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.

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

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes 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.

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 August 31, 2011.

There were 77,132,675 shares of the registrant’s common stock, par value $1.00 per share, outstanding on August 31, 2011. The registrant’s grantor stock ownership trust held an additional 10,920,444 shares of the registrant’s common stock on that date.

 

 

KB HOME
FORM 10-Q
INDEX

		Page
		Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations — Nine Months and Three Months Ended August 31, 2011 and 2010			3
Consolidated Balance Sheets — August 31, 2011 and November 30, 2010			4
Consolidated Statements of Cash Flows — Nine Months Ended August 31, 2011 and 2010			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			38
Item 3. Quantitative and Qualitative Disclosures About Market Risk			65
Item 4. Controls and Procedures			65
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			66
Item 1A. Risk Factors			68
Item 6. Exhibits			69
SIGNATURES			70
INDEX OF EXHIBITS			71
Exhibit 10.43
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

Item 1.		Financial Statements

KB HOME

(In Thousands, Except Per Share Amounts — Unaudited)

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Total revenues		$	835,994			$	1,139,033			$	367,316			$	501,003
Homebuilding:
Revenues		$	829,816			$	1,133,846			$	364,532			$	498,821
Construction and land costs			(724,085	)			(945,196	)			(302,908	)			(411,813	)
Selling, general and administrative expenses			(172,310	)			(233,795	)			(60,185	)			(78,602	)
Loss on loan guaranty			(37,330	)			—				—				—
Operating income (loss)			(103,909	)			(45,145	)			1,439				8,406
Interest income			776				1,628				123				603
Interest expense			(36,902	)			(52,108	)			(12,342	)			(16,183	)
Equity in income (loss) of unconsolidated joint ventures			(55,865	)			(4,679	)			64				(1,947	)
Homebuilding pretax loss			(195,900	)			(100,304	)			(10,716	)			(9,121	)
Financial services:
Revenues			6,178				5,187				2,784				2,182
Expenses			(2,481	)			(2,639	)			(829	)			(754	)
Equity in income (loss) of unconsolidated joint venture			(376	)			5,946				(888	)			996
Financial services pretax income			3,321				8,494				1,067				2,424
Total pretax loss			(192,579	)			(91,810	)			(9,649	)			(6,697	)
Income tax benefit (expense)			(100	)			5,000				—				5,300
Net loss		$	(192,679	)		$	(86,810	)		$	(9,649	)		$	(1,397	)
Basic and diluted loss per share		$	(2.50	)		$	(1.13	)		$	(.13	)		$	(.02	)
Basic and diluted average shares outstanding			77,004				76,866				77,047				76,909
Cash dividends declared per common share		$	.1875			$	.1875			$	.0625			$	.0625

See accompanying notes.

KB HOME

(In Thousands — Unaudited)

		August 31,				November 30,
		2011				2010
Assets
Homebuilding:
Cash and cash equivalents		$	477,406			$	904,401
Restricted cash			113,186				115,477
Receivables			79,180				108,048
Inventories			1,900,580				1,696,721
Investments in unconsolidated joint ventures			51,255				105,583
Other assets			78,382				150,076
			2,699,989				3,080,306
Financial services			21,828				29,443
Total assets		$	2,721,817			$	3,109,749
Liabilities and stockholders’ equity
Homebuilding:
Accounts payable		$	117,593			$	233,217
Accrued expenses and other liabilities			582,233				466,505
Mortgages and notes payable			1,586,703				1,775,529
			2,286,529				2,475,251
Financial services			3,321				2,620
Common stock			115,149				115,149
Paid-in capital			878,962				873,519
Retained earnings			510,750				717,852
Accumulated other comprehensive loss			(22,657	)			(22,657	)
Grantor stock ownership trust, at cost			(118,694	)			(120,442	)
Treasury stock, at cost			(931,543	)			(931,543	)
Total stockholders’ equity			431,967				631,878
Total liabilities and stockholders’ equity		$	2,721,817			$	3,109,749

See accompanying notes.

KB HOME

(In Thousands — Unaudited)

		Nine Months Ended August 31,
		2011				2010
Cash flows from operating activities:
Net loss		$	(192,679	)		$	(86,810	)
Adjustments to reconcile net loss to net cash used by operating activities:
Equity in (income) loss of unconsolidated joint ventures			56,241				(1,267	)
Distributions of earnings from unconsolidated joint ventures			6,312				10,000
Loss on loan guaranty			37,330				—
Gain on sale of operating property			(8,825	)			—
Amortization of discounts and issuance costs			1,660				1,605
Depreciation and amortization			1,636				2,628
(Gain) on early extinguishment of debt/loss on voluntary termination of revolving credit facility			(3,612	)			1,802
Tax benefits from stock-based compensation			—				1,599
Stock-based compensation expense			5,765				5,975
Inventory impairments and land option contract abandonments			23,507				16,739
Change in assets and liabilities:
Receivables			(10,940	)			182,762
Inventories			(177,770	)			(149,021	)
Accounts payable, accrued expenses and other liabilities			(46,953	)			(147,323	)
Other, net			(1,611	)			(2,832	)
Net cash used by operating activities			(309,939	)			(164,143	)
Cash flows from investing activities:
Investments in unconsolidated joint ventures			(1,974	)			(1,533	)
Proceeds from sale of operating property			80,600				—
Purchases of property and equipment, net			(74	)			(642	)
Net cash provided (used) by investing activities			78,552				(2,175	)
Cash flows from financing activities:
Change in restricted cash			2,291				(2,092	)
Repayment of senior notes			(100,000	)			—
Payments on mortgages and land contracts due to land sellers and other loans			(86,064	)			(73,371	)
Issuance of common stock under employee stock plans			1,426				1,609
Excess tax benefit associated with exercise of stock options			—				583
Payments of cash dividends			(14,423	)			(14,415	)
Repurchases of common stock			—				(350	)
Net cash used by financing activities			(196,770	)			(88,036	)
Net decrease in cash and cash equivalents			(428,157	)			(254,354	)
Cash and cash equivalents at beginning of period			908,430				1,177,961
Cash and cash equivalents at end of period		$	480,273			$	923,607

See accompanying notes.

KB HOME

(Unaudited)

1.

Basis of Presentation and Significant Accounting Policies

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

In the opinion of KB Home (the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s consolidated financial position as of August 31, 2011, the results of its consolidated operations for the nine months and three months ended August 31, 2011 and 2010, and its consolidated cash flows for the nine months ended August 31, 2011 and 2010. The results of consolidated operations for the nine months and three months ended August 31, 2011 are not necessarily indicative of the results to be expected for the full year, due to seasonal variations in operating results and other factors. The consolidated balance sheet at November 30, 2010 has been taken from the audited consolidated financial statements as of that date. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended November 30, 2010, which are contained in the Company’s Annual Report on Form 10-K for that period.

Use of Estimates

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

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid short-term debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company’s cash equivalents totaled $377.8 million at August 31, 2011 and $797.2 million at November 30, 2010. The majority of the Company’s cash and cash equivalents were invested in money market accounts and U.S. government securities.

Restricted cash of $113.2 million at August 31, 2011 consisted of $65.0 million of cash deposited with various financial institutions that is required as collateral for the Company’s cash-collateralized letter of credit facilities (the “LOC Facilities”), $26.8 million required as collateral for a surety bond and $21.4 million of cash deposited in an escrow account pursuant to a consensual plan of reorganization for one of the Company’s unconsolidated joint ventures. Restricted cash of $115.5 million at November 30, 2010 consisted of $88.7 million of cash collateral for the LOC Facilities and $26.8 million of cash collateral for a surety bond.

Loss per share

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

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Numerator:
Net loss		$	(192,679	)		$	(86,810	)		$	(9,649	)		$	(1,397	)
Denominator:
Basic and diluted average shares outstanding			77,004				76,866				77,047				76,909
Basic and diluted loss per share		$	(2.50	)		$	(1.13	)		$	(.13	)		$	(.02	)

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.

Basis of Presentation and Significant Accounting Policies (continued)

All outstanding stock options were excluded from the diluted loss per share calculations for the nine months and three months ended August 31, 2011 and 2010 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 $9.6 million for the three months ended August 31, 2011 and $1.4 million for the three months ended August 31, 2010. The Company’s comprehensive loss was $192.7 million for the nine months ended August 31, 2011 and $86.8 million for the nine months ended August 31, 2010. The accumulated balances of other comprehensive loss in the consolidated balance sheets as of August 31, 2011 and November 30, 2010 were comprised solely of adjustments recorded directly to accumulated other comprehensive loss in accordance with Accounting Standards Codification Topic No. 715, “Compensation — Retirement Benefits” (“ASC 715”). ASC 715 requires an employer to recognize the funded status of defined postretirement benefit plans as an asset or liability on the balance sheet and requires any unrecognized prior service costs and actuarial gains/losses to be recognized in accumulated other comprehensive income (loss).

2.

Stock-Based Compensation

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

Stock Options

In accordance with ASC 718, the Company estimates the grant-date fair value of its stock options using the Black-Scholes option-pricing model, which takes into account assumptions regarding an expected dividend yield, a risk-free interest rate, an expected volatility factor for the market price of the Company’s common stock and an expected term of the stock options. The following table summarizes the stock options outstanding and stock options exercisable as of August 31, 2011, as well as stock options activity during the nine months then ended:

						Weighted
						Average Exercise
		Options				Price
Options outstanding at beginning of period			8,798,613			$	24.19
Granted			20,000				9.54
Exercised			—				—
Cancelled			(275,363	)			21.44
Options outstanding at end of period			8,543,250				24.24
Options exercisable at end of period			6,123,062				28.46

As of August 31, 2011, the weighted average remaining contractual life of stock options outstanding and stock options exercisable was 7.1 years and 6.5 years, respectively. There was $3.3 million of total unrecognized compensation cost related to unvested stock option awards as of August 31, 2011. For the three months ended August 31, 2011 and 2010, stock-based compensation expense associated with stock options totaled $1.5 million and $1.4 million, respectively. For the nine months ended August 31, 2011 and 2010, stock-based compensation expense associated with stock options totaled $4.2 million and $4.3 million, respectively. Stock options outstanding and stock options exercisable had no aggregate intrinsic value as of August 31, 2011. (The intrinsic

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2.

Stock-Based Compensation (continued)

value of a stock option is the amount by which the market value of a share of the underlying common stock exceeds the exercise price of the stock option.)

Other Stock-Based Awards

From time to time, the Company grants restricted stock, phantom shares and stock appreciation rights (“SARs”) to various employees. In some cases, the Company has granted phantom shares and SARs that can be settled only in cash and are therefore accounted for as liability awards. The Company recognized income of $.5 million in the three months ended August 31, 2011 and $5.3 million in the three months ended August 31, 2010 related to restricted stock, phantom shares and SARs awards. The Company recognized total compensation expense of $.9 million in the nine months ended August 31, 2011 and total compensation income of $1.0 million in the nine months ended August 31, 2010 related to these stock-based awards. Some of the stock-based awards outstanding at August 31, 2010 were SARs that could be settled only in cash. In the third and fourth quarters of 2010, the Company offered to eligible officers and employees the opportunity to replace cash-settled SARs previously granted to them with options to purchase shares of the Company’s common stock. Each stock option issued to replace a SAR had an exercise price equal to the replaced SAR’s exercise price, and the same number of underlying shares, vesting schedule and expiration date as each such SAR. The offers did not include a re-pricing or any other changes impacting the value of the awards to the participating officers and employees, and no additional grants or awards were made to the participants as part of the offers. All of the SARs the Company received through the offers were canceled, and with forfeitures due to employee departures, the Company has canceled virtually all of its previously granted cash-settled SARs.

Approval of an Amendment to the KB Home 2010 Equity Incentive Plan

At the Company’s Annual Meeting of Stockholders held on April 7, 2011, the Company’s stockholders approved an amendment to the KB Home 2010 Equity Incentive Plan (the “Plan Amendment”) to increase the number of shares of the Company’s common stock that may be issued under the KB Home 2010 Equity Incentive Plan by an additional 4,000,000 shares. The Plan Amendment was filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2011.

3.

Segment Information

As of August 31, 2011, the Company had identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within its consolidated operations in accordance with Accounting Standards Codification Topic No. 280, “Segment Reporting.” As of August 31, 2011, the Company’s homebuilding reporting segments conducted ongoing operations in the following states:

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

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

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

The Company’s financial services reporting segment provides title and insurance services to the Company’s homebuyers. This segment also provided mortgage banking services to the Company’s homebuyers indirectly

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.

Segment Information (continued)

through KBA Mortgage, LLC (“KBA Mortgage”), a joint venture of a subsidiary of the Company and a subsidiary of Bank of America, N.A., with each partner having a 50% ownership interest in the venture. The Bank of America, N.A. subsidiary partner operated KBA Mortgage. The Company accounted for KBA Mortgage as an unconsolidated joint venture in the financial services reporting segment of the Company’s consolidated financial statements. The Company’s financial services reporting segment conducts operations in the same markets as the Company’s homebuilding reporting segments. From its formation in 2005 until June 30, 2011, KBA Mortgage provided mortgage banking services to a significant proportion of the Company’s homebuyers. During the first quarter of 2011, the Bank of America, N.A. subsidiary partner in KBA Mortgage approached the Company about exiting the joint venture due to the desire of Bank of America, N.A. to cease participating in joint venture structures in its business. As a result, effective June 27, 2011, KBA Mortgage stopped accepting loan applications, and it ceased offering mortgage banking services to the Company’s homebuyers after June 30, 2011. After June 30, 2011, Bank of America, N.A. is processing and closing only the residential consumer mortgage loans that KBA Mortgage originated for the Company’s homebuyers on or before June 26, 2011. The Company entered into a marketing services agreement with MetLife Home Loans, a division of MetLife Bank, N.A., effective June 27, 2011. Under the agreement, MetLife Home Loans’ personnel, located onsite at several of the Company’s new home communities, can offer (i) financing options and mortgage loan products to the Company’s homebuyers, (ii) to prequalify homebuyers for residential consumer mortgage loans, and (iii) to commence the loan origination process for homebuyers who elect to use MetLife Home Loans. The Company makes marketing materials and other information regarding MetLife Home Loans’ financing options and mortgage loan products available to its homebuyers and is compensated solely for the fair market value of these services. MetLife Home Loans and MetLife Bank, N.A. are not affiliates of the Company or any of its subsidiaries. The Company’s homebuyers are under no obligation to use MetLife Home Loans and may select any lender of their choice to obtain mortgage financing for the purchase of a home. The Company does not have any ownership, joint venture or other interests in or with MetLife Home Loans or MetLife Bank, N.A. or with respect to the revenues or income that may be generated from MetLife Home Loans providing mortgage banking services to, or originating residential consumer mortgage loans for, the Company’s homebuyers. The Company expects that its agreement with MetLife Home Loans will help its homebuyers obtain reliable mortgage banking services to purchase a home.

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

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

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Revenues:
West Coast		$	354,348			$	483,383			$	175,434			$	211,294
Southwest			91,411				149,364				39,479				55,914
Central			247,492				314,786				102,702				140,035
Southeast			136,565				186,313				46,917				91,578
Total homebuilding revenues			829,816				1,133,846				364,532				498,821
Financial services			6,178				5,187				2,784				2,182
Total		$	835,994			$	1,139,033			$	367,316			$	501,003

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.

Segment Information (continued)

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Pretax income (loss):
West Coast		$	9,927			$	31,080			$	3,336			$	15,024
Southwest			(113,620	)			(11,799	)			3,201				(1,802	)
Central			(12,389	)			(3,666	)			(2,187	)			5,441
Southeast			(30,177	)			(42,114	)			(7,156	)			(10,853	)
Corporate and other (a)			(49,641	)			(73,805	)			(7,910	)			(16,931	)
Total homebuilding pretax loss			(195,900	)			(100,304	)			(10,716	)			(9,121	)
Financial services			3,321				8,494				1,067				2,424
Total		$	(192,579	)		$	(91,810	)		$	(9,649	)		$	(6,697	)
Equity in income (loss) of unconsolidated joint ventures:
West Coast		$	50			$	877			$	67			$	230
Southwest			(55,902	)			(6,457	)			—				(2,177	)
Central			—				—				—				—
Southeast			(13	)			901				(3	)			—
Total		$	(55,865	)		$	(4,679	)		$	64			$	(1,947	)
Inventory impairments:
West Coast		$	1,679			$	2,630			$	328			$	1,434
Southwest			18,715				962				—				—
Central			51				—				—				—
Southeast			969				4,677				—				—
Total		$	21,414			$	8,269			$	328			$	1,434
Land option contract abandonments:
West Coast		$	112			$	722			$	—			$	722
Southwest			296				—				—				—
Central			1,074				6,340				834				—
Southeast			611				1,408				—				1,221
Total		$	2,093			$	8,470			$	834			$	1,943
Joint venture impairments:
West Coast		$	—			$	—			$	—			$	—
Southwest			53,727				—				—				—
Central			—				—				—				—
Southeast			—				—				—				—
Total		$	53,727			$	—			$	—			$	—

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.

Segment Information (continued)

		August 31,				November 30,
		2011				2010
Assets:
West Coast		$	1,082,087			$	965,323
Southwest			315,847				376,234
Central			355,638				328,938
Southeast			356,830				372,611
Corporate and other			589,587				1,037,200
Total homebuilding assets			2,699,989				3,080,306
Financial services			21,828				29,443
Total assets		$	2,721,817			$	3,109,749
Investments in unconsolidated joint ventures:
West Coast		$	38,216			$	37,830
Southwest			4,186				59,191
Central			—				—
Southeast			8,853				8,562
Total		$	51,255			$	105,583

4.

Financial Services

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

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Revenues
Interest income		$	7			$	4			$	2			$	2
Title services			1,329				736				526				350
Insurance commissions			4,392				4,447				1,806				1,830
Other			450				—				450				—
Total			6,178				5,187				2,784				2,182
Expenses
General and administrative			(2,481	)			(2,639	)			(829	)			(754	)
Operating income			3,697				2,548				1,955				1,428
Equity in income (loss) of unconsolidated joint venture			(376	)			5,946				(888	)			996
Pretax income		$	3,321			$	8,494			$	1,067			$	2,424

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4.

Financial Services (continued)

		August 31,				November 30,
		2011				2010
Assets
Cash and cash equivalents		$	2,867			$	4,029
Receivables			1,415				1,607
Investment in unconsolidated joint venture			17,526				23,777
Other assets			20				30
Total assets		$	21,828			$	29,443
Liabilities
Accounts payable and accrued expenses		$	3,321			$	2,620
Total liabilities		$	3,321			$	2,620

5.

Receivables

Receivables included amounts due from municipalities and utility companies, escrow deposits, and mortgages and notes receivable. Mortgages and notes receivable totaled $.4 million at August 31, 2011 and $40.5 million at November 30, 2010. Included in mortgages and notes receivable at November 30, 2010 was a note receivable of $40.0 million on which the Company took back the underlying real estate collateral in the second quarter of 2011.

6.

Inventories

Inventories consisted of the following (in thousands):

		August 31,				November 30,
		2011				2010
Homes, lots and improvements in production		$	1,466,803			$	1,298,085
Land under development			433,777				398,636
Total		$	1,900,580			$	1,696,721

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

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Capitalized interest at beginning of period		$	249,966			$	291,279			$	249,792			$	275,405
Capitalized interest related to consolidation of previously unconsolidated joint ventures			—				9,914				—				—
Interest incurred (a)			84,489				91,907				29,090				30,001
Interest expensed (a)			(36,902	)			(52,108	)			(12,342	)			(16,183	)
Interest amortized to construction and land costs			(52,746	)			(79,454	)			(21,733	)			(27,685	)
Capitalized interest at end of period (b)		$	244,807			$	261,538			$	244,807			$	261,538

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6.

Inventories (continued)

	(a)		Amounts for the nine months ended August 31, 2011 include a $3.6 million gain on the early extinguishment of secured debt. Amounts for the nine months ended August 31, 2010 include $1.8 million of debt issuance costs written off in connection with the Company’s voluntary reduction of the aggregate commitment under an unsecured revolving credit facility (the “Credit Facility”) from $650.0 million to $200.0 million during the first quarter of 2010 and the voluntary termination of the Credit Facility effective March 31, 2010.
	(b)		Inventory impairment charges are recognized against all inventory costs of a community, such as land, land improvements, costs of home construction and capitalized interest. Capitalized interest amounts presented in the table reflect the gross amount of capitalized interest as impairment charges recognized are not generally allocated to specific components of inventory.

7.

Inventory Impairments and Land Option Contract Abandonments

Each land parcel or community in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each land parcel or community on a quarterly basis and include, but are not limited to the following: significant decreases in sales rates, average selling prices, volume of homes delivered, gross margins on homes delivered or projected margins on homes in backlog or future housing sales; significant increases in budgeted land development and construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a land parcel or community, the identified asset is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). The Company evaluated 33 land parcels or communities for recoverability during each of the three-month periods ended August 31, 2011 and 2010. The Company evaluated 97 land parcels or communities and 88 land parcels or communities for recoverability during the nine months ended August 31, 2011 and 2010, respectively. Some of these land parcels or communities evaluated during the nine months ended August 31, 2011 and 2010 were evaluated in more than one quarterly period.

When an indicator of potential impairment is identified for a land parcel or community, the Company tests the asset for recoverability by comparing the carrying value of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by then-current conditions and trends in the market in which an asset is located as well as factors known to the Company at the time the cash flows are calculated. The undiscounted future net cash flows consider recent trends in the Company’s sales, backlog and cancellation rates. Among the trends considered with respect to the three-month and nine-month periods ended August 31, 2011 and 2010 were the after effects of a temporary surge in demand in the first two quarters of 2010 that was motivated by the April 30, 2010 expiration of the federal homebuyer tax credit, as discussed further below under “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Also taken into account were the Company’s future expectations related to the following: market supply and demand, including estimates concerning average selling prices; sales and cancellation rates; and anticipated land development, construction and overhead costs to be incurred. With respect to the three-month and nine-month periods ended August 31, 2011, these expectations reflected the Company’s experience that market conditions for its assets in inventory where impairment indicators were identified have been generally stable in 2010 and into 2011, with no significant deterioration or improvement identified as to revenue and cost drivers, excluding the temporary, though significant impact of the expiration of the federal homebuyer tax credit. Based on this experience, and taking into account the year-over-year increase in net orders in the third quarter of 2011 and the year-over-year increase in the number of new home communities, the Company’s inventory assessments considered an expected improved sales pace for the remainder of 2011.

Given the inherent challenges and uncertainties in forecasting future results, the Company’s inventory assessments at the time they are made generally assume the continuation of then-current market conditions, subject to identifying information suggesting a sustained deterioration or improvement in such conditions or other significant changes. Therefore, for most of its assets in inventory where impairment indicators are

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.

Inventory Impairments and Land Option Contract Abandonments (continued)

identified, the Company’s quarterly inventory assessments for the remainder of 2011, at the time made, will anticipate sales rates, average selling prices and costs to generally continue at or near then-current levels through an affected asset’s estimated remaining life. These estimates, trends and expectations are specific to each land parcel or community and may vary among land parcels or communities.

In its inventory assessments during the third quarter of 2011, the Company determined that the declines in its sales and backlog levels that it experienced in the third and fourth quarters of 2010 did not reflect a sustained change in market conditions preventing recoverability. Rather, the Company considered that they reflected the after effects of a temporary surge in demand in the first two quarters of 2010 that was motivated by the April 30, 2010 expiration of the federal homebuyer tax credit. Also contributing to these declines in the Company’s sales and backlog levels were strategic community count reductions the Company made in select markets in prior periods to align its operations with market activity levels.

A real estate asset is considered impaired when its carrying value 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. The discount rates used in the Company’s estimated discounted cash flows were 17% and 18% during the three months ended August 31, 2011 and 2010, respectively, and ranged from 17% to 20% during the nine-month periods ended August 31, 2011 and 2010. These discounted cash flows are impacted by the following: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each land parcel or community and may vary among land parcels or communities.

Based on the results of its evaluations, the Company recognized pretax, noncash inventory impairment charges of $.3 million in the three months ended August 31, 2011 associated with one community with a post-impairment fair value of $1.1 million. In the three months ended August 31, 2010, the Company recognized $1.4 million of pretax, noncash inventory impairment charges associated with one community with a post-impairment fair value of $2.7 million. In the nine months ended August 31, 2011, the Company recognized pretax, noncash inventory impairment charges of $21.4 million associated with nine land parcels or communities with a post-impairment fair value of $29.9 million. These charges included an $18.1 million adjustment to the fair value of real estate collateral in the Company’s Southwest homebuilding reporting segment that the Company took back on a note receivable in the second quarter of 2011. In the nine months ended August 31, 2010, the Company recognized $8.2 million of pretax, noncash inventory impairment charges associated with five land parcels or communities with a post-impairment fair value of $6.6 million. The inventory impairments the Company recorded during the three-month and nine-month periods ended August 31, 2011 and 2010 reflected declining asset values in certain markets due to unfavorable economic and competitive conditions.

As of August 31, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $366.8 million, representing 56 land parcels or communities. As of November 30, 2010, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $418.5 million, representing 72 land parcels or communities.

The Company’s inventory held under land option and other similar contracts is assessed to determine whether it continues to meet the Company’s internal investment and marketing standards. Assessments are made separately for each such land parcel on a quarterly basis and are affected by the following, 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 to not exercise certain land option and other similar contracts due to market conditions and/or changes in marketing strategy, the Company writes off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. Based on the results of its assessments, the Company recognized pretax, noncash land option contract abandonment charges of $.8 million corresponding to 209 lots in the three months ended August 31, 2011 and $1.9 million of such charges corresponding to 284 lots in the three months ended

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.

Inventory Impairments and Land Option Contract Abandonments (continued)

August 31, 2010. In the nine months ended August 31, 2011 and 2010, the Company recognized pretax, noncash land option contract abandonment charges of $2.1 million corresponding to 467 lots and $8.5 million corresponding to 685 lots, respectively. The charges for land option contract abandonments reflected the Company’s termination of land option contracts on projects that no longer met its investment standards or marketing strategy.

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

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

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

8.

Fair Value Disclosures

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

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

Fair value measurements are used for inventories on a nonrecurring basis when events and circumstances indicate the carrying value may not be recoverable. The following table presents the Company’s assets measured at fair value on a nonrecurring basis during the nine months ended August 31, 2011 and the year ended November 30, 2010 (in thousands):

		Fair Value
						August 31,				November 30,
Description		Hierarchy				2011 (a)				2010 (a)
Long-lived assets held and used		Level 2				$	75			$	1,877
Long-lived assets held and used		Level 3					29,788				9,693
Total						$	29,863			$	11,570

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.

Fair Value Disclosures (continued)

In accordance with the provisions of ASC 360, long-lived assets held and used with a carrying value of $51.3 million were written down to their fair value of $29.9 million during the nine months ended August 31, 2011, resulting in pretax, noncash inventory impairment charges of $21.4 million. Long-lived assets held and used with a carrying value of $21.4 million were written down to their fair value of $11.6 million during the year ended November 30, 2010, resulting in pretax, noncash inventory impairment charges of $9.8 million.

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

The Company’s financial instruments consist of cash and cash equivalents, restricted cash, mortgages and notes receivable, senior notes, and mortgages and land contracts due to land sellers and other loans. Fair value measurements of financial instruments are determined by various market data and other valuation techniques as appropriate. When available, the Company uses quoted market prices in active markets to determine fair value.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments, except those for which the carrying values approximate fair values (in thousands):

		August 31, 2011								November 30, 2010
		Carrying				Estimated				Carrying				Estimated
		Value				Fair Value				Value				Fair Value
Financial Liabilities:
Senior notes due 2011 at 6 3/8%		$	—			$	—			$	99,916			$	101,500
Senior notes due 2014 at 5 3/4%			249,609				236,875				249,498				246,250
Senior notes due 2015 at 5 7/8%			299,221				261,000				299,068				289,500
Senior notes due 2015 at 6 1/4%			449,782				389,250				449,745				435,375
Senior notes due 2017 at 9.1%			260,732				237,175				260,352				279,575
Senior notes due 2018 at 7 1/4%			298,978				254,250				298,893				286,500

The fair values of the Company’s senior notes are estimated based on quoted market prices. The Company repaid $100.0 million in aggregate principal amount of the Company’s 6 3/8% senior notes (the “$100 Million Senior Notes”) upon their August 15, 2011 maturity.

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

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.

Variable Interest Entities

The Company participates in joint ventures from time to time that conduct land acquisition, development and/or other homebuilding activities. Its investments in these joint ventures may create a variable interest in a variable interest entity (“VIE”), depending on the contractual terms of the arrangement. The Company analyzes its joint ventures in accordance with Accounting Standards Codification Topic No. 810, “Consolidation” (“ASC 810”), to determine whether they are VIEs and, if so, whether the Company is the primary beneficiary. All of the Company’s joint ventures at August 31, 2011 and November 30, 2010 were determined under the provisions of ASC 810 to be unconsolidated joint ventures and were accounted for using the equity method, either because they were not VIEs or, if they were VIEs, the Company was not the primary beneficiary of the VIEs.

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

In compliance with ASC 810, the Company analyzes its land option and other similar contracts to determine whether the corresponding land sellers are VIEs and, if so, whether the Company is the primary beneficiary. Although the Company does not have legal title to the underlying land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. As a result of its analyses, the Company determined that, as of August 31, 2011 and November 30, 2010, it was not the primary beneficiary of any VIEs from which it is purchasing land under land option and other similar contracts. In determining whether it is the primary beneficiary, the Company considers, among other things, whether it has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance. Such activities would include, among other things, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. The Company also considers whether it has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE.

As of August 31, 2011, the Company had cash deposits totaling $2.6 million associated with land option and other similar contracts that it determined to be unconsolidated VIEs, having an aggregate purchase price of $110.6 million, and had cash deposits totaling $13.0 million associated with land option and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $219.3 million. As of November 30, 2010, the Company had cash deposits totaling $2.6 million associated with land option and other similar contracts that the Company determined to be unconsolidated VIEs, having an aggregate purchase price of $86.1 million, and had cash deposits totaling $12.2 million associated with land option and other similar contracts that the Company determined were not VIEs, having an aggregate purchase price of $274.3 million.

The Company’s exposure to loss related to its land option and other similar contracts with third parties and unconsolidated entities consisted of its non-refundable deposits, which totaled $15.6 million at August 31, 2011 and $14.8 million at November 30, 2010 and are included in inventories in the Company’s consolidated balance sheets. In addition, the Company had outstanding letters of credit of $2.0 million at August 31, 2011 and $4.2 million at November 30, 2010 in lieu of cash deposits under certain land option or other similar contracts.

The Company also evaluates its land option and other similar contracts involving financing arrangements in accordance with Accounting Standards Codification Topic No. 470, “Debt” (“ASC 470”), and, as a result of its evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, in its consolidated balance sheets by $25.1 million at August 31, 2011 and $15.5 million at November 30, 2010.

10.

Investments in Unconsolidated Joint Ventures

The Company has investments in unconsolidated joint ventures that conduct land acquisition, development

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.

Investments in Unconsolidated Joint Ventures (continued)

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

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

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

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

With respect to the Company’s investment in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures included pretax, noncash impairment charges of $53.7 million for the nine months ended August 31, 2011 to write off the Company’s remaining investment in South Edge, LLC (“South Edge”), an unconsolidated joint venture in the Company’s Southwest homebuilding reporting segment. KB HOME Nevada Inc., a wholly-owned subsidiary of the Company, is a member of South Edge. The Company wrote off its remaining investment in South Edge based on the Company’s determination that South Edge was no longer able to perform its activities as originally intended due to a court decision in the first quarter of 2011, which is discussed further below. There were no such impairment charges for the three months ended August 31, 2011 or the three months and nine months ended August 31, 2010. Due to the Company’s write-off of its investment in South Edge, the information from the combined condensed statements of operations of the Company’s unconsolidated joint ventures for the three months ended August 31, 2011 and the combined condensed balance sheet information for the Company’s unconsolidated joint ventures as of August 31, 2011, in each case as presented in the tables below, does not include South Edge.

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

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.

Investments in Unconsolidated Joint Ventures (continued)

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Revenues		$	230			$	110,455			$	—			$	10,376
Construction and land costs			(201	)			(109,929	)			—				(9,194	)
Other income (expense), net			(4,505	)			(14,173	)			101				(5,336	)
Income (loss)		$	(4,476	)		$	(13,647	)		$	101			$	(4,154	)

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

		August 31,				November 30,
		2011				2010
Assets
Cash		$	9,672			$	14,947
Receivables			33				147,025
Inventories			182,983				575,632
Other assets			261				51,755
Total assets		$	192,949			$	789,359
Liabilities and equity
Accounts payable and other liabilities		$	3,707			$	113,478
Mortgages and notes payable			—				327,856
Equity			189,242				348,025
Total liabilities and equity		$	192,949			$	789,359

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

		August 31,				November 30,
		2011				2010
Number of investments in unconsolidated joint ventures:
South Edge (a)			—				1
Other			7				9
Total			7				10
Investments in unconsolidated joint ventures:
South Edge (a)		$	—			$	55,269
Other			51,255				50,314
Total		$	51,255			$	105,583
Outstanding debt of unconsolidated joint ventures:
South Edge (a)		$	—			$	327,856

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.

Investments in Unconsolidated Joint Ventures (continued)

The Company’s unconsolidated joint ventures finance land and inventory investments for a project through a variety of arrangements. To finance their respective land acquisition and development activities, certain of the Company’s unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. Of the Company’s unconsolidated joint ventures at November 30, 2010, only South Edge had outstanding debt, which was secured by a lien on South Edge’s assets, with a principal balance of $327.9 million. As of August 31, 2011, the principal balance of South Edge’s outstanding debt remained at $327.9 million.

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

In addition to completion and carve-out guarantees, the Company provided the Springing Guaranty to the Administrative Agent in connection with secured loans made to South Edge that comprise its outstanding debt. By its terms, the Springing Guaranty’s obligations arise after the occurrence of an involuntary bankruptcy proceeding or an involuntary bankruptcy petition filed against South Edge that is not dismissed within 60 days or for which an order or decree approving or ordering any such proceeding or petition is entered. On February 3, 2011, a bankruptcy court entered an order for relief on a Chapter 11 involuntary bankruptcy petition (the “Petition”) filed against South Edge and appointed a Chapter 11 trustee for South Edge. Although the Company believes that there are potential offsets or defenses to prevent or minimize the enforcement of the Springing Guaranty, as a result of the February 3, 2011 order for relief on the Petition, the Company considers it probable that it became responsible to pay certain amounts to the Administrative Agent related to the Springing Guaranty. Therefore, the Company’s consolidated financial statements at August 31, 2011 reflect a net payment obligation of $226.4 million, representing the Company’s estimate of the probable amount that it would pay to the Administrative Agent (on behalf of the South Edge lenders) related to the Springing Guaranty and to pay for certain fees, expenses and charges and for certain allowed general unsecured claims in the South Edge bankruptcy case. This estimate is based on the terms of a consensual agreement, effective June 10, 2011, among the Company, KB HOME Nevada Inc., the Administrative Agent, several of the lenders to South Edge, and certain of the other South Edge members and their respective parent companies (together with the Company and KB HOME Nevada Inc., the “Participating Members”) regarding a proposed consensual plan of reorganization for South Edge (the “Plan”). As a result of recording its probable net payment obligation at February 28, 2011, and taking into account accruals the Company had previously established with respect to South Edge and factoring in an offset for the estimated fair value of the South Edge land the Company expects to acquire as a result of satisfying the payment obligation, the Company recognized a charge of $22.8 million in the first quarter of 2011 that was reflected as a loss on loan guaranty in its consolidated statements of operations. This charge was in addition to the joint venture impairment charge of $53.7 million that the Company recognized in the first quarter of 2011 to write off its investment in South Edge. In the second quarter of 2011, in updating its estimate of its probable net payment obligation to reflect the terms of the consensual agreement effective June 10, 2011 regarding the Plan, the Company recorded an additional loss on loan guaranty of $14.6 million. The consensual agreement effective June 10, 2011 and the Plan are discussed further below in Note 15. Legal Matters. The Company’s probable net obligation related to South Edge may change if new information subsequently becomes available.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.

Investments in Unconsolidated Joint Ventures (continued)

Based on the terms of the Plan, the Company anticipates acquiring approximately 600 developable acres of the land owned by South Edge. Therefore, the Company considers its probable net payment obligation to be partially offset by $75.2 million, the estimated fair value of its share of the South Edge land at August 31, 2011. The Company calculated this estimated fair value using a present value methodology and assuming that it would develop the land, build and sell homes on most of the land, and sell the remainder of the developed land. This fair value estimate at August 31, 2011 reflected the Company’s expectations of the price it would receive for its share of the South Edge land in the land’s then-current state in an orderly (not a forced) transaction under then-prevailing market conditions. This fair value estimate also reflected judgments and key assumptions concerning (a) housing market supply and demand conditions, including estimates of average selling prices; (b) estimates of potential future home sales and cancellation rates; (c) anticipated entitlements and development plans for the land; (d) anticipated land development, construction and overhead costs to be incurred; and (e) a risk-free rate of return and an expected risk premium, in each case in relation to an expected 15-year life for the South Edge project.

Among the key assumptions used in the present value methodology was the anticipated appreciation in revenues and costs over the expected life of the South Edge project. For revenues, the Company applied an annual appreciation factor of 5% to the average selling prices for its homes to be delivered at the South Edge project in the current quarter to estimate the average selling prices of homes expected to be sold during the relevant 15-year period. This appreciation factor reflected the following considerations: that average selling prices in the southern Nevada market will increase over the period within a range of long-term historical trends; that average selling prices will rebound from the current depressed levels; that recent negative media coverage of the bankruptcy process and other legal and development matters involving South Edge have depressed selling prices at the South Edge project relative to the Company’s experience at communities located near South Edge; that the South Edge project is a premium master planned community in the land-constrained southern Nevada market, factors that are anticipated to increase the average selling prices of homes at the project at a rate greater than other homes in the area over the life of the project; and that the uniqueness of the South Edge project in the southern Nevada market and the size of the Company’s share of the South Edge land can be leveraged to effectively manage home sales and pricing strategies to maximize revenues and profits. The following appreciation considerations were applied to costs: a factor of 10% was applied to the cost estimates in the current quarter for the development work expected to be completed over the life of the project, representing the potential cost increases and other uncertainties inherent in estimating development costs; and a factor of 1% was applied to home construction costs for anticipated inflation of such costs, taking into account historical trends and current market conditions. In addition, incremental increases in overhead costs that would be incurred in connection with the sale of each home were assessed as a function of the 5% appreciation factor applied to the average selling prices. These revenue and cost appreciation factors were determined using judgment and assumptions believed to be appropriate based on the information known to the Company at the time. Due to the judgment and assumptions applied in the estimation process with respect to the fair value of the Company’s share of the South Edge land at August 31, 2011, including as to the anticipated appreciation in revenues and costs over the life of the South Edge project, it is possible that actual results could differ substantially from those estimated. The Company will continue to review and update as appropriate its fair value estimates of its share of the South Edge land to reflect changes in relevant market conditions and other applicable factors.

The ultimate outcome of the South Edge bankruptcy, including whether the Plan becomes effective, is uncertain. The Company believes, however, that it will realize the value of its share of the South Edge land in the bankruptcy proceeding in accordance with the Plan. If the Plan becomes effective, the Company anticipates that it would (a) acquire its share of the South Edge land as a result of a bankruptcy court-approved disposition of the land to a newly created entity in which the Company would expect to be a part owner, and (b) without further payment, satisfy or assume the respective liens of the Administrative Agent and the South Edge lenders on the land. If, on the other hand, the Plan does not become effective and instead the Company assumes the lenders’ lien position through payment on its Springing Guaranty obligation to the Administrative Agent, the Company would become a secured lender with respect to its share of the South Edge land and would expect to have first claim on the value generated from the land.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.

Investments in Unconsolidated Joint Ventures (continued)

If the Company is not able to realize some or all of the value of its share of the South Edge land, it may be required to recognize an additional expense. Based on the Company’s current estimates, this additional expense could range from near zero to potentially as much as $75 million.

11.

Other Assets

Other assets consisted of the following (in thousands):

		August 31,				November 30,
		2011				2010
Operating properties (a)		$	—			$	71,938
Cash surrender value of insurance contracts			59,920				59,103
Property and equipment, net			8,028				9,596
Debt issuance costs			4,444				5,254
Prepaid expenses			4,838				3,033
Deferred tax assets			1,152				1,152
Total		$	78,382			$	150,076

12.

Accrued Expenses and Other Liabilities

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

		August 31,				November 30,
		2011				2010
South Edge debt guaranty obligation		$	151,205			$	—
Construction defect and other litigation liabilities			136,354				124,853
Warranty liability			70,499				93,988
Employee compensation and related benefits			70,027				76,477
Accrued interest payable			27,615				42,963
Liabilities related to inventory not owned			25,145				15,549
Real estate and business taxes			7,635				8,220
Other			93,753				104,455
Total		$	582,233			$	466,505

13.

Mortgages and Notes Payable

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

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.

Mortgages and Notes Payable (continued)

		August 31,				November 30,
		2011				2010
Mortgages and land contracts due to land sellers and other loans		$	28,381			$	118,057
Senior notes due 2011 at 6 3/8%			—				99,916
Senior notes due 2014 at 5 3/4%			249,609				249,498
Senior notes due 2015 at 5 7/8%			299,221				299,068
Senior notes due 2015 at 6 1/4%			449,782				449,745
Senior notes due 2017 at 9.1%			260,732				260,352
Senior notes due 2018 at 7 1/4%			298,978				298,893
Total		$	1,586,703			$	1,775,529

During the nine months ended August 31, 2011, the Company repaid debt that was secured by a multi-level residential building, which the Company sold during the period. As the secured debt was repaid at a discount prior to its scheduled maturity, the Company recognized a gain of $3.6 million on the early extinguishment of secured debt during the nine months ended August 31, 2011.

The Company repaid $100.0 million in aggregate principal amount of the $100 Million Senior Notes upon their August 15, 2011 maturity.

Following its voluntary termination of the Credit Facility effective March 31, 2010, the Company entered into the LOC Facilities with various financial institutions to obtain letters of credit in the ordinary course of operating its business. As of August 31, 2011, $64.3 million of letters of credit were outstanding under the LOC Facilities. The LOC Facilities require the Company to deposit and maintain cash with the issuing financial institutions as collateral for its letters of credit outstanding. As of August 31, 2011, the amount of cash maintained for the LOC Facilities totaled $65.0 million and was included in restricted cash on the Company’s consolidated balance sheet as of that date. The Company may maintain, revise or, if necessary or desirable, enter into additional or expanded letter of credit facilities with the same or other financial institutions.

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

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

As of August 31, 2011, the Company was in compliance with the applicable terms of its covenants under the Company’s senior notes, the indenture, and mortgages and land contracts due to land sellers and other loans. The Company’s ability to secure future debt financing may depend in part on its ability to remain in such compliance.

14.

Commitments and Contingencies

Commitments and contingencies include typical obligations of homebuilders for the completion of contracts and

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14.

Commitments and Contingencies (continued)

those incurred in the ordinary course of business.

Warranty. The Company provides a limited warranty on all of its homes. The specific terms and conditions of these limited warranties vary depending upon the market in which the Company does business. The Company generally provides a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home. The Company estimates the costs that may be incurred under each limited warranty and records a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect the Company’s warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. The Company’s primary assumption in estimating the amounts it accrues for warranty costs is that historical claims experience is a strong indicator of future claims experience. The Company periodically assesses the adequacy of its 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 Company’s assessment includes the review of its actual warranty costs incurred to identify trends and changes in its warranty claims experience, and considers the Company’s construction quality and customer service initiatives and outside events. While the Company believes the warranty liability reflected in its consolidated balance sheets to be adequate, unanticipated changes in the legal environment, local weather, land or environmental conditions, quality of materials or methods used in the construction of homes, or customer service practices could have a significant impact on its actual warranty costs in the future and such amounts could differ from the Company’s current estimates.

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

		Nine Months Ended August 31,								Three Months Ended August 31,
		2011				2010				2011				2010
Balance at beginning of period		$	93,988			$	135,749			$	82,630			$	117,753
Warranties issued			3,236				3,720				1,255				1,783
Payments			(20,483	)			(35,210	)			(6,012	)			(17,958	)
Adjustments			(6,242	)			(2,329	)			(7,374	)			352
Balance at end of period		$	70,499			$	101,930			$	70,499			$	101,930

The warranty adjustments of approximately $7.4 million for the three months ended August 31, 2011 that were recorded as reductions to construction and land costs in the consolidated statements of operations, mainly resulted from trends in the Company’s overall warranty claims experience on homes previously delivered.

The Company’s overall warranty liability of $70.5 million at August 31, 2011 included $5.9 million for estimated remaining repair costs associated with 112 homes that have been identified as containing or suspected of containing allegedly defective drywall manufactured in China. These homes are located in Florida and were primarily delivered in 2006 and 2007. The Company’s overall warranty liability of $94.0 million at November 30, 2010 included $11.3 million for estimated remaining repair costs associated with 296 such identified affected homes. The decrease in the liability for estimated repair costs associated with identified affected homes during the nine months ended August 31, 2011 reflected the lower number of identified affected homes with unresolved repairs at August 31, 2011 compared to November 30, 2010. During the nine months ended August 31, 2011, repairs were resolved on 211 identified affected homes, and the Company identified 27 additional affected homes. For these purposes, the Company considers repairs for identified affected homes to be “resolved” when all repairs are complete and all repair costs are fully paid. Repairs for identified affected homes are considered “unresolved” if repairs are not complete and/or there are repair costs remaining to be paid.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14.

Commitments and Contingencies (continued)

The drywall used in the construction of the Company’s homes is purchased and installed by subcontractors. The Company’s subcontractors obtained drywall material from multiple domestic and foreign sources through late 2008. In late 2008, the Company directed its subcontractors to obtain only domestically sourced drywall. The Company has identified homes that contain or may contain allegedly defective drywall manufactured in China primarily by responding to homeowner-initiated warranty claims or customer service questions regarding such material or regarding conditions or items in a home that may be affected by such material. Additionally, in certain communities where there had been a high number of affected homes identified through the warranty/customer service process, the Company proactively undertook community-wide reviews that identified more affected homes. The Company completed all such community-wide reviews at the end of May 2011. The Company’s customer service personnel or, in some instances, third-party consultants handle these matters. Because of the testing process required to determine the origin of drywall material obtained before December 2008, the source of drywall for homes that have not been the subject of a customer service/warranty request or community-wide review is unknown. As a result, the Company is unable to readily identify the total number of homes that may contain the allegedly defective drywall material manufactured in China.

While the Company continues to respond to individual warranty/customer service requests as they are made, the number of additional affected homes newly identified each quarter has fallen significantly since the third quarter of 2009 to a nominal amount. Based on the significantly reduced individual warranty/customer service request rate, the completion of its community-wide reviews and the domestic sourcing of drywall material since late 2008, the Company anticipates that it has identified substantially all potentially affected homes and will receive at most only nominal additional claims in future periods.

During the nine months ended August 31, 2011 and 2010, the Company paid $11.8 million and $19.4 million, respectively, to repair identified affected homes, and estimated its additional repair costs with respect to the newly identified affected homes to be $6.3 million and $19.5 million, respectively. Since first identifying affected homes in 2009, the Company has identified a total of 464 affected homes and has resolved repairs on 352 of those homes through August 31, 2011. As of August 31, 2011, the Company has paid $38.6 million of the total estimated repair costs of $44.5 million associated with the identified affected homes.

In assessing its overall warranty liability, the Company evaluates the costs related to identified homes affected by the allegedly defective drywall material and other home warranty-related items on a combined basis. While the Company has considered the repair costs related to the identified affected homes in conjunction with its quarterly assessments of its overall warranty liability since the third quarter of 2009, the Company has experienced favorable trends in its actual warranty costs incurred with respect to other home warranty-related items. These favorable trends reflect the Company’s ongoing focus on construction quality and customer service, among other things. Based on its assessments, the Company determined that its overall warranty liability at each reporting date was sufficient with respect to the Company’s then-estimated remaining repair costs associated with identified affected homes and its overall warranty obligations on homes delivered. In light of these assessments, the Company did not incur charges in the nine months ended August 31, 2011 or in its 2010 fiscal year with respect to repair costs associated with the identified affected homes. Additionally, based on the trends in the Company’s actual warranty costs incurred, the Company’s assessment for the quarter ended August 31, 2011 resulted in the recording of warranty adjustments of approximately $7.4 million as reductions to construction and land costs. The overall warranty liability has decreased since the third quarter of 2009 in part because of the payments the Company has made to resolve repairs on identified affected homes and in part due to the decrease in the number of homes the Company has delivered over the past several years.

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

As of August 31, 2011, the Company has been named as a defendant in 10 lawsuits relating to the allegedly defective drywall material, and it may in the future be subject to other similar litigation or claims that could cause the Company to incur significant costs. Given the preliminary stages of the proceedings, the Company has

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14.

Commitments and Contingencies (continued)

not concluded whether the outcome of any of these lawsuits will be material to its consolidated financial statements.

The Company intends to seek and is undertaking efforts, including legal proceedings, to obtain reimbursement from various sources for the costs it has incurred or expects to incur to investigate and complete repairs and to defend itself in litigation associated with this drywall material. At this stage of its efforts, however, the Company has not recorded any amounts for potential recoveries as of August 31, 2011.

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

Insurance. The Company has, and requires the majority of its subcontractors to have, general liability insurance (including construction defect and bodily injury coverage) and workers’ compensation insurance. These insurance policies protect the Company against a portion of its risk of loss from claims related to its homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. In Arizona, California, Colorado and Nevada, the Company’s general liability insurance takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insureds on each project. The Company self-insures a portion of its overall risk through the use of a captive insurance subsidiary. The Company records expenses and liabilities based on the estimated costs required to cover its self-insured retention and deductible amounts under its insurance policies, and on the estimated costs of potential claims and claim adjustment expenses that are above its coverage limits or that are not covered by its policies. These estimated costs are based on an analysis of the Company’s historical claims and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $95.7 million at both August 31, 2011 and November 30, 2010. These amounts are included in accrued expenses and other liabilities in the Company’s consolidated balance sheets. The Company’s expenses associated with self-insurance totaled $2.1 million for the three months ended August 31, 2011 and $1.6 million for the three months ended August 31, 2010. For the nine months ended August 31, 2011 and 2010, the Company’s expenses associated with self-insurance totaled $6.7 million and $5.2 million, respectively.

Performance Bonds and Letters of Credit. The Company is often required to obtain performance bonds and letters of credit in support of its obligations to various municipalities and other government agencies in connection with community improvements such as roads, sewers and water, and to support similar development activities by certain of its unconsolidated joint ventures. At August 31, 2011, the Company had $392.4 million of performance bonds and $64.3 million of letters of credit outstanding. At November 30, 2010, the Company had $414.3 million of performance bonds and $87.5 million of letters of credit outstanding. If any such performance bonds or letters of credit are called, the Company would be obligated to reimburse the issuer of the performance bond or letter of credit. The Company does not believe that a material amount of any currently outstanding performance bonds or letters of credit will be called. Performance bonds do not have stated expiration dates. Rather, the Company is released from the performance bonds as the underlying performance is completed. The expiration dates of some letters of credit coincide with the expected completion dates of the related projects or obligations. Most letters of credit, however, are issued with an initial term of one year and are typically extended on a year-to-year basis until the related performance obligation is completed.

Land Option Contracts. In the ordinary course of its business, the Company enters into land option and other similar contracts to procure rights to land parcels for the construction of homes. At August 31, 2011, the Company had total deposits of $17.6 million, comprised of $15.6 million of cash deposits and $2.0 million of letters of credit, to purchase land having an aggregate purchase price of $329.8 million. The Company’s land option and other similar contracts generally do not contain provisions requiring the Company’s specific performance.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

15.

Legal Matters

South Edge, LLC Litigation

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

The Petition alleged that South Edge failed to undertake certain development-related activities and to repay amounts due on secured loans that the petitioning lenders (as part of a lending syndicate) made to South Edge in 2004 and 2007, totaling $585.0 million in initial aggregate principal amount (the “Loans”), that the petitioning lenders were undersecured, and that South Edge was generally not paying its debts as they became due. The Loans were used by South Edge to partially finance both the purchase of certain real property located near Las Vegas, Nevada and the development of a residential community on that property. The Loans are secured by the underlying property and related South Edge assets. As of August 31, 2011, the outstanding principal balance of the Loans was $327.9 million.

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

As a result of the February 3, 2011 order for relief on the Petition, the Company considers it probable that it became responsible to pay certain amounts to the Administrative Agent related to the Springing Guaranty that the Company provided in connection with the Loans, as discussed further above in Note 10. Investments in Unconsolidated Joint Ventures. Each of KB HOME Nevada Inc., the other members of South Edge and their parent companies provided a similar repayment guaranty to the Administrative Agent.

Effective June 10, 2011, the Company and the other Participating Members of South Edge became parties to a consensual agreement together with the Administrative Agent and several of the lenders to South Edge, as discussed above in Note 10. Investments in Unconsolidated Joint Ventures. The Chapter 11 trustee for South Edge has expressed its consent to the agreement. Each of the parties has agreed to use commercially reasonable efforts to support the Plan, to obtain bankruptcy court approval of a disclosure statement that will accompany the Plan, to obtain bankruptcy court confirmation of the Plan following, and subject to, the bankruptcy court’s approval of a disclosure statement, to obtain the requisite support of the South Edge lenders to the Plan, and to consummate the Plan promptly after confirmation, in each case by certain specified dates. Under the agreement, the effective date of the Plan following its confirmation is to occur on or before November 30, 2011, though it may be extended by the Participating Members and the Administrative Agent jointly by up to 30 days, depending on the date of Plan confirmation.

Pursuant to the terms of the Plan, the Company would pay to the South Edge lenders an amount between approximately $214 million and $225 million on the effective date of the Plan. The Company has deposited $21.4 million of this amount in an escrow account, which is reflected as restricted cash in its consolidated balance sheet as of August 31, 2011. The other Participating Members also would pay certain amounts to the South Edge lenders on the effective date of the Plan and have similarly deposited amounts into an escrow account. The exact sum that the Company and the other Participating Members would pay to the South Edge lenders depends on the outcome of proceedings the Chapter 11 trustee for South Edge has commenced against, among others, a South Edge member that is not a Participating Member in order to determine the amount of pledged infrastructure development funds that can be applied to the South Edge debt. In addition to their payments to the South Edge lenders, each of the Company and the other Participating Members would each be responsible for certain fees, expenses and charges and for certain allowed general unsecured claims, and would

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

15.

Legal Matters (continued)

receive the benefit of potential contributions and recoveries that would, in the aggregate, affect their respective costs related to the Plan. Taking all of this into account, the Company estimates that its probable net payment obligation under the terms of the consensual agreement effective June 10, 2011 regarding the Plan is $226.4 million, though it could possibly be as high as $240 million.

If the Plan becomes effective, the Company anticipates that it would (a) acquire its share of the land owned by South Edge (amounting to at least approximately 65% of the land and as much as approximately 68%) as a result of a bankruptcy court-approved disposition of the land to a newly created entity in which the Company would expect to be a part owner, and (b) without further payment, satisfy or assume the respective liens of the Administrative Agent and the South Edge lenders on the land. In addition, if the Plan becomes effective, the Company anticipates that all South Edge-related claims, potential guaranty obligations (including the Company’s potential Springing Guaranty obligation), and litigation between the Administrative Agent (on behalf of itself and the South Edge lenders) and the Participating Members would be resolved, although lenders holding less than 8% ownership in the Loans made to South Edge that are not currently expected to consent to the Plan and members of South Edge that are not Participating Members may assert certain claims against the Company, which claims the Company would vigorously dispute.

The agreement may be terminated by the Administrative Agent or the Participating Members upon the occurrence of certain specified events, including a failure to meet the specified dates on which the above-described activities in support of the Plan are to occur. On September 8, 2011, the bankruptcy court approved a disclosure statement designed to implement the Plan, and a hearing to confirm the Plan is scheduled for October 17, 2011. As of the date of this report, the Company believes that the other Participating Members, the Administrative Agent and the South Edge lenders that are party to the agreement are able to and will fulfill their respective obligations as contemplated under the Plan if it becomes effective.

The Administrative Agent had previously filed lawsuits in December 2008 against the South Edge members and their respective parent companies (including the Company and KB HOME Nevada Inc.) (JP Morgan Chase Bank, N.A. v. KB HOME Nevada, et al., U.S. District Court, District of Nevada (Case No. 08-CV-01711 PMP) and consolidated and related actions) (the “Lender Litigation”). The Lender Litigation seeks to enforce completion guarantees provided to the Administrative Agent in connection with the Loans, seeks to compel the South Edge members (including KB HOME Nevada Inc.) to purchase land parcels from South Edge, seeks to compel the South Edge members to provide certain financial support to South Edge, and also seeks various damages based on other guarantees and claims. The Lender Litigation has been stayed in light of the South Edge bankruptcy and, as stated above, would be resolved between the Administrative Agent (on behalf of itself and the South Edge lenders consenting to the Plan) and the Participating Members if the Plan becomes effective.

A separate arbitration proceeding was also commenced in May 2009 to address one South Edge member’s claims for specific performance by the other members to purchase land parcels from and to make certain capital contributions to South Edge or, in the alternative, damages. On July 6, 2010, the arbitration panel issued a decision denying the specific performance and damages claim asserted on behalf of South Edge, but the panel awarded the claimant damages of $36.8 million against all of the respondents. Motions to partially vacate the award were denied and judgment was entered on the award, which the respondents have appealed to the United States Courts of Appeal for the Ninth Circuit, titled Focus South Group, LLC, et al. v. KB HOME Nevada Inc, et al., (Case No. 10-17562). The appeal is pending. If the appeals of the arbitration panel’s July 6, 2010 decision ultimately are not successful, the Company has estimated that its probable maximum share of the $36.8 million awarded as damages to the claimant in the arbitration is approximately $25.5 million. This estimate is based on KB HOME Nevada Inc.’s interest in South Edge in relation to that of the other four respondents in the arbitration and the Company’s assumption that liability for the awarded amount would be joint and several among the five respondents. Although the appeal remains pending, the Company has since the third quarter of 2010 segregated an accrual for $25.5 million for this matter from its previously established reserve balances relating to South Edge. The ultimate amount of the Company’s share, however, could be subject to negotiations and/or potential arbitration among all of the respondents in the arbitration. The accrual for this matter is separate from the accrual the Company established with respect to its probable net payment obligation related to South Edge.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

15.

Legal Matters (continued)

The ultimate resolution of the South Edge bankruptcy, the Lender Litigation and the appeal of the arbitration panel decision, and the time at which any resolution is reached with respect to each matter, are uncertain and involve multiple factors, including whether the Plan becomes effective, as described above, the actions of the Chapter 11 trustee for South Edge, and court decisions. Further, the ultimate resolution of the South Edge bankruptcy (including with respect to the Company’s anticipated net payment obligation related to South Edge), the Lender Litigation and the appeal of the arbitration panel decision could have a material effect on the Company’s liquidity, as further discussed below under “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

In addition to the specific proceedings described above, the Company is involved in other litigation and regulatory proceedings incidental to its business that are in various procedural stages. The Company believes that the accruals it has recorded for probable and reasonably estimable losses with respect to these proceedings are adequate and that, as of August 31, 2011, it was not reasonably possible that an additional material loss had been incurred in an amount in excess of the estimated amounts already recognized on the Company’s consolidated financial statements. The Company evaluates its accruals for litigation and regulatory proceedings at least quarterly and, as appropriate, adjusts them to reflect (i) the facts and circumstances known to the Company at the time, including information regarding negotiations, settlements, rulings and other relevant events and developments; (ii) the advice and analyses of counsel; and (iii) the assumptions and judgment of management. Similar factors and considerations are used in establishing new accruals for proceedings as to which losses have become probable and reasonably estimable at the time an evaluation is made. Based on its experience, the Company believes that the amounts that may be claimed or alleged against it in these proceedings are not a meaningful indicator of its potential liability. The outcome of any of these proceedings, including the defense and other litigation-related costs and expenses the Company may incur, however, is inherently uncertain and could differ significantly from the estimate reflected in a related accrual, if made. Therefore, it is possible that the ultimate outcome of any proceeding, if in excess of a related accrual or if no accrual had been made, could be material to the Company’s consolidated financial statements.

16.

Stockholders’ Equity

At August 31, 2011, the Company was authorized to repurchase 4,000,000 shares of its common stock under a board-approved share repurchase program. The Company did not repurchase any of its common stock under this program in the nine months ended August 31, 2011. The Company has not repurchased common shares pursuant to a common stock repurchase plan for the past several years and any resumption of such stock repurchases will be at the discretion of the Company’s board of directors.

During the three months ended February 28, 2011, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 17, 2011 to stockholders of record on February 3, 2011. During the three months ended May 31, 2011, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on May 19, 2011 to stockholders of record on May 5, 2011. During the three months ended August 31, 2011, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on August 18, 2011 to stockholders of record on August 4, 2011. A cash dividend of $.0625 per share of common stock was also declared and paid during each of the three-month periods ended February 28, 2010, May 31, 2010 and August 31, 2010. The declaration and payment of future cash dividends on the Company’s common stock are at the discretion of the Company’s board of directors, and depend upon, among other things, the Company’s expected future earnings, cash flows, capital requirements, debt structure and any adjustments thereto, operational and financial investment strategy and general financial condition, as well as general business conditions.

17.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-06”), which provides

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

17.

Recent Accounting Pronouncements (continued)

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

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

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

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). The amendments in ASU 2011-05 allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively. For public entities, the amendments in ASU 2011-05 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company believes the adoption of this guidance concerns disclosure only and will not have a material impact on its consolidated financial position or results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

18.

Income Taxes

The Company had no income tax benefit or expense for the three months ended August 31, 2011 and an income tax benefit of $5.3 million for the three months ended August 31, 2010. For the nine months ended August 31, 2011, the Company’s income tax expense totaled $.1 million, compared to an income tax benefit of $5.0 million for the nine months ended August 31, 2010. Due to the effects of its deferred tax asset valuation allowances, carrybacks of its net operating losses (“NOLs”), and changes in its unrecognized tax benefits, the Company’s effective tax rates for the three-month and nine-month periods ended August 31, 2011 and 2010 are not meaningful items as the Company’s income tax amounts are not directly correlated to the amount of its pretax losses for those periods.

In accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”), the Company evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During the three months ended August 31, 2011, the Company recorded a valuation allowance of $2.5 million against net deferred tax assets generated from the loss for the period. During the three months ended August 31, 2010, the Company recorded a net reduction of $2.4 million to the valuation allowance against net deferred tax assets. The net reduction was comprised of a $5.4 million federal income tax benefit from the increased carryback of the Company’s 2009 net operating loss to offset earnings it generated in 2004 and 2005, partially offset by a $3.0 million valuation allowance recorded against the net deferred tax assets generated from the loss for the period. For the nine months ended August 31, 2011, the Company recorded valuation allowances of $73.3 million against the net deferred tax assets generated from losses for the period. For the nine months ended August 31, 2010, the Company recorded a net increase of $31.6 million to the valuation allowance against net deferred tax assets. The net increase was comprised of a $37.0 million valuation allowance recorded against the net deferred tax assets generated from the loss for the period, partially offset by the $5.4 million federal income tax benefit from the increased carryback of the Company’s 2009 net operating loss to offset earnings it generated in 2004 and 2005.

The Company’s net deferred tax assets totaled $1.1 million at both August 31, 2011 and November 30, 2010. The deferred tax asset valuation allowance increased to $844.4 million at August 31, 2011 from $771.1 million at November 30, 2010. This increase reflected the impact of the $73.3 million valuation allowance recorded during the nine months ended August 31, 2011.

During the three months ended August 31, 2011, the Company did not have a change to its total gross unrecognized tax benefits. During the nine months ended August 31, 2011, net reductions to the Company’s total gross unrecognized tax benefits were $.3 million. The total amount of unrecognized tax benefits, including interest and penalties, was $6.6 million as of August 31, 2011. The Company anticipates that total unrecognized tax benefits will decrease by approximately $2.0 million during the 12 months from this reporting date due to various state filings associated with the resolution of the federal audit.

The benefits of the Company’s NOLs, built-in losses and tax credits would be reduced or potentially eliminated if the Company experienced an “ownership change” under Internal Revenue Code Section 382 (“Section 382”). Based on the Company’s analysis performed as of August 31, 2011, the Company does not believe that it has experienced an ownership change as defined by Section 382, and, therefore, the NOLs, built-in losses and tax credits the Company has generated should not be subject to a Section 382 limitation as of this reporting date.

19.

Supplemental Disclosure to Consolidated Statements of Cash Flows

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

19.

Supplemental Disclosure to Consolidated Statements of Cash Flows (continued)

		Nine Months Ended August 31,
		2011				2010
Summary of cash and cash equivalents at end of period:
Homebuilding		$	477,406			$	919,851
Financial services			2,867				3,756
Total		$	480,273			$	923,607
Supplemental disclosures of cash flow information:
Interest paid, net of amounts capitalized		$	23,159			$	72,113
Income taxes paid			278				523
Income taxes refunded			182				191,345
Supplemental disclosures of noncash activities:
Increase in inventories in connection with consolidation of joint ventures		$	—			$	72,300
Increase in accounts payable, accrued expenses and other liabilities in connection with consolidation of joint ventures			—				38,861
Stock appreciation rights exchanged for stock options			—				1,816
Cost of inventories acquired through seller financing			—				53,125
Increase (decrease) in consolidated inventories not owned			9,596				(37,633	)
Acquired property securing note receivable			40,000				—

20.

Supplemental Guarantor Information