KB Home
KB HOME (Form: 10-Q, Received: 07/10/2013 16:20:39)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
  FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended May 31, 2013 .
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from [            ] to [            ].
Commission File No. 001-09195
KB HOME
(Exact name of registrant as specified in its charter)
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   ý     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   ý     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
ý
Accelerated filer
o
Non-accelerated filer
o   (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   o     No   ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of May 31, 2013.
There were 83,713,479 shares of the registrant’s common stock, par value $1.00 per share, outstanding on May 31, 2013. The registrant’s grantor stock ownership trust held an additional 10,559,844 shares of the registrant’s common stock on that date.


Table of Contents

KB HOME
FORM 10-Q
INDEX
 
 
Page
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

PART I.    FINANCIAL INFORMATION
Item 1.
Financial Statements
KB HOME
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts – Unaudited)
 

 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Total revenues
$
929,625

 
$
557,410

 
$
524,406

 
$
302,852

Homebuilding:
 
 
 
 
 
 
 
Revenues
$
924,604

 
$
552,500

 
$
521,788

 
$
300,605

Construction and land costs
(786,263
)
 
(484,873
)
 
(442,998
)
 
(253,041
)
Selling, general and administrative expenses
(129,196
)
 
(114,312
)
 
(70,099
)
 
(63,100
)
Operating income (loss)
9,145

 
(46,685
)
 
8,691

 
(15,536
)
Interest income
436

 
246

 
232

 
111

Interest expense
(29,747
)
 
(30,755
)
 
(14,507
)
 
(14,469
)
Equity in loss of unconsolidated joint ventures
(1,002
)
 
(315
)
 
(567
)
 
(243
)
Homebuilding pretax loss
(21,168
)
 
(77,509
)
 
(6,151
)
 
(30,137
)
Financial services:
 
 
 
 
 
 
 
Revenues
5,021

 
4,910

 
2,618

 
2,247

Expenses
(1,471
)
 
(1,528
)
 
(636
)
 
(693
)
Equity in income (loss) of unconsolidated joint ventures
1,087

 
89

 
(4
)
 
(53
)
Financial services pretax income
4,637

 
3,471

 
1,978

 
1,501

Total pretax loss
(16,531
)
 
(74,038
)
 
(4,173
)
 
(28,636
)
Income tax benefit
1,100

 
4,100

 
1,200

 
4,500

Net loss
$
(15,431
)
 
$
(69,938
)
 
$
(2,973
)
 
$
(24,136
)
Basic and diluted loss per share
$
(.19
)
 
$
(.91
)
 
$
(.04
)
 
$
(.31
)
Basic and diluted average shares outstanding
81,526

 
77,097

 
83,605

 
77,105

Cash dividends declared per common share
$
.0500

 
$
.0875

 
$
.0250

 
$
.0250

See accompanying notes.

3

Table of Contents

KB HOME
CONSOLIDATED BALANCE SHEETS
(In Thousands – Unaudited)
 

 
May 31,
2013
 
November 30,
2012
Assets
 
 
 
Homebuilding:
 
 
 
Cash and cash equivalents
$
538,571

 
$
524,765

Restricted cash
42,322

 
42,362

Receivables
66,121

 
64,821

Inventories
2,029,390

 
1,706,571

Investments in unconsolidated joint ventures
122,800

 
123,674

Other assets
103,797

 
95,050

 
2,903,001

 
2,557,243

Financial services
9,120

 
4,455

Total assets
$
2,912,121

 
$
2,561,698

 
 
 
 
Liabilities and stockholders’ equity
 
 
 
Homebuilding:
 
 
 
Accounts payable
$
117,804

 
$
118,544

Accrued expenses and other liabilities
378,149

 
340,345

Mortgages and notes payable
1,943,275

 
1,722,815

 
2,439,228

 
2,181,704

Financial services
2,077

 
3,188

Common stock
115,291

 
115,178

Paid-in capital
785,385

 
888,579

Retained earnings
430,682

 
450,292

Accumulated other comprehensive loss
(27,958
)
 
(27,958
)
Grantor stock ownership trust, at cost
(114,540
)
 
(115,149
)
Treasury stock, at cost
(718,044
)
 
(934,136
)
Total stockholders’ equity
470,816

 
376,806

Total liabilities and stockholders’ equity
$
2,912,121

 
$
2,561,698

See accompanying notes.

4

Table of Contents

KB HOME
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands – Unaudited)
 
 
Six Months Ended May 31,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net loss
$
(15,431
)
 
$
(69,938
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Equity in (income) loss of unconsolidated joint ventures
(85
)
 
226

Distributions of earnings from unconsolidated joint ventures
1,638

 

Amortization of discounts and issuance costs
2,387

 
1,347

Depreciation and amortization
940

 
781

Loss on early extinguishment of debt

 
2,003

Stock-based compensation
2,044

 
3,205

Inventory impairments and land option contract abandonments
284

 
16,509

Changes in assets and liabilities:
 
 
 
Receivables
(405
)
 
16,795

Inventories
(290,661
)
 
(16,131
)
Accounts payable, accrued expenses and other liabilities
32,210

 
(40,214
)
Other, net
(521
)
 
(4,464
)
Net cash used in operating activities
(267,600
)
 
(89,881
)
Cash flows from investing activities:
 
 
 
Return of investments in (contributions to) unconsolidated joint ventures
(5,651
)
 
4,550

Purchases of property and equipment, net
(752
)
 
(592
)
Net cash provided by (used in) investing activities
(6,403
)
 
3,958

Cash flows from financing activities:
 
 
 
Change in restricted cash
40

 
1,299

Proceeds from issuance of debt
230,000

 
344,831

Payment of debt issuance costs
(10,086
)
 
(6,751
)
Repayment of senior notes

 
(340,481
)
Payments on mortgages and land contracts due to land sellers and other loans
(37,830
)
 
(6,695
)
Proceeds from issuance of common stock, net
109,503

 

Issuance of common stock under employee stock plans
2,106

 
353

Payments of cash dividends
(4,179
)
 
(6,746
)
Stock repurchases
(33
)
 

Net cash provided by (used in) financing activities
289,521

 
(14,190
)
Net increase (decrease) in cash and cash equivalents
15,518

 
(100,113
)
Cash and cash equivalents at beginning of period
525,688

 
418,074

Cash and cash equivalents at end of period
$
541,206

 
$
317,961

See accompanying notes.

5

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1.
Basis of Presentation and Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. 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 our opinion, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly our consolidated financial position as of May 31, 2013 , the results of our consolidated operations for the three months and six months ended May 31, 2013 and 2012 , and our consolidated cash flows for the six months ended May 31, 2013 and 2012 . The results of our consolidated operations for the three months and six months ended May 31, 2013 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, 2012 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, 2012 , which are contained in our Annual Report on Form 10-K for that period.
Unless the context indicates otherwise, the terms “we,” “our,” and “us” used in this report refer to KB Home, a Delaware corporation, and its subsidiaries.
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. We consider all highly liquid short-term investments purchased with an original maturity of three months or less to be cash equivalents. Our cash equivalents totaled $436.8 million at May 31, 2013 and $396.3 million at November 30, 2012 . The majority of our cash and cash equivalents were invested in money market funds and interest-bearing bank deposit accounts.
Restricted cash of $42.3 million at May 31, 2013 and $42.4 million at November 30, 2012 consisted of cash deposited with various financial institutions that was required as collateral for our cash-collateralized letter of credit facilities (“LOC Facilities”).
Loss Per Share. Basic and diluted loss per share were calculated as follows (in thousands, except per share amounts):  
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Numerator:
 
 
 
 
 
 
 
Net loss
$
(15,431
)
 
$
(69,938
)
 
$
(2,973
)
 
$
(24,136
)
Denominator:
 
 
 
 
 
 
 
Basic and diluted average shares outstanding
81,526

 
77,097

 
83,605

 
77,105

Basic and diluted loss per share
$
(.19
)
 
$
(.91
)
 
$
(.04
)
 
$
(.31
)
All outstanding stock options were excluded from the diluted loss per share calculations for the three months and six months ended May 31, 2013 and 2012 because the effect of their inclusion would be antidilutive, or would decrease the reported loss per share. Additionally, the impact of the $230.0 million in aggregate principal amount of 1.375% convertible senior notes due 2019 (the “$230 Million Convertible Senior Notes”) that we issued in the first quarter of 2013 was excluded from the diluted loss per share calculations for the three months and six months ended May 31, 2013 because the effect would have been antidilutive.
Comprehensive Loss. Our comprehensive loss was $3.0 million for the three months ended May 31, 2013 and $24.1 million for the three months ended May 31, 2012 . For the six months ended May 31, 2013 and 2012, our comprehensive losses were

6

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

$15.4 million and $69.9 million , respectively. Our comprehensive losses for the three months and six months ended May 31, 2013 and 2012 were equal to our net losses for the same periods. The accumulated other comprehensive loss in our consolidated balance sheets as of May 31, 2013 and November 30, 2012 was 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”). Such adjustments are made annually as of November 30, when our benefit plan obligations are remeasured. 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). 
Revisions/Reclassifications. Effective December 1, 2012, we elected to reclassify closing cost allowances given to certain homebuyers from selling, general and administrative expenses to construction and land costs in our consolidated statements of operations. These allowances are used to cover a portion of non-recurring third-party fees, such as escrow fees, title costs, recording fees, finance processing fees, and prepaid property taxes and insurance costs that are charged to a homebuyer in connection with the closing of the sale of a home. This reclassification reduced both our housing gross profits and selling, general and administrative expenses for the three months ended May 31, 2013 and 2012 by $2.2 million and $3.3 million , respectively, which represented .4% and 1.1% of housing revenues, respectively. For the six months ended May 31, 2013 and 2012, the reclassification reduced both our housing gross profits and selling, general and administrative expenses by $4.3 million and $7.8 million , respectively, which represented .5% and 1.4% of housing revenues, respectively. The reclassification had no impact on consolidated operating income (loss) or net income (loss) amounts previously reported. All prior period amounts have been reclassified to conform to the 2013 presentation.
The format of the condensed consolidating financial statements presented in Note 19. Supplemental Guarantor Information has been revised for the periods previously reported in our annual and quarterly reports to reflect (a) the transfer of certain of our subsidiaries from non-guarantor subsidiaries to guarantor subsidiaries as a result of such subsidiaries becoming guarantor subsidiaries during the second quarter of 2013 as further discussed in Note 12. Mortgages and Notes Payable, and (b) an elective reclassification of guarantor and non-guarantor intercompany receivables and payables with corresponding offsets in the consolidating adjustments column. These intercompany receivables and payables had previously been presented on a net basis. This revised presentation of the condensed consolidating financial statements in Note 19. Supplemental Guarantor Information had no impact or effect on our consolidated financial statements for any periods presented, including our consolidated balance sheets, consolidated statements of operations and consolidated statements of cash flows.
2.
Stock-Based Compensation
We measure and recognize compensation expense associated with our grant of equity-based awards in accordance with Accounting Standards Codification Topic No. 718, “Compensation — Stock Compensation” (“ASC 718”). ASC 718 requires that 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, we estimate the grant-date fair value of 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 our common stock and an expected term of the stock options. The following table summarizes stock option transactions for the six months ended May 31, 2013 :

7

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2.
Stock-Based Compensation (continued)

 
Options
 
Weighted
Average Exercise
Price
Options outstanding at beginning of period
10,105,546

 
$
21.27

Granted

 

Exercised
(112,586
)
 
13.47

Cancelled

 

Options outstanding at end of period
9,992,960

 
$
21.36

Options exercisable at end of period
8,431,121

 
$
23.88

As of May 31, 2013 , the weighted average remaining contractual life of stock options outstanding and stock options exercisable was 5.8 years and 5.4 years , respectively. There was $.9 million of total unrecognized compensation expense related to unvested stock option awards as of May 31, 2013 . For the three months ended May 31, 2013 and 2012 , stock-based compensation expense associated with stock options totaled $.4 million and $1.2 million , respectively. For the six months ended May 31, 2013 and 2012, stock-based compensation expense associated with stock options totaled $.8 million and $2.4 million , respectively. The aggregate intrinsic value of stock options outstanding was $56.6 million at May 31, 2013 . The aggregate intrinsic value of stock options exercisable was $34.0 million at May 31, 2013 . (The intrinsic value of a stock option is the amount by which the market value of a share of the underlying common stock exceeds the exercise price of the stock option.)  
Other Stock-Based Awards. From time to time, we grant restricted stock, performance-based restricted stock units (each a “PSU”) and phantom shares to various employees. We recognized total compensation expense of $.7 million for the three months ended May 31, 2013 and $.4 million for the three months ended May 31, 2012 related to restricted stock, PSUs and phantom shares. We recognized total compensation expense of $1.3 million for the six months ended May 31, 2013 and $.8 million for the six months ended May 31, 2012 related to these stock-based awards.
3.
Segment Information
As of May 31, 2013 , we had identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within our consolidated operations in accordance with Accounting Standards Codification Topic No. 280, “Segment Reporting.” As of May 31, 2013 , our homebuilding reporting segments conducted ongoing operations in the following states:
West Coast: California
Southwest: Arizona, Nevada and New Mexico
Central: Colorado and Texas
Southeast: Florida, Maryland, North Carolina and Virginia
Our homebuilding reporting segments are engaged in the acquisition and development of land primarily for residential purposes and offer a wide variety of homes that are designed to appeal to first-time, first move-up and active adult homebuyers.
Our 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. We evaluate segment performance primarily based on segment pretax results.
Our financial services reporting segment offers insurance services to our homebuyers in the same markets as our homebuilding reporting segments and provides title services in the majority of our markets within our Central and Southeast homebuilding reporting segments. In addition, since the third quarter of 2011, this segment has earned revenues pursuant to the terms of a marketing services agreement with a preferred mortgage lender that offers mortgage banking services, including residential consumer mortgage loan (“mortgage loan”) originations, to our homebuyers who elect to use the lender. Our homebuyers are under no obligation to use our preferred mortgage lender and may select any lender of their choice to obtain mortgage financing for the purchase of a home. We make available to our homebuyers marketing materials and other information

8

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.
Segment Information (continued)

regarding our preferred mortgage lender’s financing options and mortgage loan products, and are compensated solely for the fair market value of these services. We have had no affiliation with our preferred mortgage lender or its affiliates. Except as discussed below, we have had no ownership, joint venture or other interests in or with these entities, or with respect to the revenues or income that may have been generated from their provision of mortgage banking services to, or origination of mortgage loans for, our homebuyers.
On January 21, 2013, we entered into an agreement with our current preferred mortgage lender, Nationstar Mortgage LLC (“Nationstar”), to form Home Community Mortgage, LLC (“Home Community Mortgage”), a mortgage banking company that will offer mortgage banking services to our homebuyers. We have a 49.9% ownership interest and Nationstar has a 50.1% ownership interest in Home Community Mortgage, with Nationstar providing management oversight of Home Community Mortgage’s operations. Nationstar will continue as our preferred mortgage lender until Home Community Mortgage begins offering mortgage banking services, which is expected in the latter part of 2013. We made initial capital contributions of $5.0 million to Home Community Mortgage during the three months ended May 31, 2013. Home Community Mortgage is accounted for as an unconsolidated joint venture within our financial services reporting segment.
Our reporting segments follow the same accounting policies used for our 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 our reporting segments (in thousands):
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
West Coast
$
479,594

 
$
237,884

 
$
273,490

 
$
132,651

Southwest
79,078

 
59,493

 
47,247

 
27,909

Central
226,797

 
168,030

 
120,305

 
87,756

Southeast
139,135

 
87,093

 
80,746

 
52,289

Total homebuilding revenues
924,604

 
552,500

 
521,788

 
300,605

Financial services
5,021

 
4,910

 
2,618

 
2,247

Total
$
929,625

 
$
557,410

 
$
524,406

 
$
302,852

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pretax income (loss):
 
 
 
 
 
 
 
West Coast
$
37,862

 
$
(33,454
)
 
$
28,020

 
$
(14,694
)
Southwest
841

 
(7,182
)
 
1,590

 
(2,139
)
Central
2,484

 
(4,138
)
 
2,348

 
(631
)
Southeast
(25,092
)
 
320

 
(16,768
)
 
4,579

Corporate and other (a)
(37,263
)
 
(33,055
)
 
(21,341
)
 
(17,252
)
Total homebuilding pretax loss
(21,168
)
 
(77,509
)
 
(6,151
)
 
(30,137
)
Financial services
4,637

 
3,471

 
1,978

 
1,501

Total
$
(16,531
)
 
$
(74,038
)
 
$
(4,173
)
 
$
(28,636
)

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

9

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.
Segment Information (continued)

 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Equity in income (loss) of unconsolidated joint ventures:
 
 
 
 
 
 
 
West Coast
$
(73
)
 
$
(77
)
 
$
(40
)
 
$
(32
)
Southwest
(1,164
)
 
(217
)
 
(639
)
 
(209
)
Central

 

 

 

Southeast
235

 
(21
)
 
112

 
(2
)
Total
$
(1,002
)
 
$
(315
)
 
$
(567
)
 
$
(243
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Inventory impairments:
 
 
 
 
 
 
 
West Coast
$

 
$
13,107

 
$

 
$
6,535

Southwest

 
2,135

 

 
2,135

Central

 
1,267

 

 
1,267

Southeast

 

 

 

Total
$

 
$
16,509

 
$

 
$
9,937

 
 
 
 
 
 
 
 
 
Land option contract abandonments:
 
 
 
 
 
 
 
West Coast
$
284

 
$

 
$
284

 
$

Southwest

 

 

 

Central

 

 

 

Southeast

 

 

 

Total
$
284

 
$

 
$
284

 
$



10

Table of Contents

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3.
Segment Information (continued)

 
May 31,
2013
 
November 30,
2012
Assets:
 
 
 
West Coast
$
1,109,993

 
$
930,450

Southwest
351,149

 
319,863

Central
417,172

 
369,294

Southeast
401,058

 
341,460

Corporate and other
623,629

 
596,176

Total homebuilding assets
2,903,001

 
2,557,243

Financial services
9,120

 
4,455

Total
$
2,912,121

 
$
2,561,698

 
 
 
 
Investments in unconsolidated joint ventures:
 
 
 
West Coast
$
38,763

 
$
38,372

Southwest
74,919

 
75,920

Central

 

Southeast
9,118

 
9,382

Total
$
122,800

 
$
123,674

4.
Financial Services
The following tables present financial information relating to our financial services reporting segment (in thousands):
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Revenues
 
 
 
 
 
 
 
Insurance commissions
$
2,790

 
$
2,754

 
$
1,487

 
$
1,154

Title services
1,329

 
878

 
680

 
492

Marketing services fees
900

 
1,275

 
450

 
600

Interest income
2

 
3

 
1

 
1

Total
5,021

 
4,910

 
2,618

 
2,247

Expenses
 
 
 
 
 
 
 
General and administrative
(1,471
)
 
(1,528
)
 
(636
)
 
(693
)
Operating income
3,550

 
3,382

 
1,982

 
1,554

Equity in income (loss) of unconsolidated joint ventures
1,087

 
89

 
(4
)
 
(53
)
Pretax income
$
4,637

 
$
3,471

 
$
1,978

 
$
1,501


11

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4.
Financial Services (continued)

 
May 31,
2013
 
November 30,
2012
Assets
 
 
 
Cash and cash equivalents
$
2,635

 
$
923

Receivables
964

 
1,859

Investments in unconsolidated joint ventures
5,503

 
1,630

Other assets
18

 
43

Total assets
$
9,120

 
$
4,455

Liabilities
 
 
 
Accounts payable and accrued expenses
$
2,077

 
$
3,188

Total liabilities
$
2,077

 
$
3,188

5.
Inventories
Inventories consisted of the following (in thousands):  
 
May 31,
2013
 
November 30,
2012
Homes under construction
$
543,858

 
$
454,108

Land under development
851,469

 
567,470

Land held for future development
634,063

 
684,993

Total
$
2,029,390

 
$
1,706,571


Homes under construction is comprised of costs associated with homes in various stages of construction and includes direct construction and related land acquisition and land development costs. Land under development primarily consists of land acquisition and land development costs, capitalized interest and real estate taxes associated with land undergoing improvement activity. Land held for future development principally reflects land acquisition and land development costs related to land where development activity has been suspended or has not yet begun, but is expected to occur in the future. These assets held for future development are located in various submarkets where conditions do not presently support further investment or development, or are subject to a building permit moratorium or other regulatory restrictions, or are portions of larger land parcels that we plan to build out over several years and/or that have not yet been entitled. We may also suspend development activity if we believe it will result in greater returns and/or maximize the economic performance of a community.

Our interest costs are as follows (in thousands):  
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Capitalized interest at beginning of period
$
217,684

 
$
233,461

 
$
217,161

 
$
234,917

Interest incurred (a)
67,911

 
60,020

 
34,489

 
29,609

Interest expensed (a)
(29,747
)
 
(30,755
)
 
(14,507
)
 
(14,469
)
Interest amortized to construction and land costs
(40,271
)
 
(27,694
)
 
(21,566
)
 
(15,025
)
Capitalized interest at end of period (b)
$
215,577

 
$
235,032

 
$
215,577

 
$
235,032

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.
Inventories (continued)

(b)
Inventory impairment charges are recognized against all inventory costs of a community, such as land, land development, cost of home construction and capitalized interest. Capitalized interest amounts presented in the table reflect the gross amount of capitalized interest as impairment charges recognized are not generally allocated to specific components of inventory.
6.
Inventory Impairments and Land Option Contract Abandonments
Each community or land parcel in our owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each community or land parcel on a quarterly basis and include, but are not limited to, the following: significant decreases in net orders, average selling prices, volume of homes delivered, gross profit margins on homes delivered or projected gross profit margins on homes in backlog or future housing sales; significant increases in budgeted land development and home construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a community or land parcel, the identified asset is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). We evaluated 18 and 39 communities or land parcels for recoverability during the three months ended May 31, 2013 and 2012, respectively. We evaluated 38 and 76 communities or land parcels for recoverability during the six months ended May 31, 2013 and 2012, respectively. Some of the communities or land parcels evaluated during the six months ended May 31, 2013 and 2012 were evaluated in more than one quarterly period.
When an indicator of potential impairment is identified for a community or land parcel, we test the asset for recoverability by comparing the carrying value of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by then-current conditions and trends in the market in which the asset is located as well as factors known to us at the time the cash flows are calculated. With the undiscounted future net cash flows, we also consider recent trends in our orders, backlog, cancellation rates and volume of homes delivered, as well as our expectations related to the following: product offerings; market supply and demand, including estimated average selling prices and related price appreciation; and land development, home construction and overhead costs to be incurred and related cost inflation. With respect to both the six months ended May 31, 2013 and 2012, these expectations reflected our experience that notwithstanding fluctuations in our company-wide net orders, backlog levels, homes delivered and housing gross profit margin, on a year-over-year basis, market conditions for each of our assets in inventory where impairment indicators were identified have been generally stable or improved in 2012 and 2013 , with no significant deterioration identified as to revenue and cost drivers that would prevent or otherwise impact recoverability. Based on this experience, and taking into account the signs of stability and improvement in many markets for new home sales, our inventory assessments as of May 31, 2013 considered an expected steady overall sales pace and average selling price performance for the remainder of 2013 relative to the generally improving pace and performance in recent quarters.
Given the inherent challenges and uncertainties in forecasting future results, our inventory assessments at the time they are made take into consideration whether a community or land parcel is active, meaning it is open for sales and/or undergoing development, or whether it is being held for future development. For active communities and land parcels, due to their short-term nature as compared to land held for future development, our inventory assessments generally assume the continuation of then-current market conditions, subject to identifying information suggesting significant sustained changes in such conditions. These assessments, at the time made, generally anticipate net orders, average selling prices, volume of homes delivered and costs to continue at or near then-current levels through the particular asset’s estimated remaining life. Inventory assessments for our land held for future development consider then-current market conditions as well as subjective forecasts regarding the timing and costs of land development and home construction and related cost inflation; the product(s) to be offered; and the net orders, volume of homes delivered, and selling prices and related price appreciation of the offered product(s) when an associated community is anticipated to open for sales. We evaluate various factors to develop these forecasts, including the availability of and demand for homes and finished lots within the relevant marketplace; historical, current and expected future sales trends for the marketplace; and third-party data, if available. These various estimates, trends, expectations and assumptions used in each of our inventory assessments are specific to each community or land parcel based on what we believe are reasonable forecasts for performance and may vary among communities or land parcels and may vary over time.
We record an inventory impairment charge when the carrying value of a real estate asset is greater than the undiscounted future net cash flows the asset is expected to generate. These real estate assets are written down to fair value, which is primarily

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

based on the estimated future net cash flows discounted for inherent risk associated with each such asset. Inputs used in our calculation of estimated discounted future net cash flows are specific to each affected community or land parcel and are based on our expectations for each such asset as of the applicable measurement date, including, among others, expectations related to average selling prices and delivery rates. The discount rates we used were impacted by the following at the time each assessment was made: the risk-free rate of return; expected risk premium based on estimated land development, home construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to land development or home construction cost increases; and other risks specific to the asset or conditions in the market in which the asset was located.
The following table summarizes ranges for significant quantitative unobservable inputs we utilized in our fair value measurements with respect to the impaired communities or land parcels written down to fair value during the periods presented:
 
 
Six Months Ended May 31,
 
Three Months Ended May 31,
Unobservable Input (a)
 
2013
 
2012
 
2013
 
2012
Average selling price
 
$

 
$115,200 - $498,000
 
$

 
$115,200 - $487,300
Deliveries per month
 

 
1 - 6
 

 
1 - 6
Discount rate
 
%
 
17% - 20%
 
%
 
17% - 20%
(a)
The ranges of inputs used primarily reflect the underlying variability among the various housing markets where each of the impacted communities or land parcels are located, rather than changes in prevailing market conditions.
Based on the results of our evaluations, we recognized no inventory impairment charges in the three months or six months ended May 31, 2013 . In the three months ended May 31, 2012 , we recognized inventory impairment charges of $9.9 million associated with five communities with a post-impairment fair value of $15.2 million . In the six months ended May 31, 2012 , we recognized $16.5 million of such charges associated with seven communities with a post-impairment fair value of $27.4 million . The charges we recognized in the three months and six months ended May 31, 2012 reflected challenging economic and housing market conditions in the relevant markets at the time, and were partly due to our efforts to accelerate our return on investment in those communities. Inventory impairment charges are included in construction and land costs in our consolidated statements of operations.
As of May 31, 2013 , the aggregate carrying value of our inventory that had been impacted by inventory impairment charges was $314.5 million , representing 44 communities and various other land parcels. As of November 30, 2012 , the aggregate carrying value of our inventory that had been impacted by inventory impairment charges was $307.2 million , representing 46 communities and various other land parcels.
Our inventory controlled under land option contracts and other similar contracts is assessed to determine whether it continues to meet our internal investment and marketing standards. Assessments are made separately for each optioned land parcel on a quarterly basis and are affected by the following factors relative to the market in which the asset is located, among others: current and/or anticipated net orders, average selling prices and volume of homes delivered; estimated land development and home construction costs; and projected profitability on expected future housing or land sales. When a decision is made not to exercise certain land option contracts and other similar contracts due to market conditions and/or changes in our marketing strategy, we write off the related inventory costs, including non-refundable deposits and unrecoverable pre-acquisition costs. Based on the results of our assessments, we recognized $.3 million of land option contract abandonment charges in the three months and six months ended May 31, 2013 and no such charges in the three months or six months ended May 31, 2012 .
The estimated remaining life of each community or land parcel in our 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 net order 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, we estimate our 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 anticipated delivery timelines, we expect to realize, on an overall basis, the majority of our current inventory balance within five years .

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

Due to the judgment and assumptions applied in the estimation process with respect to inventory impairments, land option contract abandonments, the remaining operating lives of our inventory assets and the realization of our inventory balances, it is possible that actual results could differ substantially from those estimated.
7.     Fair Value Disclosures
Accounting Standards Codification Topic No. 820, “Fair Value Measurements and Disclosures,” provides a framework for measuring the fair value of assets and liabilities under GAAP, and establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy can be summarized as follows:
Level 1
 
Fair value determined based on quoted prices in active markets for identical assets or liabilities.
 
 
Level 2
 
Fair value determined using significant observable inputs, such as quoted prices for similar assets or liabilities or quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that are derived principally from or corroborated by observable market data, by correlation or other means.
 
 
Level 3
 
Fair value determined using significant unobservable inputs, such as pricing models, discounted cash flows, or similar techniques.
Fair value measurements are used for inventories on a nonrecurring basis when events and circumstances indicate the carrying value is not recoverable. The following table presents the fair value hierarchy and our assets measured at fair value on a nonrecurring basis for the six months ended May 31, 2013 and the year ended November 30, 2012 (in thousands):  
 
 
Fair Value
Description
 
Hierarchy
 
May 31,
2013
 
November 30,
2012
Long-lived assets held and used (a)
 
Level 3
 
$

 
$
39,851

(a)
Amounts represent the aggregate fair value for communities or land parcels where we recognized inventory impairment charges during the period, as of the date that the fair value measurements were made. The carrying value for these communities or land parcels may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.
We had no inventory impairment charges in the three months or six months ended May 31, 2013 . During the year ended November 30, 2012, long-lived assets held and used with a carrying value of $68.0 million were written down to their fair value of $39.9 million , resulting in inventory impairment charges of $28.1 million .
The fair values for long-lived assets held and used that were determined using Level 3 inputs were primarily based on the estimated future net cash flows discounted for inherent risk associated with each asset as described in Note 6. Inventory Impairments and Land Option Contract Abandonments. The discount rates we used were impacted by the following at the time the assessment was made: the risk-free rate of return; expected risk premium based on estimated land development, home construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to land development or home construction cost increases; and other risks specific to the asset or conditions in the market in which the asset was located. These factors were specific to each affected community or land parcel and may have varied among communities or land parcels.
Our financial instruments consist of cash and cash equivalents, restricted cash, senior notes, the $230 Million Convertible 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, we use quoted market prices in active markets to determine fair value.
The following table presents the fair value hierarchy, carrying values and estimated fair values of our financial instruments, except those for which the carrying values approximate fair values (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.     Fair Value Disclosures (continued)

 
 
 
May 31, 2013
 
November 30, 2012
 
Fair Value
Hierarchy
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Senior notes
Level 2
 
$
1,671,194

 
$
1,895,795

 
$
1,670,504

 
$
1,831,596

Convertible senior notes due February 1, 2019 at 1.375%
Level 2
 
230,000

 
265,075

 

 

The fair values of our senior notes and $230 Million Convertible Senior Notes are generally estimated based on quoted market prices for these instruments. The carrying values reported for cash and cash equivalents, restricted cash, and mortgages and land contracts due to land sellers and other loans approximate fair values.
8.
Variable Interest Entities
We participate in joint ventures from time to time that conduct land acquisition, land development and/or other homebuilding activities in various markets where our homebuilding operations are located. Our investments in these joint ventures may create a variable interest in a variable interest entity (“VIE”), depending on the contractual terms of the arrangement. We analyze our joint ventures in accordance with Accounting Standards Codification Topic No. 810, “Consolidation” (“ASC 810”), to determine whether they are VIEs and, if so, whether we are the primary beneficiary. All of our joint ventures at May 31, 2013 and November 30, 2012 were determined under the provisions of ASC 810 to be unconsolidated joint ventures and were accounted for under the equity method, either because they were not VIEs and we did not have a controlling financial interest or, if they were VIEs, we were not the primary beneficiary of the VIEs.
In the ordinary course of our business, we enter into land option contracts and other similar contracts to acquire rights to land for the construction of homes. The use of such land option contracts and other similar contracts generally allows us to reduce the market risks associated with direct land ownership and development, and to reduce our capital and financial commitments, including interest and other carrying costs. Under such contracts, we typically pay a specified option 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 us, with the land seller being identified as a VIE.
In compliance with ASC 810, we analyze our land option contracts and other similar contracts to determine whether the corresponding land sellers are VIEs and, if so, whether we are the primary beneficiary. Although we do not have legal title to the underlying land, ASC 810 requires us to consolidate a VIE if we are determined to be the primary beneficiary. In determining whether we are the primary beneficiary, we consider, among other things, whether we have 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. As a result of our analyses, we determined that as of May 31, 2013 and November 30, 2012 we were not the primary beneficiary of any VIEs from which we have acquired rights to land under land option contracts and other similar contracts.
The following table presents a summary of our interests in land option contracts and other similar contracts (in thousands):
 
May 31, 2013
 
November 30, 2012
 
Cash
Deposits
 
Aggregate
Purchase Price
 
Cash
Deposits
 
Aggregate
Purchase Price
Unconsolidated VIEs
$
10,323

 
$
475,665

 
$
8,463

 
$
327,196

Other land option contracts and other similar contracts
12,012

 
232,097

 
17,219

 
298,139

 
$
22,335

 
$
707,762

 
$
25,682

 
$
625,335

In addition to the cash deposits presented in the table above, our exposure to loss related to our land option contracts and other similar contracts with third parties and unconsolidated entities consisted of pre-acquisition costs of $29.4 million at May 31,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.
Variable Interest Entities (continued)

2013 and $25.4 million at November 30, 2012 . These pre-acquisition costs and cash deposits were included in inventories in our consolidated balance sheets. We also had outstanding letters of credit of $.1 million at May 31, 2013 and $.5 million at November 30, 2012 in lieu of cash deposits under certain land option contracts and other similar contracts.
We also evaluate our land option contracts and other similar contracts for financing arrangements in accordance with Accounting Standards Codification Topic No. 470, “Debt” (“ASC 470”), and, as a result of our evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, in our consolidated balance sheets by $8.9 million at May 31, 2013 and $4.1 million at November 30, 2012 .
9.
Investments in Unconsolidated Joint Ventures
We have investments in unconsolidated joint ventures that conduct land acquisition, land development and/or other homebuilding activities in various markets where our homebuilding operations are located. Our partners in these unconsolidated joint ventures are unrelated homebuilders, and/or land developers and other real estate entities, or commercial enterprises. These investments are designed primarily to reduce market and development risks and to increase the number of lots we own or control. In some instances, participating in unconsolidated joint ventures has enabled us to acquire and develop land that we might not otherwise have had access to due to a project’s size, financing needs, duration of development or other circumstances. While we consider our participation in unconsolidated joint ventures as potentially beneficial to our homebuilding activities, we do not view such participation as essential.
We typically have obtained rights to acquire portions of the land held by the unconsolidated joint ventures in which we currently participate. When an unconsolidated joint venture sells land to our homebuilding operations, we defer recognition of our share of such unconsolidated joint venture’s earnings until a home sale is closed and title passes to a homebuyer, at which time we account for those earnings as a reduction of the cost of purchasing the land from the unconsolidated joint venture.
We and our unconsolidated joint venture partners make initial and/or ongoing capital contributions to these unconsolidated joint ventures, typically on a pro rata basis, equal to our 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. We share in the profits and losses of these unconsolidated joint ventures generally in accordance with our respective equity interests. In some instances, we recognize profits and losses related to our investment in an unconsolidated joint venture that differ from our equity interest in the unconsolidated joint venture. This may arise from impairments that we recognize related to our investment that differ from the impairments the unconsolidated joint venture recognizes with respect to the unconsolidated joint venture’s assets; differences between our basis in assets we have transferred to the unconsolidated joint venture and the unconsolidated joint venture’s basis in those assets; our deferral of the unconsolidated joint venture profits from land sales to us; or other items.
With respect to our investments in unconsolidated joint ventures, our equity in loss of unconsolidated joint ventures included no impairment charges for the six months ended May 31, 2013 or the six months ended May 31, 2012 .
The following table presents combined condensed information from the statements of operations of our unconsolidated joint ventures (in thousands):
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Revenues
$
6,356

 
$

 
$
6,356

 
$

Construction and land costs
(3,928
)
 
6

 
(3,928
)
 

Other expenses, net
(1,891
)
 
(749
)
 
(1,036
)
 
(288
)
Income (loss)
$
537

 
$
(743
)
 
$
1,392

 
$
(288
)
For the three months and six months ended May 31, 2013, combined revenues, construction and land costs, and income from our unconsolidated joint ventures primarily reflected land sales completed by an unconsolidated joint venture in Maryland.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.
Investments in Unconsolidated Joint Ventures (continued)

The following table presents combined condensed balance sheet information for our unconsolidated joint ventures (in thousands):
 
May 31,
2013
 
November 30,
2012
Assets
 
 
 
Cash
$
19,061

 
$
29,721

Receivables
6,360

 
6,104

Inventories
358,371

 
352,791

Other assets
1,183

 
1,175

Total assets
$
384,975

 
$
389,791

Liabilities and equity
 
 
 
Accounts payable and other liabilities
$
87,815

 
$
88,027

Equity
297,160

 
301,764

Total liabilities and equity
$
384,975

 
$
389,791

The following table presents information relating to our investments in unconsolidated joint ventures (dollars in thousands):
 
May 31,
2013
 
November 30,
2012
Number of investments in unconsolidated joint ventures
8

 
8

Investments in unconsolidated joint ventures
$
122,800

 
$
123,674

Our unconsolidated joint ventures finance land and inventory investments for a project through a variety of arrangements, and certain of our unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. However, none of our unconsolidated joint ventures had outstanding debt at May 31, 2013 or November 30, 2012 .
10.
Other Assets
Other assets consisted of the following (in thousands):
 
May 31,
2013
 
November 30,
2012
Cash surrender value of insurance contracts
$
67,634

 
$
64,757

Debt issuance costs (a)
22,952

 
14,563

Property and equipment, net
7,736

 
7,920

Prepaid expenses
5,475

 
7,810

Total
$
103,797

 
$
95,050

(a)
The increase in debt issuance costs as of May 31, 2013 compared to November 30, 2012 primarily reflected the costs associated with our underwritten public issuance of the $230 Million Convertible Senior Notes during the first quarter of 2013 and our entry into a $200.0 million unsecured revolving credit facility (the “Credit Facility”) during the second quarter of 2013.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


11.
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consisted of the following (in thousands):
 
May 31,
2013
 
November 30,
2012
Employee compensation and related benefits
$
108,376

 
$
97,189

Construction defect and other litigation liabilities
104,672

 
107,111

Warranty liability
53,475

 
47,822

Accrued interest payable
46,891

 
47,392

Liabilities related to inventories not owned
8,943

 
4,100

Real estate and business taxes
4,251

 
8,453

Other
51,541

 
28,278

Total
$
378,149

 
$
340,345

12.
Mortgages and Notes Payable
Mortgages and notes payable consisted of the following (in thousands):    
 
May 31,
2013
 
November 30,
2012
Mortgages and land contracts due to land sellers and other loans
$
42,081

 
$
52,311

Senior notes due February 1, 2014 at 5 3/4%
75,935

 
75,911

Senior notes due January 15, 2015 at 5 7/8%
102,038

 
101,999

Senior notes due June 15, 2015 at 6 1/4%
236,841

 
236,826

Senior notes due September 15, 2017 at 9.10%
261,732

 
261,430

Senior notes due June 15, 2018 at 7 1/4%
299,194

 
299,129

Senior notes due March 15, 2020 at 8.00%
345,454

 
345,209

Senior notes due September 15, 2022 at 7.50%
350,000

 
350,000

Convertible senior notes due February 1, 2019 at 1.375%
230,000

 

Total
$
1,943,275

 
$
1,722,815

Unsecured Revolving Credit Facility. On March 12, 2013, we entered into the Credit Facility with a syndicate of financial institutions. The Credit Facility will mature on March 12, 2016 , or on September 15, 2014 if the aggregate principal amount of our senior notes that mature in 2015 is greater than $200.0 million on that date. The Credit F acility contains an uncommitted accordion feature under which its aggregate principal amount can be increased to up to $300.0 million under certain conditions and the availability of additional bank commitments, as well as a sublimit of $100.0 million for the issuance of letters of credit, which may be utilized in combination with or to replace our LOC Facilities. Interest on amounts borrowed under the Credit Facility is payable quarterly in arrears at a rate based on either the London Interbank Offered Rate or a base rate, plus a spread that depends on our debt rating and consolidated leverage ratio (“Leverage Ratio”), as defined under the Credit Facility. The Credit Facility also requires the payment of a commitment fee ranging from .50% to .75% of the unused commitment, based on our debt rating and Leverage Ratio. As of May 31, 2013, we had no cash borrowings or letters of credit outstanding under the Credit Facility. Under the terms of the Credit Facility, we are required, among other things, to maintain compliance with various covenants, including financial covenants relating to our consolidated tangible net worth, the Leverage Ratio, and an interest coverage ratio or a minimum level of liquidity, each as defined therein. The amount of the Credit Facility available for cash borrowings or the issuance of letters of credit depends on the total cash borrowings and letters of credit outstanding under the Credit Facility and the maximum available amount under the terms of the Credit Facility. As of May 31, 2013, we

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

12.
Mortgages and Notes Payable (continued)

had $200.0 million available under the Credit Facility for cash borrowings, with up to $100.0 million available for the issuance of letters of credit.
Borrowings under the Credit Facility are required to be unconditionally guaranteed jointly and severally by certain of our subsidiaries (the “Guarantor Subsidiaries”) that meet the definition of a “significant subsidiary” as defined by Rule 1-02 of Regulation S-X (as in effect on June 1, 1996) using a 5% rather than a 10% threshold; provided that the assets of our non-guarantor subsidiaries do not in the aggregate exceed 10% of an adjusted measure of our consolidated total assets. The Guarantor Subsidiaries include certain subsidiaries that previously guaranteed our senior notes and the $230 Million Convertible Senior Notes and 12 additional subsidiaries identified in our Current Report on Form 8-K dated March 12, 2013 (the “Additional Guarantors”). On March 12, 2013, the Additional Guarantors also agreed to become guarantors under the indenture governing our senior notes and the $230 Million Convertible Senior Notes and to guaranty on a senior basis the prompt payment when due of the principal of and premium, if any, and interest on debt securities issued by us pursuant to the indenture. Each of the Guarantor Subsidiaries (including the Additional Guarantors) is a wholly owned subsidiary of ours. We may also cause other subsidiaries of ours to become Guarantor Subsidiaries if we believe it to be in our or the relevant subsidiary’s best interests.
Letter of Credit Facilities. We maintain LOC Facilities with various financial institutions to obtain letters of credit in the ordinary course of operating our business. As of both May 31, 2013 and November 30, 2012, $41.9 million of letters of credit were outstanding under our LOC Facilities. Our LOC Facilities require us to deposit and maintain cash with the issuing financial institutions as collateral for our letters of credit outstanding. We may maintain, revise or, if necessary or desirable, enter into additional or expanded letter of credit facilities or other similar facility arrangements with the same or other financial institutions.
Mortgages and Land Contracts Due to Land Sellers and Other Loans. As of May 31, 2013 , inventories having a carrying value of $85.7 million were pledged to collateralize mortgages and land contracts due to land sellers and other loans.
Senior Notes. All of our senior notes outstanding at May 31, 2013 and November 30, 2012 represent senior unsecured obligations, rank equally in right of payment with all of our existing and future indebtedness and are unconditionally guaranteed jointly and severally by the Guarantor Subsidiaries on a senior unsecured basis. Interest on each of these senior notes is payable semi-annually. At our option, these notes may be redeemed, in whole at any time or from time to time in part, at a redemption price equal to the greater of (a) 100% of the principal amount of the notes being redeemed and (b) the sum of the present values of the remaining scheduled payments of principal and interest on the notes being redeemed discounted to the redemption date at a defined rate, plus, in each case, accrued and unpaid interest on the notes being redeemed to the applicable redemption date.
On February 7, 2012, pursuant to our universal shelf registration statement filed with the SEC on September 20, 2011 (the “2011 Shelf Registration”), we issued $350.0 million of 8.00% senior notes due 2020 (the “$350 Million 8.00% Senior Notes”). We used substantially all of the net proceeds from this issuance to purchase, pursuant to the terms of tender offers that were initially made on January 19, 2012 (the “Tender Offers”), $340.0 million in aggregate principal amount of our senior notes due 2014 and 2015. The total amount paid to purchase these senior notes was $340.5 million . We incurred a loss of $2.0 million in the first quarter of 2012 related to the early redemption of debt due to a premium paid under the Tender Offers and the unamortized original issue discount. The loss on early redemption of debt was included in interest expense in our consolidated statements of operations.
Convertible Senior Notes. On January 29, 2013 and February 4, 2013, pursuant to the 2011 Shelf Registration, we issued in an underwritten public offering the $230 Million Convertible Senior Notes at 100% of the principal amount of the notes. The issuance on February 4, 2013 was made pursuant to the exercise of an option granted to the underwriters to purchase such notes to cover over-allotments. Interest on the $230 Million Convertible Senior Notes, which represent senior unsecured obligations of ours and rank equally in right of payment with all of our other senior unsecured indebtedness, is payable semi-annually in arrears on February 1 and August 1, commencing on August 1, 2013. We will also pay interest on November 1, 2018. The $230 Million Convertible Senior Notes will mature on February 1, 2019, unless converted earlier by the holders, at their option, or redeemed by us, or purchased by us at the option of the holders following the occurrence of a fundamental change, as defined in the instruments governing the $230 Million Convertible Senior Notes.

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

12.
Mortgages and Notes Payable (continued)

At any time prior to the close of business on the business day immediately preceding the maturity date, holders may convert all or any portion of their $230 Million Convertible Senior Notes. The $230 Million Convertible Senior Notes are initially convertible into shares of our common stock at a conversion rate of 36.5297 shares for each $1,000 principal amount of the notes, which represents an initial conversion price of approximately $27.37 per share and a conversion premium of approximately 47% based on the closing price of our common stock on January 29, 2013, which was $18.62 per share. This initial conversion rate equates to 8,401,831 shares of our common stock. The conversion rate is subject to adjustment upon the occurrence of certain events, including: subdivisions and combinations of our common stock; the issuance to all or substantially all holders of our common stock of stock dividends, or certain rights, options or warrants, capital stock, indebtedness, assets or cash dividends; and certain issuer tender or exchange offers. The conversion rate will not, however, be adjusted for other events, such as a third party tender or exchange offer or an issuance of common stock for cash or an acquisition, that may adversely affect the trading price of the notes or our common stock. On conversion, holders of the $230 Million Convertible Senior Notes will not be entitled to receive cash in lieu of shares of our common stock, except for cash in lieu of fractional shares.
We may not redeem the $230 Million Convertible Senior Notes prior to November 6, 2018. On or after November 6, 2018, and prior to the stated maturity date, we may at our option redeem all or part of the $230 Million Convertible Senior Notes for a cash price equal to 100% of the principal amount of the notes being redeemed, plus accrued and unpaid interest to, but not including, the redemption date. If a fundamental change, as defined in the instruments governing the $230 Million Convertible Notes, occurs prior to the stated maturity date, the holders may require us to purchase for cash all or any portion of their $230 Million Convertible Senior Notes at 100% of the principal amount of the notes, plus accrued and unpaid interest, to, but not including, the fundamental change purchase date.
The $230 Million Convertible Senior Notes are fully and unconditionally guaranteed jointly and severally by the Guarantor Subsidiaries. In the six months ended May 31, 2013, we used most of the $222.7 million in total net proceeds from the issuance of the $230 Million Convertible Senior Notes together with most of the total net proceeds from a concurrent underwritten public offering of our common stock, which is described in Note 15. Stockholders’ Equity, for general corporate purposes, including for land acquisition and land development. The remainder of such net proceeds is expected to be used in future periods for such purposes.
The indenture governing the senior notes and the $230 Million Convertible Senior Notes does not contain any financial covenants. Subject to specified exceptions, the indenture contains certain restrictive covenants that, among other things, limit our ability to incur secured indebtedness, or engage in sale-leaseback transactions involving property or assets above a certain specified value. Unlike our other senior notes, the terms governing the $265.0 million in aggregate principal amount of 9.10% senior notes due 2017 (the “ $265 Million Senior Notes”), the $350 Million 8.00% Senior Notes, the $350.0 million in aggregate principal amount of 7.50% senior notes due 2022 (the “ $350 Million 7.50% Senior Notes”), and the $230 Million Convertible Senior Notes contain certain limitations related to mergers, consolidations, and sales of assets.
As of May 31, 2013 , we were in compliance with the applicable terms of all our covenants under the Credit Facility, the senior notes, the $230 Million Convertible Senior Notes, the indenture, and the mortgages and land contracts due to land sellers and other loans. Our ability to access the Credit Facility for cash borrowings and letters of credit and our ability to secure future debt financing depends in part on our ability to remain in such compliance.
Principal payments on the senior notes, the $230 Million Convertible Senior Notes, the mortgages and land contracts due to land sellers and other loans are due as follows: 2013  – $28.2 million ; 2014 $85.1 million ; 2015 $342.3 million ; 2016 $1.3 million ; 2017 $261.7 million ; and thereafter – $1.22 billion .
13.
Commitments and Contingencies
Commitments and contingencies include typical obligations of homebuilders for the completion of contracts and those incurred in the ordinary course of business.
Warranty . We provide a limited warranty on all of our homes. The specific terms and conditions of these limited warranties vary depending upon the market in which we do business. We generally provide a structural warranty of 10 years , a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.
Commitments and Contingencies (continued)

market and state law, and a warranty of one year for other components of the home. Our limited warranty program is ordinarily how we respond to and account for homeowners’ requests to local division offices seeking repairs, including claims where we could have liability under applicable state statutes or tort law for a defective condition in or damages to a home. We estimate the costs that may be incurred under each limited warranty and record a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Our primary assumption in estimating the amounts we accrue for warranty costs is that historical claims experience is a strong indicator of future claims experience. Factors that affect our warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. We periodically assess the adequacy of our accrued warranty liability, which is included in accrued expenses and other liabilities in our consolidated balance sheets, and adjust the amount as necessary based on our assessment. Our assessment includes the review of our actual warranty costs incurred to identify trends and changes in our warranty claims experience, and considers our home construction quality and customer service initiatives and outside events. While we believe the warranty liability currently reflected in our consolidated balance sheets to be adequate, unanticipated changes or developments 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 our actual warranty costs in future periods and such amounts could differ from our current estimates.
The changes in our warranty liability are as follows (in thousands):
 
Six Months Ended May 31,
 
Three Months Ended May 31,
 
2013
 
2012
 
2013
 
2012
Balance at beginning of period
$
47,822

 
$
67,693

 
$
43,333

 
$
64,607

Warranties issued
6,319

 
2,973

 
3,553

 
1,656

Payments
(18,213
)
 
(8,703
)
 
(9,284
)
 
(4,267
)
Adjustments
17,547

 
(11,097
)
 
15,873

 
(11,130
)
Balance at end of period
$
53,475

 
$
50,866

 
$
53,475

 
$
50,866

 
Central and Southwest Florida Claims . During 2012, we received claims from homeowners in certain of our communities in central and southwest Florida that primarily involved framing, stucco, roofing and/or sealant matters on homes we delivered between 2003 and 2009, many of which have resulted in water intrusion-related issues. While we initially believed these issues were isolated, after additional investigation we determined in the fourth quarter of 2012 that more homes and communities may have been affected. In 2013, we have continued our investigations in an effort to identify the scope of the issues, to carefully and fully understand the causes and to address them as quickly and completely as possible. During the six months ended May 31, 2013 , through our continued efforts to identify, examine and repair homes that may have been impacted by these issues, the number of identified affected homes and our estimate of the total repair costs associated with those homes were revised upward. However, due to the range and varied and complex nature of the water intrusion-related issues we encountered, prior to the second quarter of 2013, we were unable to estimate the number of affected homes likely to be identified in the future and the repair costs associated with those homes. As our assessment process progressed during the three months ended May 31, 2013, we believed we had accumulated an adequate understanding of and experience with these water intrusion-related issues to be able to estimate the number of homes that are likely to be identified and the probable repair costs associated with such homes, in addition to revising our estimate of the repair costs associated with homes already identified. Based on the status of our investigations and repair efforts, our overall warranty liability at May 31, 2013 included $27.8 million for estimated remaining repair costs associated with homes in central and southwest Florida that have been identified as having water intrusion-related issues and estimated repair costs associated with similarly affected homes in central and southwest Florida that we believe are likely to be identified in the future. This amount reflects a culmination of the progressive investigation process we have conducted for this matter over the past several months and we believe it encompasses the full scope and the probable overall cost of the repair effort before insurance and other recoveries.
As of May 31, 2013 , we had identified a total of 1,140 affected homes requiring more than minor repairs and resolved repairs on 297 of them. During the six months ended May 31, 2013 , we paid $11.4 million to repair such homes. As of May 31, 2013 , we had paid $15.4 million of the total estimated repair costs of $43.2 million associated with the affected homes that have been identified and the homes that we believe are likely to be identified. Approximately half of the total estimated repair costs as of May 31, 2013 related to two attached-home communities. We consider warranty-related repairs for homes to be

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.
Commitments and Contingencies (continued)

resolved when all repairs are complete and all repair costs are fully paid. We anticipate resolving repairs on homes affected by the water intrusion-related issues by mid-2014.
As discussed below, due to the increased scope of these water-intrusion issues, we recorded charges, net of estimated probable recoveries, during the first and second quarters of 2013 to increase our overall warranty liability for all of our previously delivered homes that are covered under our limited warranty, including the homes in central and southwest Florida identified as having water intrusion-related issues. In addition to reflecting the remaining estimated repair costs associated with homes in central and southwest Florida that have been identified as having water intrusion-related issues, the charge recorded in the second quarter of 2013 included estimated repair costs associated with similarly affected homes in central and southwest Florida that we believe are likely to be identified in the future. Our investigations and repair efforts in central and southwest Florida remain ongoing. While we have been able to make a determination of the probable overall cost of the repair effort, depending on the number of additional affected homes that are identified and the actual costs we incur to repair identified affected homes in future periods, we may revise the estimated amount of our liability with respect to this matter, which could result in an increase or decrease in our overall warranty liability.
As of May 31, 2013 , based on our investigation into the central and southwest Florida water intrusion-related issues, we believe it is probable that we will recover a portion of our total estimated repair costs associated with affected homes from various sources, including subcontractors involved with the original construction of the homes and their insurers. Our investigation into the water intrusion-related issues, including the process of determining potentially responsible parties and our efforts to obtain recoveries, are ongoing, and as a result, our estimate of probable recoveries may change as additional information is obtained.
Other Claims . With respect to potential recoveries on claims regarding other homes previously delivered, we have tendered claims with responsible liability insurance carriers, seeking reimbursement of costs we have incurred to make repairs and to handle claims. We intend to continue to undertake efforts, including legal proceedings, to obtain reimbursement from various sources, including subcontractors, suppliers and their insurers, for the costs we have incurred or expect to incur to investigate and complete repairs and to defend ourselves in litigation. We have not recorded any amounts for potential future recoveries as of May 31, 2013 related to these claims regarding other homes previously delivered.
Global Settlement Regarding Allegedly Defective Drywall Material. As of May 31, 2013 , we were a defendant in eight lawsuits relating to allegedly defective drywall manufactured in China. Seven of the lawsuits are “omnibus” class actions purportedly filed on behalf of numerous homeowners asserting claims for damages against drywall manufacturers, homebuilders and other parties in the supply chain of the allegedly defective drywall material. We are also a defendant in one lawsuit brought in Florida state court by individual homeowners. On February 7, 2013, a final global settlement of claims relating to the allegedly defective drywall material, including the seven omnibus class actions in which we were named as a defendant, was approved by the federal court judge overseeing a multidistrict litigation case — In re: Chinese Manufactured Drywall Products Liability Litigation (MDL-2047) . Except as noted below, the global settlement resolved all current claims against us, including the seven omnibus class actions in which we were named as a defendant, and bars any future claims against all participating defendants, including us.  Our total obligation as a participating defendant under the global settlement was $.3 million , which we paid on March 25, 2013.  We also expect to receive certain amounts under the global settlement in 2013 based on repairs we made to homes of certain settlement class members. The plaintiffs in the Florida state court case opted out of the global settlement, and we will defend that case.  While the ultimate outcome of that case is uncertain, based on the current status of the proceedings, we do not believe the outcome will be material to our consolidated financial statements.
Overall Warranty Liability Assessment. In assessing our overall warranty liability at a reporting date, we evaluate the costs for warranty-related items on a combined basis for all of our previously delivered homes that are under our limited warranty, which would include any such homes in central and southwest Florida that have been identified as having water intrusion-related issues and similarly affected homes in central and southwest Florida that we believe are likely to be identified in the future. During the three months ended May 31, 2013 , based on our assessment of our overall warranty liability, we recorded an adjustment to increase our overall warranty liability by $15.9 million with a corresponding charge to construction and land costs in our consolidated statement of operations. This adjustment reflects our most recent estimate of remaining repair costs associated with homes in central and southwest Florida that have been identified as having water intrusion-related issues and our estimate of repair costs associated with similarly affected homes in central and southwest Florida that we believe are likely to be identified in the future, net of an increase in the estimated probable recoveries of such repair costs. As noted above,

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.
Commitments and Contingencies (continued)

prior to the three months ended May 31, 2013, we were unable to estimate the repair costs associated with affected homes in central and southwest Florida that are likely to be identified in the future. For the six months ended May 31, 2013, we recorded adjustments to increase our warranty liability by $17.5 million with a corresponding charge to construction and land costs in our consolidated statements of operations. These adjustments were comprised of increases in our estimated warranty costs, net of estimated probable recoveries of repair costs and other adjustments.
Depending on the number of additional homes in central and southwest Florida that are identified as having water intrusion-related issues, and the actual costs we incur in future periods to repair homes identified and homes that will be identified, and/or homes affected by other issues, including costs to provide affected homeowners with temporary housing, we may revise the amount of our estimated liability, which could result in an increase or decrease in our overall warranty liability. However, based on our investigations of the water intrusion-related issues in central and southwest Florida conducted since the end of the second quarter of 2013 through to the date of this report, we believe that our warranty liability is adequate to cover the estimated total repair costs on these affected homes and on homes affected by other issues.
Guarantees. In the normal course of our business, we issue certain representations, warranties and guarantees related to our home sales and land sales that may be affected by Accounting Standards Codification Topic No. 460, “Guarantees.” Based on historical evidence, we do not believe any potential liability with respect to these representations, warranties or guarantees would be material to our consolidated financial statements.
Insurance. We maintain, and require the majority of our subcontractors to maintain, general liability insurance (including construction defect and bodily injury coverage) and workers’ compensation insurance. These insurance policies protect us against a portion of our risk of loss from claims related to our homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. We self-insure a portion of our overall risk through the use of a captive insurance subsidiary. We also maintain certain other insurance policies. In Arizona, California, Colorado and Nevada, our subcontractors’ general liability insurance primarily takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insureds on each project. Enrolled subcontractors contribute toward the cost of the insurance and agree to pay a contractual amount in the future in the event of a claim related to their work. For those enrolled subcontractors, we absorb their general liability associated with the work performed on our homes within the applicable projects as part of our overall general liability insurance and our self insurance through our captive insurance subsidiary.
We record expenses and liabilities based on the estimated costs required to cover our self-insured retention and deductible amounts under our insurance policies, and the estimated costs of potential claims and claim adjustment expenses that are above our coverage limits or that are not covered by our insurance policies. These estimated costs are based on an analysis of our historical claims and include an estimate of claims incurred but not yet reported. Our estimated liabilities for such items were $90.6 million at May 31, 2013 and $93.3 million at November 30, 2012 . These amounts are included in accrued expenses and other liabilities in our consolidated balance sheets. Our expenses associated with self-insurance totaled $1.6 million for the three months ended May 31, 2013 and $2.3 million for the three months ended May 31, 2012 . For the six months ended May 31, 2013 and 2012, our expenses associated with self-insurance totaled $3.4 million and $4.6 million , respectively. These expenses were largely offset by contributions from subcontractors participating in the wrap-up policy.
Performance Bonds and Letters of Credit . We are often required to provide to various municipalities and other government agencies performance bonds and/or letters of credit to secure the completion of our projects and/or in support of obligations to build community improvements such as roads, sewers, water systems and other utilities, and to support similar development activities by certain of our unconsolidated joint ventures. At May 31, 2013 , we had $289.7 million of performance bonds and $41.9 million of letters of credit outstanding. At November 30, 2012, we had $286.1 million of performance bonds and $41.9 million of letters of credit outstanding. If any such performance bonds or letters of credit are called, we would be obligated to reimburse the issuer of the performance bond or letter of credit. We do 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, we are released from the performance bonds as the underlying performance obligations are completed. The expiration dates of some letters of credit issued in connection with community improvements coincide with the expected completion dates of the related projects or obligations. Most letters of credit, however, are issued with an initial term of one year and are typically extended on a year-to-year basis until the related performance obligations are completed.

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

13.
Commitments and Contingencies (continued)

Land Option Contracts . In the ordinary course of business, we enter into land option contracts and other similar contracts to acquire rights to land for the construction of homes. At May 31, 2013 , we had total deposits of $22.4 million , comprised of $22.3 million of cash deposits and $.1 million of letters of credit, to purchase land having an aggregate purchase price of $707.8 million . Our land option contracts and other similar contracts generally do not contain provisions requiring our specific performance.
14.
Legal Matters
Nevada Development Contract Litigation. KB HOME Nevada Inc., a wholly owned subsidiary of ours (“KB Nevada”), is a defendant in a case in the Eighth Judicial District Court in Clark County, Nevada entitled Las Vegas Development Associates, LLC, Essex Real Estate Partners, LLC, et al. v. KB HOME Nevada Inc. In 2007, Las Vegas Development Associates, LLC (“LVDA”) agreed to purchase from KB Nevada approximately 83 acres of land located near Las Vegas, Nevada. LVDA subsequently assigned its rights to Essex Real Estate Partners, LLC (“Essex”). KB Nevada and Essex entered into a development agreement relating to certain major infrastructure improvements. LVDA’s and Essex’s complaint, initially filed in 2008, alleged that KB Nevada breached the development agreement, and also alleged that KB Nevada fraudulently induced them to enter into the purchase and development agreements. LVDA’s and Essex’s lenders subsequently filed related actions that were consolidated into the LVDA/Essex matter. The consolidated plaintiffs sought rescission of the agreements or, in the alternative, compensatory damages of $55 million plus unspecified punitive damages and other damages, and interest charges in excess of $41 million (the “Claimed Damages”). KB Nevada has denied the allegations, and believes it has meritorious defenses to the consolidated plaintiffs’ claims. At a November 19, 2012 hearing, the court denied all of the consolidated plaintiffs’ motions for summary judgment on their claims. In addition, the court granted several of KB Nevada’s motions for summary judgment, eliminating, among other of the consolidated plaintiff’s claims, all claims for fraud, negligent misrepresentation, and punitive damages. With the court’s decisions, the only remaining claims against KB Nevada are for contract damages and rescission. While the ultimate outcome is uncertain — we believe it is reasonably possible that the loss in this matter could range from zero to the amount of the Claimed Damages (now excluding any punitive damages per the court’s action) plus prejudgment interest, which could be material to our consolidated financial statements — KB Nevada believes it will be successful in defending against the consolidated plaintiffs’ remaining claims and that the consolidated plaintiffs will not be awarded rescission or damages. The non-jury trial, originally set for September 2012 and then continued until January 2013, is now set for October 15, 2013.
Southern California Project Development Case. On December 27, 2011, the jury in a case entitled Estancia Coastal, LLC v. KB HOME Coastal Inc. et al. returned a verdict against KB HOME Coastal Inc., a wholly owned subsidiary, and us for $9.8 million , excluding legal fees and interest. The case related to a land option contract and a construction agreement between KB HOME Coastal Inc. and the plaintiff. Based on pre-trial analysis, the verdict was not expected, and we and KB HOME Coastal Inc. jointly filed a motion for judgment notwithstanding the verdict and a motion for a new trial, which were heard on May 18, 2012. On May 23, 2012, the trial court denied the motions and on June 4, 2012 entered a judgment in favor of the plaintiff in the amount of $9.2 million plus pre-judgment interest of approximately $.9 million . The judgment entered reflects an earlier payment by us to the plaintiff of a portion of the jury’s award and does not include legal fees and costs and post-judgment interest. We had established an accrual for this matter based on our pre-judgment estimate of the probable loss. However, as a result of the trial court’s decision and probable legal fees and costs award, we recorded a charge of $8.8 million in the second quarter of 2012 to increase the accrual for this matter to $11.7 million . On September 14, 2012, following a hearing, the trial court awarded legal fees and costs to the plaintiff of approximately $1.4 million . In the first and second quarters of 2013, we recorded charges of $.6 million and $.2 million , respectively, to reflect additional post-judgment interest. The charges recorded in 2013 and 2012 were included in selling, general and administrative expenses in our consolidated statements of operations for the applicable periods. In the second quarter of 2013, we also made a partial payment of $3.0 million , which reduced our accrual for this matter to approximately $9.5 million at May 31, 2013. Our accrual at May 31, 2013 reflects our view of the probable outcome based on the current state of the judgment in the matter. However, we and KB HOME Coastal Inc. have appealed the entry of judgment.
Other Matters. In addition to the specific proceedings described above, we are involved in other litigation and regulatory proceedings incidental to our business that are in various procedural stages. We believe that the accruals we have recorded for probable and reasonably estimable losses with respect to these proceedings are adequate and that, as of May 31, 2013 , it was not reasonably possible that an additional material loss had been incurred in an amount in excess of the estimated amounts

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

14.
Legal Matters (continued)

already recognized in our consolidated financial statements. We evaluate our accruals for litigation and regulatory proceedings at least quarterly and, as appropriate, adjust them to reflect (a) the facts and circumstances known to us at the time, including information regarding negotiations, settlements, rulings and other relevant events and developments; (b) the advice and analyses of counsel; and (c) 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 our experience, we believe that the amounts that may be claimed or alleged against us in these proceedings are not a meaningful indicator of our potential liability. The outcome of any of these proceedings, including the defense and other litigation-related costs and expenses we 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 our consolidated financial statements.
15.
Stockholders’ Equity
A summary of changes in stockholders’ equity is presented below (in thousands):
 
 
Six Months Ended May 31, 2013
 
 
Common Stock
 
Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Grantor Stock Ownership Trust
 
Treasury Stock
 
Total Stockholders’ Equity
Balance at November 30, 2012
 
$
115,178

 
$
888,579

 
$
450,292

 
$
(27,958
)
 
$
(115,149
)
 
$
(934,136
)
 
$
376,806

Net loss
 

 

 
(15,431
)
 

 

 

 
(15,431
)
Dividends on common stock
 

 

 
(4,179
)
 

 

 

 
(4,179
)
Employee stock options/other
 
113

 
1,404

 

 

 

 

 
1,517

Restricted stock awards
 

 
(325
)
 

 

 
325

 

 

Restricted stock amortization
 

 
1,257

 

 

 

 

 
1,257

Stock-based compensation
 

 
787

 

 

 

 

 
787

Issuance of common stock
 

 
(106,622
)
 

 

 

 
216,125

 
109,503

Grantor stock ownership trust
 

 
305

 

 

 
284

 

 
589

Stock repurchases
 

 

 

 

 

 
(33
)
 
(33
)
Balance at May 31, 2013
 
$
115,291

 
$
785,385

 
$
430,682

 
$
(27,958
)
 
$
(114,540
)
 
$
(718,044
)
 
$
470,816

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended May 31, 2012
 
 
Common Stock
 
Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Grantor Stock Ownership Trust
 
Treasury Stock
 
Total Stockholders’ Equity
Balance at November 30, 2011
 
$
115,171

 
$
884,190

 
$
519,844

 
$
(26,152
)
 
$
(118,059
)
 
$
(932,337
)
 
$
442,657

Net loss
 

 

 
(69,938
)
 

 

 

 
(69,938
)
Dividends on common stock
 

 

 
(6,746
)
 

 

 

 
(6,746
)
Restricted stock amortization
 

 
821

 

 

 

 

 
821

Stock-based compensation
 

 
2,384

 

 

 

 

 
2,384

Grantor stock ownership trust
 

 
(133
)
 

 

 
486

 

 
353

Balance at May 31, 2012
 
$
115,171

 
$
887,262

 
$
443,160

 
$
(26,152
)
 
$
(117,573
)
 
$
(932,337
)
 
$
369,531

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

15.
Stockholders’ Equity (continued)

On January 29, 2013, pursuant to the 2011 Shelf Registration, we issued 6,325,000 shares of our common stock, par value $1.00 per share, in an underwritten public offering at a price of $18.25 per share (the “Common Stock Offering”). We used 6,325,000 shares of treasury stock for the issuance and received net proceeds of $109.5 million after underwriting discounts, commissions and transaction expenses.
In connection with the issuance of the $230 Million Convertible Senior Notes, which is discussed in Note 12. Mortgages and Notes Payable, we established a common stock reserve account with our transfer agent to reserve the maximum number of shares of our common stock potentially deliverable upon conversion to holders of the $230 Million Convertible Senior Notes based on the terms of the instruments governing these notes. Accordingly, the common stock reserve account had a balance of 12,602,735 shares at May 31, 2013 .  The maximum number of shares would potentially be deliverable to holders only in certain limited circumstances as set forth in the instruments governing the $230 Million Convertible Notes.
As of May 31, 2013 , we were authorized to repurchase 4,000,000 shares of our common stock under a board-approved share repurchase program. We did not repurchase any shares of our common stock under this program in the six months ended May 31, 2013 . We have not repurchased 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 our board of directors.
During the three months ended May 31, 2013 , our board of directors declared a cash dividend of $.0250 per share of common stock, which was paid on May 16, 2013 to stockholders of record on May 2, 2013. During the three months ended February 28, 2013, our board of directors declared a cash dividend of $.0250 per share of common stock, which was paid on February 21, 2013 to stockholders of record on February 7, 2013. A cash dividend of $.0250 per share of common stock was declared and paid during the three months ended May 31, 2012, and a cash dividend of $.0625 per share of common stock was declared and paid during the three months ended February 29, 2012.
16.
Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), which allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both instances, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. However, in December 2011, the FASB issued Accounting Standards Update No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”), which deferred the guidance on whether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for both interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of reclassifications that were in place prior to the issuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. For public entities, the amendments in ASU 2011-05 and ASU 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively. Our adoption of this guidance, which is related to disclosure only, as of February 28, 2013 did not have a material impact on our consolidated financial statements.
In February 2013, the FASB issued Accounting Standards Update No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”), which requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, ASU 2013-02 requires an entity to present, either on the face of the income statement or in the notes to financial statements, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The amendments in ASU 2013-02 do not change the current requirements for reporting net income or other

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

16.
Recent Accounting Pronouncements (continued)

comprehensive income in financial statements. For public entities, the amendments in ASU 2013-02 are effective prospectively for reporting periods beginning after December 15, 2012. Our adoption of this guidance, which is related to disclosure only, as of May 31, 2013 did not have a material impact on our consolidated financial statements.
17.
Income Taxes
Our income tax benefit totaled $1.2 million for the three months ended May 31, 2013 and $4.5 million for the three months ended May 31, 2012 . For the six months ended May 31, 2013, our income tax benefit totaled $1.1 million , compared to $4.1 million for the six months ended May 31, 2012. The income tax benefit for the three months and six months ended May 31, 2013 primarily reflected the resolution of a state tax audit in the second quarter of 2013, which resulted in a refund receivable of $1.4 million . The income tax benefits recognized for the three months and six months ended May 31, 2012 primarily resulted from a $4.1 million state income tax refund received in the second quarter of 2012 in connection with the resolution of a state tax audit. Due to the effects of our deferred tax asset valuation allowance and changes in our unrecognized tax benefits, our effective tax rates for the three months and six months ended May 31, 2013 and May 31, 2012 are not meaningful items as our income tax amounts are not directly correlated to the amount of our pretax losses for those periods.
In accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”), we evaluate our deferred tax assets quarterly to determine if adjustments to the valuation allowance are required. ASC 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with respect to whether deferred tax assets will be realized. The ultimate realization of deferred tax assets depends primarily on the generation of future taxable income during the periods in which the differences become deductible. The value of our deferred tax assets will depend on applicable income tax rates. We increased our deferred tax asset valuation allowance by $.3 million during the three months ended May 31, 2013 and reduced our deferred tax asset valuation allowance by $.4 million during the six months ended May 31, 2013 to account for adjustments to our deferred tax assets associated with the vesting of equity-based awards in those periods. For the three months and six months ended May 31, 2012 , we recorded valuation allowances of $9.7 million and $28.0 million , respectively, against the net deferred tax assets generated from the losses for those periods.
We had no net deferred tax assets at May 31, 2013 or November 30, 2012 as we maintained a full valuation allowance against our deferred tax assets. The deferred tax asset valuation allowance decreased to $879.7 million at May 31, 2013 from $880.1 million at November 30, 2012 , reflecting the $.4 million valuation allowance adjustment recorded during the six months ended May 31, 2013 .
During the three months and six months ended May 31, 2013 , our total gross unrecognized tax benefits increased by $.1 million . The total amount of gross unrecognized tax benefits, including interest and penalties, that would affect the effective tax rate was $1.3 million as of May 31, 2013 . We anticipate that total unrecognized tax benefits will decrease by an amount ranging from $.4 million to $1.3 million during the twelve months from this reporting date due to various state tax filings associated with the resolution of a federal tax audit.
The benefits of our net operating losses (“NOL”), built-in losses and tax credits would be reduced or potentially eliminated if we experienced an “ownership change” under Internal Revenue Code Section 382 (“Section 382”). Based on our analysis performed as of May 31, 2013 , we do not believe we have experienced an ownership change as defined by Section 382, and, therefore, the NOLs, built-in losses and tax credits we have generated should not be subject to a Section 382 limitation as of this reporting date.
18.
Supplemental Disclosure to Consolidated Statements of Cash Flows
The following are supplemental disclosures to the consolidated statements of cash flows (in thousands):  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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


 
Six Months Ended May 31,
 
2013
 
2012
Summary of cash and cash equivalents at end of period:
 
 
 
Homebuilding
$
538,571

 
$
314,258

Financial services
2,635

 
3,703

Total
$
541,206

 
$
317,961

 
 
Supplemental disclosures of cash flow information:
 
 
 
Interest paid, net of amounts capitalized
$
30,246

 
$
28,711

Income taxes paid
542

 
647

Income taxes refunded
61

 
4,376

 
 
 
 
Supplemental disclosures of noncash activities:
 
 
 
Increase (decrease) in consolidated inventories not owned
$
4,842

 
$
(3,611
)
Cost of inventories acquired through seller financing
27,600

 

19.
Supplemental Guarantor Information
Our obligations to pay principal, premium, if any, and interest under our senior notes and the $230 Million Convertible Senior Notes and borrowings, if any, under the Credit Facility are guaranteed on a joint and several basis by the Guarantor Subsidiaries. The guarantees are full and unconditional and the Guarantor Subsidiaries are 100% owned by us. Pursuant to the terms of the indenture governing our senior notes and the $230 Million Convertible Senior Notes, and the terms of the Credit Facility, if any of the Guarantor Subsidiaries ceases to be a “significant subsidiary” as defined by Rule 1-02 of Regulation S-X (as in effect on June 1, 1996) using a 5% rather than a 10% threshold (provided that the assets of our non-guarantor subsidiaries do not in the aggregate exceed 10% of an adjusted measure of our consolidated total assets), it will be automatically and unconditionally released and discharged from its guaranty of our senior notes, the $230 Million Convertible Senior Notes and the Credit Facility so long as all guarantees by such Guarantor Subsidiary of any other of our or our subsidiaries’ indebtedness are terminated at or prior to the time of such release. We have determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor Subsidiaries is presented.
The supplemental financial information for all periods presented below reflects the relevant subsidiaries that were Guarantor Subsidiaries as of May 31, 2013 and the revisions/reclassifications discussed in Note 1. Basis of Presentation and Significant Accounting Policies.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

19.
Supplemental Guarantor Information (continued)

Condensed Consolidated Statement of Operations
Six Months Ended May 31, 2013 (in thousands) 
 
KB Home
Corporate
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Consolidating
Adjustments
 
Total
Revenues
$

 
$
826,912

 
$
102,713

 
$

 
$
929,625

Homebuilding:
 
 
 
 
 
 
 
 
 
Revenues
$

 
$
826,912

 
$
97,692

 
$

 
$
924,604

Construction and land costs

 
(702,036
)
 
(84,227
)
 

 
(786,263
)
Selling, general and administrative expenses
(34,152
)
 
(79,126
)
 
(15,918
)
 

 
(129,196
)
Operating income (loss)
(34,152
)
 
45,750

 
(2,453
)
 

 
9,145

Interest income
429

 
2

 
5

 

 
436

Interest expense
29,607

 
(56,866
)
 
(2,488
)
 

 
(29,747
)
Equity in loss of unconsolidated joint ventures

 
(999
)
 
(3
)
 

 
(1,002
)
Homebuilding pretax loss
(4,116
)
 
(12,113
)
 
(4,939
)
 

 
(21,168
)
Financial services pretax income

 

 
4,637