KB HOME - Quarter Report: 2010 May (Form 10-Q)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

Construction and land costs

Selling, general and administrative expenses

 

 

Operating loss

 

Interest income

Interest expense, net of amounts capitalized

Equity in loss of unconsolidated joint ventures

 

 

Homebuilding pretax loss

 

 

Revenues

Expenses

Equity in income of unconsolidated joint venture

 

 

Financial services pretax income

 

 

Income tax benefit (expense)

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

Restricted cash

Receivables

Inventories

Investments in unconsolidated joint ventures

Other assets

 

 

 

 

 

 

 

 

 

Accounts payable

Accrued expenses and other liabilities

Mortgages and notes payable

 

 

 

 

 

 

Common stock

Paid-in capital

Retained earnings

Accumulated other comprehensive loss

Grantor stock ownership trust, at cost

Treasury stock, at cost

 

 

 

 

 

Net loss

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

Equity in (income) loss of unconsolidated joint ventures

Distributions of earnings from unconsolidated joint ventures

Amortization of discounts and issuance costs

Depreciation and amortization

Loss on voluntary termination of revolving credit facility

Tax benefits from stock-based compensation

Stock-based compensation expense

Inventory impairments and land option contract abandonments

Change in assets and liabilities:

Receivables

Inventories

Accounts payable, accrued expenses and other liabilities

Other, net

 

 

 

 

Investments in unconsolidated joint ventures, net

Purchases of property and equipment, net

 

 

 

 

Change in restricted cash

Repayment of senior subordinated notes

Payments on mortgages, land contracts and other loans

Issuance of common stock under employee stock plans

Excess tax benefit associated with exercise of stock options

Payments of cash dividends

Repurchases of common stock

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

Cash and cash equivalents at end of period

 

 

Options outstanding at beginning of period

 

Granted

 

Exercised

 

Cancelled

 

 

Options outstanding at end of period

 

 

Options exercisable at end of period

 

Revenues:

West Coast

Southwest

Central

Southeast

 

Total homebuilding revenues

Financial services

 

 

Total revenues

 

 

Pretax income (loss):

West Coast

Southwest

Central

Southeast

Corporate and other (a)

 

Total homebuilding pretax loss

Financial services

 

 

Total pretax loss

 

 

Equity in income (loss) of unconsolidated joint ventures:

West Coast

Southwest

Central

Southeast

 

 

Total

 

 

Inventory impairments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

Land option contract abandonments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

 

Joint venture impairments:

West Coast

Southwest

Central

Southeast

 

 

Total

 

Assets:

West Coast

Southwest

Central

Southeast

Corporate and other

 

Total homebuilding assets

Financial services

 

 

Total assets

 

 

Investments in unconsolidated joint ventures:

West Coast

Southwest

Central

Southeast

 

 

Total

 

Revenues

Interest income

Title services

Insurance commissions

 

Total

 

Expenses

General and administrative

 

Operating income

Equity in income of unconsolidated joint venture

 

 

Pretax income

 

Assets

Cash and cash equivalents

Receivables

Investment in unconsolidated joint venture

Other assets

 

 

Total assets

 

 

Liabilities

Accounts payable and accrued expenses

 

 

Total liabilities

 

 

Homes, lots and improvements in production

 

Land under development

 

 

Total

 

 

Capitalized interest at beginning of period

 

Capitalized interest related to consolidation of previously unconsolidated joint ventures

 

Interest incurred (a)

 

Interest expensed (a)

 

Interest amortized

 

 

Capitalized interest at end of period (b)

 

 

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

 

 

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

 

 

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

 

Long-lived assets held and used

 

 

Financial Liabilities:

Senior notes due 2011 at 6 3/8%

Senior notes due 2014 at 5 3/4%

Senior notes due 2015 at 5 7/8%

Senior notes due 2015 at 6 1/4%

Senior notes due 2017 at 9.1%

Senior notes due 2018 at 7 1/4%

the 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 $4.1 million at November 30, 2009. Creditors, if any, of these VIEs had no recourse against the Company.

As of May 31, 2010, the Company had cash deposits totaling $1.5 million associated with land option and other contracts that the Company determined to be unconsolidated VIEs, having an aggregate purchase price of $32.9 million, and had cash deposits totaling $18.2 million associated with land option and other contracts that the Company determined were not VIEs, having an aggregate purchase price of $324.9 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, which totaled $19.7 million at May 31, 2010 and $9.6 million at November 30, 2009. In addition, the Company had outstanding letters of credit of $5.7 million at May 31, 2010 and $8.7 million at November 30, 2009 in lieu of cash deposits under certain land option contracts.

The Company also evaluates its land option contracts in accordance with Accounting Standards Codification Topic No. 470, “Debt” (“ASC 470”), and, as a result of its evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, on its consolidated balance sheets by $21.6 million at May 31, 2010 and $36.1 million at November 30, 2009.

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 governed by each unconsolidated joint venture’s respective operating agreement and related documents.

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

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

 

Revenues

Construction and land costs

Other expenses, net

 

 

Loss

 

With respect to the Company’s investment in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures for the three months and six months ended May 31, 2009 included pretax, noncash impairment charges of $7.2 million and $14.8 million, respectively. There were no such charges for the three months or six months ended May 31, 2010.

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

 

Assets

Cash

Receivables

Inventories

Other assets

 

 

Total assets

 

 

Liabilities and equity

Accounts payable and other liabilities

Mortgages and notes payable

Equity

 

 

Total liabilities and equity

 

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

 

Number of investments in unconsolidated joint ventures:

With limited recourse debt (a)

With non-recourse debt (b)

Other (c)

 

 

Total

 

Investments in unconsolidated joint ventures:

With limited recourse debt

With non-recourse debt

Other

 

 

Total

 

 

Outstanding debt of unconsolidated joint ventures:

With limited recourse debt

With non-recourse debt

Other

 

 

Total (d)

 

The unconsolidated joint ventures finance land and inventory investments through a variety of arrangements. To finance their respective land acquisition and development activities, certain of the Company’s unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. The Company’s unconsolidated joint ventures had aggregate outstanding debt, substantially all of which was secured, of approximately $380.3 million at May 31, 2010 and $514.2 million at November 30, 2009. Various financial and non-financial covenants apply to the outstanding debt of the unconsolidated joint ventures, and a failure to comply with any applicable 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.

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.

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 May 31, 2010, the Company’s potential responsibility under its loan-to-value maintenance guarantees relating to approximately $7.9 million of outstanding debt held by two unconsolidated joint ventures totaled approximately $3.8 million, if any liability were determined to be due thereunder. This amount 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 any attempted enforcement of such guarantees.

Notwithstanding the Company’s potential unconsolidated joint venture guaranty and indemnity responsibilities and the resolutions it has reached in certain instances with unconsolidated joint venture lenders with respect to those potential responsibilities, at this time the Company does not believe, except as described below, that its existing exposure under its outstanding 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 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 unconsolidated joint venture’s debt and with the Company’s and its partners’ respective land purchases from the unconsolidated joint venture. At May 31, 2010, this unconsolidated joint venture had total outstanding indebtedness of approximately $372.4 million and, if this guaranty were then enforced, the Company’s maximum potential responsibility under the guaranty would have been approximately $182.7 million in principal amount, which amount does not account for any offsets or defenses that could be available to the Company.

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 and are currently exploring resolutions with the lenders. In a separate proceeding, the members (including the Company) of one of these unconsolidated joint ventures participated in an arbitration regarding their respective performance

obligations in order to address one member’s claims for specific performance and, in the alternative, damages. On July 6, 2010, a decision was issued in this arbitration proceeding. In its decision, the arbitration panel denied the specific performance claims and awarded damages in an amount well below the amount claimed. The Company’s potential proportional responsibility for the damages awarded is not considered to be material to the Company’s consolidated financial position or results of operations. The litigation commenced by the lenders remains ongoing, and there is no assurance that the parties involved will reach satisfactory resolutions. Further, if satisfactory resolutions are not reached, there is no assurance as to whether the ultimate outcome of any of the litigation would not be material to the Company’s consolidated financial position or results of operations.

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

 

Mortgages and land contracts due to land sellers and other loans

Senior notes due 2011 at 6 3/8%

Senior notes due 2014 at 5 3/4%

Senior notes due 2015 at 5 7/8%

Senior notes due 2015 at 6 1/4%

Senior notes due 2017 at 9.1%

Senior notes due 2018 at 7 1/4%

 

 

Total

 

At November 30, 2009, the Company had a Credit Facility with a syndicate of lenders that was scheduled to mature in November 2010. To reduce costs associated with maintaining the Credit Facility, effective December 28, 2009, the Company voluntarily reduced the aggregate commitment under the Credit Facility from $650.0 million to $200.0 million and effective March 31, 2010, the Company voluntarily terminated the Credit Facility.

With the Credit Facility’s termination, the Company proceeded to enter into the LOC Facilities with various banks to obtain letters of credit in the ordinary course of its business. As of May 31, 2010, $81.9 million of letters of credit were outstanding under the LOC Facilities. The LOC Facilities require the Company to deposit and maintain cash with the banks as collateral for its letters of credit outstanding. As of May 31, 2010, the amount of cash maintained for the LOC Facilities totaled $82.7 million, and was included in restricted cash on the Company’s consolidated balance sheet as of that date. The Company may in the future enter into similar facilities with other financial institutions.

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

In the second quarter of 2010, the Company voluntarily replaced letters of credit it previously posted as collateral for certain mortgages and notes payable with cash collateral deposited in an account. As of May 31, 2010, this required cash collateral, which relates to a multi-level residential building the Company is operating as a rental property, totaled $25.1 million and was included in restricted cash on the Company’s consolidated balance sheet as of that date.

The indenture governing the Company’s 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; or engage in sale-leaseback transactions involving property or assets above a certain specified value. The terms governing the Company’s senior notes due 2017 contain certain limitations related to mergers, consolidations, and sales of assets.

As of May 31, 2010, the Company was in compliance with the applicable terms of all of its covenants under the Company’s senior notes, senior notes indenture, and mortgages and land contracts due to land sellers and other loans. The Company’s ability to secure future debt financing may depend in part on its ability to remain in such compliance.

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 a 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.

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

 

Balance at beginning of period

 

Warranties issued

 

Payments and adjustments

 

 

Balance at end of period

 

The Company’s warranty liability of $117.8 million at May 31, 2010 includes $17.7 million associated with the remaining repair of approximately 317 homes primarily delivered in 2006 and 2007 and located in Florida and Louisiana that were identified as containing or suspected of containing allegedly defective drywall manufactured in China. The Company believes that its overall warranty liability at May 31, 2010 is sufficient with respect to its general limited warranty obligations and the estimated costs remaining to repair the identified homes impacted by the allegedly defective drywall. The Company is continuing to review whether there are any additional homes delivered in Florida, Louisiana or other locations that contain or may contain this drywall material and depending on the outcome of its review and its actual claims experience, the Company may need to increase its warranty liability in future periods. The amount accrued to repair these homes is based largely on the Company’s estimates of future costs. If the actual costs to repair these homes differ from the estimated costs, the Company may revise its warranty estimate for this issue.

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

The Company will seek reimbursement from various sources for the costs it expects to incur to investigate and complete repairs and to defend itself in litigation associated with this drywall material. At this early stage of its efforts to investigate and complete repairs and to respond to litigation, however, the Company has not recorded any amounts for potential recoveries as of May 31, 2010.

In the normal course of its business, the Company issues certain representations, warranties and guarantees related to its home sales and land sales that may be affected by Accounting Standards Codification Topic No. 460, “Guarantees.” Based on historical evidence, the Company does not believe any 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. In Arizona, California, Colorado and Nevada, the Company’s general liability insurance takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insureds on each project. The Company self-insures a portion of its overall risk through the use of a captive insurance subsidiary. The Company records expenses and liabilities based on the 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 that are not covered by its policies. These estimated costs are based on an analysis of the Company’s historical claims and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $98.3 million at May 31, 2010 and $107.0 million at November 30, 2009. These amounts are included in accrued expenses and other liabilities in the Company’s consolidated balance sheets. The Company’s expenses associated with self-insurance totaled $1.8 million for the three months ended May 31, 2010 and $1.4 million for the three months ended May 31, 2009. The Company’s expenses associated with self-insurance totaled $3.6 million for the six months ended May 31, 2010 and $3.5 million for the six months ended May 31, 2009.

The Company is often required to obtain performance bonds and letters of credit in support of its obligations to various municipalities and other government agencies in connection with community improvements such as roads, sewers and water, and to certain unconsolidated joint ventures. At May 31, 2010, the Company had $479.9 million of performance bonds and $81.9 million of letters of credit outstanding. In the event any such performance bonds or letters of credit were called, the Company would be obligated to reimburse the issuer of the performance bond or letter of credit. The Company does not believe that a material amount of any currently outstanding performance bonds or letters of credit will be called. Performance bonds do not have stated expiration dates. Rather, the Company is released from the performance bonds as the underlying performance is completed. The expiration dates of letters of credit issued in connection with community improvements and certain unconsolidated joint ventures coincide with the expected completion dates of the related projects or obligations. If the obligations related to a project are ongoing, the relevant letters of credit are typically extended on a year-to-year basis.

In the ordinary course of its business, the Company enters into land option contracts (or similar agreements) to procure land for the construction of homes. At May 31, 2010, the Company had total deposits of $25.4 million, comprised of cash deposits of $19.7 million and letters of credit of $5.7 million, to purchase land having an aggregate purchase price of $357.8 million. The Company’s land option contracts generally do not contain provisions requiring the Company’s specific performance.

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, certain of its current and former officers, and the board of directors committee that oversees the KB Home 401(k) Savings Plan (“401(k) Plan”). 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 KB Home who participated in the 401(k) 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 401(k) Plan about the Company’s alleged prior stock option backdating practices and by failing to remove the Company’s stock as an investment option under the 401(k) Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their 401(k) Plan accounts than they would have earned but for defendants’ alleged breach of duties.

The parties to the litigation executed a settlement agreement on February 26, 2010 and an amended settlement agreement on April 5, 2010. On April 12, 2010, the court preliminarily approved the amended settlement and the conditional certification of the settlement class described in the amended settlement. The preliminarily approved settlement is not material to the consolidated financial position or results of operations of the Company. The court set the fairness hearing on the proposed settlement for July 26, 2010.

On October 2, 2009, the staff of the SEC notified the Company that a formal order of investigation had been issued regarding possible accounting and disclosure issues. Although the SEC has not indicated, and the Company cannot be certain as to, the scope of the SEC’s investigation, the information requests from the SEC received to date relate to the Company’s impairments, including both inventory and joint ventures. The Company is cooperating with the staff of the SEC in connection with the investigation. The Company cannot predict the outcome of, or the timeframe for, the conclusion of this matter.

In addition to those described in this report, the Company is involved in litigation and government proceedings incidental to its business. These proceedings are in various procedural stages and, based on reports of counsel, the Company believes as of the date of this report that provisions or accruals made for any potential losses (to the extent estimable) are adequate and that any liabilities or costs arising out of these proceedings are not likely to have a materially adverse effect on its consolidated financial position or results of operations. The outcome of any of these proceedings, however, is inherently uncertain, and if unfavorable outcomes were to occur, there is a possibility that they would, individually or in the aggregate, have a materially adverse effect on the Company’s consolidated financial position or results of operations.

As of May 31, 2010, the Company was authorized to repurchase four million shares of its common stock under a board-approved share repurchase program. The Company did not repurchase any shares of its common stock under this program in the six months ended May 31, 2010. The Company has not repurchased common shares pursuant to a common stock repurchase plan for the past several years and any resumption of such stock repurchases will be at the discretion of the Company’s board of directors. The Company acquired $.4 million of common stock in the six months ended May 31, 2010, 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.

During the quarter ended February 28, 2010, the Company’s board of directors declared a cash dividend of

$.0625 per share of common stock, which was paid on February 18, 2010 to stockholders of record on February 4, 2010. During the quarter ended May 31, 2010, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on May 20, 2010 to stockholders of record on May 6, 2010.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-06”), which provides amendments to Accounting Standards Codification Subtopic No. 820-10, “Fair Value Measurements and Disclosures — Overall.” ASU 2010-06 requires additional disclosures and clarifications of existing disclosures for recurring and nonrecurring fair value measurements. The revised guidance is effective for interim and annual reporting periods beginning after December 15, 2009. ASU 2010-06 concerns disclosure only and did not have an impact on the Company’s financial position or results of operations.

The Company’s income tax expense totaled $.1 million for the three months ended May 31, 2010, compared to an income tax benefit of $5.2 million for the three months ended May 31, 2009. The Company’s effective income tax expense rate was .3% in the second quarter of 2010, compared to an effective income tax benefit rate of 6.2% for the second quarter of 2009. For the six months ended May 31, 2010, the Company’s income tax expense totaled $.3 million compared to an income tax benefit of $6.7 million for the six months ended May 31, 2009. The Company’s effective income tax expense rate was .4% in the six months ended May 31, 2010, compared to an effective income tax benefit rate of 4.7% for the year-earlier period. The year-over-year difference in the Company’s 2010 second quarter effective tax rate was primarily due to the recognition of a $4.6 million federal and state income tax receivable in the second quarter of 2009 based on the status of federal audits and amended state filings. For the six months ended May 31, 2010, the difference in the effective tax rate compared to the year-earlier period resulted primarily from the recognition of the $4.6 million receivable and the reversal of a $1.8 million liability for unrecognized federal and state tax benefits during the 2009 period.

In accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”), the Company evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During the three months ended May 31, 2010, the Company recorded a valuation allowance of $12.8 million against the net deferred tax assets generated from the loss for the period. During the three months ended May 31, 2009, the Company recorded a similar valuation allowance of $31.7 million against net deferred tax assets. For the six months ended May 31, 2010 and 2009, the Company recorded valuation allowances of $34.0 million and $54.4 million, respectively, against the net deferred tax assets generated from the losses for those periods.

The Company’s net deferred tax assets totaled $1.1 million at both May 31, 2010 and November 30, 2009. The deferred tax asset valuation allowance increased to $784.0 million at May 31, 2010 from $750.0 million at November 30, 2009. This increase reflected the net impact of the $34.0 million valuation allowance recorded during the first six months of 2010.

During the three months ended May 31, 2010, the Company had $.1 million of additions and $.4 million of reductions to its total gross unrecognized tax benefits as a result of the current status of federal and state audits. During the six months ended May 31, 2010, additions and reductions to the Company’s total gross unrecognized tax benefits were $.3 million and $.7 million, respectively. The total amount of gross unrecognized tax benefits, including interest and penalties, was $9.0 million as of May 31, 2010. The Company anticipates that total unrecognized tax benefits will decrease by an amount ranging from $3.0 million to $4.0 million during the twelve months from this reporting date due to various state filings associated with the resolution of the federal audit.

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 the Company’s analysis performed as of May 31, 2010, the Company does not believe it has experienced an ownership change 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 as of this reporting date.

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

Summary of cash and cash equivalents at the end of the period:

Homebuilding

Financial services

 

 

Total

 

 

Supplemental disclosures of cash flow information:

Interest paid, net of amounts capitalized

Income taxes paid

Income taxes refunded

 

 

Supplemental disclosures of noncash activities:

Increase in inventories in connection with consolidation of joint ventures

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

Cost of inventories acquired through seller financing

Decrease in consolidated inventories not owned

 

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