KB HOME - Quarter Report: 2009 February (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended February 28, 2009.

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

For the transition period from [       ] to [       ].

KB HOME

(Exact name of registrant as specified in its charter)

Delaware		95-3666267
(State of incorporation)		(IRS employer identification number)

10990 Wilshire Boulevard
Los Angeles, California 90024
(310) 231-4000
(Address and telephone number of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ       No o

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o       No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of February 28, 2009.

Common stock, par value $1.00 per share: 88,072,926 shares outstanding, including 11,830,582 shares held by the registrant’s Grantor Stock Ownership Trust and excluding 27,047,379 shares held in treasury.

 

 

KB HOME
FORM 10-Q
INDEX

		Page
		Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations — Three Months Ended February 28, 2009 and February 29, 2008			3
Consolidated Balance Sheets — February 28, 2009 and November 30, 2008			4
Consolidated Statements of Cash Flows — Three Months Ended February 28, 2009 and February 29, 2008			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			50
Item 4. Controls and Procedures			50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			51
Item 1A. Risk Factors			52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			52
Item 4. Submission of Matters to a Vote of Security Holders			52
Item 6. Exhibits			53
SIGNATURES			54
INDEX OF EXHIBITS			55
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts — Unaudited)

		Three Months Ended
		February 28,				February 29,
		2009				2008
Total revenues		$	307,361			$	794,224
Homebuilding:
Revenues		$	305,741			$	791,308
Construction and land costs			(290,958	)			(912,641	)
Selling, general and administrative expenses			(61,175	)			(127,638	)
Operating loss			(46,392	)			(248,971	)
Interest income			3,513				13,032
Interest expense, net of amounts capitalized			(8,652	)			—
Equity in loss of unconsolidated joint ventures			(9,742	)			(39,878	)
Homebuilding pretax loss			(61,273	)			(275,817	)
Financial services:
Revenues			1,620				2,916
Expenses			(860	)			(1,119	)
Equity in income of unconsolidated joint venture			941				6,148
Financial services pretax income			1,701				7,945
Total pretax loss			(59,572	)			(267,872	)
Income tax benefit (expense)			1,500				(300	)
Net loss		$	(58,072	)		$	(268,172	)
Basic and diluted loss per share		$	(.75	)		$	(3.47	)
Basic and diluted average shares outstanding			77,375				77,363
Cash dividends declared per common share		$	.0625			$	.25

See accompanying notes.

CONSOLIDATED BALANCE SHEETS
(In Thousands — Unaudited)

		February 28,				November 30,
		2009				2008
Assets
Homebuilding:
Cash and cash equivalents		$	1,020,911			$	1,135,399
Restricted cash			111,208				115,404
Receivables			161,031				357,719
Inventories			2,021,765				2,106,716
Investments in unconsolidated joint ventures			174,993				177,649
Other assets			95,582				99,261
			3,585,490				3,992,148
Financial services			52,531				52,152
Total assets		$	3,638,021			$	4,044,300
Liabilities and stockholders’ equity
Homebuilding:
Accounts payable		$	477,591			$	541,294
Accrued expenses and other liabilities			645,960				721,397
Mortgages and notes payable			1,737,968				1,941,537
			2,861,519				3,204,228
Financial services			8,841				9,467
Common stock			115,120				115,120
Paid-in capital			864,854				865,123
Retained earnings			864,496				927,324
Accumulated other comprehensive loss			(17,402	)			(17,402	)
Grantor stock ownership trust, at cost			(128,557	)			(129,326	)
Treasury stock, at cost			(930,850	)			(930,234	)
Total stockholders’ equity			767,661				830,605
Total liabilities and stockholders’ equity		$	3,638,021			$	4,044,300

See accompanying notes.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands — Unaudited)

		Three Months Ended
		February 28,				February 29,
		2009				2008
Cash flows from operating activities:
Net loss		$	(58,072	)		$	(268,172	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Equity in loss of unconsolidated joint ventures			8,801				33,730
Distributions of earnings from unconsolidated joint ventures			662				6,547
Amortization of discounts and issuance costs			340				586
Depreciation and amortization			1,486				2,797
Tax benefit associated with exercise of stock options			1,152				1,663
Stock-based compensation expense			468				1,387
Inventory impairments and land option contract abandonments			24,670				187,575
Change in assets and liabilities:
Receivables			197,449				92,585
Inventories			57,448				186,032
Accounts payable, accrued expenses and other liabilities			(133,016	)			(228,969	)
Other, net			2,131				6,585
Net cash provided by operating activities			103,519				22,346
Cash flows from investing activities:
Change in restricted cash			4,196				—
Investments in unconsolidated joint ventures			(7,748	)			(24,449	)
Sales (purchases) of property and equipment, net			(821	)			5,376
Net cash used by investing activities			(4,373	)			(19,073	)
Cash flows from financing activities:
Repayment of senior subordinated notes			(200,000	)			—
Payments on mortgages, land contracts and other loans			(8,843	)			(353	)
Issuance of common stock under employee stock plans			795				1,822
Payments of cash dividends			(4,756	)			(19,355	)
Repurchases of common stock			(616	)			(557	)
Net cash used by financing activities			(213,420	)			(18,443	)
Net decrease in cash and cash equivalents			(114,274	)			(15,170	)
Cash and cash equivalents at beginning of period			1,141,518				1,343,742
Cash and cash equivalents at end of period		$	1,027,244			$	1,328,572

See accompanying notes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation and Significant Accounting Policies

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

In the opinion of KB Home (the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s consolidated financial position as of February 28, 2009, the results of its consolidated operations for the three months ended February 28, 2009 and February 29, 2008, and its consolidated cash flows for the three months ended February 28, 2009 and February 29, 2008. The results of operations for the three months ended February 28, 2009 are not necessarily indicative of the results to be expected for the full year, due to seasonal variations in operating results and other factors. The consolidated balance sheet at November 30, 2008 has been taken from the audited consolidated financial statements as of that date. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended November 30, 2008, which are contained in the Company’s Annual Report on Form 10-K for that period.

Use of Estimates

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and, as such, include amounts based on informed estimates and judgments of management. Actual results could differ from these estimates.

Loss per share

Basic loss per share is calculated by dividing the net loss by the average number of common shares outstanding for the period. Diluted loss per share is calculated by dividing the net loss by the average number of common shares outstanding including all potentially dilutive shares issuable under outstanding stock options. All outstanding stock options were excluded from the diluted loss per share calculation for the three months ended February 28, 2009 and February 29, 2008 because the effect of their inclusion would be antidilutive, or would decrease the reported loss per share.

Comprehensive loss

The Company’s comprehensive loss was $58.1 million for the three months ended February 28, 2009 and $268.2 million for the three months ended February 29, 2008. The accumulated balances of other comprehensive loss in the consolidated balance sheets as of February 28, 2009 and November 30, 2008 are comprised solely of adjustments recorded directly to accumulated other comprehensive loss in accordance with Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R),” which requires an employer to recognize the funded status of a defined postretirement benefit plan as an asset or liability on the balance sheet and requires any unrecognized prior service costs and actuarial gains/losses to be recognized in accumulated other comprehensive income (loss).

Reclassifications

Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to the 2009 presentation.

2. Stock-Based Compensation

The Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective transition method

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2. Stock-Based Compensation (continued)

effective December 1, 2005. SFAS No. 123(R) requires a public entity to measure compensation cost associated with awards of equity instruments based on the grant-date fair value of the awards over the requisite service period. SFAS No. 123(R) requires public entities to initially measure compensation cost associated with awards of liability instruments based on their current fair value. The fair value of that award is to be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period.

Stock Options

In accordance with SFAS No. 123(R), the Company estimates the grant-date fair value of its stock options using the Black-Scholes option-pricing model, which takes into account assumptions regarding the dividend yield, the risk-free interest rate, the expected stock-price volatility and the expected term of the stock options. The following table summarizes the stock options outstanding and stock options exercisable as of February 28, 2009, as well as stock options activity during the three months then ended:

						Weighted
						Average Exercise
		Options				Price
Options outstanding at beginning of period			7,847,402			$	30.11
Granted			—				—
Exercised			—				—
Cancelled			(3,266,860	)			28.39
Options outstanding at end of period			4,580,542			$	31.33
Options exercisable at end of period			4,163,826			$	31.03

As of February 28, 2009, the weighted average remaining contractual lives of stock options outstanding and stock options exercisable were 8.9 years and 9.0 years, respectively. There was $1.7 million of total unrecognized compensation cost related to unvested stock option awards as of February 28, 2009. For the three months ended February 28, 2009 and February 29, 2008, stock-based compensation expense associated with stock options totaled $.5 million and $1.3 million, respectively. The aggregate intrinsic value of stock options outstanding and stock options exercisable were each negligible as of February 28, 2009. (The intrinsic value of a stock option is the amount by which the market value of a share of the Company’s common stock exceeds the exercise price of the stock option.)

On February 9, 2009, in connection with the settlement of the derivative litigation described below in Note 12. Legal Matters in the Notes to Consolidated Financial Statements in this Form 10-Q, the Company’s former chairman and chief executive officer relinquished 3,011,452 stock options to the Company, and those stock options were cancelled.

Other Stock-Based Awards

From time to time, the Company grants restricted stock, phantom shares and stock appreciation rights to various employees. The Company recognized total compensation income of $.6 million in the first quarter of 2009 and total compensation expense of $2.9 million in the first quarter of 2008 related to these stock-based awards.

3. Segment Information

As of February 28, 2009, the Company has identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within its consolidated operations in accordance with Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Segment Information (continued)

Enterprise and Related Information.” As of February 28, 2009, the Company’s homebuilding reporting segments conducted ongoing operations in the following states:

West Coast: California
Southwest: Arizona and Nevada
Central: Colorado and Texas
Southeast: Florida, North Carolina and South Carolina

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

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

The Company’s financial services reporting segment provides title and insurance services to the Company’s homebuyers. The financial services reporting segment also provides mortgage banking services to the Company’s homebuyers indirectly through Countrywide KB Home Loans, LLC (“Countrywide KB Home Loans”), a joint venture between a Company subsidiary and CWB Venture Management Corporation, a subsidiary of Bank of America N.A. The Company’s financial services reporting segment conducts operations in the same markets as the Company’s homebuilding reporting segments.

The Company’s reporting segments follow the same accounting policies used for the Company’s consolidated financial statements. Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent, stand-alone entity during the periods presented.

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

		Three Months Ended
		February 28,				February 29,
		2009				2008
Revenues:
West Coast		$	108,520			$	241,076
Southwest			52,273				241,847
Central			77,645				151,889
Southeast			67,303				156,496
Total homebuilding revenues			305,741				791,308
Financial services			1,620				2,916
Total revenues		$	307,361			$	794,224
Pretax income (loss):
West Coast		$	(12,322	)		$	(71,987	)
Southwest			(20,738	)			(55,427	)
Central			(6,156	)			(29,942	)
Southeast			(13,825	)			(104,112	)
Corporate and other (a)			(8,232	)			(14,349	)
Total homebuilding pretax loss			(61,273	)			(275,817	)
Financial services			1,701				7,945
Total pretax loss		$	(59,572	)		$	(267,872	)

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Segment Information (continued)

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

		Three Months Ended
		February 28,				February 29,
		2009				2008
Equity in income (loss) of unconsolidated joint ventures:
West Coast		$	195			$	(9,374	)
Southwest			(7,687	)			(5,175	)
Central			21				(1,514	)
Southeast			(2,271	)			(23,815	)
Total		$	(9,742	)		$	(39,878	)
Inventory impairments:
West Coast		$	6,991			$	52,114
Southwest			11,927				52,010
Central			—				17,285
Southeast			5,469				58,915
Total		$	24,387			$	180,324
Inventory abandonments:
West Coast		$	283			$	—
Southwest			—				187
Central			—				—
Southeast			—				7,064
Total		$	283			$	7,251
Joint venture impairments:
West Coast		$	—			$	8,106
Southwest			5,426				4,944
Central			—				471
Southeast			2,186				22,835
Total		$	7,612			$	36,356

		February 28,				November 30,
		2009				2008
Assets:
West Coast		$	1,065,784			$	1,086,503
Southwest			455,110				497,034
Central			428,204				443,168
Southeast			430,174				453,771
Corporate and other			1,206,218				1,511,672
Total homebuilding assets			3,585,490				3,992,148
Financial services			52,531				52,152
Total assets		$	3,638,021			$	4,044,300

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Segment Information (continued)

		February 28,				November 30,
		2009				2008
Investments in unconsolidated joint ventures:
West Coast		$	55,661			$	55,856
Southwest			110,933				113,564
Central			3,360				3,339
Southeast			5,039				4,890
Total		$	174,993			$	177,649

4. Financial Services

Financial information related to the Company’s financial services reporting segment is as follows (in thousands):

		Three Months Ended
		February 28,				February 29,
		2009				2008
Revenues
Interest income		$	17			$	47
Title services			187				438
Insurance commissions			1,416				2,431
Total			1,620				2,916
Expenses
General and administrative			(860	)			(1,119	)
Operating income			760				1,797
Equity in income of unconsolidated joint venture			941				6,148
Pretax income		$	1,701			$	7,945

		February 28,				November 30,
		2009				2008
Assets
Cash and cash equivalents		$	6,333			$	6,119
Receivables			479				1,240
Investment in unconsolidated joint venture			45,674				44,733
Other assets			45				60
Total assets		$	52,531			$	52,152
Liabilities
Accounts payable and accrued expenses		$	8,841			$	9,467
Total liabilities		$	8,841			$	9,467

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.		Inventories
		Inventories consisted of the following (in thousands):

		February 28,				November 30,
		2009				2008
Homes, lots and improvements in production		$	1,564,918			$	1,649,838
Land under development			456,847				456,878
Total		$	2,021,765			$	2,106,716

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

		Three Months Ended
		February 28,				February 29,
		2009				2008
Capitalized interest at beginning of period		$	361,619			$	348,084
Interest incurred			29,258				38,502
Interest expensed			(8,652	)			—
Interest amortized			(16,892	)			(28,576	)
Capitalized interest at end of period (a)		$	365,333			$	358,010

6.		Inventory Impairments and Abandonments
		Each parcel or community in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each parcel or community on a quarterly basis and include, but are not limited to: significant decreases in sales rates, average selling prices, volume of homes delivered, gross margins on homes delivered or projected margins on homes in backlog or future housing sales; significant increases in budgeted land development and construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a parcel or community, the identified inventory is evaluated 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”). When an indicator of potential impairment is identified, the Company tests the asset for recoverability by comparing the carrying amount of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by trends and factors known to the Company at the time they are calculated and the Company’s expectations related to: market supply and demand, including estimates concerning average selling prices; sales and cancellation rates; and anticipated land development, construction and overhead costs to be incurred. These estimates, trends and expectations are specific to each community and may vary among communities.
		A real estate asset is considered impaired when its carrying amount is greater than the undiscounted future net cash flows the asset is expected to generate. Impaired real estate assets are written down to fair value, which is primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6.		Inventory Impairments and Abandonments (continued)
		in the market in which the asset is located at the time the assessment is made. These factors are specific to each community and may vary among communities.
		Based on the results of its evaluations, the Company recognized pretax, noncash inventory impairment charges of $24.4 million in the first quarter of 2009 and $180.3 million in the first quarter of 2008. As of February 28, 2009, the aggregate carrying value of inventory impacted by pretax, noncash impairment charges was $939.9 million, representing 159 communities and various other land parcels. As of November 30, 2008, the aggregate carrying value of inventory impacted by pretax, noncash impairment charges was $1.01 billion, representing 163 communities and various other land parcels.
		The Company’s optioned inventory is assessed to determine whether it continues to meet the Company’s internal investment standards. Assessments are made separately for each optioned parcel on a quarterly basis and are affected by, among other factors: current and/or anticipated sales rates, average selling prices and home delivery volume; estimated land development and construction costs; and projected profitability on expected future housing or land sales. When a decision is made not to exercise certain land option contracts due to market conditions and/or changes in market strategy, the Company writes off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. Based on the results of its assessments, the Company recognized land option contract abandonment charges of $.3 million in the first quarter of 2009 and $7.3 million in the first quarter of 2008.
		The inventory impairment charges and land option contract abandonment charges are included in construction and land costs in the Company’s consolidated statements of operations.
		Due to the judgment and assumptions applied in the estimation process with respect to impairments and land option contract abandonments, it is possible that actual results could differ substantially from those estimated.
7.		Fair Value Disclosures
		Effective December 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”), for its assets and liabilities measured at fair value on a nonrecurring basis. SFAS No. 157 provides guidance for using fair value to measure assets and liabilities, defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, expands disclosures about fair value measurements, and establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
		The fair value hierarchy can be summarized as follows:

		Level 1		Fair value determined based on quoted prices in active markets for identical assets or liabilities.
		Level 2		Fair value determined using significant observable inputs, such as quoted prices for similar assets or liabilities or quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that are derived principally from or corroborated by observable market data, by correlation or other means.
		Level 3		Fair value determined using significant unobservable inputs, such as discounted cash flows, or similar techniques.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.		Fair Value Disclosures (continued)
		The Company’s assets measured at fair value on a nonrecurring basis are summarized below (in thousands):

Fair Value Measurements Using

Quoted

Significant

Three Months

Prices in

Other

Significant

Ended

Active

Observable

Unobservable

February 28,

Markets

Inputs

Inputs

Total Gains

Description

2009

(Level 1)

(Level 2)

(Level 3)

(Losses)

Long-lived assets held and used

$

25,650

$

—

$

—

$

25,650

$

(24,387

)

		In accordance with the provisions of SFAS No. 144, long-lived assets held and used with a carrying amount of $50.0 million were written down to their fair value of $25.6 million, resulting in noncash inventory impairment charges of $24.4 million for the three months ended February 28, 2009. These charges were included in the Company’s construction and land costs in the consolidated statement of operations for the period.
		Fair values for long-lived assets held and used are primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development; construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each community and may vary among communities.
8.		Consolidation of Variable Interest Entities
		In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FASB Interpretation No. 46(R)”), to clarify the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities, called variable interest entities (“VIEs”), in which equity investors do not have the characteristics of a controlling interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. Under FASB Interpretation No. 46(R), an enterprise that absorbs a majority of the VIE’s expected losses, receives a majority of the VIE’s expected residual returns, or both, is considered to be the primary beneficiary of the VIE and must consolidate the entity in its financial statements.
		The Company participates in joint ventures from time to time for the purpose of conducting land acquisition, development and/or other homebuilding activities. Its investments in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. The Company analyzes its joint ventures in accordance with FASB Interpretation No. 46(R) when they are entered into or upon a reconsideration event. All of the Company’s joint ventures at February 28, 2009 and November 30, 2008 were determined to be unconsolidated joint ventures either because they were not VIEs or, if they were VIEs, the Company was not the primary beneficiary of the VIEs.
		In the ordinary course of its business, the Company enters into land option contracts (or similar agreements) in order to procure land for the construction of homes. The use of such option and other contracts generally allows the Company to reduce the risks associated with direct land ownership and development, reduces the Company’s capital and financial commitments, including interest and other carrying costs, and minimizes the amount of the Company’s land inventories on its consolidated balance sheet. Under such land option contracts, the Company will pay a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of FASB Interpretation No. 46(R), certain of

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.		Consolidation of Variable Interest Entities (continued)
		the Company’s land option contracts may create a variable interest for the Company, with the land seller being identified as a VIE.
		In compliance with FASB Interpretation No. 46(R), the Company analyzes its land option contracts and other contractual arrangements when they are entered into or upon a reconsideration event, and as a result has consolidated the fair value of certain VIEs from which the Company is purchasing land under option contracts. Although the Company does not have legal title to the land, FASB Interpretation No. 46(R) requires the Company to consolidate the VIE if the Company is determined to be the primary beneficiary. The consolidation of VIEs in which the Company was determined to be the primary beneficiary increased its inventories, with a corresponding increase to accrued expenses and other liabilities, on the Company’s consolidated balance sheets by $15.5 million at both February 28, 2009 and November 30, 2008. The liabilities related to the Company’s consolidation of VIEs from which it has arranged to purchase land under option and other contracts represent the difference between the purchase price of land not yet purchased and the Company’s cash deposits. The Company’s cash deposits related to these land option and other contracts totaled $3.4 million at both February 28, 2009 and November 30, 2008. Creditors, if any, of these VIEs have no recourse against the Company. As of February 28, 2009, excluding consolidated VIEs, the Company had cash deposits totaling $24.3 million associated with land option and other contracts having an aggregate purchase price of $484.6 million.
		The Company’s exposure to loss related to its land option and other contracts with third parties and unconsolidated entities consisted of its non-refundable deposits totaling $27.7 million at February 28, 2009 and $33.1 million at November 30, 2008. In addition, the Company posted letters of credit of $17.9 million at February 28, 2009 and $32.5 million at November 30, 2008 in lieu of cash deposits under certain land option contracts.
		The Company also evaluates land option and other contracts in accordance with Statement of Financial Accounting Standards No. 49, “Accounting for Product Financing Arrangements” (“SFAS No. 49”), and, as a result of its evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, on its consolidated balance sheets by $73.6 million at February 28, 2009 and $81.5 million at November 30, 2008.
9.		Investments in Unconsolidated Joint Ventures
		The Company participates in unconsolidated joint ventures that conduct land acquisition, development and/or other homebuilding activities in various markets, typically where the Company’s homebuilding operations are located. The Company’s partners in these unconsolidated joint ventures are unrelated homebuilders, land developers and other real estate entities, or commercial enterprises. Through these unconsolidated joint ventures, the Company seeks to reduce and share market and development risks and to reduce its investment in land inventory, while potentially increasing the number of homesites it controls or will own. In some instances, participating in unconsolidated joint ventures enables the Company to acquire and develop land that it might not otherwise have access to due to a project’s size, financing needs, duration of development or other circumstances. While the Company views its participation in unconsolidated joint ventures as beneficial to its homebuilding activities, it does not view such participation as essential.
		The Company and/or its unconsolidated joint venture partners typically obtain options or enter into other arrangements to have the right to purchase portions of the land held by the unconsolidated joint ventures. The prices for these land options or other arrangements are generally negotiated prices that approximate fair value. When an unconsolidated joint venture sells land to the Company’s homebuilding operations, the Company defers recognition of its share of such unconsolidated joint venture earnings until a home sale is closed and title passes to a homebuyer, at which time the Company accounts for those earnings as a reduction of the cost of purchasing the land from the unconsolidated joint venture.
		The Company and its unconsolidated joint venture partners make initial or ongoing capital contributions to these unconsolidated joint ventures, typically on a pro rata basis. The obligations to make capital contributions are

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.		Investments in Unconsolidated Joint Ventures (continued)
		governed by each unconsolidated joint venture’s respective operating agreement and related documents.
		Each unconsolidated joint venture is obligated to maintain financial statements in accordance with U.S. generally accepted accounting principles. The Company shares in profits and losses of these unconsolidated joint ventures generally in accordance with its respective equity interests.
		The following table presents combined condensed statement of operations information for the Company’s unconsolidated joint ventures (in thousands):

		Three Months Ended
		February 28,				February 29,
		2009				2008
Revenues		$	11,476			$	27,383
Construction and land costs			(18,501	)			(38,640	)
Other expenses, net			(6,135	)			(7,570	)
Loss		$	(13,160	)		$	(18,827	)

With respect to the Company’s investment in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures included pretax, noncash impairment charges of $7.6 million for the three months ended February 28, 2009 and $36.4 million for the three months ended February 29, 2008.

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

		February 28,				November 30,
		2009				2008
Assets
Cash		$	17,414			$	29,194
Receivables			143,635				143,926
Inventories			1,025,331				1,029,306
Other assets			55,115				55,289
Total assets		$	1,241,495			$	1,257,715
Liabilities and equity
Accounts payable and other liabilities		$	95,248			$	85,064
Mortgages and notes payable			858,832				871,279
Equity			287,415				301,372
Total liabilities and equity		$	1,241,495			$	1,257,715

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.		Investments in Unconsolidated Joint Ventures (continued)
		The following table presents information relating to the Company’s investments in unconsolidated joint ventures and the aggregate outstanding debt of its unconsolidated joint ventures as of the dates specified, categorized by the nature of the Company’s potential responsibility under a guaranty, if any, for such debt (dollars in thousands):

		February 28,				November 30,
		2009				2008
Number of investments in unconsolidated joint ventures:
With recourse debt (a)			1				1
With limited recourse debt (b)			4				4
With non-recourse debt (c)			10				10
Other (d)			9				10
Total			24				25
Investments in unconsolidated joint ventures:
With recourse debt		$	3,361			$	3,339
With limited recourse debt			—				1,360
With non-recourse debt			24,564				24,590
Other			147,068				148,360
Total		$	174,993			$	177,649
Outstanding debt of unconsolidated joint ventures:
With recourse debt		$	2,546			$	3,249
With limited recourse debt			110,550				112,700
With non-recourse debt			372,238				381,393
Other			373,498				373,937
Total (e)		$	858,832			$	871,279

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.

Investments in Unconsolidated Joint Ventures (continued)

			In most cases, the Company may have also entered into a completion guaranty and/or a carve-out guaranty with the lenders for the unconsolidated joint ventures identified in categories (a) through (d).
	(e)		The “Total” amounts represent the aggregate outstanding debt of the unconsolidated joint ventures in which the Company participates. The amounts do not represent the Company’s potential responsibility for such debt, if any. In most cases, the Company’s maximum potential responsibility for any portion of such debt, if any, is limited to either a specified maximum amount or an amount equal to its pro rata interest in the relevant unconsolidated joint venture, as further described below.

		The unconsolidated joint ventures finance land and inventory investments through a variety of arrangements. To finance their respective land acquisition and development activities, many of the Company’s unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. The unconsolidated joint ventures had outstanding debt, substantially all of which was secured, of approximately $858.8 million at February 28, 2009 and $871.3 million at November 30, 2008. The unconsolidated joint ventures are subject to various financial and non-financial covenants in conjunction with their debt, primarily related to fair value of collateral and minimum land purchase or sale requirements within a specified period. In a few instances, the financial covenants are based on the Company’s financial position. The inability of an unconsolidated joint venture to comply with its debt covenants could result in a default and cause lenders to seek to enforce guarantees, if applicable, as described below.
		In certain instances, the Company and/or its partner(s) in an unconsolidated joint venture provide guarantees and indemnities to the unconsolidated joint venture’s lenders that may include one or more of the following: (a) a completion guaranty; (b) a loan-to-value maintenance guaranty; and/or (c) a carve-out guaranty. A completion guaranty refers to the actual physical completion of improvements for a project and/or the obligation to contribute equity to an unconsolidated joint venture to enable it to fund its completion obligations. A loan-to-value maintenance guaranty refers to the payment of funds to maintain the applicable loan balance at or below a specific percentage of the value of an unconsolidated joint venture’s secured collateral (generally land and improvements). A carve-out guaranty refers to the payment of (i) losses a lender suffers due to certain bad acts or omissions by an unconsolidated joint venture or its partners, such as fraud or misappropriation, or due to environmental liabilities arising with respect to the relevant project, or (ii) outstanding principal and interest and certain other amounts owed to lenders upon the filing by an unconsolidated joint venture of a voluntary bankruptcy petition or the filing of an involuntary bankruptcy petition by creditors of the unconsolidated joint venture in which an unconsolidated joint venture or its partners collude or which the unconsolidated joint venture fails to contest.
		In most cases, the Company’s maximum potential responsibility under these guarantees and indemnities is limited to either a specified maximum dollar amount or an amount equal to its pro rata interest in the relevant unconsolidated joint venture. In a few cases, the Company has entered into agreements with its unconsolidated joint venture partners to be reimbursed or indemnified with respect to the guarantees the Company has provided to an unconsolidated joint venture’s lenders for any amounts the Company may pay pursuant to such guarantees above its pro rata interest in the unconsolidated joint venture. If the Company’s unconsolidated joint venture partners are unable to fulfill their reimbursement or indemnity obligations, or otherwise fail to do so, the Company could incur more than its allocable share under the relevant guaranty. Should there be indications that advances (if made) will not be voluntarily repaid by an unconsolidated joint venture partner under any such reimbursement arrangements, the Company vigorously pursues all rights and remedies available to it under the applicable agreements, at law or in equity to enforce its rights.
		The Company’s potential responsibility under its completion guarantees, if triggered, is highly dependent on the facts of a particular case. In any event, the Company believes its actual responsibility under these guarantees is limited to the amount, if any, by which an unconsolidated joint venture’s outstanding borrowings exceed the value of its assets, but may be substantially less than this amount.
		At February 28, 2009, the Company’s potential responsibility under its loan-to-value maintenance guarantees totaled approximately $44.3 million, if any liability were determined to be due thereunder. This amount

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.		Investments in Unconsolidated Joint Ventures (continued)
		represents the Company’s maximum responsibility under such loan-to-value maintenance guarantees assuming the underlying collateral has no value and without regard to defenses that could be available to the Company against attempted enforcement of such guarantees.
		Notwithstanding these potential responsibilities, at this time the Company does not believe that its exposure under its existing completion, loan-to-value and carve-out guarantees and indemnities related to unconsolidated joint venture debt is material to the Company’s consolidated financial position, results of operations or liquidity.
		The lenders for two of the Company’s unconsolidated joint ventures have filed lawsuits against some of the unconsolidated joint ventures’ members, and certain of those members’ parent companies, seeking to recover damages under completion guarantees, among other claims. The Company and the other parent companies, together with the members, are defending the lawsuits in which they have been named. The Company does not believe that these lawsuits will have a material impact on the Company’s consolidated financial position or results of operations.
		In addition to the above-described guarantees and indemnities, the Company has also provided a several guaranty to the lenders of one of the Company’s unconsolidated joint ventures. By its terms, the guaranty purports to guarantee the repayment of principal and interest and certain other amounts owed to the unconsolidated joint venture’s lenders when an involuntary bankruptcy proceeding is filed against the unconsolidated joint venture that is not dismissed within 60 days or for which an order approving relief under bankruptcy law is entered, even if the unconsolidated joint venture or its partners do not collude in the filing and the unconsolidated joint venture contests the filing. The Company’s potential responsibility under this several guaranty fluctuates with the outstanding borrowings against the unconsolidated joint venture’s debt and with the Company’s and its partners’ respective land purchases from the unconsolidated joint venture. At February 28, 2009, this unconsolidated joint venture had total outstanding indebtedness of approximately $373.5 million and, if this guaranty were then enforced, the Company’s maximum potential responsibility under the guaranty would have been approximately $182.7 million, which amount does not account for any offsets or defenses that could be available to the Company. This unconsolidated joint venture has received notices from its lenders’ administrative agent alleging a number of defaults under its loan agreement. The Company is currently exploring resolutions with the lenders, the lenders’ administrative agent and the Company’s unconsolidated joint venture partners, but there is no assurance that the Company will reach a satisfactory resolution with all of the parties involved.
		Certain of the Company’s other unconsolidated joint ventures operating in difficult market conditions are in default of their debt agreements with their lenders or are at risk of defaulting. In addition, certain of the Company’s unconsolidated joint venture partners have curtailed funding of their allocable joint venture obligations. The Company is carefully managing its investments in these particular unconsolidated joint ventures and is working with the relevant lenders and unconsolidated joint venture partners to reach satisfactory resolutions. In some instances, the Company may decide to opportunistically purchase its partners’ interests and would consolidate the joint venture, which would result in an increase in mortgages and notes payable on the Company’s consolidated balance sheets. However, such purchases may not resolve a claimed default by the joint venture under its debt agreements. Additionally, the Company may seek new equity partners to participate in its unconsolidated joint ventures or, based on market conditions and other strategic considerations, may decide to withdraw from an unconsolidated joint venture and allow the unconsolidated joint venture’s lenders to exercise their remedies with respect to the underlying collateral (subject to any relevant defenses available to the Company). Based on the terms and amounts of the debt involved for these particular unconsolidated joint ventures and the terms of the applicable joint venture operating agreements, the Company does not believe that its exposure related to any defaults by or with respect to these particular unconsolidated joint ventures is material to the Company’s consolidated financial position, results of operations or liquidity.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.		Mortgages and Notes Payable
		Mortgages and notes payable consisted of the following (in thousands):

		February 28,				November 30,
		2009				2008
Mortgages and land contracts due to land sellers and other loans		$	92,594			$	96,368
Senior subordinated notes due December 15, 2008 at 8 5/8%			—				200,000
Senior notes due 2011 at 6 3/8%			349,001				348,908
Senior notes due 2014 at 5 3/4%			249,259				249,227
Senior notes due 2015 at 5 7/8%			298,737				298,692
Senior notes due 2015 at 6 1/4%			449,664				449,653
Senior notes due 2018 at 7 1/4%			298,713				298,689
Total		$	1,737,968			$	1,941,537

		The Company has an unsecured revolving credit facility (the “Credit Facility”) with a syndicate of lenders that matures in November 2010. Interest on the Credit Facility is payable monthly at the London Interbank Offered Rate plus an applicable spread on amounts borrowed. At February 28, 2009, the Company had no cash borrowings outstanding and $208.8 million in letters of credit outstanding under the Credit Facility. The aggregate commitment under the Credit Facility will be permanently reduced from $800.0 million to $650.0 million in the second quarter of 2009 because the Company’s consolidated tangible net worth was below $800.0 million at February 28, 2009. Under the terms of the Credit Facility, the Company is required, among other things, to maintain a minimum consolidated tangible net worth and certain financial statement ratios, and is subject to limitations on acquisitions, inventories and indebtedness.
		On December 15, 2008, the Company repaid $200.0 million of 8 5/8% senior subordinated notes (the $200 Million Senior Subordinated Notes”) which matured on that date.
		The Company’s indenture governing its senior notes does not contain any financial maintenance covenants. Subject to specified exceptions, the senior notes indenture contains certain restrictive covenants that, among other things, limit the Company’s ability to incur secured indebtedness; engage in sale-leaseback transactions involving property or assets above a certain specified value; or engage in mergers, consolidations, or sales of assets.
		As of February 28, 2009, the Company was in compliance with the applicable terms of all of its covenants under its Credit Facility and senior notes indenture. However, the Company’s ability to continue to borrow funds depends in part on its ability to remain in such compliance. The Company’s inability to do so could make it more difficult and expensive to maintain its current level of external debt financing or to obtain additional financing.
11.		Commitments and Contingencies
		The Company provides a limited warranty on all of its homes. The specific terms and conditions of warranties vary depending upon the market in which the Company does business. The Company generally provides a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home. The Company estimates the costs that may be incurred under each limited warranty and records a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect the Company’s warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. The Company’s primary assumption in estimating the amounts it accrues for warranty costs is that historical claims experience is a strong indicator of future claims experience. The Company periodically assesses the adequacy of its recorded warranty liabilities, which are included in accrued expenses and other liabilities in the consolidated balance sheets, and adjusts the amounts as necessary based on its assessment.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11.		Commitments and Contingencies (continued)
		The changes in the Company’s warranty liability are as follows (in thousands):

		Three Months Ended
		February 28,				February 29,
		2009				2008
Balance at beginning of period		$	145,369			$	151,525
Warranties issued			1,993				6,934
Payments and adjustments			(5,138	)			(7,542	)
Balance at end of period		$	142,224			$	150,917

		In the normal course of its business, the Company issues certain representations, warranties and guarantees related to its home sales and land sales that may be affected by FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Based on historical evidence, the Company does not believe any of these representations, warranties or guarantees would result in a material effect on its consolidated financial position or results of operations.
		The Company has, and requires the majority of its subcontractors to have, general liability insurance (including construction defect coverage) and workers’ compensation insurance. These insurance policies protect the Company against a portion of its risk of loss from claims related to its homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. The Company self-insures a portion of its overall risk through the use of a captive insurance subsidiary. The Company records expenses and liabilities based on the costs required to cover its self-insured retention and deductible amounts under its insurance policies, and on the estimated costs of potential claims and claim adjustment expenses above its coverage limits or not covered by its policies. These estimated costs are based on an analysis of the Company’s historical claims and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $105.7 million at February 28, 2009 and $101.5 million at November 30, 2008. These amounts are included in accrued expenses and other liabilities in the consolidated balance sheets.
		The Company is often required to obtain performance bonds and letters of credit in support of its obligations to various municipalities and other government agencies in connection with community improvements such as roads, sewers and water. At February 28, 2009, the Company had $706.8 million of performance bonds and $208.8 million of letters of credit outstanding. In the event any such performance bonds or letters of credit are called, the Company would be obligated to reimburse the issuer of the performance bond or letter of credit. At this time, the Company does not believe that a material amount of any currently outstanding performance bonds or letters of credit will be called. Performance bonds do not have stated expiration dates. Rather, the Company is released from the performance bonds as the underlying performance is completed. The expiration dates of letters of credit issued in connection with community improvements coincide with the expected completion dates of the related projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis.
		Borrowings outstanding, if any, and letters of credit issued under the Company’s Credit Facility are guaranteed by certain of the Company’s subsidiaries (the “Guarantor Subsidiaries”).
		In the ordinary course of its business, the Company enters into land option contracts to procure land for the construction of homes. At February 28, 2009, the Company had total deposits of $45.6 million, comprised of cash deposits of $27.7 million and letters of credit of $17.9 million, to purchase land with a total remaining purchase price of $503.5 million. The Company’s land option contracts generally do not contain provisions requiring the Company’s specific performance.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

12.		Legal Matters
		Derivative Litigation and Related Proceedings
		In the summer of 2006, four shareholder derivative lawsuits were filed, ostensibly on behalf of the Company, alleging, among other things, that the defendants (various current and former directors and officers of the Company) breached their fiduciary duties to the Company by, among other things, backdating grants of stock options to various current and former executives in violation of the Company’s stockholder-approved stock option plans. Two of the lawsuits were state court actions filed in Los Angeles County Superior Court, and two were federal actions filed in the United States District Court for the Central District of California. The two federal lawsuits also included substantive claims under the federal securities laws.
		On December 9, 2008, the Company entered into a global settlement agreement with the plaintiffs in both the federal court and state court actions. On February 9, 2009, the United States District Court issued an order approving the settlement agreement and dismissing the federal lawsuits. On March 9, 2009, the Los Angeles County Superior Court similarly issued an order dismissing the state lawsuits. As part of the global settlement, the Company resolved all outstanding issues between it and its former chairman and chief executive officer.  This resolution included, among other things, a payment of $8.5 million from the former chairman and chief executive officer to the Company.  This payment is reflected in the Company’s consolidated statement of operations for the first quarter of 2009, and was partially offset by legal and other expenses incurred during the quarter in connection with the settlement.
		ERISA Litigation
		On March 16, 2007, plaintiffs Reba Bagley and Scott Silver filed an action brought under Section 502 of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al., in the United States District Court for the Central District of California. The action was brought against the Company, its directors, and certain of its current and former officers. After the court allowed leave to file an amended complaint, plaintiffs filed an amended complaint adding Tolan Beck and Rod Hughes as additional plaintiffs and dismissing certain individuals as defendants. All four plaintiffs claim to be former employees of the Company who participated in the KB Home 401(k) Savings Plan (the “Plan”). Plaintiffs allege on behalf of themselves and on behalf of all others similarly situated that all defendants breached fiduciary duties owed to plaintiffs and purported class members under ERISA by failing to disclose information to and providing misleading information to participants in the Plan about alleged prior stock option backdating practices of the Company and by failing to remove the Company’s stock as an investment option under the Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their Plan accounts than they would have earned but for defendants’ alleged breach of duties. Plaintiffs seek unspecified money damages and injunctive and other equitable relief.
		On November 24, 2008, the court approved a stipulation to stay all discovery and other proceedings in order to allow the parties time to attempt to settle the claims through mediation. A mediation session was held on January 27, 2009, but a settlement has not been reached. The court has tentatively scheduled the trial to begin on November 9, 2010. Plaintiffs have served discovery requests on the Company, the other defendants and several third parties. The Company has also served the plaintiffs with discovery requests. While the Company believes it has strong defenses to the ERISA claims, it has not concluded whether an unfavorable outcome is likely to be material to its consolidated financial position or results of operations.
		Other Matters
		The Company is also involved in litigation and governmental proceedings incidental to its business. These cases are in various procedural stages and, based on reports of counsel, the Company believes 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 its consolidated financial position or results of operations.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.		Stockholders’ Equity
		On January 22, 2009, the Company adopted an amendment to a Rights Agreement between the Company and ChaseMellon Shareholder Services L.L.C., as rights agent, dated February 4, 1999 (the “1999 Rights Agreement”).  The amendment to the 1999 Rights Agreement was designed to preserve the value of certain of the Company’s deferred tax assets.  Under the 1999 Rights Agreement as amended, under certain circumstances, each preferred share purchase right that was issued pursuant to the 1999 Rights Agreement as a dividend on March 5, 1999 entitled the holder to purchase 1/100th of a share of the Company’s Series A Participating Cumulative Preferred Stock at an exercise price of $85.00, subject to adjustment. The terms relating to the exercise and redemption of these rights is described in the Company’s Annual Report on Form 10-K for the year ended November 30, 2008. These rights expired on March 5, 2009.
		On January 22, 2009, the Company also adopted a Rights Agreement between the Company and Mellon Investor Services LLC, as rights agent, dated as of that date (the “2009 Rights Agreement”), and declared a dividend distribution of one preferred share purchase right for each outstanding share of common stock that was payable to stockholders of record as of the close of business on March 5, 2009. Subject to the terms, provisions and conditions of the 2009 Rights Agreement, if these rights become exercisable, each right would initially represent the right to purchase from the Company 1/100th of a share of its Series A Participating Cumulative Preferred Stock for a purchase price of $85.00 (the “Purchase Price”). If issued, each fractional share of preferred stock would generally give a stockholder approximately the same dividend, voting and liquidation rights as does one share of the Company’s common stock. However, prior to exercise, a right does not give its holder any rights as a stockholder, including without limitation any dividend, voting or liquidation rights. The rights will not be exercisable until the earlier of (i) ten calendar days after a public announcement by the Company that a person or group has become an Acquiring Person (as that term is defined under the 2009 Rights Agreement) and (ii) ten business days after the commencement of a tender or exchange offer by a person or group if upon consummation of the offer the person or group would beneficially own 4.9% or more of the Company’s outstanding common stock.
		Until these rights become exercisable (the “Distribution Date”), common stock certificates will evidence the rights and may contain a notation to that effect. Any transfer of shares of the Company’s common stock prior to the Distribution Date will constitute a transfer of the associated rights. After the Distribution Date, the rights may be transferred other than in connection with the transfer of the underlying shares of the Company’s common stock. If there is an Acquiring Person on the Distribution Date or a person or group becomes an Acquiring Person after the Distribution Date, each holder of a right, other than rights that are or were beneficially owned by an Acquiring Person, which will be void, will thereafter have the right to receive upon exercise of a right and payment of the Purchase Price, that number of shares of the Company’s common stock having a market value of two times the Purchase Price. After the later of the Distribution Date and the time the Company publicly announces that an Acquiring Person has become such, the Company’s board of directors may exchange the rights, other than rights that are or were beneficially owned by an Acquiring Person, which will be void, in whole or in part, at an exchange ratio of one share of common stock per right, subject to adjustment.
		At any time prior to the later of the Distribution Date and the time the Company publicly announces that an Acquiring Person becomes such, the Company’s board of directors may redeem all of the then-outstanding rights in whole, but not in part, at a price of $0.001 per right, subject to adjustment (the “Redemption Price”). The redemption will be effective immediately upon the board of directors’ action, unless the action provides that such redemption will be effective at a subsequent time or upon the occurrence or nonoccurrence of one or more specified events, in which case the redemption will be effective in accordance with the provisions of the action. Immediately upon the effectiveness of the redemption of the rights, the right to exercise the rights will terminate and the only right of the holders of rights will be to receive the Redemption Price, with interest thereon. With the approval of the 2009 Rights Agreement by the Company’s stockholders at the Company’s 2009 Annual Meeting of Stockholders on April 2, 2009, the rights issued pursuant to the 2009 Rights Agreement will expire on the earliest of (a) the close of business on March 5, 2019, (b) the time at which the rights are redeemed, (c) the time at which the rights are exchanged, (d) the time at which the Company’s board of directors determines that a related provision in the Company’s Restated Certificate of Incorporation is no longer necessary, and (e) the close of business on the first day of a taxable year of the Company to which the Company’s board of directors determines that no tax benefits may be carried forward.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.		Stockholders’ Equity (continued)
		As of February 28, 2009, the Company was authorized to repurchase four million shares under a board-approved stock repurchase program. The Company did not repurchase any of its common stock under this program in the first quarter of 2009. The Company acquired $.6 million of common stock in the first quarter of 2009, which were previously issued shares delivered to the Company by employees to satisfy withholding taxes on the vesting of restricted stock awards. These transactions are not considered repurchases under the share repurchase program.
		On February 9, 2009, in connection with the settlement of the derivative litigation described above in Note 12. Legal Matters in the Notes to Consolidated Financial Statements in this Form 10-Q, the Company’s former chairman and chief executive officer relinquished 1,379,594 shares of restricted stock to the Company. These shares were transferred to the Company and are reflected as treasury stock.
		During the quarter ended February 28, 2009, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 19, 2009 to stockholders of record on February 5, 2009.
14.		Recent Accounting Pronouncements
		In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) amends Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”), and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively. The Company is currently evaluating the potential impact of adopting SFAS No. 141(R) on its consolidated financial position and results of operations.
		In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 160 on its consolidated financial position and results of operations.
		In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163, “Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60” (“SFAS No. 163”). SFAS No. 163 clarifies how Statement of Financial Accounting Standards No. 60, “Accounting and Reporting by Insurance Enterprises” applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. SFAS No. 163 also requires expanded disclosures about financial guarantee insurance contracts. SFAS No. 163 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 163 on its consolidated financial position and results of operations.
		In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP No. EITF 03-6-1”). Under FSP No. EITF 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP No. EITF 03-6-1 is effective for

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14.		Recent Accounting Pronouncements (continued)
		financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years and requires retrospective application. The Company is currently evaluating the impact of adopting FSP No. EITF 03-6-1 on its earnings per share.
		In December 2008, the FASB issued FASB Staff Position No. FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP No. FAS 140-4 and FIN 46(R)-8”). FSP No. FAS 140-4 and FIN 46(R)-8 amends Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”), to require public entities to provide additional disclosures about transfers of financial assets. It also amends FASB Interpretation No. 46(R), to require public enterprises, including sponsors that have a variable interest in a VIE, to provide additional disclosures about their involvement with VIEs. FSP No. FAS 140-4 and FIN 46(R)-8 is related to disclosure only and will not have an impact on the Company’s consolidated financial position or results of operations.
15.		Income Taxes
		The Company’s income tax benefit totaled $1.5 million for the three months ended February 28, 2009, compared to income tax expense of $.3 million for the three months ended February 29, 2008. The Company’s effective income tax benefit rate was 2.5% in the first quarter of 2009 compared to an effective income tax expense rate of .1% for the first quarter of 2008. The difference in the Company’s effective tax rate for the three months ended February 28, 2009 compared to the year-earlier quarter resulted primarily from the reversal of a $1.8 million liability for unrecognized tax benefits based on the current status of federal and state audits.
		In accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), the Company evaluates its deferred tax assets quarterly to determine if valuation allowances are required. SFAS No. 109 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. To the extent the Company generates taxable income in the future to utilize these tax benefits, the Company would expect to reverse the valuation allowance and decrease its effective tax rate on future income. However, to the extent the Company generates future operating losses, it would be required to increase the valuation allowance on its net deferred tax assets and its income tax provision would be adversely affected. During the three months ended February 28, 2009, the Company recorded a valuation allowance of $22.7 million against the net deferred tax assets generated from the net loss during the period. During the three months ended February 29, 2008, the Company recorded a similar valuation allowance of $100.0 million against net deferred tax assets. The Company’s net deferred tax assets totaled $1.1 million at both February 28, 2009 and November 30, 2008. The deferred tax asset valuation allowance increased to $879.8 million at February 28, 2009 from $878.8 million at November 30, 2008. This increase reflected the net impact of the $22.7 million valuation allowance recorded during the quarter, offset by a reduction of deferred tax assets due to the forfeiture of certain equity-based awards.
		During the first quarter of 2009, the Company had $3.3 million of additions and $5.1 million of reductions to the its total unrecognized tax benefits as a result of the current status of federal and state audits. The total amount of unrecognized tax benefits, including interest and penalties, was $24.3 million as of February 28, 2009. The Company does not anticipate that total unrecognized tax benefits will significantly increase or decrease during the twelve months from this reporting date.
		The benefits of the Company’s net operating losses, built-in losses and tax credits would be reduced or potentially eliminated if the Company experienced an “ownership change” under Internal Revenue Code Section 382 (“Section 382”). Based on an analysis performed under Section 382, as of February 28, 2009, the Company does not believe it has experienced a change in ownership as defined by Section 382 and, therefore, the net operating losses, built-in losses and tax credits the Company has generated should not be subject to a Section 382 limitation.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

16. Supplemental Disclosure to Consolidated Statements of Cash Flows

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

		Three Months Ended
		February 28, 2009				February 29, 2008
Summary of cash and cash equivalents:
Homebuilding		$	1,020,911			$	1,316,949
Financial services			6,333				11,623
Total		$	1,027,244			$	1,328,572
Supplemental disclosures of cash flow information:
Interest paid, net of amounts capitalized		$	42,263			$	35,940
Income taxes refunded			(231,150	)			(105,885	)
Supplemental disclosures of noncash activities:
Cost of inventories acquired through seller financing		$	5,069			$	—
Decrease in consolidated inventories not owned			(7,902	)			(84,905	)

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

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

17. Supplemental Guarantor Information (continued)

Condensed Consolidating Statements of Operations
Three Months Ended February 28, 2009 (in thousands)

		KB Home				Guarantor				Non-Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	253,831			$	53,530			$	—			$	307,361
Homebuilding:
Revenues		$	—			$	253,831			$	51,910			$	—			$	305,741
Construction and land costs			—				(239,783	)			(51,175	)			—				(290,958	)
Selling, general and administrative expenses			(9,324	)			(39,400	)			(12,451	)			—				(61,175	)
Operating loss			(9,324	)			(25,352	)			(11,716	)			—				(46,392	)
Interest income			2,993				176				344				—				3,513
Interest expense, net of amounts capitalized			9,127				(17,647	)			(132	)			—				(8,652	)
Equity in loss of unconsolidated joint ventures			—				(7,470	)			(2,272	)			—				(9,742	)
Homebuilding pretax income (loss)			2,796				(50,293	)			(13,776	)			—				(61,273	)
Financial services pretax income			—				—				1,701				—				1,701
Total pretax income (loss)			2,796				(50,293	)			(12,075	)			—				(59,572	)
Income tax benefit (expense)			(100	)			1,200				400				—				1,500
Equity in net loss of subsidiaries			(60,768	)			—				—				60,768				—
Net loss		$	(58,072	)		$	(49,093	)		$	(11,675	)		$	60,768			$	(58,072	)

Condensed Consolidating Statements of Operations
Three Months Ended February 29, 2008 (in thousands)

		KB Home				Guarantor				Non-Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	626,450			$	167,774			$	—			$	794,224
Homebuilding:
Revenues		$	—			$	626,450			$	164,858			$	—			$	791,308
Construction and land costs			—				(685,882	)			(226,759	)			—				(912,641	)
Selling, general and administrative expenses			(14,693	)			(74,230	)			(38,715	)			—				(127,638	)
Operating loss			(14,693	)			(133,662	)			(100,616	)			—				(248,971	)
Interest income			11,882				1,073				77				—				13,032
Interest expense, net of amounts capitalized			18,226				(8,679	)			(9,547	)			—				—
Equity in loss of unconsolidated joint ventures			—				(2,566	)			(37,312	)			—				(39,878	)
Homebuilding pretax income (loss)			15,415				(143,834	)			(147,398	)			—				(275,817	)
Financial services pretax income			—				—				7,945				—				7,945
Total pretax income (loss)			15,415				(143,834	)			(139,453	)			—				(267,872	)
Income tax expense			—				(150	)			(150	)			—				(300	)
Equity in net loss of subsidiaries			(283,587	)			—				—				283,587				—
Net loss		$	(268,172	)		$	(143,984	)		$	(139,603	)		$	283,587			$	(268,172	)

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

17. Supplemental Guarantor Information (continued)

Condensed Consolidating Balance Sheets
February 28, 2009 (in thousands)

		KB Home				Guarantor				Non-Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Assets
Homebuilding:
Cash and cash equivalents		$	883,285			$	19,380			$	118,246			$	—			$	1,020,911
Restricted cash			111,208				—				—				—				111,208
Receivables			16,151				127,118				17,762				—				161,031
Inventories			—				1,761,212				260,553				—				2,021,765
Investments in unconsolidated joint ventures			—				174,993				—				—				174,993
Other assets			79,471				14,056				2,055				—				95,582
			1,090,115				2,096,759				398,616				—				3,585,490
Financial services			—				—				52,531				—				52,531
Investments in subsidiaries			(9,589	)			—				—				9,589				—
Total assets		$	1,080,526			$	2,096,759			$	451,147			$	9,589			$	3,638,021
Liabilities and stockholders’ equity
Homebuilding:
Accounts payable, accrued expenses and other liabilities		$	148,824			$	779,367			$	195,360			$	—			$	1,123,551
Mortgages and notes payable			1,645,374				92,594				—				—				1,737,968
			1,794,198				871,961				195,360				—				2,861,519
Financial services			—				—				8,841				—				8,841
Intercompany			(1,481,333	)			1,274,672				206,661				—				—
Stockholders’ equity			767,661				(49,874	)			40,285				9,589				767,661
Total liabilities and stockholders’ equity		$	1,080,526			$	2,096,759			$	451,147			$	9,589			$	3,638,021