeles Superior Court. These actions, which ostensibly are brought on our behalf, allege, among other things, that defendants (various of our current and former directors and officers) breached their fiduciary duties to us by, among other things, backdating grants of stock options to various current and former executives in violation of our shareholder-approved stock option plans. Defendants have not yet responded to the complaints. On January 22, 2007, the Court entered an order, pursuant to an agreement among the parties and us, providing, among other things, that, to preserve the

status quo without prejudicing any party’s substantive rights, our former Chairman and Chief Executive Officer shall not exercise any of his outstanding options, at any price, during the period in which the order is in effect. Pursuant to further stipulated orders, these terms remain in effect and are now scheduled to expire on February 1, 2008, unless otherwise agreed in writing. The plaintiffs have agreed to stay their cases while the parallel federal court derivative lawsuits discussed below are pursued. A stipulation and order effectuating the parties’ agreement to stay the state court actions was entered by the court on February 7, 2007. The parties may extend the agreement that options will not be exercised by our former Chairman and Chief Executive Officer beyond the current February 1, 2008 expiration date.

 

On August 16, 2006, a shareholder derivative lawsuit, Redfield v. Karatz, et al., was filed in the United States District Court for the Central District of California. On August 31, 2006, a virtually identical shareholder derivative lawsuit, Staehr v. Karatz, et al., was also filed in the United States District Court for the Central District of California. These actions, which ostensibly are brought on our behalf, allege, among other things, that defendants (various of our current and former directors and officers) breached their fiduciary duties to us by, among other things, backdating grants of stock options to various current and former executives in violation of our shareholder-approved stock option plans. Unlike Wildt and Davidson, however, these lawsuits also include substantive claims under the federal securities laws. On January 9, 2007, plaintiffs filed a consolidated complaint. All defendants filed motions to dismiss the complaint on April 2, 2007. Subsequently, plaintiffs filed a motion for partial summary judgment against certain of the defendants. Pursuant to stipulated orders, the motions to dismiss and the motion for partial summary judgment have been taken off calendar to permit the parties to explore settlement via mediation. The latest order provides that unless otherwise agreed to by the parties or order by the court, the motions shall be back on calendar as of late March 2008. Discovery has not commenced.

 

Government Investigations

 

In August 2006, we announced that we had received an informal inquiry from the SEC relating to our stock option grant practices. In January 2007, we were informed that the SEC is conducting a formal investigation of this matter. The DOJ is also looking into these practices but has informed KB Home that it is not a target of this investigation. We have cooperated with these government agencies and intend to continue to do so.

 

ERISA Litigation

 

A complaint dated March 14, 2007 in an action brought under Section 502 of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al., was filed in the United States District Court for the Central District of California. The action is brought against us, our directors, and certain of our current and former officers. Plaintiffs allege that they are bringing the action on behalf of all participants in the KB Home 401(k) Savings Plan (the “401(k) Plan”). Plaintiffs allege that the defendants breached fiduciary duties owed to members of the 401(k) Plan by virtue of issuing backdated option grants and failing to disclose this information to the 401(k) Plan participants. Plaintiffs claim that this conduct unjustly enriched certain defendants to the detriment of the 401(k) Plan and its participants, and caused the 401(k) Plan to invest in our securities at allegedly artificially inflated prices. The action purports to assert three causes of action for various alleged breaches of fiduciary duty. We have filed a motion to dismiss all claims alleged against us. The Court heard oral argument on the motion on November 19, 2007, after which the Court took the motion under submission. The Court has not yet ruled on the motion, and because of the pendency of the motion, no discovery has been taken in the action.

 

Storm Water Matter

 

In January 2003, we received a request for information from the EPA pursuant to Section 308 of the Clean Water Act. Several other public homebuilders have received similar requests. The request sought information about storm water pollution control program implementation at certain of our construction sites, and we provided information pursuant to the request. In May 2004, on behalf of the EPA, the DOJ tentatively asserted that certain regulatory requirements applicable to storm water discharges had been violated on certain occasions at certain of our construction sites, and civil penalties and injunctive relief might be warranted. The DOJ has also proposed certain steps it would expect us to take in the future relating to compliance with the EPA’s requirements applicable to storm water discharges. We have defenses to the claims that have been asserted and are exploring with the EPA, DOJ and other homebuilders methods of resolving the matter. To resolve the matter, the DOJ will want us to pay civil penalties and sign a consent decree affecting our storm water pollution practices at construction sites.

Other Matters

 

We are also involved in litigation and governmental proceedings incidental to our business. These cases are in various procedural stages and, based on reports of counsel, we believe that provisions or reserves made for potential losses are adequate and any liabilities or costs arising out of currently pending litigation should not have a materially adverse effect on our consolidated financial position or results of operations.

EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following sets forth certain information regarding our executive officers as of December 31, 2007:  

 

 

 

 

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

 

 

As of December 31, 2007, there were 880 holders of record of our common stock. Our common stock is traded on the New York Stock Exchange under the ticker symbol “KBH.” The following table sets forth, for the periods indicated, the price ranges of our common stock:

 

 

 

We paid quarterly cash dividends of $.25 per common share in 2007 and 2006.

 

The declaration and payment of cash dividends on shares of our common stock, whether at current levels or at all, are at the discretion of our board of directors, and depend upon, among other things, our future earnings, cash flows, capital requirements, operational investment strategy, and our general financial condition and general business conditions. In addition, debt instruments to which we are a party contain restrictions on the payment of cash dividends. Based on the most restrictive of these provisions, $283.2 million was available for payment of cash dividends at November 30, 2007.

 

The description of our equity compensation plans required by Item 201(d) of Regulation S-K is incorporated herein by reference to Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K.

 

The following table summarizes our purchases of our own equity securities during the three months ended November 30, 2007:

 

 

On December 8, 2005, our board of directors authorized a share repurchase program under which we may repurchase up to 10 million shares of our common stock. Acquisitions under the share repurchase program may be made in open market or private transactions and will be made strategically from time to time at management’s discretion based on its assessment of market conditions and buying opportunities. At November 30, 2007, we were authorized to repurchase four million shares under this share repurchase program. During the three months ended November 30, 2007, no shares were repurchased pursuant to this share repurchase program. The 73,049 shares purchased during the three months ended November 30, 2007 were previously issued shares delivered to us by employees to satisfy withholding taxes on the vesting of restricted stock awards. These transactions are not considered repurchases pursuant to the share repurchase program.

Stock Performance Graph

 

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

 

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

 

 

The above graph is based on the KB Home common stock and index prices calculated as of the last trading day before December 1^st of the year-end periods presented. Our November 30, 2007 closing common stock price on the New York Stock Exchange was $20.89 per share. On December 31, 2007, our common stock closed at $21.60 per share. The performance of our common stock depicted in the graphs above represents past performance only and is not indicative of future performance. Total return assumes $100 invested at market close on November 30, 2002 in KB Home common stock, the S&P Homebuilding Index, the Dow Jones Home Construction Index and the S&P 500 Index including reinvestment of dividends.

 

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

 

KB HOME

SELECTED FINANCIAL INFORMATION

(In Thousands, Except Per Share Amounts)

 

 

 

RESULTS OF OPERATIONS

 

Overview.  Revenues are generated from our homebuilding operations and our financial services operations. On July 10, 2007, we sold our 49% equity interest in our publicly traded French subsidiary, KBSA. Accordingly, our French operations are presented as discontinued operations in this report and the financial results of prior periods have been reclassified to conform to the current year presentation. The following table presents a summary of our consolidated results of operations for the years ended November 30, 2007, 2006 and 2005 (in thousands, except per share amounts):

 

 

Continuing the downward trends that began in 2006, conditions in the overall housing market were challenging throughout 2007 and became increasingly difficult as the year progressed. Several factors weighed on the housing industry during the year, including a persistent oversupply of new and resale homes available for sale that reached historically high levels; rising foreclosure activity; heightened competition for home sales; reduced home affordability due largely to a record increase in average home prices during the first half of this decade; turmoil in the mortgage finance and credit markets; diminished real estate speculation; and decreased consumer confidence in purchasing homes. Our results for 2007 reflect the impact of these difficult conditions. They also reflect our efforts to reduce inventory investments and community counts to better align our operations with a housing market experiencing significantly reduced activity from the peak levels of a few years ago.

 

With the prolonged market downturn, we have experienced successive negative year-over-year comparisons in our net orders (new orders for homes less cancellations) for the past several quarters. As a result, our current backlog levels are significantly below year-earlier levels and we delivered fewer homes and generated less revenue in 2007 than in 2006. Our revenues in 2007 were also negatively affected by decreases in our average selling prices in three of our four homebuilding segments compared to year-earlier levels due to competitive pressures and changes in our product mix.

At the same time, intensified competition and pricing pressures, slowing sales rates, and sustained high cancellation rates in many of our markets during 2007 lowered the fair value of certain of our assets and led us to reassess our land positions. This caused us to incur non-cash charges during the year for impairments in the value of our inventory, joint ventures and goodwill and for the abandonment of certain land option contracts. These non-cash charges and lower revenues in 2007 compressed our gross margins compared to the prior year.

 

Further impacting our results for 2007 was a substantial valuation allowance we established in the fourth quarter against certain deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). The deferred tax assets were produced largely from the inventory impairments we took during the year, and the valuation allowance was established in light of the continued downturn of the housing market and uncertainty as to its length and magnitude. To the extent that we generate sufficient taxable income in the future to utilize the tax benefits of the related deferred tax assets, we expect to experience a reduction in our effective income tax rate as the valuation allowance is reversed.

 

We reported a loss from continuing operations in 2007 resulting from the combination of fewer deliveries, lower average selling prices, compressed gross margins, non-cash charges for inventory and joint venture impairments, land option contract abandonments, goodwill impairments and the valuation allowance for deferred tax assets. We do not expect the business climate in most of the markets we serve and the overall housing market to improve in 2008.

 

Our total revenues of $6.42 billion for the year ended November 30, 2007 declined 32% from $9.38 billion in 2006, which had increased 15% from $8.15 billion in 2005. The decrease in total revenues in 2007 was primarily due to a decrease in housing revenues, reflecting fewer homes delivered and lower average selling prices compared to 2006. The increase in our revenues in 2006 was driven by an increase in housing revenues stemming from an increase in homes delivered and higher average selling prices compared to the prior year. Included in our total revenues were financial services revenues of $15.9 million in 2007, $20.2 million in 2006 and $31.4 million in 2005. The decline in financial services revenues in 2007 compared to 2006 was mainly due to fewer homes delivered from our homebuilding operations and the termination of our escrow coordination business in 2007. The decrease in financial services revenues in 2006 compared to 2005 was primarily due to the change in the mortgage banking operations of KB Home Mortgage Company (“KBHMC”) in the fourth quarter of 2005 to an unconsolidated joint venture. On September 1, 2005, we sold substantially all the mortgage banking assets of KBHMC to Countrywide and in a separate transaction established Countrywide KB Home Loans. We and Countrywide each have a 50% ownership interest in Countrywide KB Home Loans, which is accounted for as an unconsolidated joint venture in the financial services reporting segment of our consolidated financial statements.

 

Our continuing operations generated an after-tax loss of $1.41 billion in 2007 due to pretax, non-cash charges of $1.41 billion for inventory and joint venture impairments and the abandonment of land option contracts, and $107.9 million for goodwill impairment recognized during the year. The majority of the inventory and joint venture impairments related to our West Coast and Southwest reporting segments, and the goodwill impairment related solely to our Southwest reporting segment. Our 2007 loss from continuing operations also reflected a non-cash charge of $514.2 million to establish a valuation allowance for certain deferred tax assets. In 2006, we reported after-tax income from continuing operations of $392.9 million, down from $754.5 million in 2005 primarily due to a decrease in the operating margin in our homebuilding operations. Our 2006 results included charges of $431.2 million associated with inventory and joint venture impairments and land option contract abandonments, and a gain of $27.6 million related to the sale of our ownership interest in an unconsolidated joint venture. In 2007, we posted a loss per diluted share from continuing operations of $18.33 compared to earnings per diluted share from continuing operations of $4.74 in 2006 and $8.54 in 2005.

 

Income from discontinued operations, net of income taxes, totaled $485.4 million in 2007, including a $438.1 million after-tax gain on the sale of our French operations. Income from discontinued operations, net of income taxes, totaled $89.4 million in 2006 and $69.2 million in 2005. Discontinued operations are comprised solely of our French operations.

 

Overall, we posted a net loss of $929.4 million, or $12.04 per diluted share (including the French discontinued operations) in 2007. This compares to net income of $482.4 million, or $5.82 per diluted share, in 2006 and $823.7 million, or $9.32 per diluted share, in 2005.

Our backlog at November 30, 2007 consisted of 6,322 homes, representing future housing revenues of approximately $1.50 billion. These backlog levels decreased 40% and 47%, respectively, from the 10,575 homes in backlog, representing approximately $2.83 billion in future revenues, at November 30, 2006. These decreases were due to the effects of several successive quarters of negative year-over-year net order comparisons and lower average selling prices, reflecting persistently deteriorating housing market conditions. Our homebuilding operations generated 2,574 net orders in the fourth quarter of 2007, down 32% from 3,763 net orders in the fourth quarter of 2006. Net orders in the fourth quarter of 2007 decreased year-over-year in each of our reporting segments. The fourth quarter 2007 cancellation rate of 58% was the same as the cancellation rate we experienced in the fourth quarter of 2006, but was higher than the 50% cancellation rate we experienced in the third quarter of 2007.

 

HOMEBUILDING

 

We have grouped our homebuilding activities into four reportable segments, which we refer to as West Coast, Southwest, Central and Southeast. As of November 30, 2007, our reportable homebuilding segments consisted of operations located in the following states: West Coast — California; Southwest — Arizona, Nevada and New Mexico; Central — Colorado, Illinois and Texas; Southeast — Florida, Georgia, Maryland, North Carolina, South Carolina and Virginia.

 

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

 

 

Revenues.  Homebuilding revenues totaled $6.40 billion in 2007, decreasing 32% from $9.36 billion in 2006, which had increased 15% from $8.12 billion in 2005. The decrease in 2007 compared to 2006 reflected lower housing revenues due to fewer homes delivered and a lower average selling price. The increase in 2006 compared to 2005 resulted primarily from higher housing revenues driven by an increase in homes delivered and a higher average selling price.

Housing revenues totaled $6.21 billion in 2007, $9.24 billion in 2006 and $8.10 billion in 2005. In 2007, housing revenues decreased 33% from the previous year due to a 26% decline in homes delivered and a 9% decrease in the average selling price. In 2006, housing revenues increased 14% from 2005 due to a 4% increase in homes delivered and a 10% increase in the average selling price.

 

We delivered 23,743 homes in 2007, down from 32,124 homes in 2006, reflecting year-over-year decreases in each of our reporting segments. The lower delivery volume in 2007 was due, in part, to our reducing our community count to better align our operations with reduced housing market activity.

 

In 2006, we delivered 32,124 homes, up from 31,009 homes delivered in 2005. The growth in homes delivered in 2006 reflected year-over-year increases of 9% and 16% in our West Coast and Southeast segments, respectively, partially offset by decreases of 5% and 3% in homes delivered from our Southwest and Central segments, respectively.

 

Our average new home selling price decreased 9% in 2007 to $261,600 from $287,700 in 2006. Year-over-year average selling prices declined 11% in our West Coast segment, 16% in our Southwest segment and 6% in our Southeast segment due to weak consumer demand and heightened competition from homebuilders and other sellers, which put downward pressure on home prices. The average selling price in our Central segment increased 5% in 2007 from the previous year, solely due to changes in product mix.

 

Our 2006 average new home price had increased 10% from $261,200 in 2005, primarily due to the delivery in 2006 of homes purchased in the latter half of 2005, when market conditions were more favorable. Increases in our average selling prices in 2006 were more significant in the West Coast, Southwest and Southeast segments, with a slight increase in the Central segment.

 

Land sale revenues totaled $189.0 million in 2007, $116.6 million in 2006 and $23.5 million in 2005. Generally, land sale revenues fluctuate with our decisions to maintain or decrease our land ownership position in certain markets based upon the volume of our holdings, our marketing strategy, the strength and number of competing developers entering particular markets at given points in time, the availability of land in markets we serve and prevailing market conditions. Land sale revenues were more significant in 2007 and 2006 compared to 2005 as deteriorating market conditions caused us to reassess our future sales expectations which resulted in our selling land that no longer fit our marketing strategy rather than holding it for future development.

 

Operating Income.  Our homebuilding operations posted an operating loss of $1.36 billion in 2007, a decrease of $1.93 billion from operating income of $570.3 million in 2006, reflecting losses from both housing operations and land sales. The operating loss in 2007 represented a negative 21.2% of homebuilding revenues. In 2006, operating income as a percent of homebuilding revenues was 6.1%. The 2007 operating loss was due to a decrease in our housing gross margin, which fell to a negative 5.7% in 2007 from a positive 19.3% for the same period of 2006. The change in our housing gross margin was largely the result of pretax non-cash charges of $1.18 billion for inventory impairments and land option contract abandonments in 2007 primarily in our West Coast and Southwest segments. These impairment and abandonment charges resulted from declining market conditions, which depressed new home values and sales rates in certain housing markets across the country. Poor market conditions also depressed land values and led us to terminate our options on projects that no longer met our internal investment standards. Excluding inventory impairment and abandonment charges ($1.18 billion in 2007 and $309.5 million in 2006), our housing gross margin would have been 13.3% in 2007 and 22.7% in 2006.

 

Operating income decreased to $570.3 million in 2006, down from $1.19 billion in 2005. As a percentage of homebuilding revenues, operating income decreased to 6.1% in 2006 from 14.6% in 2005, mainly due to a lower housing gross margin, which decreased to 19.3% in 2006 from 26.7% in 2005. The decrease in housing gross margin was primarily due to a greater use of price concessions and sales incentives to meet competitive conditions and to aggregate charges of $309.5 million associated with inventory impairments and the abandonment of land option contracts we no longer planned to pursue.

 

In 2007, our land sales generated losses of $74.3 million, including impairment charges of $74.8 million relating to future land sales. Our land sales generated losses of $93.4 million in 2006, including impairment charges of $63.1 million relating to future land sales. In 2005, land sales generated profits of $3.7 million, including $9.6 million of impairment charges.

We evaluate our land and housing inventory for recoverability in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) whenever indicators of potential impairment exist. Based on our evaluations, we recognized non-cash charges for the impairment of inventory of $1.11 billion in 2007, $228.7 million in 2006 and $26.7 million in 2005.

 

The higher impairment charge in 2007 reflects the increasingly challenging housing market conditions that we experienced during the year that lowered the value of certain assets compared to prior periods. These conditions included a significant oversupply of homes available for sale, reduced housing affordability and tighter credit conditions that are keeping prospective buyers from trading up or entering the market, higher foreclosure activity, and heightened competition. As a result, our sales rates, sales prices and gross margins declined in 2007, lowering the fair value of certain inventory positions and resulting in the impairment of inventory. Further deterioration in housing market conditions may lead to additional non-cash impairment charges in the future or cause us to reevaluate our strategy concerning certain assets that could result in future charges associated with the abandonment of land option contracts. In 2006, most of our inventory impairment and abandonment charges were incurred in the fourth quarter, as conditions became more challenging in certain markets, mainly as a result of a growing imbalance between new home supply and demand. These market dynamics caused a decline in the fair value of certain inventory positions and led us to reassess our strategy concerning certain inventory positions.

 

When we determine that we no longer plan to exercise land purchase option contracts due to market conditions and/or changes in market strategy, we write off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. We recognized abandonment charges associated with land option contracts of $144.0 million in 2007, $143.9 million in 2006 and $16.2 million in 2005. The inventory impairment charges and land option contract abandonments are included in construction and land costs in our consolidated statements of operations.

 

Selling, general and administrative expenses totaled $824.6 million in 2007 compared with $1.12 billion in 2006 and $979.6 million in 2005. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses were 13.3% in 2007, 12.2% in 2006 and 12.1% in 2005.

 

Goodwill Impairment.  We have recorded goodwill in connection with various acquisitions in prior years. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we test goodwill for potential impairment annually as of November 30 and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During the third quarter of 2007, we determined that it was necessary to evaluate goodwill for impairment due to deteriorating conditions in certain housing markets, the significant inventory impairments we identified and recognized during the quarter in accordance with SFAS No. 144, and the decline in the market price of our common stock to a level below our per share book value. We evaluated goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is to identify potential impairment by comparing the fair value of a reporting unit to the book value, including goodwill. If the fair value of a reporting unit exceeds the book value, goodwill is not considered impaired. If the book value exceeds the fair value, the second step of the process is performed to measure the amount of impairment. Our goodwill evaluations utilized discounted cash flow analyses and market multiple analyses of historical and forecasted operating results of our reporting units. Inherent in our fair value determinations are certain judgments and estimates relating to future cash flows, including the interpretation of current economic indicators and market valuations, and assumptions about our strategic plans with regard to our operations. A change in such assumptions may cause a change in the results of the analyses performed. In addition, to the extent significant changes occur in market conditions, overall economic conditions or our strategic operational plans, it is possible that goodwill not currently impaired may become impaired in the future. Based on the results of our evaluation, we recorded an impairment charge of $107.9 million in the third quarter of 2007 related to our Southwest reporting segment, where the goodwill previously recorded was determined to be impaired. We recorded the charge at our corporate level since all goodwill is carried at that level. The annual impairment test we performed as of November 30, 2007 indicated no additional impairments. The impairment tests we performed as of November 30, 2006 and 2005 indicated no goodwill impairment.

 

Interest Income.  Interest income, which is generated from short-term investments and mortgages and notes receivable, amounted to $28.6 million in 2007, $5.5 million in 2006 and $3.5 million in 2005. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of our short-term

investments and our mortgages and notes receivable, as well as fluctuations in interest rates. The increase in interest income in 2007 compared to 2006 reflects a substantial increase in short-term investments due to the higher level of cash generated in 2007.

 

Loss on Early Redemption/Interest Expense, Net of Amounts Capitalized.  In 2007, we completed the early redemption of $650.0 million of debt. On July 27, 2007, we redeemed all $250.0 million of our 91/2% senior subordinated notes due in 2011 at a price of 103.167% of the principal amount of the notes, plus accrued interest to the date of redemption. On July 31, 2007, we repaid in full an unsecured $400.0 million term loan (the “$400 Million Term Loan”), together with accrued interest to the date of repayment. The $400 Million Term Loan was scheduled to mature on April 11, 2011. We incurred a loss of $13.0 million associated with the early extinguishment of this debt, primarily due to a call premium on the senior subordinated notes and the write-off of unamortized debt issuance costs.

 

Interest expense results principally from borrowings to finance land purchases, housing inventory and other operating and capital needs. During 2007, all of our interest was capitalized and, consequently, we had no interest expense, net of amounts capitalized. In 2006, interest expense, net of amounts capitalized, totaled $16.7 million. Gross interest incurred during 2007 decreased by $38.2 million, to $199.6 million, from $237.8 million incurred in 2006, mainly due to lower debt levels in 2007. The percentage of interest capitalized in 2007 increased to 100% from 93% in 2006 due to an increase in inventory qualifying for interest capitalization compared to 2006.

 

In 2006, interest expense, net of amounts capitalized, increased to $16.7 million from $16.3 million in 2005. Gross interest incurred in 2006 was $78.7 million higher than the amount incurred in 2005, reflecting higher debt levels in 2006. The percentage of interest capitalized in 2005 was 90%.

 

Equity in Income (Loss) of Unconsolidated Joint Ventures.  Our unconsolidated joint ventures operate in certain markets where our consolidated homebuilding operations are located. These unconsolidated joint ventures posted combined revenues of $662.7 million in 2007, $167.5 million in 2006 and $212.3 million in 2005. The increase in revenues in 2007 over the prior year was primarily due to an increase in the number of lots sold by these unconsolidated joint ventures. The decrease in unconsolidated joint venture revenues in 2006 from 2005 reflected a change in product mix. Activities performed by our unconsolidated joint ventures generally include buying, developing and selling land, and, in some cases, constructing and delivering homes. Our unconsolidated joint ventures delivered 127 homes in 2007, 4 homes in 2006 and 83 homes in 2005. Unconsolidated joint ventures generated combined losses of $51.6 million in 2007 and $48.6 million in 2006, and combined income of $34.7 million in 2005. In 2007, our equity in loss of unconsolidated joint ventures of $151.9 million included a charge of $156.4 million to recognize the impairment of certain unconsolidated joint ventures mainly in our West Coast, Southwest and Southeast segments. In 2006, our equity in loss of unconsolidated joint ventures of $20.8 million included a charge of $58.6 million to recognize the impairment of certain unconsolidated joint ventures in our West Coast and Southeast segments and a gain of $27.6 million related to the sale of our ownership interest in an unconsolidated joint venture. In 2005, our equity in income from unconsolidated joint ventures totaled $14.2 million.

HOMEBUILDING SEGMENTS

 

The following table sets forth financial information related to our homebuilding reporting segments for the years indicated (in thousands):