KB Home
KB HOME (Form: 10-Q, Received: 04/09/2010 17:11:41)
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended February 28, 2010.
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule  12b-2 of the Exchange Act.
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o
(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 þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of February 28, 2010.
Common stock, par value $1.00 per share: 88,025,838 shares outstanding, including 11,195,833 shares held by the registrant’s Grantor Stock Ownership Trust and excluding 27,095,467 shares held in treasury.
 
 

 

 


 

KB HOME
FORM 10-Q
INDEX
         
    Page  
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    53  
 
       
    54  
 
       
  Exhibit 10.56
  Exhibit 31.1
  Exhibit 31.2
  Exhibit 32.1
  Exhibit 32.2

 

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
KB HOME
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts — Unaudited)
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Total revenues
  $ 263,978     $ 307,361  
 
           
 
               
Homebuilding:
               
Revenues
  $ 262,511     $ 305,741  
Construction and land costs
    (226,540 )     (290,958 )
Selling, general and administrative expenses
    (72,203 )     (61,175 )
 
           
 
               
Operating loss
    (36,232 )     (46,392 )
 
               
Interest income
    424       3,513  
Interest expense, net of amounts capitalized
    (19,407 )     (8,652 )
Equity in loss of unconsolidated joint ventures
    (1,184 )     (9,742 )
 
           
 
               
Homebuilding pretax loss
    (56,399 )     (61,273 )
 
           
 
               
Financial services:
               
Revenues
    1,467       1,620  
Expenses
    (893 )     (860 )
Equity in income of unconsolidated joint venture
    1,321       941  
 
           
 
               
Financial services pretax income
    1,895       1,701  
 
           
 
               
Total pretax loss
    (54,504 )     (59,572 )
Income tax benefit (expense)
    (200 )     1,500  
 
           
 
               
Net loss
  $ (54,704 )   $ (58,072 )
 
           
 
               
Basic and diluted loss per share
  $ (.71 )   $ (.75 )
 
           
 
               
Basic and diluted average shares outstanding
    76,834       77,375  
 
           
 
               
Cash dividends declared per common share
  $ .0625     $ .0625  
 
           
See accompanying notes.

 

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KB HOME
CONSOLIDATED BALANCE SHEETS
(In Thousands — Unaudited)
                 
    February 28,     November 30,  
    2010     2009  
Assets
               
 
               
Homebuilding:
               
Cash and cash equivalents
  $ 1,198,635     $ 1,174,715  
Restricted cash
    90,222       114,292  
Receivables
    126,304       337,930  
Inventories
    1,580,130       1,501,394  
Investments in unconsolidated joint ventures
    105,737       119,668  
Other assets
    155,760       154,566  
 
           
 
               
 
    3,256,788       3,402,565  
 
               
Financial services
    28,670       33,424  
 
           
 
               
Total assets
  $ 3,285,458     $ 3,435,989  
 
           
 
               
Liabilities and stockholders’ equity
               
 
               
Homebuilding:
               
Accounts payable
  $ 312,672     $ 340,977  
Accrued expenses and other liabilities
    503,462       560,368  
Mortgages and notes payable
    1,815,261       1,820,370  
 
           
 
               
 
    2,631,395       2,721,715  
 
           
 
               
Financial services
    6,449       7,050  
 
               
Common stock
    115,121       115,120  
Paid-in capital
    861,001       860,772  
Retained earnings
    746,936       806,443  
Accumulated other comprehensive loss
    (22,244 )     (22,244 )
Grantor stock ownership trust, at cost
    (121,657 )     (122,017 )
Treasury stock, at cost
    (931,543 )     (930,850 )
 
           
 
               
Total stockholders’ equity
    647,614       707,224  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 3,285,458     $ 3,435,989  
 
           
See accompanying notes.

 

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KB HOME
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands — Unaudited)
                 
    Three Months Ended February 28,  
    2010     2009  
Cash flows from operating activities:
               
Net loss
  $ (54,704 )   $ (58,072 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Equity in (income) loss of unconsolidated joint ventures
    (137 )     8,801  
Distributions of earnings from unconsolidated joint ventures
    5,000       662  
Amortization of discounts and issuance costs
    530       340  
Depreciation and amortization
    892       1,486  
Loss on voluntary reduction of revolving credit facility
    1,366        
Tax benefits from stock-based compensation
    2,050       1,152  
Stock-based compensation expense
    2,065       468  
Inventory impairments and land option contract abandonments
    13,362       24,670  
Change in assets and liabilities:
               
Receivables
    194,227       197,449  
Inventories
    (48,487 )     57,448  
Accounts payable, accrued expenses and other liabilities
    (92,321 )     (133,016 )
Other, net
    (5,579 )     2,131  
 
           
 
               
Net cash provided by operating activities
    18,264       103,519  
 
           
 
               
Cash flows from investing activities:
               
Investments in unconsolidated joint ventures
    (2,340 )     (7,748 )
Purchases of property and equipment, net
    (191 )     (821 )
 
           
 
               
Net cash used by investing activities
    (2,531 )     (8,569 )
 
           
 
               
Cash flows from financing activities:
               
Change in restricted cash
    24,070       4,196  
Repayment of senior subordinated notes
          (200,000 )
Payments on mortgages, land contracts and other loans
    (11,082 )     (8,843 )
Issuance of common stock under employee stock plans
    232       795  
Payments of cash dividends
    (4,803 )     (4,756 )
Repurchases of common stock
    (350 )     (616 )
 
           
 
               
Net cash provided (used) by financing activities
    8,067       (209,224 )
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    23,800       (114,274 )
Cash and cash equivalents at beginning of period
    1,177,961       1,141,518  
 
           
 
               
Cash and cash equivalents at end of period
  $ 1,201,761     $ 1,027,244  
 
           
See accompanying notes.

 

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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 United States for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted.
In the opinion of KB Home (the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s consolidated financial position as of February 28, 2010, the results of its consolidated operations for the three months ended February 28, 2010 and 2009, and its consolidated cash flows for the three months ended February 28, 2010 and 2009. The results of operations for the three months ended February 28, 2010 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, 2009 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, 2009, which are contained in the Company’s Annual Report on Form 10-K for that period.
Use of Estimates
The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP and, therefore, include amounts based on informed estimates and judgments of management. Actual results could differ from these estimates.
Loss per share
Basic loss per share is calculated by dividing the net loss by the average number of common shares outstanding for the period. Diluted loss per share is calculated by dividing the net loss by the average number of common shares outstanding including all potentially dilutive shares issuable under outstanding stock options. All outstanding stock options were excluded from the diluted loss per share calculation for the three months ended February 28, 2010 and 2009 because the effect of their inclusion would be antidilutive, or would decrease the reported loss per share.
Comprehensive loss
The Company’s comprehensive loss was $54.7 million for the three months ended February 28, 2010 and $58.1 million for the three months ended February 28, 2009. The accumulated balances of other comprehensive loss in the consolidated balance sheets as of February 28, 2010 and November 30, 2009 are comprised solely of adjustments recorded directly to accumulated other comprehensive loss in accordance with Accounting Standards Codification Topic No. 715, “Compensation — Retirement Benefits” (“ASC 715”). ASC 715 requires an employer to recognize the funded status of defined postretirement benefit plans as an asset or liability on the balance sheet and requires any unrecognized prior service costs and actuarial gains/losses to be recognized in accumulated other comprehensive income (loss).
Reclassifications
Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to the 2010 presentation.
2.  
Stock-Based Compensation
The Company adopted the fair value recognition provisions of Accounting Standards Codification Topic No. 718, “Compensation — Stock Compensation” (“ASC 718”), using the modified prospective transition method

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2.  
Stock-Based Compensation (continued)
effective December 1, 2005. ASC 718 requires a public entity to measure compensation cost associated with awards of equity instruments based on the grant-date fair value of the awards over the requisite service period. ASC 718 requires public entities to initially measure compensation cost associated with awards of liability instruments based on their current fair value. The fair value of that award is to be remeasured subsequently at each reporting date through the settlement date. Changes in fair value during the requisite service period will be recognized as compensation cost over that period.
Stock Options
In accordance with ASC 718, the Company estimates the grant-date fair value of its stock options using the Black-Scholes option-pricing model, which takes into account assumptions regarding the dividend yield, the risk-free interest rate, the expected stock-price volatility and the expected term of the stock options. The following table summarizes the stock options outstanding and stock options exercisable as of February 28, 2010, as well as stock options activity during the three months then ended:
                 
            Weighted  
            Average Exercise  
    Options     Price  
 
               
Options outstanding at beginning of period
    5,711,701     $ 27.39  
 
               
Granted
    122,956       14.96  
 
               
Exercised
    (1,000 )     13.95  
 
               
Cancelled
    (128,432 )     15.44  
 
             
 
               
Options outstanding at end of period
    5,705,225       27.39  
 
             
 
               
Options exercisable at end of period
    4,153,377       31.19  
 
             
As of February 28, 2010, the weighted average remaining contractual life of stock options outstanding and stock options exercisable was 8.3 years and 7.8 years, respectively. There was $6.7 million of total unrecognized compensation cost related to unvested stock option awards as of February 28, 2010. For the three months ended February 28, 2010 and 2009, stock-based compensation expense associated with stock options totaled $1.5 million and $.5 million, respectively. The aggregate intrinsic value of stock options outstanding and stock options exercisable was $2.9 million and $1.7 million, respectively, as of February 28, 2010. (The intrinsic value of a stock option is the amount by which the market value of a share of the underlying stock exceeds the exercise price of the stock option.)
Other Stock-Based Awards
From time to time, the Company grants restricted stock, phantom shares and stock appreciation rights to various employees. The Company recognized total compensation expense of $6.0 million in the three months ended February 28, 2010 and total compensation income of $.6 million in the three months ended February 28, 2009 related to these stock-based awards.
3.  
Segment Information
As of February 28, 2010, the Company has identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within its consolidated operations in accordance with Accounting Standards Codification Topic No. 280, “Segment Reporting.”

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3.  
Segment Information (continued)
As of February 28, 2010, the Company’s homebuilding reporting segments conducted ongoing operations in the following states:
West Coast: California
Southwest: Arizona and Nevada
Central: Colorado and Texas
Southeast: Florida, Maryland, North Carolina, South Carolina and Virginia
The Company’s homebuilding reporting segments are engaged in the acquisition and development of land primarily for residential purposes and offer a wide variety of homes that are designed to appeal to first-time, move-up and active adult homebuyers.
The Company’s homebuilding reporting segments were identified based primarily on similarities in economic and geographic characteristics, product types, regulatory environments, methods used to sell and construct homes and land acquisition characteristics. The Company evaluates segment performance primarily based on segment pretax results.
The Company’s financial services reporting segment provides title and insurance services to the Company’s homebuyers. This segment also provides mortgage banking services to the Company’s homebuyers indirectly through KBA Mortgage, LLC (“KBA Mortgage”) (formerly known as KB Home Mortgage, LLC), a joint venture with a subsidiary of Bank of America, N.A. The Company’s financial services reporting segment conducts operations in the same markets as the Company’s homebuilding reporting segments.
The Company’s reporting segments follow the same accounting policies used for the Company’s consolidated financial statements. Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent, stand-alone entity during the periods presented, nor are they indicative of the results to be expected in future periods.
The following tables present financial information relating to the Company’s reporting segments (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
Revenues:
               
West Coast
  $ 108,434     $ 108,520  
Southwest
    33,848       52,273  
Central
    82,925       77,645  
Southeast
    37,304       67,303  
 
           
Total homebuilding revenues
    262,511       305,741  
Financial services
    1,467       1,620  
 
           
 
               
Total revenues
  $ 263,978     $ 307,361  
 
           
 
               
Pretax income (loss):
               
West Coast
  $ 3,357     $ (12,322 )
Southwest
    (4,463 )     (20,738 )
Central
    (7,304 )     (6,156 )
Southeast
    (20,186 )     (13,825 )
Corporate and other (a)
    (27,803 )     (8,232 )
 
           
Total homebuilding pretax loss
    (56,399 )     (61,273 )
Financial services
    1,895       1,701  
 
           
 
               
Total pretax loss
  $ (54,504 )   $ (59,572 )
 
           
     
(a)  
Corporate and other includes corporate general and administrative expenses.

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3.  
Segment Information (continued)
                 
    Three Months Ended February 28,  
    2010     2009  
Equity in income (loss) of unconsolidated joint ventures:
               
West Coast
  $ 100     $ 195  
Southwest
    (2,175 )     (7,687 )
Central
          21  
Southeast
    891       (2,271 )
 
           
 
               
Total
  $ (1,184 )   $ (9,742 )
 
           
 
               
Inventory impairments:
               
West Coast
  $ 1,196     $ 6,991  
Southwest
    962       11,927  
Central
           
Southeast
    4,677       5,469  
 
           
 
               
Total
  $ 6,835     $ 24,387  
 
           
 
               
Land option contract abandonments:
               
West Coast
  $     $ 283  
Southwest
           
Central
    6,340        
Southeast
    187        
 
           
 
               
Total
  $ 6,527     $ 283  
 
           
 
               
Joint venture impairments:
               
West Coast
  $     $  
Southwest
          5,426  
Central
           
Southeast
          2,186  
 
           
 
               
Total
  $     $ 7,612  
 
           
                 
    February 28,     November 30,  
    2010     2009  
Assets:
               
West Coast
  $ 844,125     $ 838,510  
Southwest
    356,319       346,035  
Central
    327,757       357,688  
Southeast
    388,482       361,551  
Corporate and other
    1,340,105       1,498,781  
 
           
Total homebuilding assets
    3,256,788       3,402,565  
Financial services
    28,670       33,424  
 
           
 
               
Total assets
  $ 3,285,458     $ 3,435,989  
 
           

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3.  
Segment Information (continued)
                 
    February 28,     November 30,  
    2010     2009  
Investments in unconsolidated joint ventures:
               
West Coast
  $ 42,176     $ 54,795  
Southwest
    55,394       56,779  
Central
           
Southeast
    8,167       8,094  
 
           
 
Total
  $ 105,737     $ 119,668  
 
           
4.  
Financial Services
The following tables present financial information relating to the Company’s financial services reporting segment (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
Revenues
               
Interest income
  $ 1     $ 17  
Title services
    156       187  
Insurance commissions
    1,310       1,416  
 
           
Total
    1,467       1,620  
 
               
Expenses
               
General and administrative
    (893 )     (860 )
 
           
Operating income
    574       760  
Equity in income of unconsolidated joint venture
    1,321       941  
 
           
 
               
Pretax income
  $ 1,895     $ 1,701  
 
           
                 
    February 28,     November 30,  
    2010     2009  
Assets
               
Cash and cash equivalents
  $ 3,126     $ 3,246  
Receivables
    442       1,395  
Investment in unconsolidated joint venture
    25,069       28,748  
Other assets
    33       35  
 
           
 
               
Total assets
  $ 28,670     $ 33,424  
 
           
 
               
Liabilities
               
Accounts payable and accrued expenses
  $ 6,449     $ 7,050  
 
           
 
               
Total liabilities
  $ 6,449     $ 7,050  
 
           

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5.  
Inventories
Inventories consisted of the following (in thousands):
                 
    February 28,     November 30,  
    2010     2009  
 
               
Homes, lots and improvements in production
  $ 1,142,113     $ 1,091,851  
 
               
Land under development
    438,017       409,543  
 
           
 
               
Total
  $ 1,580,130     $ 1,501,394  
 
           
The Company’s interest costs are as follows (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Capitalized interest at beginning of period
  $ 291,279     $ 361,619  
 
               
Capitalized interest related to consolidation of previously unconsolidated joint ventures
    9,914        
 
               
Interest incurred (a)
    32,051       29,258  
 
               
Interest expensed (a)
    (19,407 )     (8,652 )
 
               
Interest amortized
    (23,386 )     (16,892 )
 
           
 
               
Capitalized interest at end of period (b)
  $ 290,451     $ 365,333  
 
           
     
(a)  
Amounts for the three months ended February 28, 2010 include $1.4 million of debt issuance costs written off in connection with the Company’s voluntary reduction of the aggregate commitment under its unsecured revolving credit facility (the “Credit Facility”) from $650.0 million to $200.0 million.
 
(b)  
Inventory impairment charges are recognized against all inventory costs of a community, such as land, land improvements, costs of home construction and capitalized interest. Capitalized interest amounts presented in the table reflect the gross amount of capitalized interest as impairment charges recognized are not generally allocated to specific components of inventory.
6.  
Inventory Impairments and Land Option Contract Abandonments
Each land parcel or community in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each land parcel or community on a quarterly basis and include, but are not limited to: significant decreases in sales rates, average selling prices, volume of homes delivered, gross margins on homes delivered or projected margins on homes in backlog or future housing sales; significant increases in budgeted land development and construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a land parcel or community, the identified inventory is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). When an indicator of potential impairment is identified, the Company tests the asset for recoverability by comparing the carrying amount of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by trends and factors known to the Company at the time they are calculated and the Company’s expectations related to: market supply and demand, including estimates concerning average selling prices; sales and cancellation rates; and anticipated land development, construction and overhead costs to be incurred. These estimates, trends and expectations are specific to each land parcel or community and may vary among land parcels or communities.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6.  
Inventory Impairments and Abandonments (continued)
A real estate asset is considered impaired when its carrying amount is greater than the undiscounted future net cash flows the asset is expected to generate. Impaired real estate assets are written down to fair value, which is primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each land parcel or community and may vary among land parcels or communities.
Based on the results of its evaluations, the Company recognized pretax, noncash inventory impairment charges of $6.8 million in the first quarter of 2010 and $24.4 million in the first quarter of 2009. As of February 28, 2010, the aggregate carrying value of inventory impacted by pretax, noncash inventory impairment charges was $558.8 million, representing 107 communities and various other land parcels. As of November 30, 2009, the aggregate carrying value of inventory impacted by pretax, noncash inventory impairment charges was $603.9 million, representing 128 communities and various other land parcels.
The Company’s optioned inventory is assessed to determine whether it continues to meet the Company’s internal investment standards and marketing strategy. Assessments are made separately for each optioned parcel on a quarterly basis and are affected by, among other factors: current and/or anticipated sales rates, average selling prices and home delivery volume; estimated land development and construction costs; and projected profitability on expected future housing or land sales. When a decision is made not to exercise certain land option contracts due to market conditions and/or changes in market strategy, the Company writes off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. Based on the results of its assessments, the Company recognized land option contract abandonment charges of $6.5 million in the first quarter of 2010 and $.3 million in the first quarter of 2009.
The inventory impairment and land option contract abandonment charges are included in construction and land costs in the Company’s consolidated statements of operations.
Due to the judgment and assumptions applied in the estimation process with respect to inventory impairments and land option contract abandonments, 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.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7.  
Fair Value Disclosures (continued)
The following table presents the Company’s assets measured at fair value on a nonrecurring basis (in thousands):
                                         
            Fair Value Measurements Using        
            Quoted     Significant              
    Three Months     Prices in     Other     Significant        
    Ended     Active     Observable     Unobservable        
    February 28,     Markets     Inputs     Inputs        
Description   2010 (a)     (Level 1)     (Level 2)     (Level 3)     Total Losses  
 
                                       
Long-lived assets held and used
  $ 3,907     $     $     $ 3,907     $ (6,835 )
 
                             
     
(a)  
Amount represents the aggregate fair values for communities where the Company recognized noncash inventory impairment charges during the period, as of the date that the fair value measurements were made. The carrying value for these communities may have subsequently increased or decreased from the fair value reflected due to activity that has occurred since the measurement date.
In accordance with the provisions of ASC 360, long-lived assets held and used with a carrying amount of $10.7 million were written down to their fair value of $3.9 million during the three months ended February 28, 2010, resulting in noncash inventory impairment charges of $6.8 million.
The fair values for long-lived assets held and used, determined using Level 3 inputs, were primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each land parcel or community and may vary among land parcels or communities.
The following table presents the carrying values and estimated fair values of the Company’s financial instruments, except for those for which the carrying values approximate fair values (in thousands):
                                 
    February 28, 2010     November 30, 2009  
    Carrying     Estimated     Carrying     Estimated  
    Value     Fair Value     Value     Fair Value  
Financial Liabilities:
                               
Senior notes due 2011 at 6 3/8%
  $ 99,828     $ 102,000     $ 99,800     $ 100,250  
Senior notes due 2014 at 5 3/4%
    249,393       238,750       249,358       234,375  
Senior notes due 2015 at 5 7/8%
    298,922       278,640       298,875       276,000  
Senior notes due 2015 at 6 1/4%
    449,709       420,750       449,698       419,063  
Senior notes due 2017 at 9.1%
    259,997       276,263       259,884       276,263  
Senior notes due 2018 at 7 1/4%
    298,813       282,000       298,787       281,250  
The fair values of the Company’s senior notes are estimated based on quoted market prices.
The carrying amounts reported for cash and cash equivalents, restricted cash, and mortgages and land contracts due to land sellers and other loans approximate fair values.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8.  
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (“FASB”) revised the authoritative guidance for determining the primary beneficiary of a variable interest entity (“VIE”). In December 2009, the FASB issued Accounting Standards Update No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” (“ASU 2009-17”), which provides amendments to Accounting Standards Codification Topic No. 810, “Consolidation” (“ASC 810”) to reflect the revised guidance. The amendments to ASC 810 replace the quantitative-based risk and rewards calculation for determining which reporting entity, if any, has a controlling interest in a VIE with an approach focused on identifying which reporting entity has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. The amendments also require additional disclosures about a reporting entity’s involvement with VIEs. The Company adopted the amended provisions of ASC 810 effective December 1, 2009. The adoption of the amended provisions of ASC 810 did not have a material effect on the Company’s consolidated financial position or results of operations.
The Company participates in joint ventures from time to time for the purpose of conducting land acquisition, development and/or other homebuilding activities. Its investments in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. The Company analyzes its joint ventures in accordance with ASC 810 to determine whether they are VIEs and, if so, whether the Company is the primary beneficiary. All of the Company’s joint ventures at February 28, 2010 and November 30, 2009 were determined under the provisions of ASC 810 applicable at each such date to be unconsolidated joint ventures either because they were not VIEs or, if they were VIEs, the Company was not the primary beneficiary of the VIEs.
In the ordinary course of its business, the Company enters into land option contracts (or similar agreements) in order to procure land for the construction of homes. The use of such land option and other contracts generally allows the Company to reduce the risks associated with direct land ownership and development, reduces the Company’s capital and financial commitments, including interest and other carrying costs, and minimizes the amount of the Company’s land inventories on its consolidated balance sheets. Under such land option contracts, the Company will pay a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of ASC 810, certain of the Company’s land option contracts may create a variable interest for the Company, with the land seller being identified as a VIE.
In compliance with ASC 810, the Company analyzes its land option contracts and other contractual arrangements to determine whether the corresponding land sellers are VIEs and, if so, whether the Company is the primary beneficiary. Although the Company does not have legal title to the optioned land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. As a result of its analyses, the Company determined that as of February 28, 2010 it was not the primary beneficiary of any VIEs from which it is purchasing land under land option contracts. Since adopting the amended provisions of ASC 810, in determining whether it is the primary beneficiary, the Company considers, among other things, whether it has the power to direct the activities of the VIE that most significantly impact the entity’s economic performance. Such activities would include, among other things, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. The Company also considers whether it has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE.
Based on its analyses as of November 30, 2009, which were performed before the Company adopted the amended provisions of ASC 810, the Company determined that it was the primary beneficiary of certain VIEs from which it was purchasing land under land option contracts and, therefore, consolidated such VIEs. Prior to its adoption of the amended provisions of ASC 810, in determining whether it was the primary beneficiary, the Company considered, among other things, the size of its deposit relative to the contract price, the risk of obtaining land entitlement approval, the risk associated with land development required under the land option contract, and the risk of changes in the market value of the optioned land during the contract period. The consolidation of VIEs in which the Company determined it was the primary beneficiary increased inventories,

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8.  
Variable Interest Entities (continued)
with a corresponding increase to accrued expenses and other liabilities, on the Company’s consolidated balance sheets by $21.0 million at November 30, 2009. The liabilities related to the Company’s consolidation of VIEs from which it has arranged to purchase land under option and other contracts represent the difference between the purchase price of land not yet purchased and the Company’s cash deposits. The Company’s cash deposits related to these land option and other contracts totaled $4.1 million at November 30, 2009. Creditors, if any, of these VIEs had no recourse against the Company.
As of February 28, 2010, the Company had cash deposits totaling $1.2 million associated with land option and other contracts that the Company determined to be unconsolidated VIEs, having an aggregate purchase price of $26.7 million, and had cash deposits totaling $7.3 million associated with land option and other contracts that the Company determined were not VIEs, having an aggregate purchase price of $189.5 million.
The Company’s exposure to loss related to its land option and other contracts with third parties and unconsolidated entities consisted of its non-refundable deposits, which totaled $8.5 million at February 28, 2010 and $9.6 million at November 30, 2009. In addition, the Company had outstanding letters of credit of $4.2 million at February 28, 2010 and $8.7 million at November 30, 2009 in lieu of cash deposits under certain land option contracts.
The Company also evaluates land option contracts in accordance with Accounting Standards Codification Topic No. 470, “Debt” (“ASC 470”), and, as a result of its evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, on its consolidated balance sheets by $22.8 million at February 28, 2010 and $36.1 million at November 30, 2009.
9.  
Investments in Unconsolidated Joint Ventures
The Company participates in unconsolidated joint ventures that conduct land acquisition, development and/or other homebuilding activities in various markets, typically where the Company’s homebuilding operations are located. The Company’s partners in these unconsolidated joint ventures are unrelated homebuilders, land developers and other real estate entities, or commercial enterprises. Through these unconsolidated joint ventures, the Company seeks to reduce and share market and development risks and to reduce its investment in land inventory, while potentially increasing the number of homesites it controls or will own. In some instances, participating in unconsolidated joint ventures enables the Company to acquire and develop land that it might not otherwise have access to due to a project’s size, financing needs, duration of development or other circumstances. While the Company views its participation in unconsolidated joint ventures as beneficial to its homebuilding activities, it does not view such participation as essential.
The Company and/or its unconsolidated joint venture partners typically obtain options or enter into other arrangements to have the right to purchase portions of the land held by the unconsolidated joint ventures. The prices for these land options or other arrangements are generally negotiated prices that approximate fair value. When an unconsolidated joint venture sells land to the Company’s homebuilding operations, the Company defers recognition of its share of such unconsolidated joint venture earnings until a home sale is closed and title passes to a homebuyer, at which time the Company accounts for those earnings as a reduction of the cost of purchasing the land from the unconsolidated joint venture.
The Company and its unconsolidated joint venture partners make initial or ongoing capital contributions to these unconsolidated joint ventures, typically on a pro rata basis. The obligations to make capital contributions are governed by each unconsolidated joint venture’s respective operating agreement and related documents.
Each unconsolidated joint venture is obligated to maintain financial statements in accordance with GAAP. The Company shares in profits and losses of these unconsolidated joint ventures generally in accordance with its respective equity interests.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9.  
Investments in Unconsolidated Joint Ventures (continued)
The following table presents combined condensed statement of operations information for the Company’s unconsolidated joint ventures (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Revenues
  $ 85,802     $ 11,476  
Construction and land costs
    (88,520 )     (18,501 )
Other expenses, net
    (322 )     (6,135 )
 
           
 
               
Loss
  $ (3,040 )   $ (13,160 )
 
           
With respect to the Company’s investment in unconsolidated joint ventures, its equity in loss of unconsolidated joint ventures included pretax, noncash impairment charges of $7.6 million for the three months ended February 28, 2009. There were no such charges for the three months ended February 28, 2010.
The following table presents combined condensed balance sheet information for the Company’s unconsolidated joint ventures (in thousands):
                 
    February 28,     November 30,  
    2010     2009  
 
               
Assets
               
Cash
  $ 16,414     $ 12,816  
Receivables
    142,418       142,639  
Inventories
    586,069       709,130  
Other assets
    56,746       56,939  
 
           
 
               
Total assets
  $ 801,647     $ 921,524  
 
           
 
               
Liabilities and equity
               
Accounts payable and other liabilities
  $ 57,536     $ 94,533  
Mortgages and notes payable
    384,427       514,172  
Equity
    359,684       312,819  
 
           
 
               
Total liabilities and equity
  $ 801,647     $ 921,524  
 
           
The following table presents information relating to the Company’s investments in unconsolidated joint ventures and the outstanding debt of unconsolidated joint ventures as of the dates specified, categorized by the nature of the Company’s potential responsibility under a guaranty, if any, for such debt (dollars in thousands):
                 
    February 28,     November 30,  
    2010     2009  
 
               
Number of investments in unconsolidated joint ventures:
               
With limited recourse debt (a)
    2       2  
With non-recourse debt (b)
          2  
Other (c)
    9       9  
 
           
 
               
Total
    11       13  
 
           

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9.  
Investments in Unconsolidated Joint Ventures (continued)
                 
    February 28,     November 30,  
    2010     2009  
 
               
Investments in unconsolidated joint ventures:
               
With limited recourse debt
  $ 1,386     $ 1,277  
With non-recourse debt
          9,983  
Other
    104,351       108,408  
 
           
 
               
Total
  $ 105,737     $ 119,668  
 
           
 
               
Outstanding debt of unconsolidated joint ventures:
               
With limited recourse debt
  $ 12,045     $ 11,198  
With non-recourse debt
          130,025  
Other
    372,382       372,949  
 
           
 
               
Total (d)
  $ 384,427     $ 514,172  
 
           
     
(a)  
This category consists of unconsolidated joint ventures as to which the Company has entered into a loan-to-value maintenance guaranty with respect to a portion of each such unconsolidated joint venture’s outstanding secured debt.
 
(b)  
This category consists of unconsolidated joint ventures as to which the Company does not have a guaranty or any other obligation to repay or to support the value of the collateral (which collateral includes any letters of credit) underlying such unconsolidated joint ventures’ respective outstanding secured debt.
 
(c)  
This category consists of unconsolidated joint ventures with no outstanding debt and an unconsolidated joint venture as to which the Company has entered into a several guaranty. This guaranty, by its terms, purports to require the Company to guarantee the repayment of a portion of the unconsolidated joint venture’s outstanding debt in the event an involuntary bankruptcy proceeding is filed against the unconsolidated joint venture that is not dismissed within 60 days or for which an order approving relief under bankruptcy law is entered, even if the unconsolidated joint venture or its partners do not collude in the filing and the unconsolidated joint venture contests the filing, as further described below.
 
   
In most cases, the Company may have also entered into a completion guaranty and/or a carve-out guaranty with the lenders for the unconsolidated joint ventures identified in categories (a) through (c) as further described below.
 
(d)  
The “Total” amounts represent the aggregate outstanding debt of the unconsolidated joint ventures in which the Company participates. The amounts do not represent the Company’s potential responsibility for such debt, if any. In most cases, the Company’s maximum potential responsibility for any portion of such debt, if any, is limited to either a specified maximum amount or an amount equal to its pro rata interest in the relevant unconsolidated joint venture, as further described below.
The unconsolidated joint ventures finance land and inventory investments through a variety of arrangements. To finance their respective land acquisition and development activities, certain of the Company’s unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. The Company’s unconsolidated joint ventures had aggregate outstanding debt, substantially all of which was secured, of approximately $384.4 million at February 28, 2010 and $514.2 million at November 30, 2009. Various financial and non-financial covenants apply to the outstanding debt of the unconsolidated joint ventures, and a failure to comply with any applicable debt covenants could result in a default and cause lenders to seek to enforce guarantees, if applicable, as described below.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9.  
Investments in Unconsolidated Joint Ventures (continued)
In certain instances, the Company and/or its partner(s) in an unconsolidated joint venture provide guarantees and indemnities to the unconsolidated joint venture’s lenders that may include one or more of the following: (a) a completion guaranty; (b) a loan-to-value maintenance guaranty; and/or (c) a carve-out guaranty. A completion guaranty refers to the actual physical completion of improvements for a project and/or the obligation to contribute equity to an unconsolidated joint venture to enable it to fund its completion obligations. A loan-to-value maintenance guaranty refers to the payment of funds to maintain the applicable loan balance at or below a specific percentage of the value of an unconsolidated joint venture’s secured collateral (generally land and improvements). A carve-out guaranty refers to the payment of (i) losses a lender suffers due to certain bad acts or omissions by an unconsolidated joint venture or its partners, such as fraud or misappropriation, or due to environmental liabilities arising with respect to the relevant project, or (ii) outstanding principal and interest and certain other amounts owed to lenders upon the filing by an unconsolidated joint venture of a voluntary bankruptcy petition or the filing of an involuntary bankruptcy petition by creditors of the unconsolidated joint venture in which an unconsolidated joint venture or its partners collude or which the unconsolidated joint venture fails to contest.
In most cases, the Company’s maximum potential responsibility under these guarantees and indemnities is limited to either a specified maximum dollar amount or an amount equal to its pro rata interest in the relevant unconsolidated joint venture. In a few cases, the Company has entered into agreements with its unconsolidated joint venture partners to be reimbursed or indemnified with respect to the guarantees the Company has provided to an unconsolidated joint venture’s lenders for any amounts the Company may pay pursuant to such guarantees above its pro rata interest in the unconsolidated joint venture. If the Company’s unconsolidated joint venture partners are unable to fulfill their reimbursement or indemnity obligations, or otherwise fail to do so, the Company could incur more than its allocable share under the relevant guaranty. Should there be indications that advances (if made) will not be voluntarily repaid by an unconsolidated joint venture partner under any such reimbursement arrangements, the Company vigorously pursues all rights and remedies available to it under the applicable agreements, at law or in equity to enforce its rights.
The Company’s potential responsibility under its completion guarantees, if triggered, is highly dependent on the facts of a particular case. In any event, the Company believes its actual responsibility under these guarantees is limited to the amount, if any, by which an unconsolidated joint venture’s outstanding borrowings exceed the value of its assets, but may be substantially less than this amount.
At February 28, 2010, the Company’s potential responsibility under its loan-to-value maintenance guarantees relating to approximately $12.0 million of outstanding debt held by two unconsolidated joint ventures totaled approximately $3.8 million, if any liability were determined to be due thereunder. This amount represents the Company’s maximum responsibility under such loan-to-value maintenance guarantees assuming the underlying collateral has no value and without regard to defenses that could be available to the Company against any attempted enforcement of such guarantees.
Notwithstanding the Company’s potential unconsolidated joint venture guaranty and indemnity responsibilities and the resolutions it has reached in certain instances with unconsolidated joint venture lenders with respect to those potential responsibilities, at this time the Company does not believe, except as described below, that its existing exposure under its outstanding completion, loan-to-value and carve-out guarantees and indemnities related to unconsolidated joint venture debt is material to the Company’s consolidated financial position or results of operations.
The lenders for two of the Company’s unconsolidated joint ventures have filed lawsuits against some of the unconsolidated joint ventures’ members, and certain of those members’ parent companies, seeking to recover damages under completion guarantees, among other claims. The Company and the other parent companies, together with the members, are defending the lawsuits in which they have been named and are currently exploring resolutions with the lenders, but there is no assurance that the parties involved will reach satisfactory resolutions. In a separate proceeding, the members (including the Company) of one of these unconsolidated joint ventures are currently in arbitration regarding their respective performance obligations in order to address one member’s claims for specific performance and, in the alternative, damages. A decision in this arbitration

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9.  
Investments in Unconsolidated Joint Ventures (continued)
proceeding is pending. In the interim, the parties to the arbitration and the lenders to this unconsolidated joint venture have agreed to engage in a mediation process in order to reach negotiated settlements of the outstanding disputes and a restructuring of the unconsolidated joint venture’s outstanding debt. There is no assurance that the mediation process will be successful, and a broad range of outcomes is possible, both for the mediation process or, if the mediation is not successful, for the arbitration. Given the present uncertainty, it is possible that the ultimate outcome could be material to the Company’s consolidated financial position or results of operations.
In addition to the above-described guarantees and indemnities, the Company has also provided a several guaranty to the lenders of the Company’s unconsolidated joint venture that is the subject of the above-described arbitration/mediation proceedings. By its terms, the guaranty purports to guarantee the repayment of principal and interest and certain other amounts owed to the unconsolidated joint venture’s lenders when an involuntary bankruptcy proceeding is filed against the unconsolidated joint venture that is not dismissed within 60 days or for which an order approving relief under bankruptcy law is entered, even if the unconsolidated joint venture or its partners do not collude in the filing and the unconsolidated joint venture contests the filing. The Company’s potential responsibility under this several guaranty fluctuates with the unconsolidated joint venture’s debt and with the Company’s and its partners’ respective land purchases from the unconsolidated joint venture. At February 28, 2010, this unconsolidated joint venture had total outstanding indebtedness of approximately $372.4 million and, if this guaranty were then enforced, the Company’s maximum potential responsibility under the guaranty would have been approximately $182.7 million, which amount does not account for any offsets or defenses that could be available to the Company. This unconsolidated joint venture has received notices from its lenders’ administrative agent alleging a number of defaults under its loan agreement. As noted above, the Company is currently exploring resolutions with the parties involved, but there is no assurance that a satisfactory outcome will be reached.
10.  
Mortgages and Notes Payable
Mortgages and notes payable consisted of the following (in thousands):
                 
    February 28,     November 30,  
    2010     2009  
 
               
Mortgages and land contracts due to land sellers and other loans
  $ 158,599     $ 163,968  
Senior notes due 2011 at 6 3/8%
    99,828       99,800  
Senior notes due 2014 at 5 3/4%
    249,393       249,358  
Senior notes due 2015 at 5 7/8%
    298,922       298,875  
Senior notes due 2015 at 6 1/4%
    449,709       449,698  
Senior notes due 2017 at 9.1%
    259,997       259,884  
Senior notes due 2018 at 7 1/4%
    298,813       298,787  
 
           
 
               
Total
  $ 1,815,261     $ 1,820,370  
 
           
At February 28, 2010, the Company had a Credit Facility with a syndicate of lenders that was scheduled to mature in November 2010. Interest on the Credit Facility was payable monthly at the London Interbank Offered Rate plus an applicable spread on amounts borrowed. In order to reduce costs associated with maintaining the Credit Facility, the Company voluntarily reduced the aggregate commitment under the Credit Facility from $650.0 million to $200.0 million, effective December 28, 2009. At February 28, 2010, the Company had no borrowings outstanding and $148.2 million in letters of credit outstanding under the Credit Facility. On March 24, 2010, the Company exercised its right to permanently terminate the entire commitment under the Credit Facility and, as a result, requested to terminate the terms of the Credit Facility. These terminations became effective on March 31, 2010.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10.  
Mortgages and Notes Payable (continued)
The indenture governing the Company’s senior notes does not contain any financial maintenance covenants. Subject to specified exceptions, the senior notes indenture contains certain restrictive covenants that, among other things, limit the Company’s ability to incur secured indebtedness; engage in sale-leaseback transactions involving property or assets above a certain specified value; or engage in mergers, consolidations, or sales of assets.
As of February 28, 2010, the Company was in compliance with the applicable terms of all of its covenants under the Credit Facility, senior notes indenture, and mortgages and land contracts due to land sellers and other loans. The Company’s ability to continue to borrow funds depends in part on its ability to remain in such compliance. As noted above, the Company voluntarily terminated the Credit Facility effective March 31, 2010.
11.  
Commitments and Contingencies
The Company provides a limited warranty on all of its homes. The specific terms and conditions of warranties vary depending upon the market in which the Company does business. The Company generally provides a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home. The Company estimates the costs that may be incurred under each limited warranty and records a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect the Company’s warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. The Company’s primary assumption in estimating the amounts it accrues for warranty costs is that historical claims experience is a strong indicator of future claims experience. The Company periodically assesses the adequacy of its recorded warranty liabilities, which are included in accrued expenses and other liabilities in the consolidated balance sheets, and adjusts the amounts as necessary based on its assessment.
The changes in the Company’s warranty liability are as follows (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Balance at beginning of period
  $ 135,749     $ 145,369  
 
               
Warranties issued
    1,192       1,993  
 
               
Payments and adjustments
    (6,392 )     (5,138 )
 
           
 
               
Balance at end of period
  $ 130,549     $ 142,224  
 
           
The Company’s warranty liability of $130.5 million at February 28, 2010 includes $18.6 million associated with the repair of approximately 323 homes primarily delivered in 2006 and 2007 and located in Florida and Louisiana that were identified as containing or suspected of containing allegedly defective drywall manufactured in China. The Company believes that its overall warranty liability at February 28, 2010 is sufficient with respect to its general limited warranty obligations and the estimated costs remaining to repair the identified homes impacted by the allegedly defective drywall. The Company is continuing to review whether there are any additional homes delivered in Florida, Louisiana or other locations that contain or may contain this drywall material and depending on the outcome of its review and its actual claims experience, the Company may need to increase its warranty liability in future periods. Because the actual costs paid to date to repair the identified homes have been minimal, the amount accrued to repair these homes is based largely on the Company’s estimates of future costs. If the actual costs to repair these homes differ from the estimated costs, the Company may revise its warranty estimate for this issue.
The Company has been named as a defendant in one lawsuit relating to this drywall material, and it may in the future be subject to other similar litigation or claims that could cause the Company to incur significant costs.

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
11.  
Commitments and Contingencies (continued)
Given the preliminary stages of the proceedings, the Company has not concluded whether the outcome, if unfavorable, is likely to be material to its consolidated financial position or results of operations.
The Company will seek reimbursement from various sources for the costs it expects to incur to investigate and complete repairs and to defend itself in litigation associated with this drywall material. At this early stage of its efforts to investigate and complete repairs and to respond to litigation, however, the Company has not recorded any amounts for potential recoveries as of February 28, 2010.
In the normal course of its business, the Company issues certain representations, warranties and guarantees related to its home sales and land sales that may be affected by Accounting Standards Codification Topic No. 460, “Guarantees.” Based on historical evidence, the Company does not believe any of these representations, warranties or guarantees would result in a material effect on its consolidated financial position or results of operations.
The Company has, and requires the majority of its subcontractors to have, general liability insurance (including construction defect coverage) and workers’ compensation insurance. These insurance policies protect the Company against a portion of its risk of loss from claims related to its homebuilding activities, subject to certain self-insured retentions, deductibles and other coverage limits. In Arizona, California, Colorado and Nevada, the Company’s general liability insurance takes the form of a wrap-up policy, where eligible subcontractors are enrolled as insureds on each project. The Company self-insures a portion of its overall risk through the use of a captive insurance subsidiary. The Company records expenses and liabilities based on the costs required to cover its self-insured retention and deductible amounts under its insurance policies, and on the estimated costs of potential claims and claim adjustment expenses above its coverage limits or that are not covered by its policies. These estimated costs are based on an analysis of the Company’s historical claims and include an estimate of construction defect claims incurred but not yet reported. The Company’s estimated liabilities for such items were $105.7 million at February 28, 2010 and $107.0 million at November 30, 2009. These amounts are included in accrued expenses and other liabilities in the consolidated balance sheets. The Company’s expenses associated with self-insurance totaled $1.8 million for the three months ended February 28, 2010 and $2.1 million for the three months ended February 28, 2009.
The Company is often required to obtain performance bonds and letters of credit in support of its obligations to various municipalities and other government agencies in connection with community improvements such as roads, sewers and water, and to certain unconsolidated joint ventures. At February 28, 2010, the Company had $533.0 million of performance bonds and $148.2 million of letters of credit outstanding. In the event any such performance bonds or letters of credit were called, the Company would be obligated to reimburse the issuer of the performance bond or letter of credit. The Company does not believe that a material amount of any currently outstanding performance bonds or letters of credit will be called. Performance bonds do not have stated expiration dates. Rather, the Company is released from the performance bonds as the underlying performance is completed. The expiration dates of letters of credit issued in connection with community improvements and certain unconsolidated joint ventures coincide with the expected completion dates of the related projects or obligations. If the obligations related to a project are ongoing, the relevant letters of credit are typically extended on a year-to-year basis.
The borrowings outstanding, if any, and letters of credit that were issued under the Credit Facility were guaranteed by certain of the Company’s subsidiaries (the “Guarantor Subsidiaries”).
In the ordinary course of its business, the Company enters into land option contracts to procure land for the construction of homes. At February 28, 2010, the Company had total deposits of $12.7 million, comprised of cash deposits of $8.5 million and letters of credit of $4.2 million, to purchase land having an aggregate purchase price of $216.2 million. The Company’s land option contracts generally do not contain provisions requiring the Company’s specific performance.

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12.  
Legal Matters
ERISA Litigation
On March 16, 2007, plaintiffs Reba Bagley and Scott Silver filed an action brought under Section 502 of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al. , in the United States District Court for the Central District of California. The action was brought against the Company, its directors, certain of its current and former officers, and the board of directors committee that oversees the KB Home 401(k) Savings Plan (“401(k) Plan”). After the court allowed leave to file an amended complaint, plaintiffs filed an amended complaint adding Tolan Beck and Rod Hughes as additional plaintiffs and dismissing certain individuals as defendants. All four plaintiffs claim to be former employees of KB Home who participated in the 401(k) Plan. Plaintiffs allege on behalf of themselves and on behalf of all others similarly situated that all defendants breached fiduciary duties owed to plaintiffs and purported class members under ERISA by failing to disclose information to and providing misleading information to participants in the 401(k) Plan about the Company’s alleged prior stock option backdating practices and by failing to remove the Company’s stock as an investment option under the 401(k) Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their 401(k) Plan accounts than they would have earned but for defendants’ alleged breach of duties.
The parties to the litigation executed a settlement agreement on February 26, 2010. On March 1, 2010, plaintiffs filed a Motion for Preliminary Approval of the Settlement, Certification of a Settlement Class, Approval of Notice Plan and To Set a Time for Fairness Hearing. On March 15, 2010, the court held a hearing on the motion at which it granted preliminary approval of the settlement and requested that the parties make certain revisions to the settlement papers. A hearing to decide the fairness of the settlement has not yet been scheduled.
Other Matters
On October 2, 2009, the staff of the SEC notified the Company that a formal order of investigation had been issued regarding possible accounting and disclosure issues. The staff has stated that its investigation should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. The Company is cooperating with the staff of the SEC in connection with the investigation. The Company cannot predict the outcome of, or the timeframe for, the conclusion of this matter.
In addition to those described in this report, the Company is involved in litigation and government proceedings incidental to its business. These proceedings are in various procedural stages and, based on reports of counsel, the Company believes as of the date of this report that provisions or accruals made for any potential losses (to the extent estimable) are adequate and that any liabilities or costs arising out of these proceedings are not likely to have a materially adverse effect on its consolidated financial position or results of operations. The outcome of any of these proceedings, however, is inherently uncertain, and if unfavorable outcomes were to occur, there is a possibility that they would, individually or in the aggregate, have a materially adverse effect on the Company’s consolidated financial position or results of operations.
13.  
Stockholders’ Equity
At February 28, 2010, the Company was authorized to repurchase four million shares of its common stock under a board-approved share repurchase program. The Company did not repurchase any of its common stock under this program in the first quarter of 2010. The Company acquired $.4 million of common stock in the first quarter of 2010, which were previously issued shares delivered to the Company by employees to satisfy withholding taxes on the vesting of restricted stock awards. These transactions are not considered repurchases under the share repurchase program.
During the quarter ended February 28, 2010, the Company’s board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 18, 2010 to stockholders of record on February 4, 2010.

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
14.  
Recent Accounting Pronouncements
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-06”), which provides amendments to Accounting Standards Codification Subtopic No. 820-10, “Fair Value Measurements and Disclosures — Overall.” ASU 2010-06 requires additional disclosures and clarifications of existing disclosures for recurring and nonrecurring fair value measurements. The revised guidance is effective for interim and annual reporting periods beginning after December 15, 2009. ASU 2010-06 concerns disclosure only and will not have an impact on the Company’s financial position or results of operations.
15.  
Income Taxes
The Company’s income tax expense totaled $.2 million for the three months ended February 28, 2010, compared to an income tax benefit of $1.5 million for the three months ended February 28, 2009. The Company’s effective income tax expense rate was .4% in the first quarter of 2010 compared to an effective income tax benefit rate of 2.5% for the first quarter of 2009. The year-over-year difference in the Company’s 2010 first quarter effective tax rate was primarily due to the reversal of a $1.8 million liability for unrecognized tax benefits in the first quarter of 2009.
In accordance with Accounting Standards Codification Topic No. 740, “Income Taxes” (“ASC 740”), the Company evaluates its deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. During the three months ended February 28, 2010, the Company recorded a valuation allowance of $21.2 million against the net deferred tax assets generated from the net loss for the period. During the three months ended February 28, 2009, the Company recorded a similar valuation allowance of $22.7 million against net deferred tax assets. The Company’s net deferred tax assets totaled $1.1 million at both February 28, 2010 and November 30, 2009. The deferred tax asset valuation allowance increased to $771.2 million at February 28, 2010 from $750.0 million at November 30, 2009. This increase reflected the net impact of the $21.2 million valuation allowance recorded during the first quarter of 2010.
During the quarter ended February 28, 2010, the Company had $.2 million of additions and $.3 million of reductions to its total gross unrecognized tax benefits as a result of the current status of federal and state audits. The total amount of unrecognized tax benefits, including interest and penalties, was $9.3 million as of February 28, 2010. The Company anticipates that total unrecognized tax benefits will decrease by an amount ranging from $3.0 million to $4.0 million during the twelve months from this reporting date due to various state filings associated with the resolution of the federal audit.
The benefits of the Company’s net operating losses, built-in losses and tax credits would be reduced or potentially eliminated if the Company experienced an “ownership change” under Internal Revenue Code Section 382 (“Section 382”). Based on the Company’s analysis performed as of February 28, 2010, the Company does not believe it has experienced an ownership change as defined by Section 382, and, therefore, the net operating losses, built-in losses and tax credits the Company has generated should not be subject to a Section 382 limitation as of this reporting date.
16.  
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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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
16.  
Supplemental Disclosure to Consolidated Statements of Cash Flows (continued)
                 
    Three Months Ended February 28,  
    2010     2009  
Summary of cash and cash equivalents at end of period:
               
Homebuilding
  $ 1,198,635     $ 1,020,911  
Financial services
    3,126       6,333  
 
           
 
               
Total
  $ 1,201,761     $ 1,027,244  
 
           
 
               
Supplemental disclosures of cash flow information:
               
Interest paid, net of amounts capitalized
  $ 36,841     $ 42,263  
Income taxes paid
    115       77  
Income taxes refunded
    190,906       231,227  
 
           
 
               
Supplemental disclosures of noncash activities:
               
Increase in inventories in connection with consolidation of joint ventures
  $ 72,300     $  
Increase in accounts payable, accrued expenses and other liabilities in connection with consolidation of joint ventures
    38,861        
Cost of inventories acquired through seller financing
    5,713       5,069  
Decrease in consolidated inventories not owned
    (34,402 )     (7,902 )
 
           
17.  
Supplemental Guarantor Information
The Company’s obligation to pay principal, premium, if any, and interest under its senior notes are guaranteed on a joint and several basis by the Guarantor Subsidiaries. The guarantees are full and unconditional and the Guarantor Subsidiaries are 100% owned by the Company. The Guarantor Subsidiaries also provided a guaranty under the Credit Facility until it was terminated on March 31, 2010, as discussed below under Note 18. Subsequent Event. The Company has determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor Subsidiaries is presented.

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
17.  
Supplemental Guarantor Information (continued)
Condensed Consolidated Statements of Operations
Three Months Ended February 28, 2010 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Revenues
  $     $ 238,791     $ 25,187     $     $ 263,978  
 
                             
 
                                       
Homebuilding:
                                       
Revenues
  $     $ 238,791     $ 23,720     $     $ 262,511  
Construction and land costs
          (200,504 )     (26,036 )           (226,540 )
Selling, general and administrative expenses
    (23,138 )     (40,460 )     (8,605 )           (72,203 )
 
                             
 
                                       
Operating loss
    (23,138 )     (2,173 )     (10,921 )           (36,232 )
Interest income
    359       31       34             424  
Interest expense, net of amounts capitalized
    (1,839 )     (15,952 )     (1,616 )           (19,407 )
Equity in income (loss) of unconsolidated joint ventures
          (2,075 )     891             (1,184 )
 
                             
 
                                       
Homebuilding pretax loss
    (24,618 )     (20,169 )     (11,612 )           (56,399 )
 
                                       
Financial services pretax income
                1,895             1,895  
 
                             
 
                                       
Total pretax loss
    (24,618 )     (20,169 )     (9,717 )           (54,504 )
Income tax expense
    (100 )     (100 )                 (200 )
Equity in net loss of subsidiaries
    (29,986 )                 29,986        
 
                             
 
                                       
Net loss
  $ (54,704 )   $ (20,269 )   $ (9,717 )   $ 29,986     $ (54,704 )
 
                             
Condensed Consolidated Statements of Operations
Three Months Ended February 28, 2009 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Revenues
  $     $ 253,831     $ 53,530     $     $ 307,361  
 
                             
 
                                       
Homebuilding:
                                       
Revenues
  $     $ 253,831     $ 51,910     $     $ 305,741  
Construction and land costs
          (239,783 )     (51,175 )           (290,958 )
Selling, general and administrative expenses
    (9,324 )     (39,400 )     (12,451 )           (61,175 )
 
                             
 
                                       
Operating loss
    (9,324 )     (25,352 )     (11,716 )           (46,392 )
Interest income
    2,993       176       344             3,513  
Interest expense, net of amounts capitalized
    9,127       (17,647 )     (132 )           (8,652 )
Equity in loss of unconsolidated joint ventures
          (7,470 )     (2,272 )           (9,742 )
 
                             
 
                                       
Homebuilding pretax income (loss)
    2,796       (50,293 )     (13,776 )           (61,273 )
 
                                       
Financial services pretax income
                1,701             1,701  
 
                             
 
                                       
Total pretax income (loss)
    2,796       (50,293 )     (12,075 )           (59,572 )
Income tax benefit (expense)
    (100 )     1,200       400             1,500  
Equity in net loss of subsidiaries
    (60,768 )                 60,768        
 
                             
 
                                       
Net loss
  $ (58,072 )   $ (49,093 )   $ (11,675 )   $ 60,768     $ (58,072 )
 
                             

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
17.  
Supplemental Guarantor Information (continued)
Condensed Consolidated Balance Sheets
February 28, 2010 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Assets
                                       
Homebuilding:
                                       
Cash and cash equivalents
  $ 1,062,390     $ 18,736     $ 117,509     $     $ 1,198,635  
Restricted cash
    90,222                         90,222  
Receivables
    864       105,557       19,883             126,304  
Inventories
          1,432,866       147,264             1,580,130  
Investments in unconsolidated joint ventures
          96,184       9,553             105,737  
Other assets
    69,636       85,880       244             155,760  
 
                             
 
    1,223,112       1,739,223       294,453             3,256,788  
 
                                       
Financial services
                28,670             28,670  
Investments in subsidiaries
    1,454                   (1,454 )      
 
                             
 
                                       
Total assets
  $ 1,224,566     $ 1,739,223     $ 323,123     $ (1,454 )   $ 3,285,458  
 
                             
 
                                       
Liabilities and stockholders’ equity
                                       
Homebuilding:
                                       
Accounts payable, accrued expenses and other liabilities
  $ 123,160     $ 544,188     $ 148,786     $     $ 816,134  
Mortgages and notes payable
    1,656,662       158,599                   1,815,261  
 
                             
 
    1,779,822       702,787       148,786             2,631,395  
 
                                       
Financial services
                6,449             6,449  
Intercompany
    (1,202,870 )     1,057,544       145,326              
Stockholders’ equity
    647,614       (21,108 )     22,562       (1,454 )     647,614  
 
                             
 
                                       
Total liabilities and stockholders’ equity
  $ 1,224,566     $ 1,739,223     $ 323,123     $ (1,454 )   $ 3,285,458  
 
                             
November 30, 2009 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Assets
                                       
Homebuilding:
                                       
Cash and cash equivalents
  $ 995,122     $ 56,969     $ 122,624     $     $ 1,174,715  
Restricted cash
    114,292                         114,292  
Receivables
    191,747       109,536       36,647             337,930  
Inventories
          1,374,617       126,777             1,501,394  
Investments in unconsolidated joint ventures
          115,402       4,266             119,668  
Other assets
    68,895       85,856       (185 )           154,566  
 
                             
 
    1,370,056       1,742,380       290,129             3,402,565  
 
                                       
Financial services
                33,424             33,424  
Investments in subsidiaries
    35,955                   (35,955 )      
 
                             
 
                                       
Total assets
  $ 1,406,011     $ 1,742,380     $ 323,553     $ (35,955 )   $ 3,435,989  
 
                             
 
                                       
Liabilities and stockholders’ equity
                                       
Homebuilding:
                                       
Accounts payable, accrued expenses and other liabilities
  $ 147,264     $ 588,203     $ 165,878     $     $ 901,345  
Mortgages and notes payable
    1,656,402       163,967       1             1,820,370  
 
                             
 
    1,803,666       752,170       165,879             2,721,715  
 
                                       
Financial services
                7,050             7,050  
Intercompany
    (1,104,879 )     990,210       114,669              
Stockholders’ equity
    707,224             35,955       (35,955 )     707,224  
 
                             
 
                                       
Total liabilities and stockholders’ equity
  $ 1,406,011     $ 1,742,380     $ 323,553     $ (35,955 )   $ 3,435,989  
 
                             

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
17.  
Supplemental Guarantor Information (continued)
Condensed Consolidated Statements of Cash Flows
Three Months Ended February 28, 2010 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Cash flows from operating activities:
                                       
Net loss
  $ (54,704 )   $ (20,269 )   $ (9,717 )   $ 29,986     $ (54,704 )
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
                                       
Inventory impairments and land option contract abandonments
          8,498       4,864             13,362  
Changes in assets and liabilities:
                                       
Receivables
    190,883       (14,373 )     17,717             194,227  
Inventories
          (23,136 )     (25,351 )           (48,487 )
Accounts payable, accrued expenses and other liabilities
    (24,098 )     (48,474 )     (19,749 )           (92,321 )
Other, net
    (5,408 )     2,313       9,282             6,187  
 
                             
 
                                       
Net cash provided (used) by operating activities
    106,673       (95,441 )     (22,954 )     29,986       18,264  
 
                             
 
                                       
Cash flows from investing activities:
                                       
Investments in unconsolidated joint ventures
          1,950       (4,290 )           (2,340 )
Purchases of property and equipment, net
          (171 )     (20 )           (191 )
 
                             
 
                                       
Net cash provided (used) by investing activities
          1,779       (4,310 )           (2,531 )
 
                             
 
                                       
Cash flows from financing activities:
                                       
Change in restricted cash
    24,070                         24,070  
Payments on mortgages, land contracts and other loans
          3,452       (14,534 )           (11,082 )
Issuance of common stock under employee stock plans
    232                         232  
Payments of cash dividends
    (4,803 )                       (4,803 )
Repurchases of common stock
    (350 )                       (350 )
Intercompany
    (58,554 )     51,977       36,563       (29,986 )      
 
                             
 
                                       
Net cash provided (used) by financing activities
    (39,405 )     55,429       22,029       (29,986 )     8,067  
 
                             
 
                                       
Net increase (decrease) in cash and cash equivalents
    67,268       (38,233 )     (5,235 )           23,800  
Cash and cash equivalents at beginning of period
    995,122       56,969       125,870             1,177,961  
 
                             
 
                                       
Cash and cash equivalents at end of period
  $ 1,062,390     $ 18,736     $ 120,635     $     $ 1,201,761  
 
                             

 

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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
17.  
Supplemental Guarantor Information (continued)
Condensed Consolidated Statements of Cash Flows
Three Months Ended February 28, 2009 (in thousands)
                                         
                    Non-              
    KB Home     Guarantor     Guarantor     Consolidating        
    Corporate     Subsidiaries     Subsidiaries     Adjustments     Total  
 
                                       
Cash flows from operating activities:
                                       
Net loss
  $ (58,072 )   $ (49,093 )   $ (11,675 )   $ 60,768     $ (58,072 )
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
                                       
Inventory impairments and land option contract abandonments
          20,885       3,785             24,670  
Changes in assets and liabilities:
                                       
Receivables
    202,449       (405 )     (4,595 )           197,449  
Inventories
          (36,367 )     93,815             57,448  
Accounts payable, accrued expenses and other liabilities
    (42,783 )     515       (90,748 )           (133,016 )
Other, net
    4,619       8,913       1,508             15,040  
 
                             
 
                                       
Net cash provided (used) by operating activities
    106,213       (55,552 )     (7,910 )     60,768       103,519  
 
                             
 
                                       
Cash flows from investing activities:
                                       
Investments in unconsolidated joint ventures
          (6,838 )     (910 )           (7,748 )
Sales (purchases) of property and equipment, net
          (885 )     64             (821 )
 
                             
 
                                       
Net cash used by investing activities
          (7,723 )     (846 )           (8,569 )
 
                             
 
                                       
Cash flows from financing activities:
                                       
Change in restricted cash
    4,196                         4,196  
Repayment of senior subordinated notes
    (200,000 )                       (200,000 )
Payments on mortgages, land contracts and other loans
          (8,843 )                 (8,843 )
Issuance of common stock under employee stock plans
    795                         795  
Payments of cash dividends
    (4,756 )                       (4,756 )
Repurchases of common stock
    (616 )                       (616 )
Intercompany
    18,777       66,431       (24,440 )     (60,768 )      
 
                             
 
                                       
Net cash provided (used) by financing activities
    (181,604 )     57,588       (24,440 )     (60,768 )     (209,224 )
 
                             
 
                                       
Net decrease in cash and cash equivalents
    (75,391 )     (5,687 )     (33,196 )           (114,274 )
Cash and cash equivalents at beginning of period
    987,057       25,067       129,394             1,141,518  
 
                             
 
                                       
Cash and cash equivalents at end of period
  $ 911,666     $ 19,380     $ 96,198     $     $ 1,027,244  
 
                             
18.  
Subsequent Event
On March 24, 2010, pursuant to the terms of the Credit Facility, the Company notified Bank of America, N.A., the Administrative Agent for the Credit Facility, of the Company’s decision to exercise its right to permanently terminate the entire commitment under the Credit Facility and, as a result, to terminate the terms of the Credit Facility. These terminations became effective on March 31, 2010. Upon the termination of the Credit Facility, the then outstanding letters of credit under the Credit Facility were transferred to an $85.0 million cash-collateralized letter of credit facility that the Company established with Bank of America, N.A. The Company terminated the Credit Facility and entered into the cash-collateralized letter of credit facility as a cost-savings measure. The Company may enter into similar letter of credit agreements with other financial institutions.
The information presented in Note 17. Supplemental Guarantor Information above does not reflect the termination of the Credit Facility. As a result of the termination, six of the Company’s subsidiaries have been released and discharged from guaranteeing the Credit Facility and no longer have any obligations with respect to the Company’s senior notes (the “Released Subsidiaries”). Each of the Released Subsidiaries is not a

 

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“significant subsidiary,” as defined under Rule 1-02(w) of Regulation S-X, and does not guarantee any other indebtedness of the Company. Each Released Subsidiary may be required to again provide a guarantee with respect to the Company’s senior notes if it becomes a “significant subsidiary.” Three of the Company’s subsidiaries continue to provide a guarantee with respect to the Company’s senior notes.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
OVERVIEW
Revenues are generated from our homebuilding operations and our financial services operations. The following table presents a summary of our consolidated results of operations for the three months ended February 28, 2010 and 2009 (in thousands, except per share amounts):
                 
    Three Months Ended February 28,  
    2010     2009  
Revenues:
               
Homebuilding
  $ 262,511     $ 305,741  
Financial services
    1,467       1,620  
 
           
 
               
Total
  $ 263,978     $ 307,361  
 
           
 
               
Pretax income (loss):
               
Homebuilding
  $ (56,399 )   $ (61,273 )
Financial services
    1,895       1,701  
 
           
 
               
Total pretax loss
    (54,504 )     (59,572 )
Income tax benefit (expense)
    (200 )     1,500  
 
           
 
               
Net loss
  $ (54,704 )   $ (58,072 )
 
           
 
               
Basic and diluted loss per share
  $ (.71 )   $ (.75 )
 
           
Operating conditions remained challenging during the first quarter of 2010, reflecting the ongoing effect of the housing market’s prolonged and severe downturn, which began in 2006, and the weak U.S. economy. In several housing markets, including a number of our served markets, a persistent oversupply of homes available for sale (including lender-owned homes acquired through foreclosures and short sales), continued to exert downward pressure on home selling prices and heighten competition for sales. At the same time, demand for housing was constrained by a combination of relatively high unemployment, tight mortgage lending standards and weak consumer confidence. These negative factors were offset to some extent by improved housing affordability stemming from lower selling prices, relatively low mortgage interest rates, tax credit incentives for homebuyers, and other government programs supportive of homeownership and home purchases. Though recent data suggest that some housing markets may be stabilizing or starting to rebound compared to prior periods, it is difficult to predict when or if a widespread and sustained recovery may occur.
During the housing market downturn of the past few years, we have focused on three primary goals: generating cash and maintaining a strong balance sheet; restoring the profitability of our homebuilding operations; and positioning our business to capitalize on a housing market recovery when it occurs. To advance these goals, we have pursued various initiatives to enhance our operational productivity and have rolled out redesigned and value-engineered new product, including The Open Series ™ line of homes, across our markets. We have tailored The Open Series and our other new product offerings to meet the affordability needs of our core customers — first-time, move-up and active adult homebuyers. Largely through these initiatives, we improved our housing gross margin in each quarter of 2009 and in the first quarter of 2010, as measured against the corresponding prior-year periods, even though our average selling prices decreased in each period.
In 2010, restoring the profitability of our homebuilding operations is our highest priority. During the first quarter of 2010, we continued to build on the substantial progress we made last year toward achieving this goal, narrowing our net loss on a year-over-year basis for the seventh consecutive quarter, despite generating lower revenues compared to the first quarter of 2009. This performance primarily reflected lower asset impairment and land option contract abandonment charges and improvements in our housing gross margin, partly offset by an increase in our selling, general and administrative expenses.

 

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Our total revenues of $264.0 million for the three months ended February 28, 2010 decreased 14% from $307.4 million for the year-earlier period, mainly due to a decline in our housing revenues. Housing revenues totaled $262.2 million in the first quarter of 2010, down 14% from $304.5 million in the first quarter of 2009, reflecting an 8% year-over-year decrease in homes delivered and a 6% year-over-year decline in the average selling price. We use the term “home” in this discussion and analysis to refer to a single-family residence, whether it is a single-family home or other type of residential property. We delivered 1,326 homes in the first quarter of 2010 at an average selling price of $197,700, compared with 1,445 homes delivered at an average selling price of $210,700 in the year-earlier quarter.
The decrease in the number of homes delivered in the first quarter of 2010 was largely due to a 9% year-over-year reduction in the number of active communities we operated. “Active communities” are those that deliver five or more homes in a particular period. We have strategically reduced our overall community count in previous quarters, primarily by exiting underperforming markets, operating fewer communities in weaker markets and curtailing land acquisition and development activities, to align our operations with reduced housing market activity and to support our profitability and strong balance sheet goals. The year-over-year decline in total homes delivered in the first quarter of 2010 reflected decreases of 3%, 19% and 37% in our West Coast, Southwest and Southeast segments, respectively, partly offset by an 18% increase in our Central segment. With emerging signs of potentially improved operating conditions going forward in 2010 and into 2011, we currently anticipate gradually increasing our land acquisition activity and the number of active communities we operate, as further discussed below under “Outlook.”
The decline in our average selling price in the first quarter of 2010 relative to the year-earlier quarter was primarily due to targeted price reductions we implemented in some markets in response to competitive conditions, as well as our ongoing rollout of new product, including The Open Series , at lower price points compared to our previous products. The year-over-year decrease in our overall average selling price reflected declines of 20%, 10% and 11% in our Southwest, Central and Southeast segments, respectively, partly offset by a 3% increase in the West Coast segment.
Included in our total revenues were financial services revenues of $1.5 million in the three months ended February 28, 2010, compared to $1.6 million in the three months ended February 28, 2009. Financial services revenues decreased slightly in the first quarter of 2010 compared to a year ago, primarily due to our delivering fewer homes, which reduced title and insurance services revenues.
We incurred a net loss of $54.7 million, or $.71 per diluted share, in the three months ended February 28, 2010, compared to a net loss of $58.1 million, or $.75 per diluted share, in the three months ended February 28, 2009. Our net loss narrowed in the first quarter of 2010 on a year-over-year basis, largely due to a reduction in pretax, noncash charges for asset impairments and land option contract abandonments and an increase in our housing gross margin, partly offset by higher selling, general and administrative expenses. Our net loss for the quarter ended February 28, 2010 included pretax, noncash charges of $13.4 million for inventory impairments and land option contract abandonments, a decrease of 59% from the $32.3 million of pretax, noncash charges for inventory and joint venture impairments and land option contract abandonments in the year-earlier quarter. Our housing gross margin increased by 8.8 percentage points to 13.7% in the first quarter of 2010 from 4.9% in the first quarter of 2009. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, improved by 5.8 percentage points to 18.8% in the first quarter of 2010 from 13.0% in the year-earlier quarter. Our selling, general and administrative expenses in the first quarter of 2010 rose 18% to $72.2 million, up from $61.2 million in the year-earlier quarter, reflecting, among other things, increased compensation expense associated with cash-settled, stock-based awards as a result of an increase in our stock price, and higher legal expenses.
Consistent with our goal of maintaining a strong financial position, we ended the first quarter of 2010 with $1.29 billion of cash and cash equivalents and restricted cash, and no borrowings outstanding under the Credit Facility. Our debt balance totaled $1.82 billion at February 28, 2010, essentially unchanged from the balance at November 30, 2009. Our ratio of debt to total capital was 73.7% at February 28, 2010, compared to 72.0% at November 30, 2009. Our ratio of net debt to total capital, which reflects our cash position, was 44.8% at February 28, 2010, compared to 42.9% at November 30, 2009.

 

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Our total backlog at February 28, 2010 was comprised of 2,713 homes, representing projected future housing revenues of approximately $523.8 million, compared to a backlog at February 28, 2009 of 2,651 homes, representing projected future housing revenues of approximately $559.8 million. The number of homes in backlog rose 2% year over year mainly due to the increase in our net orders in the first quarter of 2010. This marked the first year-over-year increase in the number of homes in our quarter-end backlog in more than four years. Net orders from our homebuilding operations rose 5% to 1,913 in the first quarter of 2010 from 1,827 in the first quarter of 2009, largely due to a decrease in our cancellation rate. As a percentage of gross orders, our cancellation rate improved to 22% in the first quarter of 2010 from 28% in the year-earlier quarter. As a percentage of beginning backlog, the cancellation rate was 26% in the first quarter of 2010 and 31% in the year-earlier quarter.
HOMEBUILDING
We have grouped our homebuilding activities into four reportable segments, which we refer to as West Coast, Southwest, Central and Southeast. As of February 28, 2010, our reportable homebuilding segments consisted of ongoing operations located in the following states: West Coast — California; Southwest — Arizona and Nevada; Central — Colorado and Texas; and Southeast — Florida, Maryland, North Carolina, South Carolina and Virginia.
The following table presents a summary of certain financial and operational data for our homebuilding operations (dollars in thousands, except average selling price):
                 
    Three Months Ended February 28,  
    2010     2009  
Revenues:
               
Housing
  $ 262,158     $ 304,454  
Land
    353       1,287  
 
           
 
               
Total
    262,511       305,741  
 
           
 
               
Costs and expenses:
               
Construction and land costs
               
Housing
    226,194       289,423  
Land
    346       1,535  
 
           
Total
    226,540       290,958  
Selling, general and administrative expenses
    72,203       61,175  
 
           
 
               
Total
    298,743       352,133  
 
           
 
               
Operating loss
  $ (36,232 )   $ (46,392 )
 
           
 
               
Homes delivered
    1,326       1,445  
Average selling price
  $ 197,700     $ 210,700  
Housing gross margin
    13.7 %     4.9 %
 
               
Selling, general and administrative expenses as a percentage of housing revenues
    27.5 %     20.1 %
 
               
Operating loss as a percentage of homebuilding revenues
    -13.8 %     -15.2 %
The following tables present homes delivered, net orders and cancellation rates (based on gross orders) by reporting segment and with respect to our unconsolidated joint ventures for the three-month periods ended February 28, 2010 and 2009, and our ending backlog at February 28, 2010 and 2009:

 

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    Three Months Ended February 28,  
    Homes Delivered     Net Orders     Cancellation Rates  
Segment   2010     2009     2010     2009     2010     2009  
 
                                               
West Coast
    340       351       429       459       17 %     26 %
 
                                               
Southwest
    216       267       313       222       14       27  
 
                                               
Central
    529       447       715       622       29       29  
 
                                               
Southeast
    241       380       456       524       21       28  
 
                                   
 
                                               
Total
    1,326       1,445       1,913       1,827       22 %     28 %
 
                                   
 
                                               
Unconsolidated joint ventures
    21       23       19       28       21 %     48 %
 
                                   
                                 
    February 28,  
                    Backlog - Value  
    Backlog - Homes     (In Thousands)  
Segment   2010     2009     2010     2009  
 
                               
West Coast
    612       689     $ 193,938     $ 214,997  
 
                               
Southwest
    379       303       59,439       57,169  
 
                               
Central
    1,105       892       172,068       153,538  
 
                               
Southeast
    617       767       98,305       134,135  
 
                       
 
                               
Total
    2,713       2,651     $ 523,750     $ 559,839  
 
                       
 
                               
Unconsolidated joint ventures
    35       76     $ 13,825     $ 30,180  
 
                       
Revenues . Homebuilding revenues totaled $262.5 million in the three months ended February 28, 2010, decreasing 14% from $305.7 million in the corresponding period of 2009, mainly due to a decline in housing revenues. Housing revenues of $262.2 million for the three months ended February 28, 2010 fell by $42.3 million, or 14%, from $304.5 million in the year-earlier period, due to an 8% year-over-year decrease in homes delivered and a 6% year-over-year decline in the average selling price. We delivered 1,326 homes in the first quarter of 2010, down from 1,445 homes delivered in the year-earlier quarter, primarily due to a 9% year-over-year reduction in the number of active communities we operated.
Our overall average selling price of $197,700 for the quarter ended February 28, 2010 declined from $210,700 in the year-earlier quarter, reflecting decreases of 20%, 10% and 11% in our Southwest, Central and Southeast segments, respectively. Selling price declines, which varied depending on local market conditions, reflected difficult economic and job market conditions, intense competition from homebuilders and sellers of existing homes (including lender-owned homes acquired through foreclosures and short sales), and our ongoing rollout of new, value-engineered product at price points lower than those of our previous products to meet consumer demand for affordable homes. Our average selling price increased 3% in the West Coast segment, primarily due to changes in product mix.
Land sale revenues totaled $.4 million in the three months ended February 28, 2010 and $1.3 million in the year-earlier period. Generally, land sale revenues fluctuate with our decisions to maintain or decrease our land ownership position in certain markets based upon the volume of our holdings, our marketing strategy, the strength and number of competing developers entering particular markets at given points in time, the availability of land in markets we serve and prevailing market conditions.
Operating Loss. Our homebuilding operations generated operating losses of $36.2 million for the three months ended February 28, 2010 and $46.4 million for the three months ended February 28, 2009, due to losses from housing operations. Our homebuilding operating losses represented negative 13.8% of homebuilding revenues in the first quarter of 2010 and negative 15.2% of homebuilding revenues in the year-earlier quarter. The

 

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homebuilding operating loss decreased on a percentage basis in the three months ended February 28, 2010 compared to the year-earlier quarter due to an improvement in our housing gross margin, partly offset by an increase in our selling, general and administrative expenses as a percentage of revenues.
Within our homebuilding operations, our 2010 first quarter operating loss decreased by $10.2 million or 22% from the year-earlier quarter, reflecting lower pretax, noncash charges for inventory impairments and land option contract abandonments and an improved housing gross margin. Inventory impairment and land option contract abandonment charges totaled $13.4 million in the first quarter of 2010, down 46% from $24.7 million in the first quarter of 2009.
We recorded pretax, noncash inventory impairment charges of $6.8 million in the first quarter of 2010, corresponding to four communities or land parcels with a post-impairment fair value of $3.9 million. In the first quarter of 2009, such charges totaled $24.4 million and corresponded to 18 communities or land parcels with a post-impairment fair value of $25.6 million. In the first quarter of 2010, land option contract abandonment charges totaled $6.5 million and corresponded to 401 lots. In the first quarter of 2009, land option contract abandonment charges totaled $.3 million and corresponded to 14 lots.
The inventory impairments we recorded in the first quarters of 2010 and 2009 reflected declining asset values in certain markets due to the difficult economic and housing market conditions in both periods. The charges for land option contract abandonments reflected our termination of land option contracts on projects that no longer met our investment standards or marketing strategy. Our housing gross margin improved 8.8 percentage points to 13.7% in the first quarter of 2010 from 4.9% in the year-earlier quarter. Our housing gross margin, excluding inventory impairment and land option contract abandonment charges, was 18.8% in the first quarter of 2010 and 13.0% in the first quarter of 2009. The year-over-year improvement in our housing gross margin reflects the impact of our delivering more of our new, value-engineered product, such as The Open Series , which is designed to reduce direct construction costs and increase operating efficiencies compared to our previous products, consistent with our KBnxt operational business model. Our margins were also favorably impacted by the inventory-related charges incurred in prior periods, which lowered our land cost basis.
Our land sales generated break-even results in the first quarter of 2010, compared to a loss of $.2 million in the first quarter of 2009.
As of February 28, 2010, the aggregate carrying value of inventory that had been impacted by pretax, noncash inventory impairment charges was $558.8 million, representing 107 communities and various other land parcels. As of November 30, 2009, the aggregate carrying value of inventory that had been impacted by pretax, noncash inventory impairment charges was $603.9 million, representing 128 communities and various other land parcels.
Selling, general and administrative expenses totaled $72.2 million in the first quarter of 2010, increasing by $11.0 million, or 18%, from $61.2 million in the year-earlier quarter. The year-over-year increase was mainly due to increased compensation expense associated with cash-settled stock appreciation rights and phantom shares as a result of an increase in our stock price, and higher legal expenses, primarily related to legal defense costs incurred with respect to our former chairman and chief executive officer in connection with federal government claims brought against him. As a percentage of housing revenues, selling, general and administrative expenses rose to 27.5% in the first quarter of 2010 from 20.1% in the first quarter of 2009, reflecting the year-over-year increase in our expenses and decline in our housing revenues. Overall, it is difficult to predict both the compensation expense associated with the cash-settled, stock-based awards that are tied to our stock price, and the legal defense costs to be incurred in the future. However, at this time, we believe our 2010 second quarter selling, general and administrative expenses and related ratio may again be negatively affected by these two expense items. Nevertheless, we are hopeful that these items will have less of an impact on our ratio for the remainder of the year as our revenues grow. Based on our current outlook, we anticipate selling, general and administrative expenses as a percentage of housing revenues for the full 2010 year to be approximately 18.5%, though significant changes in our stock price could impact this ratio.
Interest Income . Interest income, which is generated from short-term investments and mortgages receivable, totaled $.4 million in the first quarter of 2010 and $3.5 million in the first quarter of 2009. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of short-term investments and mortgages receivable, as well as fluctuations in interest rates. Interest income decreased in the first quarter of 2010 compared to the year-earlier quarter due to lower interest rates.

 

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Interest Expense, Net of Amounts Capitalized . Interest expense results principally from borrowings to finance land purchases, housing inventory and other operating and capital needs. Our interest expense, net of amounts capitalized, totaled $19.4 million in the three months ended February 28, 2010 and $8.7 million in the three months ended February 28, 2009. Interest expense for the three months ended February 28, 2010 included $1.4 million of debt issuance costs written off in connection with our voluntary reduction of the aggregate commitment under the Credit Facility from $650.0 million to $200.0 million. The percentage of interest capitalized declined to 41% in the first quarter of 2010 from 70% in the year-earlier quarter due to a decrease in the amount of inventory qualifying for interest capitalization, reflecting the inventory reduction strategies we implemented in previous quarters, and our suspension of land development in certain communities. Gross interest incurred increased to $32.1 million in the first quarter of 2010 from $29.3 million in the corresponding quarter of 2009, primarily as a result of the write off of $1.4 million of debt issuance costs and a higher overall average interest rate in 2010.
Equity in Loss of Unconsolidated Joint Ventures . Our equity in loss of unconsolidated joint ventures decreased to $1.2 million in the three months ended February 28, 2010 compared to $9.7 million in the three months ended February 28, 2009. Our equity in loss of unconsolidated joint ventures in the first quarter of 2009 included noncash charges of $7.6 million to recognize the impairment of certain unconsolidated joint venture investments. There were no such impairment charges in the first quarter of 2010. Activities performed by our unconsolidated joint ventures generally include buying, developing and selling land, and, in some cases, constructing and delivering homes. Our unconsolidated joint ventures delivered 21 homes in the first three months of 2010 and 23 homes in the first three months of 2009. Our unconsolidated joint ventures posted combined revenues of $85.8 million in the first quarter of 2010 compared to $11.5 million in the year-earlier quarter. The increased revenue primarily related to the sale of land by an unconsolidated joint venture in our Southeast segment. Unconsolidated joint ventures generated combined losses of $3.0 million in the first quarter of 2010 and $13.2 million in the corresponding quarter of 2009.
NON-GAAP FINANCIAL MEASURES
This report contains information about our housing gross margin, excluding inventory impairment and land option contract abandonment charges, and our ratio of net debt to total capital, both of which are not calculated in accordance with GAAP. We believe these non-GAAP financial measures are relevant and useful to investors in understanding our operations and the leverage employed in our operations, and may be helpful in comparing us with other companies in the homebuilding industry to the extent they provide similar information. However, because the housing gross margin, excluding inventory impairment and land option contract abandonment charges, and the ratio of net debt to total capital are not calculated in accordance with GAAP, these financial measures may not be completely comparable to other companies in the homebuilding industry and, thus, should not be considered in isolation or as an alternative to operating performance measures prescribed by GAAP. Rather, these non-GAAP financial measures should be used to supplement their respective most directly comparable GAAP financial measures in order to provide a greater understanding of the factors and trends affecting our operations.
Housing Gross Margin, Excluding Inventory Impairment and Land Option Contract Abandonment Charges. The following table reconciles our housing gross margin calculated in accordance with GAAP to the non-GAAP financial measure of our housing gross margin, excluding inventory impairment and land option contract abandonment charges (dollars in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Housing revenues
  $ 262,158     $ 304,454  
Housing construction and land costs
    (226,194 )     (289,423 )
 
           
 
               
Housing gross margin
    35,964       15,031  
Add: Inventory impairment and land option contract abandonment charges
    13,362       24,670  
 
           
Housing gross margin, excluding inventory impairment and land option contract abandonment charges
  $ 49,326     $ 39,701  
 
           

 

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Housing gross margin as a percentage of housing revenues
    13.7 %     4.9 %
 
           
 
               
Housing gross margin, excluding inventory impairment and land option contract abandonment charges, as a percentage of housing revenues
    18.8 %     13.0 %
 
           
Housing gross margin, excluding inventory impairment and land option contract abandonment charges, is a non-GAAP financial measure, which we calculate by dividing housing revenues less housing construction and land costs before pretax, noncash inventory impairment and land option contract abandonment charges associated with housing operations recorded during a given period, by housing revenues. The most directly comparable GAAP financial measure is housing gross margin. We believe housing gross margin, excluding inventory impairment and land option contract abandonment charges, is a relevant and useful financial measure to investors in evaluating our performance as it measures the gross profit we generated specifically on the homes delivered during a given period and enhances the comparability of housing gross margins between periods. This financial measure assists us in making strategic decisions regarding product mix, product pricing and construction pace. We also believe investors will find housing gross margin, excluding inventory impairment and land option contract abandonment charges, relevant and useful because it represents a profitability measure that may be compared to a prior period without regard to variability of charges for inventory impairments or land option contract abandonments.
Ratio of Net Debt to Total Capital. The following table reconciles our ratio of debt to total capital calculated in accordance with GAAP to the non-GAAP financial measure of our ratio of net debt to total capital (dollars in thousands):
                 
    February 28,     November 30,  
    2010     2009  
 
               
Mortgages and notes payable
  $ 1,815,261     $ 1,820,370  
Stockholders’ equity
    647,614       707,224  
 
           
 
               
Total capital
  $ 2,462,875     $ 2,527,594  
 
           
 
               
Ratio of debt to total capital
    73.7 %     72.0 %
 
           
 
               
Mortgages and notes payable
  $ 1,815,261     $ 1,820,370  
Less: Cash and cash equivalents and restricted cash
    (1,288,857 )     (1,289,007 )
 
           
Net debt
    526,404       531,363  
Stockholders’ equity
    647,614       707,224  
 
           
 
               
Total capital
  $ 1,174,018     $ 1,238,587  
 
           
 
               
Ratio of net debt to total capital
    44.8 %     42.9 %
 
           
The ratio of net debt to total capital is a non-GAAP financial measure, which we calculate by dividing mortgages and notes payable, net of homebuilding cash and cash equivalents and restricted cash, by total capital (mortgages and notes payable, net of homebuilding cash and cash equivalents and restricted cash, plus stockholders’ equity). The most directly comparable GAAP financial measure is the ratio of debt to total capital. We believe the ratio of net debt to total capital is a relevant and useful financial measure to investors in understanding the leverage employed in our operations and as an indicator of our ability to obtain external financing.

 

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HOMEBUILDING SEGMENTS
The following table presents financial information related to our homebuilding reporting segments for the periods indicated (in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
West Coast:
               
Revenues
  $ 108,434     $ 108,520  
Construction and land costs
    (80,029 )     (99,625 )
Selling, general and administrative expenses
    (16,338 )     (16,162 )
 
           
Operating income (loss)
    12,067       (7,267 )
Other, net
    (8,710 )     (5,055 )
 
           
 
               
Pretax income (loss)
  $ 3,357     $ (12,322 )
 
           
 
               
Southwest:
               
Revenues
  $ 33,848     $ 52,273  
Construction and land costs
    (27,023 )     (57,026 )
Selling, general and administrative expenses
    (6,589 )     (7,146 )
 
           
Operating income (loss)
    236       (11,899 )
Other, net
    (4,699 )     (8,839 )
 
           
 
               
Pretax loss
  $ (4,463 )   $ (20,738 )
 
           
 
               
Central:
               
Revenues
  $ 82,925     $ 77,645  
Construction and land costs
    (73,668 )     (67,672 )
Selling, general and administrative expenses
    (13,180 )     (12,855 )
 
           
Operating loss
    (3,923 )     (2,882 )
Other, net
    (3,381 )     (3,274 )
 
           
 
               
Pretax loss
  $ (7,304 )   $ (6,156 )
 
           
 
               
Southeast:
               
Revenues
  $ 37,304     $ 67,303  
Construction and land costs
    (43,612 )     (64,368 )
Selling, general and administrative expenses
    (9,454 )     (11,949 )
 
           
Operating loss
    (15,762 )     (9,014 )
Other, net
    (4,424 )     (4,811 )
 
           
 
               
Pretax loss
  $ (20,186 )   $ (13,825 )
 
           
West Coast — Our West Coast segment generated total revenues of $108.4 million in the first quarter of 2010 and $108.5 million in the year-earlier quarter, with all revenues in each period generated from housing operations. Housing revenues for the first quarter of 2010 were essentially flat with the first quarter of 2009, reflecting a 3% year-over-year decrease in homes delivered that was offset by a 3% year-over-year increase in the average selling price. We delivered 340 homes in the first quarter of 2010, down from 351 homes delivered in the year-earlier quarter, partly due to a 16% year-over-year decrease in the average number of active communities we operated in this segment. The average selling price increased to $318,900 in the quarter ended February 28, 2010 from $309,200 in the year-earlier quarter, mainly due to a change in product mix and somewhat improved operating conditions in certain markets within this segment.
This segment posted pretax income of $3.4 million for the three months ended February 28, 2010 and a pretax loss of $12.3 million for the three months ended February 28, 2009. Pretax results improved in the first quarter of 2010 compared to the year-earlier quarter mainly due to an improved gross margin. The gross margin increased to 26.2% in the first quarter of 2010 from 8.2% in the year-earlier quarter, partly due to a decrease in pretax, noncash charges for inventory impairments and land option contract abandonments. These charges totaled $1.2 million in the first quarter of 2010 and $7.3 million in the year-earlier quarter. As a percentage of revenues, such

 

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inventory valuation charges were 1% in the first quarter of 2010 compared to 7% in the first quarter of 2009. The increase in the gross margin also reflected reduced direct construction costs and improved operating efficiencies. Selling, general and administrative expenses totaled $16.3 million in the first quarter of 2010 and $16.2 million in the first quarter of 2009.
Southwest — Total revenues from our Southwest segment decreased 35% to $33.8 million in the first quarter of 2010 from $52.3 million in the year-earlier quarter due to a decrease in housing revenues, with all revenues in each period produced from housing operations. Housing revenues fell year over year due to a 19% year-over-year decrease in homes delivered and a 20% year-over-year decline in the average selling price. We delivered 216 homes at an average selling price of $156,600 in the first quarter of 2010 compared to 267 homes delivered at an average selling price of $195,800 in the year-earlier period. The year-over-year decrease in homes delivered was primarily due to a 16% year-over-year decrease in the number of active communities we operated in this segment. The decline in the average selling price reflected competitive conditions, as well as our rollout of new product at lower price points compared to those of our previous product.
This segment posted pretax losses of $4.5 million in the three months ended February 28, 2010 and $20.7 million in the year-earlier period. The pretax loss narrowed in the first quarter of 2010 compared to the first quarter of 2009, largely due to a decrease in noncash inventory and joint venture impairment charges. The gross margin was positive 20.2% in the first quarter of 2010 compared to a negative 9.1% in the first quarter of 2009. There were $1.0 million of inventory impairment charges in the first quarter of 2010, while the year-earlier quarter included $11.9 million of such charges. As a percentage of revenues, inventory impairment charges were 3% in the first quarter of 2010 and 23% in the first quarter of 2009. Selling, general and administrative expenses decreased by $.5 million, or 8%, to $6.6 million in the quarter ended February 28, 2010 from $7.1 million in the year-earlier quarter, primarily due to overhead reductions and other cost-saving initiatives. Other, net expenses included no unconsolidated joint venture impairment charges in the first quarter of 2010, and $5.4 million of such charges in the first quarter of 2009.
Central — Our Central segment generated total revenues of $82.9 million for the three months ended February 28, 2010, up 7% from $77.6 million for the three months ended February 28, 2009, mainly due to an increase in housing revenues. Housing revenues increased 6% to $82.5 million in the first quarter of 2010 from $77.5 million in the year-earlier quarter, as a result of an 18% year-over-year increase in homes delivered, partly offset by a 10% year-over-year decline in the average selling price. In the first quarter of 2010, we delivered 529 homes at an average selling price of $156,100, compared to 447 homes delivered at an average selling price of $173,500 in the first quarter of 2009. The increase in homes delivered reflected a 15% year-over-year increase in the number of active communities we operated in this segment. The lower average selling price reflected competitive conditions and our rollout of new product at lower price points compared to those of our previous product. Land sale revenues totaled $.4 million in the three months ended February 28, 2010 and $.1 million in the year-earlier period.
Pretax losses from this segment totaled $7.3 million in the first quarter of 2010 and $6.2 million in the year-earlier quarter. In the first quarter of 2010, the pretax loss increased by $1.1 million from the year-earlier quarter, mainly due to an increase in noncash land option contract abandonment charges. The gross margin decreased to 11.2% in the first quarter of 2010 from 12.8% in the first quarter of 2009. In the first quarter of 2010, there were $6.3 million of land option contract abandonment charges, compared to no such charges in the year-earlier quarter. As a percentage of revenues, land option contract abandonment charges were 8% in the first quarter of 2010. Selling, general and administrative expenses totaled $13.2 million in the first quarter of 2010 and $12.9 million in the first quarter of 2009.
Southeast —Total revenues from our Southeast segment decreased 45% to $37.3 million in the three months ended February 28, 2010 from $67.3 million in the three months ended February 28, 2009, primarily due to a decrease in housing revenues. Housing revenues declined 44% to $37.3 million in the first quarter of 2010 from $66.1 million in the year-earlier quarter due to a 37% year-over-year decrease in homes delivered and an 11% year-over-year decrease in the average selling price. We delivered 241 homes in the first quarter of 2010, down from 380 homes delivered in the year-earlier quarter, largely due to a 30% year-over-year decrease in the number of active communities we operated in this segment. The average selling price declined to $154,800 in the first quarter of 2010 from $174,000 in the year-earlier quarter, reflecting competitive conditions and our rollout of new product at lower price points compared to those of our previous product. There were no land sale revenues from this segment during the first quarter of 2010. Land sale revenues from this segment totaled $1.2 million in the first quarter of 2009.

 

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Pretax losses from this segment totaled $20.2 million in the three months ended February 28, 2010 and $13.8 million for the year-earlier period. The loss from this segment increased in the first three months of 2010 from the year-earlier period, reflecting a lower gross margin, partly offset by lower selling, general and administrative expenses. The gross margin fell to a negative 16.9% in the first quarter of 2010 from a positive 4.4% in the first quarter of 2009, largely due to the decline in the average selling price. There was $4.9 million of pretax, noncash inventory impairment and land option contract abandonment charges in the first quarter of 2010, compared to $5.5 million of inventory impairment charges in the first quarter of 2009. As a percentage of revenues, these inventory-related charges were 13% in the first quarter of 2010 and 8% in the first quarter of 2009. Selling, general and administrative expenses decreased by $2.4 million, or 21%, to $9.5 million in the first quarter of 2010 from $11.9 million in the year-earlier quarter as a result of our actions to reduce overhead costs. Other, net expenses included no unconsolidated joint venture impairments in the first quarter of 2010 and $2.2 million of such charges in the year-earlier quarter.
FINANCIAL SERVICES
Our financial services segment provides title and insurance services to our homebuyers. This segment also provides mortgage banking services to our homebuyers indirectly through KBA Mortgage. We and a subsidiary of Bank of America, N.A., each have a 50% ownership interest in KBA Mortgage. KBA Mortgage is operated by our joint venture partner and is accounted for as an unconsolidated joint venture in the financial services reporting segment of our consolidated financial statements.
The following table presents a summary of selected financial and operational data for our financial services segment (dollars in thousands):
                 
    Three Months Ended February 28,  
    2010     2009  
 
               
Revenues
  $ 1,467     $ 1,620  
Expenses
    (893 )     (860 )
Equity in income of unconsolidated joint venture
    1,321       941  
 
           
 
               
Pretax income
  $ 1,895     $ 1,701  
 
           
 
               
Total originations (a):
               
Loans
    1,042       1,099  
Principal
  $ 186,318     $ 205,011  
Percentage of homebuyers using KBA Mortgage
    81 %     78 %
 
               
Loans sold to third parties (a):
               
Loans
    1,108       1,112  
Principal
  $ 198,760     $ 210,267  
     
(a)  
Loan originations and sales occur within KBA Mortgage.
Revenues . Financial services revenues totaled $1.5 million for the three months ended February 28, 2010 and $1.6 million for the three months ended February 28, 2009, and included revenues from interest income, title services and insurance commissions. The year-over-year decrease in financial services revenues in the first quarter of 2010 resulted mainly from lower revenues from title and insurance services, reflecting fewer homes delivered from our homebuilding operations.
Expenses . General and administrative expenses totaled $.9 million in both the first quarter of 2010 and first quarter of 2009.
Equity in Income of Unconsolidated Joint Venture . The equity in income of unconsolidated joint venture of $1.3 million in the first three months of 2010 and $.9 million in the first three months of 2009 related to our 50% interest in KBA Mortgage. The increase in unconsolidated joint venture income in the first quarter of 2010 compared to the year-earlier quarter was mainly due to increased margins on loan sales and reduced expenses.

 

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KBA Mortgage originated 1,042 loans in the first quarter of 2010 compared to 1,099 loans in the year-earlier quarter. The percentage of our homebuyers using KBA Mortgage as a loan originator increased to 81% for the three months ended February 28, 2010 from 78% for the three months ended February 28, 2009.
INCOME TAXES
Our income tax expense totaled $.2 million for the three months ended February 28, 2010, compared to an income tax benefit of $1.5 million for the three months ended February 28, 2009. Our effective income tax expense rate was .4% in the first quarter of 2010 compared to an effective income tax benefit rate of 2.5% for the first quarter of 2009. The year-over-year difference in our 2010 first quarter effective tax rate was primarily due to the reversal of a $1.8 million liability for unrecognized tax benefits in the first quarter of 2009.
In accordance with ASC 740, we evaluate our deferred tax assets quarterly to determine if valuation allowances are required. During the three months ended February 28, 2010, we recorded a valuation allowance of $21.2 million against the net deferred tax assets generated from the net loss for the period. During the three months ended February 28, 2009, we recorded a similar valuation allowance of $22.7 million against net deferred tax assets. Our net deferred tax assets totaled $1.1 million at both February 28, 2010 and November 30, 2009. The deferred tax asset valuation allowance increased to $771.2 million at February 28, 2010 from $750.0 million at November 30, 2009. This increase reflected the net impact of the $21.2 million valuation allowance recorded during the first quarter of 2010.
The benefits of our net operating losses, built-in losses and tax credits would be reduced or potentially eliminated if we experienced an “ownership change” under Section 382. Based on our analysis performed as of February 28, 2010, we do not believe that we have experienced an ownership change as defined by Section 382, and, therefore, the net operating losses, built-in losses and tax credits we have generated should not be subject to a Section 382 limitation as of this reporting date.
Liquidity and Capital Resources
Overview. Historically, we have funded our homebuilding and financial services operations with internally generated cash flows and external sources of debt and equity financing.
In light of the prolonged downturn in the housing market and in order to be well-positioned for future growth opportunities, we remain focused on maintaining a strong financial position. We ended the first quarter of 2010 with $1.29 billion of cash and cash equivalents and restricted cash, and no borrowings under the Credit Facility.
Capital Resources. At February 28, 2010, we had $1.82 billion of mortgages and notes payable outstanding, essentially unchanged from the balance at November 30, 2009.
Our financial leverage, as measured by the ratio of debt to total capital, was 73.7% at February 28, 2010 compared to 72.0% at November 30, 2009. Our ratio of net debt to total capital at February 28, 2010 was 44.8%, compared to 42.9% at November 30, 2009.
At February 28, 2010, we had no borrowings outstanding and $148.2 million in letters of credit outstanding under the Credit Facility. At the $200.0 million aggregate commitment level, we had $51.8 million available for future borrowings at February 28, 2010. Effective December 28, 2009, we voluntarily reduced the aggregate Credit Facility to $200.0 million from $650.0 million as a cost-savings measure.
On March 24, 2010, pursuant to the terms of the Credit Facility, we notified Bank of America, N.A., the Administrative Agent for the Credit Facility, of our decision to exercise our right to permanently terminate the entire commitment under the Credit Facility and, as a result, to terminate the terms of the Credit Facility. These terminations became effective on March 31, 2010. Upon the termination of the Credit Facility, the then outstanding letters of credit under the Credit Facility were transferred to an $85.0 million cash-collateralized letter of credit facility that we established with Bank of America, N.A. We terminated the Credit Facility and entered into the cash-collateralized letter of credit facility as a cost-savings measure. We may enter into similar letter of credit agreements with other financial institutions.
Under the terms of the Credit Facility, we were required, among other things, to maintain a minimum consolidated tangible net worth and certain financial statement ratios, and were subject to limitations on

 

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acquisitions, inventories and indebtedness. Specifically, the Credit Facility required us to maintain a minimum consolidated tangible net worth of $1.00 billion, reduced by the cumulative deferred tax valuation allowances not to exceed $721.8 million (“Permissible Deferred Tax Valuation Allowances”). The minimum consolidated tangible net worth requirement was increased by the amount of the proceeds from any issuance of capital stock and 50% of our cumulative consolidated net income, before the effect of deferred tax valuation allowances, for each quarter after May 31, 2008 where we had cumulative consolidated net income. There was no decrease when we had cumulative consolidated net losses. At February 28, 2010, our applicable minimum consolidated tangible net worth requirement was $278.2 million.
Other financial statement ratios required under the Credit Facility consisted of maintaining at the end of each fiscal quarter a Coverage Ratio greater than 1.00 to 1.00 and a Leverage Ratio less than 2.00 to 1.00, 1.25 to 1.00, or 1.00 to 1.00, depending on our Coverage Ratio. The Coverage Ratio was the ratio of our consolidated adjusted EBITDA to consolidated interest expense (as defined under the Credit Facility) over the previous 12 months. The Leverage Ratio was the ratio of our consolidated total indebtedness (as defined under the Credit Facility) to the sum of consolidated tangible net worth and Permissible Deferred Tax Valuation Allowances (“Adjusted Consolidated Tangible Net Worth”).
If our Coverage Ratio was less than 1.00 to 1.00, we would not be in default under the Credit Facility provided that our Leverage Ratio was less than 1.00 to 1.00 and we established with the Credit Facility’s administrative agent an interest reserve account (“Interest Reserve Account”) equal to the amount of interest incurred on a consolidated basis during the most recent completed quarter, multiplied by the number of quarters that remained until the Credit Facility’s scheduled maturity date of November 2010, not to exceed a maximum of four. We could withdraw all amounts deposited in the Interest Reserve Account when our Coverage Ratio at the end of a fiscal quarter was greater than or equal to 1.00 to 1.00, provided that there was no default under the Credit Facility at the time the amounts were withdrawn. An Interest Reserve Account was not required when our actual Coverage Ratio was greater than or equal to 1.00 to 1.00.
The covenants under the Credit Facility represented the most restrictive covenants we had as of February 28, 2010 and November 30, 2009 with respect to our mortgages and notes payable. The following table presents certain key financial metrics we were required to maintain under our Credit Facility at February 28, 2010 and our actual ratios:
         
    February 28, 2010
    Covenant    
Financial Covenant   Requirement   Actual
 
       
Minimum consolidated tangible net worth
  $278.2 million   $641.6 million
Coverage Ratio
  (a)   (a)
Leverage Ratio (b)
  < 1.00   .40
Investment in subsidiaries and joint ventures as a percentage of Adjusted Consolidated Tangible Net Worth
  <35%   10%
Borrowing base in excess of senior indebtedness (as defined)
  Greater than zero   $598.9 million
     
(a)  
Our Coverage Ratio of .79 was less than 1.00 to 1.00 as of February 28, 2010. With our Leverage Ratio as of November 30, 2009 below 1.00 to 1.00, we maintained an Interest Reserve Account to remain in compliance with the terms of the Credit Facility. The Interest Reserve Account had a balance of $90.2 million at February 28, 2010. As discussed above, we voluntarily terminated the Credit Facility effective March 31, 2010.
 
(b)  
The Leverage Ratio requirement varied based on our Coverage Ratio. If our Coverage Ratio was greater than or equal to 1.50 to 1.00, the Leverage Ratio requirement was less than 2.00 to 1.00. If our Coverage Ratio was between 1.00 and 1.50 to 1.00, the Leverage Ratio requirement was less than 1.25 to 1.00. If our Coverage Ratio was less than 1.00 to 1.00, the Leverage Ratio requirement was less than or equal to 1.00 to 1.00.

 

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The following table presents the same financial metrics and actual ratios at November 30, 2009:
         
    November 30, 2009
    Covenant    
Financial Covenant   Requirement   Actual
 
       
Minimum consolidated tangible net worth
  $278.2 million   $700.9 million
Coverage Ratio
  (a)   (a)
Leverage Ratio
  < 1.00   .39
Investment in subsidiaries and joint ventures as a percentage of Adjusted Consolidated Tangible Net Worth
  <35%   11%
Borrowing base in excess of senior indebtedness (as defined)
  Greater than zero   $474.7 million
     
(a)  
Our Coverage Ratio of .77 was less than 1.00 to 1.00 as of November 30, 2009. With our Leverage Ratio as of August 31, 2009 below 1.00 to 1.00, we maintained an Interest Reserve Account of $114.3 million in the fourth quarter of 2009 to remain in compliance with the terms of the Credit Facility. The Interest Reserve Account had a balance of $114.3 million at November 30, 2009.
If our Coverage Ratio was less than 2.00 to 1.00, we were restricted from optional payment or prepayment of principal, interest or any other amount for subordinated obligations before their maturity; payments to retire, redeem, purchase or acquire for value shares of capital stock from or with non-employees; and investments in a holder of 5% or more of our capital stock if the purpose of the investment was to avoid default. These restrictions did not apply if (a) our unrestricted cash equaled or exceeded the aggregate commitment; (b) there were no outstanding borrowings under the Credit Facility; and (c) there was no default under the Credit Facility.
Other covenants contained in the Credit Facility provided that (a) transactions with employees for exchanges of capital stock, such as payments for incentive and employee benefit plans or cashless exercises of stock options, cannot exceed $5.0 million in any fiscal year; (b) our unimproved land book value cannot exceed consolidated tangible net worth; (c) investments in subsidiaries and joint ventures (as defined in the Credit Facility) cannot exceed 35% of Adjusted Consolidated Tangible Net Worth; (d) speculative home deliveries within a given quarter cannot exceed 40% of the previous 12 months’ total deliveries; and (e) the borrowing base (as defined in the Credit Facility) cannot be lower than total senior indebtedness (as defined in the Credit Facility).
The indenture governing our senior notes does not contain any financial maintenance covenants. Subject to specified exceptions, the senior notes indenture contains certain restrictive covenants that, among other things, limit our ability to incur secured indebtedness; engage in sale-leaseback transactions involving property or assets above a certain specified value; or engage in mergers, consolidations, or sales of assets.
As of February 28, 2010, we were in compliance with the applicable terms of all of our covenants under the Credit Facility, senior notes indenture, and mortgages and land contracts due to land sellers and other loans. Our ability to continue to borrow funds depends in part on our ability to remain in such compliance. As discussed above, we voluntarily terminated the Credit Facility effective March 31, 2010.
As further discussed below under “Off-Balance Sheet Arrangements, Contractual Obligations and Commercial Commitments,” various financial and non-financial covenants apply to the outstanding debt of our unconsolidated joint ventures, and a failure to comply with any applicable debt covenants could result in a default and cause lenders to seek to enforce guarantees, if applicable, provided by us and/or our corresponding unconsolidated joint venture partner(s).
During the quarter ended February 28, 2010, our board of directors declared a cash dividend of $.0625 per share of common stock, which was paid on February 18, 2010 to stockholders of record on February 4, 2010.
Depending on available terms, we also finance certain land acquisitions with purchase-money financing from land sellers or with other forms of financing from third parties. At February 28, 2010, we had outstanding mortgages and land contracts due to land sellers and other loans payable in connection with such financing of $158.6 million.

 

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Consolidated Cash Flows. Operating, investing and financing activities provided net cash of $23.8 million in the three months ended February 28, 2010 and used net cash of $114.3 million in the three months ended February 28, 2009.
Operating Activities. Operating activities provided net cash flows of $18.3 million in the three months ended February 28, 2010 and $103.5 million in the corresponding period of 2009. The year-over-year change in net operating cash flows was largely due to an increase in inventories in the first quarter of 2010, reflecting land acquisition activity in the current period to support future growth in our community count, homes delivered and revenues as part of our strategy to restore our homebuilding operations to profitability, as further discussed below under “Outlook.” In contrast, in the first quarter of 2009, we strategically reduced our inventories and curtailed land purchases to align our operations with reduced housing market activity and our outlook at that time with respect to future operating conditions, and to support our profitability and strong balance sheet goals.
In the first three months of 2010, sources of operating cash included a decrease in receivables of $194.2 million, mainly due to a $190.7 million federal income tax refund we received during the quarter as a result of the carryback of our 2009 net operating loss to offset earnings generated in 2004 and 2005. The cash provided was partly offset by a net decrease in accounts payable, accrued expenses and other liabilities of $92.3 million, a net loss of $54.7 million, a net increase in inventories of $48.5 million (excluding inventory impairments and land option contract abandonments, $5.7 million of inventories acquired through seller financing and a decrease of $34.4 million in consolidated inventories not owned) and other operating uses of $5.6 million.
In the first three months of 2009, sources of operating cash included a net decrease in receivables of $197.4 million, due to a $221.0 million federal income tax refund we received during the quarter, a decrease in inventories of $57.4 million (excluding inventory impairments and land option contract abandonments, $5.1 million of inventories acquired through seller financing and a decrease of $7.9 million in consolidated inventories not owned), other operating sources of $2.1 million and various noncash items added to the net loss. Partially offsetting the cash provided was a net loss of $58.1 million and a decrease in accounts payable, accrued expenses and other liabilities of $133.0 million.
Investing Activities . Investing activities used net cash of $2.5 million in the three months ended February 28, 2010 and $8.6 million in the year-earlier period. In the first three months of 2010, cash of $2.3 million was used for investments in unconsolidated joint ventures and $.2 million was used for net purchases of property and equipment. In the first three months of 2009, we used cash of $7.8 million for investments in unconsolidated joint ventures and $.8 million for net purchases of property and equipment.
Financing Activities . Financing activities provided net cash of $8.0 million in the three months ended February 28, 2010 and used net cash of $209.2 million in the three months ended February 28, 2009. In the first three months of 2010, $24.1 million of cash was provided from a reduction in the balance of the Interest Reserve Account (which is restricted cash) and $.2 million of cash was provided from the issuance of common stock under employee stock plans. The cash provided was partially offset by net payments on short-term borrowings of $11.1 million, dividend payments of $4.8 million and repurchases of common stock of $.4 million in connection with the satisfaction of employee withholding taxes on vested restricted stock.
In the first three months of 2009, cash was used for the repayment of $200.0 million of 8 5/8% senior subordinated notes, which matured on December 15, 2008, net payments on short-term borrowings of $8.8 million, dividend payments of $4.8 million and repurchases of common stock of $.6 million in connection with the satisfaction of employee withholding taxes on vested restricted stock. These uses of cash were partly offset by $4.2 million of cash provided from a reduction in the balance of the Interest Reserve Account and $.8 million of cash provided from the issuance of common stock under employee stock plans.
Shelf Registration Statement. We have an automatically effective universal shelf registration statement on file with the SEC. The registration statement registers the offering of debt and equity securities that we may issue from time to time in amounts to be determined.
Share Repurchase Program. At February 28, 2010, we were authorized to repurchase four million shares of our common stock under a board-approved share repurchase program. We did not repurchase any of our common stock under this program in the first quarter of 2010.
In the present environment, we are carefully managing our use of cash for investments internal to our business, investments to grow our business and potential additional debt reductions or potential modifications to our

 

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overall debt maturity schedule. Based on our current capital position, we believe we have adequate resources and sufficient access to external financing sources to satisfy our current and reasonably anticipated future requirements for funds to acquire capital assets and land, consistent with our marketing strategies and investment standards, to construct homes, to finance our financial services operations, and to meet any other needs in the ordinary course of our business, both on a short- and long-term basis. Although we anticipate that our asset acquisition and development activities will remain limited in the near term as markets stabilize, we are analyzing potential asset acquisitions and will use our present financial strength to acquire assets in desirable, long-term markets when the prices, timing and strategic fit are compelling.
Off-Balance Sheet Arrangements, Contractual Obligations and Commercial Commitments
We participate in unconsolidated joint ventures that conduct land acquisition, development and/or other homebuilding activities in various markets, typically where our homebuilding operations are located. Our partners in these unconsolidated joint ventures are unrelated homebuilders, land developers and other real estate entities, or commercial enterprises. Through these unconsolidated joint ventures, we seek to reduce and share market and development risks and to reduce our investment in land inventory, while potentially increasing the number of homesites we control or will own. In some instances, participating in unconsolidated joint ventures enables us to acquire and develop land that we might not otherwise have access to due to a project’s size, financing needs, duration of development or other circumstances. While we view our participation in unconsolidated joint ventures as beneficial to our homebuilding activities, we do not view such participation as essential.
We and/or our unconsolidated joint venture partners typically obtain options or enter into other arrangements to have the right to purchase portions of the land held by the unconsolidated joint ventures. The prices for these land options or other arrangements are generally negotiated prices that approximate fair value. When an unconsolidated joint venture sells land to our homebuilding operations, we defer recognition of our share of such unconsolidated joint venture 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 or ongoing capital contributions to these unconsolidated joint ventures, typically on a pro rata basis. The obligations to make capital contributions are governed by each unconsolidated joint venture’s respective operating agreement and related documents. We also share in the profits and losses of these unconsolidated joint ventures generally in accordance with our respective equity interests. These unconsolidated joint ventures had total assets of $801.6 million at February 28, 2010 and $921.5 million at November 30, 2009. Our investment in these unconsolidated joint ventures totaled $105.7 million at February 28, 2010 and $119.7 million at November 30, 2009. We expect our investments in unconsolidated joint ventures to continue to decrease over time and are reviewing each investment to ensure it fits into our current overall strategic plans and business objectives.
The unconsolidated joint ventures finance land and inventory investments through a variety of arrangements. To finance their respective land acquisition and development activities, certain of our unconsolidated joint ventures have obtained loans from third-party lenders that are secured by the underlying property and related project assets. Our unconsolidated joint ventures had aggregate outstanding debt, substantially all of which was secured, of approximately $384.4 million at February 28, 2010 and $514.2 million at November 30, 2009. Various financial and non-financial covenants apply to the outstanding debt of the unconsolidated joint ventures, and a failure to comply with any applicable debt covenants could result in a default and cause lenders to seek to enforce guarantees, if applicable, as described below.
In certain instances, we and/or our partner(s) in an unconsolidated joint venture provide guarantees and indemnities to the unconsolidated joint venture’s lenders that may include one or more of the following: (a) a completion guaranty; (b) a loan-to-value maintenance guaranty; and/or (c) a carve-out guaranty. A completion guaranty refers to the actual physical completion of improvements for a project and/or the obligation to contribute equity to an unconsolidated joint venture to enable it to fund its completion obligations. A loan-to-value maintenance guaranty refers to the payment of funds to maintain the applicable loan balance at or below a specific percentage of the value of an unconsolidated joint venture’s secured collateral (generally land and improvements). A carve-out guaranty refers to the payment of (i) losses a lender suffers due to certain bad acts or omissions by an unconsolidated joint venture or its partners, such as fraud or misappropriation, or due to environmental liabilities arising with respect to the relevant project, or (ii) outstanding principal and interest and

 

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certain other amounts owed to lenders upon the filing by an unconsolidated joint venture of a voluntary bankruptcy petition or the filing of an involuntary bankruptcy petition by creditors of the unconsolidated joint venture in which an unconsolidated joint venture or its partners collude or which the unconsolidated joint venture fails to contest.
In most cases, our maximum potential responsibility under these guarantees and indemnities is limited to either a specified maximum dollar amount or an amount equal to our pro rata interest in the relevant unconsolidated joint venture. In a few cases, we have entered into agreements with our unconsolidated joint venture partners to be reimbursed or indemnified with respect to the guarantees we have provided to an unconsolidated joint venture’s lenders for any amounts we may pay pursuant to such guarantees above our pro rata interest in the unconsolidated joint venture. If our unconsolidated joint venture partners are unable to fulfill their reimbursement or indemnity obligations, or otherwise fail to do so, we could incur more than our allocable share under the relevant guaranty. Should there be indications that advances (if made) will not be voluntarily repaid by an unconsolidated joint venture partner under any such reimbursement arrangements, we vigorously pursue all rights and remedies available to us under the applicable agreements, at law or in equity to enforce our rights.
Our potential responsibility under our completion guarantees, if triggered, is highly dependent on the facts of a particular case. In any event, we believe our actual responsibility under these guarantees is limited to the amount, if any, by which an unconsolidated joint venture’s outstanding borrowings exceed the value of its assets, but may be substantially less than this amount.
At February 28, 2010, our potential responsibility under our loan-to-value maintenance guarantees relating to approximately $12.0 million of outstanding debt held by two unconsolidated joint ventures totaled approximately $3.8 million, if any liability were determined to be due thereunder. This amount represents our maximum responsibility under such loan-to-value maintenance guarantees assuming the underlying collateral has no value and without regard to defenses that could be available to us against any attempted enforcement of such guarantees.
Notwithstanding our potential unconsolidated joint venture guaranty and indemnity responsibilities and the resolutions we have reached in certain instances with unconsolidated joint venture lenders with respect to those potential responsibilities, at this time we do not believe, except as described below, that our existing exposure under our outstanding completion, loan-to-value and carve-out guarantees and indemnities related to unconsolidated joint venture debt is material to our consolidated financial position or results of operations.
The lenders for two of our unconsolidated joint ventures have filed lawsuits against some of the unconsolidated joint ventures’ members, and certain of those members’ parent companies, seeking to recover damages under completion guarantees, among other claims. We and the other parent companies, together with the members, are defending the lawsuits in which they have been named and are currently exploring resolutions with the lenders, but there is no assurance that the parties involved will reach satisfactory resolutions. In a separate proceeding, the members (including us) of one of these unconsolidated joint ventures are currently in arbitration regarding their respective performance obligations in order to address one member’s claims for specific performance and, in the alternative, damages. A decision in this arbitration proceeding is pending. In the interim, the parties to the arbitration and the lenders to this unconsolidated joint venture have agreed to engage in a mediation process in order to reach negotiated settlements of the outstanding disputes and a restructuring of the unconsolidated joint venture’s outstanding debt. There is no assurance that the mediation process will be successful, and a broad range of outcomes is possible, both for the mediation process or, if the mediation is not successful, for the arbitration. Given the present uncertainty, it is possible that the ultimate outcome could be material to our consolidated financial position or results of operations.
In addition to the above-described guarantees and indemnities, we have also provided a several guaranty to the lenders of our unconsolidated joint venture that is the subject of the above-described arbitration/mediation proceedings. By its terms, the guaranty purports to guarantee the repayment of principal and interest and certain other amounts owed to the unconsolidated joint venture’s lenders when an involuntary bankruptcy proceeding is filed against the unconsolidated joint venture that is not dismissed within 60 days or for which an order approving relief under bankruptcy law is entered, even if the unconsolidated joint venture or its partners do not collude in the filing and the unconsolidated joint venture contests the filing. Our potential responsibility under this several guaranty fluctuates with the unconsolidated joint venture’s debt and with our and our partners’ respective land purchases from the unconsolidated joint venture. At February 28, 2010, this unconsolidated joint venture had total outstanding indebtedness of approximately $372.4 million and, if this guaranty were then enforced, our maximum potential responsibility under the guaranty would have been approximately $182.7

 

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million, which amount does not account for any offsets or defenses that could be available to us. This unconsolidated joint venture has received notices from its lenders’ administrative agent alleging a number of defaults under its loan agreement. As noted above, we are currently exploring resolutions with the parties involved, but there is no assurance that a satisfactory outcome will be reached.
In June 2009, the FASB revised the authoritative guidance for determining the primary beneficiary of a VIE. In December 2009, the FASB issued ASU 2009-17, which provides amendments to ASC 810 to reflect revised guidance. The amendments to ASC 810 replace the quantitative-based risk and rewards calculation for determining which reporting entity, if any, has a controlling interest in a VIE with an approach focused on identifying which reporting entity has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. The amendments also require additional disclosures about a reporting entity’s involvement with VIEs. We adopted the amended provisions of ASC 810 effective December 1, 2009. The adoption of the amended provisions of ASC 810 did not have a material effect on our consolidated financial position or results of operations.
We participate in joint ventures from time to time for the purpose of conducting land acquisition, development and/or other homebuilding activities. Our investments in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. We analyze our joint ventures in accordance with ASC 810 to determine whether they are VIEs and, if so, whether we are the primary beneficiary. All of our joint ventures at February 28, 2010 and November 30, 2009 were determined under the provisions of ASC 810 applicable at each such date to be unconsolidated joint ventures either because they were not VIEs 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 (or similar agreements) in order to procure land for the construction of homes. The use of such land option and other contracts generally allows us to reduce the risks associated with direct land ownership and development, reduces our capital and financial commitments, including interest and other carrying costs, and minimizes the amount of our land inventories on our consolidated balance sheets. Under such land option contracts, we will pay a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of ASC 810, certain of our land option 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 contractual arrangements 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 optioned land, ASC 810 requires us to consolidate a VIE if we are determined to be the primary beneficiary. As a result of our analyses, we determined that as of February 28, 2010 we were not the primary beneficiary of any VIEs from which we are purchasing land under land option contracts. Since adopting the amended provisions of ASC 810, 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 entity’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. We also consider whether we have the obligation to absorb losses of the VIE or the right to receive benefits from the VIE.
Based on our analyses as of November 30, 2009, which were performed before we adopted the amended provisions of ASC 810, we determined that we were the primary beneficiary of certain VIEs from which we were purchasing land under land option contracts and, therefore, consolidated such VIEs. Prior to our adoption of the amended provisions of ASC 810, in determining whether we were the primary beneficiary, we considered, among other things, the size of our deposit relative to the contract price, the risk of obtaining land entitlement approval, the risk associated with land development required under the land option contract, and the risk of changes in the market value of the optioned land during the contract period. The consolidation of VIEs in which we determined we were the primary beneficiary increased inventories, with a corresponding increase to accrued expenses and other liabilities, on our consolidated balance sheets by $21.0 million at November 30, 2009. The liabilities related to our consolidation of VIEs from which we have arranged to purchase land under option and other contracts represent the difference between the purchase price of land not yet purchased and our cash deposits. Our cash deposits related to these land option and other contracts totaled $4.1 million at November 30, 2009. Creditors, if any, of these VIEs have no recourse against us.

 

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As of February 28, 2010, we had cash deposits totaling $1.2 million associated with land option and other contracts that we determined to be unconsolidated VIEs, having an aggregate purchase price of $26.7 million, and had cash deposits totaling $7.3 million associated with land option and other contracts that we determined were not VIEs, having an aggregate purchase price of $189.5 million.
We also evaluate land option contracts in accordance with ASC 470, and, as a result of our evaluations, increased inventories, with a corresponding increase to accrued expenses and other liabilities, on our consolidated balance sheets by $22.8 million at February 28, 2010 and $36.1 million at November 30, 2009.
Critical Accounting Policies
The preparation of our consolidated financial statements requires the use of judgment in the application of accounting policies and estimates of uncertain matters. There have been no significant changes to our critical accounting policies and estimates during the three months ended February 28, 2010 from those disclosed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended November 30, 2009.
Recent Accounting Pronouncements
In January 2010, the FASB issued ASU 2010-06, which provides amendments to Accounting Standards Codification Subtopic No. 820-10, “Fair Value Measurements and Disclosures — Overall.” ASU 2010-06 requires additional disclosures and clarifications of existing disclosures for recurring and nonrecurring fair value measurements. The revised guidance is effective for interim and annual reporting periods beginning after December 15, 2009. ASU 2010-06 concerns disclosure only and will not have an impact on our financial position or results of operations.
Outlook
Our backlog at February 28, 2010 totaled 2,713 net orders, representing projected future housing revenues of approximately $523.8 million. By comparison, at February 28, 2009, our backlog totaled 2,651 net orders, representing projected future housing revenues of approximately $559.8 million. The 2% year-over-year increase in the number of net orders in our quarter-end backlog was primarily due to the increase in our first quarter net orders in 2010 compared to 2009. The 6% year-over-year decline in the projected future housing revenues in our backlog reflects our lower average selling prices in the first quarter of 2010 compared with the year-earlier quarter, which stem from intense price competition in certain of our served markets and our rollout of new product at lower price points than those of our previous product. Compared to our year-end 2009 levels, our net orders in backlog and their projected future revenues increased 28% and 24%, respectively.
Net orders generated by our homebuilding operations increased 5% to 1,913 in the first quarter of 2010 from the 1,827 net orders generated in the corresponding quarter of 2009, even though we operated from 9% fewer active communities in the first quarter of 2010 compared to the year-earlier period. The increase in our net orders reflected improvement in our cancellation rate. As a percentage of gross orders, our first quarter cancellation rate improved to 22% in 2010, from 28% in 2009. As a percentage of beginning backlog, the cancellation rate was 26% in the first quarter of 2010 and 31% in the year-earlier quarter.
Throughout 2009, we and the homebuilding industry in general faced persistently challenging operating conditions in most housing markets due to an increased supply of homes available for sale and restrained demand. The primary factors behind these conditions included mounting sales of lender-owned homes acquired through mortgage foreclosures and short sales, exacerbated by increasing mortgage delinquencies; a generally poor economic and employment environment; tightened mortgage credit standards and reduced credit availability; and relatively weak consumer confidence. Though recent data suggest that some housing markets may be stabilizing or starting to rebound relative to this time last year, it remains highly uncertain when and to what extent housing markets or the broader economy may experience a meaningful and sustained recovery.
Moreover, several obstacles to a recovery could arise or intensify in 2010, which alone or in combination may further increase the supply of homes available for sale and/or constrain demand. On the supply side, these obstacles include increased foreclosure activity and additional lender-owned inventory entering the market due to

 

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the lifting of voluntary lender foreclosure moratoriums, greater voluntary or involuntary mortgage defaults or short sales, and increases in mortgage interest rates. On the demand side, potential obstacles include persistent weakness or further deterioration in economic conditions, employment levels and/or consumer confidence; continued or further tightening in mortgage credit lending standards; and reduced government support for housing. For instance, the Federal Reserve completed a $1.25 trillion mortgage-backed securities purchase program on March 31, 2010, which could cause mortgage interest rates to increase and/or reduce the availability of mortgage financing, and federal home purchase tax credits are scheduled to expire in April 2010.
Though market conditions may remain volatile, our highest priority for 2010 is restoring the profitability of our homebuilding operations. We continue to make progress toward this goal, having narrowed our first quarter net loss on a year-over-year basis for the seventh consecutive quarterly period. In addition, during the first quarter of 2010, we generated year-over-year improvement in our housing gross margin and experienced fewer and lower magnitude charges for asset impairments and land option contract abandonments, trends that we currently believe will continue throughout 2010.
Within a context of disciplined spending and careful operational cost control, we believe that restoring the profitability of our homebuilding operations will require stronger revenue growth, and that such growth can be achieved through the continued rollout of our new, value-engineered product, an increase in the number of our active communities, and a larger inventory base. This tactical shift is reflected in the operations of our Central segment, which, as reported above, produced year-over-year increases in segment revenues and homes delivered during the first quarter, as a result of operating from 15% more active communities than in the first quarter of 2009. To enable this kind of growth across our enterprise as 2010 proceeds, we are pursuing a land acquisition strategy guided by the principles of our KBnxt operational business model, emphasizing ownership or control of well-priced land parcels within our existing served markets or in nearby submarkets that in the aggregate represent a three-to-four year supply of developable land.
We believe we have the financial and operational resources to seize land acquisition opportunities as they arise, and we are confident that the number of attractive opportunities will increase as housing markets improve over time. As a result, we currently anticipate that the number of our active communities will increase on a year-over-year basis in the latter half of 2010 resulting in an overall active community count for the year that is roughly flat with 2009. Based on this assumption, we expect to deliver between 8,300 and 9,000 homes in 2010. Further, we expect some increase in revenues to come from diminishing downward pricing pressures in certain of our served markets compared to prior periods.
We believe the transformations that we have made in our business in recent years—the redesign of our product line, the reduction in our overhead, the improvement in our operating efficiencies, and the strategic redeployment of capital into housing markets that we believe have high future growth prospects from those that do not—have put us in a position to achieve profitability in the latter part of 2010, depending on the extent to which housing markets continue to stabilize and eventually recover.
Despite our progress, our overall outlook remains cautious given the significant potential obstacles noted above and the uncertainty as to when each of our served markets may begin a sustained recovery. Our ability to generate positive results from our strategic initiatives and planned land acquisition activities, including achieving profitability, remains limited by current negative supply and demand dynamics in many housing markets, which are unlikely to abate soon, and by the expected curtailment in government programs and incentives designed to support homeownership and/or home purchases. We continue to believe a meaningful improvement in housing market conditions will require a sustained decrease in unsold homes, price stabilization, reduced mortgage delinquency and foreclosure rates, and the restoration of both consumer and credit market confidence that support a decision to buy a home. We cannot predict when these events may occur. Moreover, if conditions in our served markets decline further, we may need to take additional noncash charges for inventory and joint venture impairments and land option contract abandonments, and we may decide that we need to reduce, slow or even abandon our land acquisition plans for those markets. Our 2010 results could also be adversely affected if general economic conditions do not meaningfully improve or actually decline, if job losses accelerate or weak employment levels persist, if mortgage delinquencies, short sales and foreclosures increase, if consumer mortgage lending becomes less available or more expensive, or if consumer confidence weakens, any or all of which could further delay a recovery in housing markets or result in further deterioration in operating conditions. Despite these difficulties and risks, we believe we are well-positioned, financially and operationally, to advance our primary goals and expand our business when the general housing market stabilizes and longer term demographic, economic and population growth trends once again drive demand for homeownership.

 

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Forward-Looking Statements
Investors are cautioned that certain statements contained in this document, as well as some statements by us in periodic press releases and other public disclosures and some oral statements by us to securities analysts and stockholders during presentations, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “hopes,” and similar expressions constitute forward-looking statements. In addition, any statements concerning future financial or operating performance (including future revenues, homes delivered, net orders, selling prices, expenses, expense ratios, margins, earnings or earnings per share, or growth or growth rates), future market conditions, future interest rates, and other economic conditions, ongoing business strategies or prospects, future dividends and changes in dividend levels, the value of backlog (including amounts that we expect to realize upon delivery of homes included in backlog and the timing of those deliveries), potential future acquisitions and the impact of completed acquisitions, future share repurchases and possible future actions, which may be provided by us, are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our operations, economic and market factors, and the homebuilding industry, among other things. These statements are not guarantees of future performance, and we have no specific policy or intention to update these statements.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The most important risk factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to: general economic, employment and business conditions; adverse market conditions that could result in additional impairments or abandonment charges and operating losses, including an oversupply of unsold homes, declining home prices and increased foreclosure and short sale activity, among other things; conditions in the capital and credit markets (including consumer mortgage lending standards, the availability of consumer mortgage financing and mortgage foreclosure rates); material prices and availability; labor costs and availability; changes in interest rates; inflation; our debt level; weak or declining consumer confidence, either generally or specifically with respect to purchasing homes; competition for home sales from other sellers of new and existing homes, including sellers of homes obtained through foreclosures or short sales; weather conditions, significant natural disasters and other environmental factors; government actions, policies, programs and regulations directed at or affecting the housing market (including, but not limited to, tax credits, tax incentives and/or subsidies for home purchases, and programs intended to modify existing mortgage loans and to prevent mortgage foreclosures), the homebuilding industry, or construction activities; the availability and cost of land in desirable areas; legal or regulatory proceedings or claims; the ability and/or willingness of participants in our unconsolidated joint ventures to fulfill their obligations; our ability to access capital, including our capacity under our unsecured revolving credit facility; our ability to use the net deferred tax assets we have generated; our ability to successfully implement our current and planned product, geographic and market positioning (including, but not limited to, our efforts to expand our inventory base with desirable land positions or interests at reasonable cost), revenue growth and cost reduction strategies; consumer interest in our new product designs, including The Open Series ; and other events outside of our control. Please see our periodic reports and other filings with the SEC for a further discussion of these and other risks and uncertainties applicable to our business.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We primarily enter into debt obligations to support general corporate purposes, including the operations of our subsidiaries. We are subject to interest rate risk on our senior notes. For fixed rate debt, changes in interest rates generally affect the fair value of the debt instrument, but not our earnings or cash flows. Under our current policies, we do not use interest rate derivative instruments to manage our exposure to changes in interest rates.
The following table presents principal cash flows by scheduled maturity, weighted average interest rates and the estimated fair value of our long-term debt obligations as of February 28, 2010 (dollars in thousands):
                 
            Weighted Average  
Fiscal Year of Expected Maturity   Fixed Rate Debt     Interest Rate  
 
               
2010
  $       %
2011
    99,828       6.4  
2012
           
2013
           
2014
    249,393       5.8  
Thereafter
    1,307,441       7.0  
 
             
 
               
Total
  $ 1,656,662       6.7  
 
             
 
               
Fair value at February 28, 2010
  $ 1,598,403          
 
             
For additional information regarding our market risk, refer to Item 7A, Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the year ended November 30, 2009.
Item 4. Controls and Procedures
We have established disclosure controls and procedures to ensure that information we are required to disclose in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and accumulated and communicated to management, including the President and Chief Executive Officer (the “Principal Executive Officer”) and Senior Vice President and Chief Accounting Officer (the “Principal Financial Officer”), as appropriate, to allow timely decisions regarding required disclosure. Under the supervision and with the participation of senior management, including our Principal Executive Officer and our Principal Financial Officer, we evaluated our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934. Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of February 28, 2010.

 

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Table of Contents

PART II. OTHER INFORMATION
Item 1. Legal Proceedings
ERISA Litigation
On March 16, 2007, plaintiffs Reba Bagley and Scott Silver filed an action brought under Section 502 of ERISA, 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al. , in the United States District Court for the Central District of California. The action was brought against us, our directors, certain of our current and former officers, and the board of directors committee that oversees the 401(k) Plan. After the court allowed leave to file an amended complaint, plaintiffs filed an amended complaint adding Tolan Beck and Rod Hughes as additional plaintiffs and dismissing certain individuals as defendants. All four plaintiffs claim to be former employees of KB Home who participated in the 401(k) Plan. Plaintiffs allege on behalf of themselves and on behalf of all others similarly situated that all defendants breached fiduciary duties owed to plaintiffs and purported class members under ERISA by failing to disclose information to and providing misleading information to participants in the 401(k) Plan about our alleged prior stock option backdating practices and by failing to remove our stock as an investment option under the 401(k) Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their 401(k) Plan accounts than they would have earned but for defendants’ alleged breach of duties.
The parties to the litigation executed a settlement agreement on February 26, 2010. On March 1, 2010, plaintiffs filed a Motion for Preliminary Approval of the Settlement, Certification of a Settlement Class, Approval of Notice Plan and To Set a Time for Fairness Hearing. On March 15, 2010, the court held a hearing on the motion at which it granted preliminary approval of the settlement and requested that the parties make certain revisions to the settlement papers. A hearing to decide the fairness of the settlement has not yet been scheduled.
Other Matters
On October 2, 2009, the staff of the SEC notified us that a formal order of investigation had been issued regarding possible accounting and disclosure issues. The staff has stated that its investigation should not be construed as an indication by the SEC that there has been any violation of the federal securities laws. We are cooperating with the staff of the SEC in connection with the investigation. We cannot predict the outcome of, or the timeframe for, the conclusion of this matter.
In addition to those described in this report, we are involved in litigation and government proceedings incidental to our business. These proceedings are in various procedural stages and, based on reports of counsel, we believe as of the date of this report that provisions or accruals made for any potential losses (to the extent estimable) are adequate and that any liabilities or costs arising out of these proceedings are not likely to have a materially adverse effect on our consolidated financial position or results of operations. The outcome of any of these proceedings, however, is inherently uncertain, and if unfavorable outcomes were to occur, there is a possibility that they would, individually or in the aggregate, have a materially adverse effect on our consolidated financial position or results of operations.

 

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Table of Contents

Item 1A. Risk Factors
There have been no material changes to the risk factors we previously disclosed in our Annual Report on Form 10-K for the year ended November 30, 2009.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table summarizes our purchases of our own equity securities during the three months ended February 28, 2010:
                                 
                            Maximum  
                    Total Number of     Number of Shares  
                    Shares Purchased     That May Yet be  
    Total Number             as Part of Publicly     Purchased Under  
    of Shares     Average Price     Announced Plans     the Plans  
Period   Purchased     Paid per Share     or Programs     or Programs  
 
                               
December 1 – 31
        $             4,000,000  
January 1 – 31
    23,393       14.96             4,000,000  
February 1 – 28
                      4,000,000  
 
                         
 
                               
Total
    23,393     $ 14.96                
 
                         
On December 8, 2005, our board of directors authorized a share repurchase program under which we may repurchase up to 10 million shares of our common stock. Acquisitions under the share repurchase program may be made in open market or private transactions and will be made strategically from time to time at management’s discretion based on its assessment of market conditions and buying opportunities. At February 28, 2010, we were authorized to repurchase four million shares of our common stock under this share repurchase program. During the three months ended February 28, 2010, no shares were repurchased pursuant to this share repurchase program. The 23,393 shares purchased during the three months ended February 28, 2010 were previously issued shares delivered to us by employees to satisfy withholding taxes on the vesting of restricted stock awards. These transactions are not considered repurchases under the share repurchase program.
Item 6. Exhibits
Exhibits
         
  10.56 *  
KB Home 2010 Equity Incentive Plan.
       
 
  10.57 *  
Form of Indemnification Agreement, filed as an exhibit to the Company’s Current Report on Form 8-K dated April 2, 2010, is incorporated by reference herein.
       
 
  31.1    
Certification of Jeffrey T. Mezger, President and Chief Executive Officer of KB Home Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of William R. Hollinger, Senior Vice President and Chief Accounting Officer of KB Home Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32.1    
Certification of Jeffrey T. Mezger, President and Chief Executive Officer of KB Home Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  32.2    
Certification of William R. Hollinger, Senior Vice President and Chief Accounting Officer of KB Home Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
  *  
Management contract or compensatory plan or arrangement in which executive officers are eligible to participate.

 

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Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  KB HOME
 
Registrant
 
 
Dated April 8, 2010  /s/ JEFFREY T. MEZGER    
  Jeffrey T. Mezger   
  President and Chief Executive Officer
(Principal Executive Officer) 
 
     
Dated April 8, 2010  /s/ WILLIAM R. HOLLINGER    
  William R. Hollinger   
  Senior Vice President and Chief Accounting Officer
(Principal Financial Officer) 
 
 

 

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Table of Contents

INDEX OF EXHIBITS
         
  10.56 *  
KB Home 2010 Equity Incentive Plan.
       
 
  10.57 *  
Form of Indemnification Agreement, filed as an exhibit to the Company’s Current Report on Form 8-K dated April 2, 2010, is incorporated by reference herein.
       
 
  31.1    
Certification of Jeffrey T. Mezger, President and Chief Executive Officer of KB Home Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  31.2    
Certification of William R. Hollinger, Senior Vice President and Chief Accounting Officer of KB Home Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
  32.1    
Certification of Jeffrey T. Mezger, President and Chief Executive Officer of KB Home Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
 
  32.2    
Certification of William R. Hollinger, Senior Vice President and Chief Accounting Officer of KB Home Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
       
  *  
Management contract or compensatory plan or arrangement in which executive officers are eligible to participate.

 

54

Exhibit 10.56
KB HOME
2010 EQUITY INCENTIVE PLAN
Effective April 1, 2010

 

 


 

TABLE OF CONTENTS
         
    Page  
 
ARTICLE 1. PURPOSE
    1  
ARTICLE 2. DEFINITIONS AND CONSTRUCTION
    1  
ARTICLE 3. SHARES SUBJECT TO THE PLAN
    8  
3.1 Number of Shares
    8  
3.2 Stock Distributed
    9  
ARTICLE 4. GRANTING OF AWARDS
    9  
4.1 Participation
    9  
4.2 Award Agreement
    9  
4.3 Programs
    9  
4.4 Limitations Applicable to Section 16 Persons
    9  
4.5 Fiscal Year Award Limit
    9  
4.6 Minimum Vesting
    9  
4.7 At-Will Employment
    10  
4.8 Stand-Alone and Tandem Awards
    10  
ARTICLE 5. PERFORMANCE-BASED COMPENSATION
    10  
5.1 Purpose
    10  
5.2 Applicability
    10  
5.3 Types of Awards
    10  
5.4 Procedures with Respect to Performance-Based Awards
    11  
5.5 Payment of Performance-Based Awards
    11  
5.6 Additional Limitations
    11  
ARTICLE 6. GRANTING OF OPTIONS
    11  
6.1 Granting of Options to Eligible Individuals
    11  
6.2 Qualification of Incentive Stock Options
    11  
6.3 Option Exercise Price
    12  
6.4 Option Term
    12  
6.5 Option Vesting
    12  
6.6 Substitute Awards
    12  
6.7 Substitution of Stock Appreciation Rights
    13  

 

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TABLE OF CONTENTS
(continued)
         
    Page  
 
ARTICLE 7. EXERCISE OF OPTIONS
    13  
7.1 Partial Exercise
    13  
7.2 Manner of Exercise
    13  
7.3 Notification Regarding Disposition
    13  
ARTICLE 8. AWARD OF RESTRICTED STOCK
    14  
8.1 Award of Restricted Stock
    14  
8.2 Rights as Stockholders
    14  
8.3 Restrictions
    14  
8.4 Repurchase or Forfeiture of Restricted Stock
    15  
8.5 Certificates for Restricted Stock
    15  
8.6 Section 83(b) Election
    15  
ARTICLE 9. AWARD OF PERFORMANCE AWARDS, STOCK PAYMENTS AND RESTRICTED STOCK UNITS
    15  
9.1 Performance Awards
    15  
9.2 Stock Payments
    16  
9.3 Restricted Stock Units
    16  
9.4 Term
    16  
9.5 Exercise or Purchase Price
    16  
ARTICLE 10. AWARD OF STOCK APPRECIATION RIGHTS
    16  
10.1 Grant of Stock Appreciation Rights
    16  
10.2 Stock Appreciation Right Term
    17  
10.3 Stock Appreciation Right Vesting
    17  
10.4 Manner of Exercise
    17  
10.5 Payment
    18  
ARTICLE 11. ADDITIONAL TERMS OF AWARDS
    18  
11.1 Payment
    18  
11.2 Tax Withholding
    18  
11.3 Transferability of Awards
    19  
11.4 Conditions to Issuance of Shares
    20  
11.5 Forfeiture Provisions
    21  

 

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TABLE OF CONTENTS
(continued)
         
    Page  
 
11.6 Prohibition on Repricing
    21  
11.7 Permitted Replacement Awards
    21  
11.8 Shareholder Approval of Certain Accelerations
    21  
ARTICLE 12. ADMINISTRATION
    21  
12.1 Committee
    21  
12.2 Duties and Powers of Committee
    21  
12.3 Action by the Committee
    22  
12.4 Authority of Committee
    22  
12.5 Decisions Binding
    23  
12.6 Delegation of Authority
    23  
ARTICLE 13. MISCELLANEOUS PROVISIONS
    23  
13.1 Amendment, Suspension or Termination of the Plan
    23  
13.2 Changes in Common Stock or Assets of the Company, Acquisition or Liquidation of the Company and Other Corporate Events
    24  
13.3 No Stockholder Rights
    26  
13.4 Paperless Administration
    26  
13.5 Effect of Plan upon Other Compensation Plans
    27  
13.6 Compliance with Laws
    27  
13.7 Titles and Headings, References to Sections of the Code, the Securities Act or Exchange Act
    27  
13.8 Governing Law
    27  
13.9 Section 409A
    27  
13.10 No Rights to Awards
    28  
13.11 Unfunded Status of Awards
    28  
13.12 Indemnification
    28  
13.13 Term
    29  

 

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KB HOME
2010 EQUITY INCENTIVE PLAN
ARTICLE 1.
PURPOSE
The purpose of the KB Home 2010 Equity Incentive Plan (the “ Plan ”) is to attract, motivate and retain the services of Employees, Non-Employee Directors and Consultants by enabling them to participate in the growth and financial success of KB Home (the “ Company ”) and to align their individual interests to those of the Company’s stockholders.
ARTICLE 2.
DEFINITIONS AND CONSTRUCTION
Wherever the following terms are used in the Plan they shall have the meanings specified below:
1. “ Affiliate ” shall mean a person or entity that directly or indirectly controls or is controlled by, or is under common control with, the Company.
2. “ Award ” shall mean, as the case may be, a grant under the Plan of Options, Restricted Stock, Restricted Stock Units, Performance Awards, Stock Payments or Stock Appreciation Rights.
3. “ Award Agreement ” shall mean any written notice, terms and conditions, contract or other instrument or document evidencing an Award, including in electronic form, which shall contain any terms and conditions with respect to the Award as the Committee shall determine consistent with the Plan and any applicable Program.
4. “ Award Limit ” shall mean with respect to Awards payable in Shares or in cash, as the case may be, the respective limit set forth in Section 4.5.
5. “ Board ” shall mean the Board of Directors of the Company.
6. A “ Change of Ownership ” shall be deemed to have occurred if any of the following has occurred: (a) any one person, or more than one person acting as a group, acquires ownership of stock of the Company that, together with stock held by such person or group, constitutes more than 50% of the total fair market value or total voting power of the stock of the Company, as determined in accordance with Section 1.409A-3(i)(5)(v) of the Treasury Regulations; provided , that if a person or group is considered either to own more than 50% of the total fair market value or total voting power of the stock of the Company, or to own more than the market value or total voting power specified in (b) below, and such person or group acquires additional stock of the Company, the acquisition of additional stock by such person or group shall not be considered to cause a “Change of Ownership”; (b) any one person, or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the Company possessing 30% or more of the total voting power of the stock of the Company, as determined in accordance with Section 1.409A-3(i)(5)(vi) of the Treasury Regulations; provided ,

 

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that if a person or group is considered to possess 30% or more of the total voting power of the stock of the Company, and such person or group acquires additional stock of the Company, the acquisition of additional stock by such person or group shall not be considered to cause a “Change of Ownership”; (c) a majority of the members of the Board is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the Board before the date of the appointment or election, as determined in accordance with Section 1.409A-3(i)(5)(vi) of the Treasury Regulations; or (d) any one person, or more than one person acting as a group, acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from the Company that have a total gross fair market value equal to or more than 40% of the total gross fair market value of all of the assets of the Company immediately before such acquisition or acquisitions, as determined in accordance with Section 1.409A-3(i)(5)(vii) of the Treasury Regulations; provided , that a transfer of assets shall not be treated as a “Change of Ownership” when such transfer is made to an entity that is controlled by the stockholders of the Company, as determined in accordance with Section 1.409A-3(i)(5)(vii)(B) of the Treasury Regulations.
7. “ Code ” shall mean the Internal Revenue Code of 1986, as amended from time to time, together with the Treasury Regulations and official guidance promulgated by the U.S. Department of Treasury.
8. “ Committee ” shall mean the Management Development and Compensation Committee of the Board or another committee of the Board designated by the Board that consists solely of Directors meeting the qualifications described in Section 12.1.
9. “ Common Stock ” shall mean the common stock of the Company, par value $1.00 per share.
10. “ Company Stock Administrator ” shall mean the stock administrator of the Company, or such other person or entity designated by the Committee, or his, her or its office, as applicable, whether or not employed by the Company.
11. “ Consultant ” shall mean any consultant or advisor engaged to provide services to the Company or any Affiliate that qualifies as a consultant or advisor under the instructions for use of a Form S-8 Registration Statement.
12. “ Covered Employee ” shall mean any Employee who is, or who the Committee believes may become, a “covered employee” within the meaning of Section 162(m) of the Code.
13. “ Director ” shall mean a member of the Board.
14. “ Effective Date ” shall mean the date the Plan is first approved by the Company’s stockholders in accordance with the requirements of the Company’s by-laws, the applicable Securities Exchange and Sections 162(m) and 422 of the Code.
15. “ Eligible Individual ” shall mean any person who is an Employee, a Consultant or a Non-Employee Director, as determined by the Committee or the Board.

 

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16. “ Employee ” shall mean any officer or other employee (as determined in accordance with Section 3401(c) of the Code) of the Company or of any Affiliate.
17. “ Equity Restructuring ” shall mean a nonreciprocal transaction between the Company and its stockholders, such as a stock dividend, stock split, spin-off, rights offering or recapitalization through a large, nonrecurring cash dividend, that affects the Shares (or other securities of the Company) or the Share price (or the price of other securities), and results upon its implementation in a change in the per-Share value of the Shares underlying outstanding Awards.
18. “ Exchange Act ” shall mean the Securities Exchange Act of 1934.
19. “ Fair Market Value ” shall mean, as of any given date, the value of a Share determined as follows:
(1) If the Common Stock is listed on any Securities Exchange, its Fair Market Value shall be the closing sales price for a Share as quoted on such Securities Exchange for such date or, if there is no closing sales price for a Share on the date in question, the closing sales price for a Share on the last preceding date for which such quotation exists, as reported by The Wall Street Journal or such other source (whether in print or electronic) as the Committee deems reliable;
(2) If the Common Stock is not listed on any Securities Exchange, but the Common Stock is regularly quoted by a recognized securities dealer, its Fair Market Value shall be the mean of the high bid and low asked prices for such date or, if there are no high bid and low asked prices for a Share on such date, the high bid and low asked prices for a Share on the last preceding date for which such information exists, as reported by The Wall Street Journal or such other source (whether in print or electronic) as the Committee deems reliable; or
(3) If the Common Stock is neither listed on any Securities Exchange nor regularly quoted by a recognized securities dealer, its Fair Market Value shall be established by the Committee in good faith.
20. “ Full Value Award ” shall mean any Award other than (i) an Option, (ii) a Stock Appreciation Right or (iii) any other Award for which the Holder must pay the intrinsic value existing as of the date of grant (whether directly or by forgoing a right to receive a payment from the Company or any Affiliate) as a condition to exercising or receiving payment under it.
21. “ Greater Than 10% Stockholder ” shall mean an individual then owning (within the meaning of Section 424(d) of the Code) more than 10% of the total combined voting power of all classes of stock of the Company or any subsidiary corporation (as defined in Section 424(f) of the Code) or parent corporation (as defined in Section 424(e) of the Code) thereof.
22. “ Holder ” shall mean a person who has been granted an Award.
23. “ Incentive Stock Option ” shall mean an Option that is intended to qualify as an incentive stock option and conforms to the applicable provisions of Section 422 of the Code.

 

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24. “ Non-Employee Director ” shall mean a Director of the Company who is not an Employee.
25. “ Non-Qualified Stock Option ” shall mean an Option that is not an Incentive Stock Option.
26. “ Option ” shall mean a right to purchase Shares at a specified exercise price, granted under Article 6. An Option shall be either a Non-Qualified Stock Option or an Incentive Stock Option; provided , however , that Options granted to Non-Employee Directors and Consultants shall only be Non-Qualified Stock Options.
27. “ Performance Award ” shall mean a cash bonus award, stock bonus award, performance award or incentive award that is paid in cash, Shares or a combination of both, awarded under Section 9.1.
28. “ Performance-Based Compensation ” shall mean any compensation that is intended to qualify as “performance-based compensation” as described in Section 162(m)(4)(C) of the Code.
29. “ Performance Criteria ” shall mean the criteria that the Committee selects for an Award for purposes of establishing the Performance Goal or Performance Goals for a Performance Period. The Performance Criteria that shall be used to establish Performance Goals are limited to the following: (i) income/loss (e.g., operating income/loss, EBIT or similar measures, net income/loss, earnings/loss per share, residual or economic earnings), (ii) cash flow (e.g., operating cash flow, total cash flow, EBITDA, cash flow in excess of cost of capital or residual cash flow, cash flow return on investment and cash flow sufficient to achieve financial ratios or a specified cash balance), (iii) returns (e.g., on revenues, investments, assets, capital and equity), (iv) working capital (e.g., working capital divided by revenues), (v) margins (e.g., variable margin, profits divided by revenues, gross margins and margins divided by revenues), (vi) liquidity (e.g., total or net debt, debt reduction, debt-to-capital, debt-to-EBITDA and other liquidity ratios), (vii) revenues, cost initiative and stock price metrics (e.g., revenues, stock price, total shareholder return, expenses, cost structure improvements and costs divided by revenues or other metrics) and (viii) strategic metrics (e.g., market share, customer satisfaction, employee satisfaction, service quality, unit volume, orders, backlog, traffic, deliveries, cancellation rates, productivity, operating efficiency, inventory management, community count, goals related to acquisitions, divestitures or other transactions and goals related to KBnxt operational business model principles, including goals based on a per-employee, per-delivery or other basis).
30. “ Performance Goals ” shall mean, for a Performance Period, one or more goals established in writing by the Committee for the Performance Period based upon one or more Performance Criteria. Depending on the Performance Criteria used to establish such Performance Goals, the Performance Goals may be expressed in terms of overall Company performance, either independently or as compared to one or more companies, performance of specific subsidiaries or business units, either independently or as compared to one or more companies’ subsidiaries or business units, or otherwise as determined by the Committee. If the Committee believes, in its sole discretion, that an equitable adjustment to any Performance Goal is advisable

 

4


 

in light of new developments or circumstances, the Committee may provide for one or more objectively determinable adjustments. Such adjustments may include or arise from one or more of the following: (i) items related to a change in accounting principle; (ii) items relating to financing activities; (iii) expenses for restructuring or productivity initiatives; (iv) other non-operating items; (v) items related to acquisitions; (vi) items attributable to the business operations of any entity acquired by the Company during the Performance Period; (vii) items related to the disposal of a business or segment of a business; (viii) items related to discontinued operations that do not qualify as a segment of a business under applicable accounting standards; (ix) items attributable to any stock dividend, stock split, combination or exchange of stock occurring during the Performance Period; (x) any other items of significant income or expense which are determined to be appropriate adjustments; (xi) items relating to unusual or extraordinary corporate transactions, events or developments, (xii) items related to amortization of acquired intangible assets; (xiii) items that are outside the scope of the Company’s core, on-going business activities; (xiv) items related to acquired in-process research and development; (xv) items relating to changes in tax laws; (xvi) items relating to major licensing or partnership arrangements; (xvii) items relating to asset impairment charges; (xviii) items relating to gains or losses for litigation, arbitration and contractual settlements; or (xix) items relating to any other unusual or nonrecurring events or changes in applicable laws or business conditions. For all Awards intended to qualify as Performance-Based Compensation, such determinations shall be made within the time prescribed by, and otherwise in compliance with, Section 162(m) of the Code.
31. “ Performance Period ” shall mean one or more periods of time, which may be of varying and overlapping durations, as the Committee may select, over which the attainment of one or more Performance Goals will be measured for the purpose of determining a Holder’s right to, and the payment of, a Performance Award.
32. “ Permitted Transferee ” shall mean, with respect to a Holder, any person entitled to use a Form S-8 Registration Statement to exercise Awards originally granted to the Holder and to sell Shares issued pursuant to Awards originally granted to the Holder.
33. “ Program ” shall mean any program adopted by the Committee pursuant to the Plan containing terms and conditions intended to govern one or more specific types of Awards and/or the manner in which they may be granted.
34. “ QDRO ” shall mean a domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended from time to time, or the regulations or official guidance promulgated thereunder.
35. “ Restricted Stock ” shall mean Shares awarded under Article 8 that are subject to certain restrictions and may be subject to risk of forfeiture or repurchase.
36. “ Restricted Stock Units ” shall mean the right to receive Shares or the value of Shares awarded under Section 9.3.
37. “ Retirement ” shall mean an Employee’s severance from employment with the Company and its Affiliates for any reason other than a leave of absence, termination for cause,

 

5


 

death or disability, at such time as the Employee’s age and years of service with the Company and its Affiliates equals at least 65 or more, provided that the Employee is then at least 55 years of age. The Company shall have the sole right to determine whether an Employee’s severance from employment constitutes a Retirement.
38. “ Securities Act ” shall mean the Securities Act of 1933.
39. “ Securities Exchange ” shall mean the New York Stock Exchange or any other securities exchange, national market system or automated quotation system on which the Shares are listed, quoted or traded.
40. “ Shares ” shall mean shares of Common Stock.
41. “ Stock Appreciation Right ” shall mean a stock appreciation right as described and granted under Article 10.
42. “ Stock Payment ” shall mean (a) a payment in the form of Shares or (b) a right to purchase Shares, however denominated or described, as part of a bonus, deferred compensation or other arrangement, in any such case awarded under Section 9.2.
43. “ Substitute Award ” shall mean an Award granted under the Plan upon the assumption of, or in substitution for, outstanding equity awards previously granted by a company or other entity, in connection with a corporate transaction, such as a merger, combination, consolidation or acquisition of property or stock; provided , however , that in no event shall the term “Substitute Award” be construed to refer to an Award made in connection with the cancellation and repricing of an Option or Stock Appreciation Right.
44. “Termination of Service” shall mean,
(1) As to a Consultant, the time when the engagement of a Holder as a Consultant to the Company or an Affiliate is terminated for any reason, with or without cause, including, without limitation, by resignation, discharge, death or retirement, but excluding terminations where the Consultant simultaneously commences or remains in employment or service with the Company or any Affiliate.
(2) As to a Non-Employee Director, the time when a Holder who is a Non-Employee Director ceases to be a Director for any reason, with or without cause, including, without limitation, a termination by resignation, failure to be elected, death or retirement, but excluding terminations where the Holder simultaneously commences employment or service with the Company or any Affiliate.
(3) As to an Employee, the time when the employee-employer relationship between a Holder and the Company or any Affiliate is terminated for any reason, with or without cause, including, without limitation, a termination by resignation, discharge, death, disability or retirement; but excluding terminations where the Holder simultaneously commences or remains in employment or service with the Company or any Affiliate.

 

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The Committee, in its sole discretion, shall determine the effect of all matters and questions relating to Terminations of Service, including, without limitation, the question of whether a Termination of Service resulted from a discharge for cause and all questions of whether particular leaves of absence constitute a Termination of Service; provided , however , that, with respect to Incentive Stock Options, unless the Committee otherwise provides in the terms of the Program, Award Agreement or otherwise, a leave of absence, change in status from an employee to an independent contractor or other change in the employee-employer relationship shall constitute a Termination of Service only if and to the extent that any such event interrupts employment for the purposes of Section 422(a)(2) of the Code. For purposes of the Plan, a Holder’s employee-employer relationship or consultancy relationship shall be deemed to be terminated in the event that the Affiliate employing or contracting with such Holder ceases to remain an Affiliate following any merger, sale of stock or other corporate transaction or event (including, without limitation, a spin-off).
Notwithstanding the foregoing, with respect to any Award that constitutes “deferred compensation” subject to the requirements of Section 409A of the Code, a Termination of Service shall not be deemed to have occurred until there also has been a “separation from service” within the meaning of Section 409A of the Code, as determined in accordance with Section 1.409A-1(h) of the Treasury Regulations; provided that (i) for a Holder who provides services to the Company as an Employee, a separation from service shall be deemed to occur when the Holder has experienced a termination of employment with the Company and the facts and circumstances indicate that the Holder and the Company reasonably anticipate that either (A) no further services will be performed by the Holder for the Company after a certain date or (B) the level of bona fide services the Holder will perform for the Company after a certain date (whether as an Employee or as an independent contractor) will permanently decrease to no more than 20% of the average level of bona fide services performed by the Holder (whether as an Employee or an independent contractor) over the immediately preceding 36-month period (or the full period of services performed for the Company if the Holder has been performing services for less than 36 months); and (ii) for a Holder who provides services to the Company as an independent contractor, a separation from service shall be deemed to occur upon expiration or termination of all contracts under which services are performed by the Holder for the Company, provided that such expiration or termination constitutes a good-faith and complete severing of the contractual relationship between the Holder and the Company, and provided, further, that for a Holder who provides services to the Company as both an Employee and an independent contractor, a separation from service shall generally not occur until the Holder has ceased providing services for the Company as both an Employee and an independent contractor pursuant to clauses (i) and (ii) of this sentence. For purposes of determining whether a separation from service has occurred, services performed for the Company shall include services performed both for the Company and for any other corporation that is a member of the same “controlled group” as the Company under Section 414(b) of the Code or any other trade or business (such as a partnership) that is under common control with the Company as determined under Section 414(c) of the Code, in each case as modified by Section 1.409A-1(h)(3) of the Treasury Regulations and substituting “at least 50 percent” for “at least 80 percent” each place it appears in Section 1563(a) of the Code or Section 1.414(c)-2 of the Treasury Regulations.

 

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45. “ Treasury Regulations ” shall mean the final, temporary and proposed regulations promulgated by the U.S. Department of the Treasury under the Code, as such regulations may be amended from time to time.
ARTICLE 3.
SHARES SUBJECT TO THE PLAN
3.1 Number of Shares .
(a) Subject to adjustment as provided in Section 3.1(b) and Section 13.2, a total of Three Million Five Hundred Thousand (3,500,000) Shares shall be authorized for grant under the Plan. This limit includes Shares that were authorized for grant under the Company’s 2001 Stock Incentive Plan but that were not issued or subject to outstanding awards as of the Effective Date. Any Share that is subject to an Award that could be settled with Shares and is not a Full Value Award shall be deducted from this limit at the ratio of one (1) Share for every one (1) Share subject to the Award. Any Share that is subject to a Full Value Award that could be settled with Shares shall be deducted from this limit at the ratio of 1.78 Shares for every one (1) Share subject to the Award. After the Effective Date, no new awards may be granted under the 2001 Stock Incentive Plan, but any awards under the 2001 Stock Incentive Plan that are outstanding as of the Effective Date shall continue to be subject to the terms and conditions of the 2001 Stock Incentive Plan.
(b) If an Award expires or is canceled, forfeited or settled for cash (in whole or in part), the Shares subject to such Award shall, to the extent of such expiration, cancellation, forfeiture or cash settlement, again be available as Shares authorized for grant under the Plan, in accordance with Section 3.1(d) below. Notwithstanding anything to the contrary contained herein, Shares tendered by a Holder or withheld by the Company in payment of the exercise price of an Award or to satisfy any tax withholding obligation with respect to an Award shall not be available as Shares authorized for grant under the Plan.
(c) Substitute Awards shall not reduce the Shares authorized for grant under the Plan. Additionally, in the event that a company acquired by the Company or any Affiliate or with which the Company or any Affiliate combines has shares available under a pre-existing plan approved by stockholders and not adopted in contemplation of such acquisition or combination, the shares available for grant pursuant to the terms of such pre-existing plan (as adjusted, to the extent appropriate, using the exchange ratio or other adjustment or valuation ratio or formula used in such acquisition or combination to determine the consideration payable to the holders of common stock of the entities party to such acquisition or combination) may be used for Awards under the Plan and shall not reduce the Shares authorized for grant under the Plan; provided , that Awards using such available shares shall not be made after the date awards could have been made under the terms of the pre-existing plan, absent the acquisition or combination, and shall only be made to individuals who were not employed by or providing services to the Company or its Affiliates immediately prior to such acquisition or combination.
(d) Each Share that again becomes available for grant pursuant to this Section 3.1 shall be added back as (i) one (1) Share if such Share was subject to an Award other than a Full Value Award, and (ii) as 1.78 Share if such Share was subject to a Full Value Award.

 

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3.2 Stock Distributed . Any Shares distributed pursuant to an Award may consist, in whole or in part, of authorized and unissued Common Stock, treasury Common Stock or Common Stock purchased on the open market.
ARTICLE 4.
GRANTING OF AWARDS
4.1 Participation. The Committee may, from time to time, select from among all Eligible Individuals, those to whom an Award shall be granted.
4.2 Award Agreement . Each Award shall be evidenced by an Award Agreement. Award Agreements shall contain such terms and conditions as may be determined by the Committee that are not inconsistent with the Plan, including any terms and conditions that are necessary for Awards to comply with, or be exempt from, the requirements of Section 409A of the Code. Award Agreements evidencing Awards intended to qualify as Performance-Based Compensation shall contain such terms and conditions as may be necessary to meet the applicable provisions of Section 162(m) of the Code. Award Agreements evidencing Incentive Stock Options shall contain such terms and conditions as may be necessary to meet the applicable provisions of Section 422 of the Code.
4.3 Programs . The Board or the Committee may from time to time establish Programs pursuant to the Plan. An Award Agreement evidencing an Award granted pursuant to any Program shall comply with the terms and conditions of such Program and the Plan.
4.4 Limitations Applicable to Section 16 Persons . Notwithstanding any other provision of the Plan, the Plan, any Award granted to any individual who is then subject to Section 16 of the Exchange Act, and any applicable Program, shall be subject to any additional limitations set forth in any applicable exemptive rule under Section 16 of the Exchange Act (including Rule 16b-3 of the Exchange Act and any amendments thereto) that are requirements for the application of such exemptive rule. To the extent permitted by applicable law, the Plan and each Program and Award shall be deemed amended to the extent necessary to conform to such applicable exemptive rule.
4.5 Fiscal Year Award Limit. Notwithstanding any provision in the Plan to the contrary, and subject to Section 13.2, the maximum aggregate number of Shares with respect to one or more Awards that may be granted to any one person during any fiscal year of the Company shall be One Million (1,000,000) and the maximum aggregate amount of cash that may be paid to any one person during any fiscal year of the Company with respect to one or more Performance Awards payable in cash shall be Five Million Dollars ($5,000,000). To the extent required by Section 162(m) of the Code, Shares subject to Awards that are canceled shall continue to be counted against the Award Limit specified in the preceding sentence.
4.6 Minimum Vesting . The minimum time-based vesting period for an Award that is subject to the satisfaction of one or more Performance Goals or other performance-based criteria shall be one (1) year. With the exception of Stock Payments that are not subject to vesting, each other Award shall be subject to a minimum three (3) year time-based vesting period; provided, however, the Committee may provide for (a) an equal portion of each such Award to vest in

 

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annual installments during such three (3) year period, (b) a longer (but not shorter) time-based vesting period for an Award so long as the vesting schedule is not more favorable to the Holder than the default schedule specified above or (c) the acceleration of vesting to the extent permitted by Section 11.8.
4.7 At-Will Employment . Nothing in the Plan, any Program or any Award Agreement shall confer upon any Holder any right to be employed by or to serve as a Director or Consultant for the Company or any Affiliate, or to continue in such employment or service, or shall interfere with or restrict in any way the rights of the Company and any Affiliate, which rights are hereby expressly reserved, to discharge any Holder at any time for any reason whatsoever, with or without cause, and with or without notice, or to terminate or change all other terms and conditions of employment or engagement, except to the extent expressly provided otherwise in a written agreement between the Holder and the Company or any Affiliate.
4.8 Stand-Alone and Tandem Awards . Awards granted pursuant to the Plan may, in the sole discretion of the Committee, be granted either alone, in addition to, or in tandem with, any other Award granted pursuant to the Plan. Awards granted in addition to or in tandem with other Awards may be granted either at the same time as or (subject to the requirements of Section 409A of the Code) at a different time from the grant of such other Awards.
ARTICLE 5.
PERFORMANCE-BASED COMPENSATION
5.1 Purpose . The Committee, in its sole discretion, may determine at the time an Award is granted whether such Award is intended to qualify as Performance-Based Compensation. If the Committee, in its sole discretion, decides to grant such an Award to an Eligible Individual that is intended to qualify as Performance-Based Compensation, then the provisions of this Article 5 shall control over any contrary provision contained in the Plan. The Committee may in its sole discretion grant Awards to other Eligible Individuals that are based on Performance Criteria or Performance Goals but that do not satisfy the requirements of this Article 5 and that are not intended to qualify as Performance-Based Compensation.
5.2 Applicability . The grant of an Award to an Eligible Individual for a particular Performance Period shall not require the grant of an Award to such Eligible Individual in any subsequent Performance Period (or entitle such Eligible Individual to any such grant) and the grant of an Award to any one Eligible Individual shall not require the grant of an Award to any other Eligible Individual in such period or in any other period (or entitle any such other Eligible Individual to any such grant).
5.3 Types of Awards . Notwithstanding anything in the Plan to the contrary, the Committee may grant any Award to a Covered Employee in a manner intended to qualify as Performance-Based Compensation, including, without limitation, Restricted Stock for which the restrictions lapse upon the attainment of specified Performance Goals, and any Performance Awards described in Article 9 that vest or become exercisable or payable upon the attainment of one or more specified Performance Goals.

 

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5.4 Procedures with Respect to Performance-Based Awards . To the extent necessary to comply with the requirements of Section 162(m)(4)(C) of the Code, with respect to any Award granted one or more Covered Employees and that is intended to qualify as Performance-Based Compensation, no later than 90 days following the commencement of any Performance Period (or such earlier time as may be required under Section 162(m) of the Code), the Committee shall, in writing, (a) designate one or more Eligible Individuals, (b) select the Performance Criteria applicable to the Performance Period, (c) establish objective Performance Goals, and amounts of such Awards, as applicable, which may be earned for such Performance Period based on the Performance Criteria, and (d) specify an objective relationship between the Performance Criteria and the Performance Goals and the amounts of such Awards, as applicable, to be earned by each Covered Employee for such Performance Period. Following the completion of each Performance Period, the Committee shall certify in writing whether and the extent to which the applicable Performance Goals have been achieved for such Performance Period. In determining the amount earned or payable under such Awards, to the extent provided under any applicable Program or Award Agreement, the Committee shall have the right to reduce or eliminate (but not to increase) the amount earned or payable at a given level of performance to take into account additional factors that the Committee may deem relevant, including, without limitation, the assessment of individual or Company performance for the Performance Period.
5.5 Payment of Performance-Based Awards . Unless otherwise provided in the applicable Program or Award Agreement, as to an Award that is intended to qualify as Performance-Based Compensation, the Holder must be employed by the Company or an Affiliate throughout the Performance Period. Unless otherwise provided in the applicable Performance Goals, Program or Award Agreement, a Holder shall be eligible to receive payment pursuant to such Awards for a Performance Period only if and to the extent the Performance Goals for such period are achieved.
5.6 Additional Limitations . Notwithstanding any other provision of the Plan and except as otherwise determined by the Committee, any Award that is granted to a Covered Employee and is intended to qualify as Performance-Based Compensation shall be subject to any additional limitations set forth in Section 162(m) of the Code that are requirements for qualification as Performance-Based Compensation, and the Plan, any applicable Program and the Award Agreement shall be deemed amended to the extent necessary to conform to such requirements.
ARTICLE 6.
GRANTING OF OPTIONS
6.1 Granting of Options to Eligible Individuals . The Committee is authorized to grant Options to Eligible Individuals on such terms and conditions as it may determine that are not inconsistent with the Plan; provided, however , that no Option shall be granted to any Employee or Consultant of an Affiliate unless the Company is an “eligible issuer of service recipient stock” with respect to such person within the meaning of Section 409A of the Code.
6.2 Qualification of Incentive Stock Options . No Incentive Stock Option shall be granted to any person who is not an Employee of the Company or any subsidiary corporation of the Company (as defined in Section 424(f) of the Code). No person who is a Greater Than 10%

 

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Stockholder may be granted an Incentive Stock Option unless such Incentive Stock Option conforms to the applicable provisions of Section 422 of the Code. Any Incentive Stock Option granted under the Plan may be modified by the Committee, with the consent of the Holder, to disqualify such Option from treatment as an “incentive stock option” under Section 422 of the Code. To the extent that the aggregate Fair Market Value of Shares with respect to which “incentive stock options” (within the meaning of Section 422 of the Code, but without regard to Section 422(d) of the Code) are exercisable for the first time by a Holder during any calendar year under the Plan, and all other plans of the Company and any subsidiary or parent corporation thereof (each as defined in Section 424(f) and (e) of the Code, respectively), exceeds $100,000, the Options shall be treated as Non-Qualified Stock Options to the extent required by Section 422 of the Code. The requirements set forth in the preceding sentence shall be applied by taking Options and other “incentive stock options” into account in the order in which they were granted and the Fair Market Value of Shares shall be determined as of the time the respective instruments were granted. Subject to adjustment as provided in Section 3.1(b) and Section 13.2, no more than One Million Seven Hundred and Fifty Thousand (1,750,000) Shares may be issued pursuant to the exercise of Incentive Stock Options granted under the Plan.
6.3 Option Exercise Price . The exercise price per Share subject to each Option shall be set by the Committee, but shall not be less than 100% of the Fair Market Value of a Share on the date the Option is granted (or on the date the Option is modified, extended or renewed for purposes of Section 409A of the Code or, as to an Incentive Stock Option, Section 424(h) of the Code). In addition, in the case of Incentive Stock Options granted to a Greater Than 10% Stockholder, such price shall not be less than 110% of the Fair Market Value of a Share on the date the Option is granted (or the date the Option is modified, extended or renewed for purposes of Section 424(h) of the Code).
6.4 Option Term . The term of each Option shall be set by the Committee in its sole discretion; provided , however , that the term shall not be more than ten (10) years from the date the Option is granted, or five (5) years from the date an Incentive Stock Option is granted to a Greater Than 10% Stockholder. The Committee shall determine the time period, including the time period following a Termination of Service, during which a Holder has the right to exercise the vested Options, which time period may not extend beyond the term of the Option.
6.5 Option Vesting. Subject to Section 4.6, the Committee shall determine the period of time and other conditions that must be satisfied before the Holder’s right to exercise an Option, in whole or in part, shall vest. Such vesting may be based on service with the Company or an Affiliate, any of the Performance Criteria, or any other criterion or condition determined by the Committee. No portion of an Option that cannot be exercised at the Holder’s Termination of Service shall thereafter become exercisable.
6.6 Substitute Awards . Notwithstanding the foregoing provisions of this Article 6 to the contrary, in the case of an Option that is a Substitute Award, the price per share of the shares subject to such Option may be less than the Fair Market Value per share on the date of grant; provided , that the excess of: (a) the aggregate Fair Market Value (as of the date such Substitute Award is granted) of the shares subject to the Substitute Award, over (b) the aggregate exercise price thereof does not exceed the excess of: (x) the aggregate Fair Market Value (as of the time immediately preceding the transaction giving rise to the Substitute Award, such Fair Market

 

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Value to be determined by the Committee) of the shares of the predecessor entity that were subject to the grant assumed or substituted for by the Company, over (y) the aggregate exercise price of such shares, and that the grant of the Substitute Award otherwise satisfies the requirements of Section 1.409A-1(b)(5)(v)(D) of the Treasury Regulations or, in the case of an Incentive Stock Option, Section 1.424-1(a) of the Treasury Regulations.
6.7 Substitution of Stock Appreciation Rights . The Committee may provide in the applicable Program or the Award Agreement evidencing the grant of an Option that the Committee, in its sole discretion, shall have the right to substitute a Stock Appreciation Right for such Option at any time prior to or upon exercise of such Option; provided, that such Stock Appreciation Right shall be exercisable with respect to the same number of Shares for which such substituted Option would have been exercisable and such Stock Appreciation Right shall have the same exercise price and the same remaining vesting schedule and term as such Option.
ARTICLE 7.
EXERCISE OF OPTIONS
7.1 Partial Exercise . An exercisable Option may be exercised in whole or in part. However, an Option shall not be exercisable with respect to fractional shares and the Committee may require that, by the terms of the Option, a partial exercise must be with respect to a minimum number of Shares.
7.2 Manner of Exercise . All or a portion of an exercisable Option shall be deemed exercised upon delivery of all of the following to the Company Stock Administrator:
(a) A written or electronic notice complying with the applicable rules established by the Company Stock Administrator stating that the Option, or a portion thereof, is exercised. The notice must be signed in writing or electronically by the Holder or other person then entitled to exercise the Option or such portion of the Option;
(b) Such representations and documents as the Company Stock Administrator, in its sole discretion, deems necessary or advisable to effect compliance with all applicable laws and regulations, and the rules of any applicable Securities Exchange. The Company Stock Administrator may, in its sole discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer notices to agents and registrars;
(c) In the event that the Option shall be exercised by any person other than the Holder who is permitted to exercise the Option in accordance with Section 11.3, appropriate proof of the right of such person to exercise the Option, as determined in the sole discretion of the Company Stock Administrator; and
(d) Full payment of the exercise price and applicable withholding taxes to the Company for the Shares with respect to which the Option, or portion thereof, is exercised, in a manner permitted by Section 11.1 and 11.2.
7.3 Notification Regarding Disposition . The Holder shall give the Company Stock Administrator prompt written or electronic notice of any disposition of Shares acquired by

 

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exercise of an Incentive Stock Option which occurs within (a) two years from the date of granting (including the date the Option is modified, extended or renewed for purposes of Section 424(h) of the Code) such Option to such Holder, or (b) one year after the transfer of such shares to such Holder.
ARTICLE 8.
AWARD OF RESTRICTED STOCK
8.1 Award of Restricted Stock .
(a) The Committee is authorized to grant Restricted Stock to Eligible Individuals, and shall determine such terms and conditions, including the restrictions applicable to each Award of Restricted Stock, that are not inconsistent with the Plan, and may impose such conditions on the issuance of such Restricted Stock, as it deems appropriate.
(b) The Committee shall establish the purchase price, if any, and form of payment for Restricted Stock; provided , however , that if a purchase price is charged, such purchase price shall be no less than the par value of the Shares to be purchased, unless otherwise permitted by applicable state law. In all cases, legal consideration shall be required for each issuance of Restricted Stock.
8.2 Rights as Stockholders . Subject to Section 8.4, upon the grant of a Restricted Stock Award, the Holder shall have, unless otherwise provided in the terms of the applicable Award Agreement, all the rights of a stockholder with respect to the Shares subject to the Award, subject to the restrictions in the applicable Program or in his or her Award Agreement, including the right to receive all dividends and other distributions paid or made with respect to the Shares; provided , however , that if the lifting or lapsing of the restrictions on an Award of Restricted Stock is subject to satisfaction of one or more Performance Goals, the Holder shall not be entitled to receive dividends or other distributions with respect to the Shares subject to the Award unless and until each of the applicable Performance Goals has been satisfied, at which time declared and accrued but unpaid dividends and distributions from and after the date of grant of the Award shall become payable to the Holder as soon as practicable. Notwithstanding anything in the foregoing to the contrary, dividends and other distributions made with respect to the Shares subject to an Award shall only be payable to the Holder of the Award to the extent provided by the Committee under the applicable Program or Award Agreement.
8.3 Restrictions . All Shares of Restricted Stock (including any Shares received by Holders thereof with respect to Shares of Restricted Stock as a result of stock dividends, stock splits or any other form of recapitalization) shall, under the terms of the applicable Program or Award Agreement, be subject to such restrictions and vesting requirements as the Committee shall provide. Such restrictions may include, without limitation, restrictions concerning voting rights and transferability and such restrictions may lapse separately or in combination at such times and pursuant to such circumstances or based on such criteria as selected by the Committee, including, without limitation, criteria based on the Holder’s duration of employment or service with the Company or its Affiliates, applicable Performance Criteria, Company performance or individual performance. Restricted Stock may not be sold or encumbered until all applicable restrictions are satisfied, terminated or expire.

 

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8.4 Repurchase or Forfeiture of Restricted Stock . If no purchase price was paid by a Holder in cash or property for a grant of Restricted Stock, upon a Termination of Service the Holder’s rights in any Shares of Restricted Stock then subject to restrictions shall terminate, and such Shares of Restricted Stock shall be surrendered to the Company and cancelled without consideration. If a purchase price was paid by a Holder in cash or property for a grant of Restricted Stock, upon a Termination of Service the Company shall have the right to repurchase from the Holder the Shares of Restricted Stock then subject to restrictions at a cash price per Share equal to the purchase price paid by the Holder in cash or property for such Shares of Restricted Stock or such other amount as may be specified under the applicable Program or in the applicable Award Agreement.
8.5 Certificates for Restricted Stock . Restricted Stock granted pursuant to the Plan may be evidenced in such manner as the Company Stock Administrator shall determine. Certificates, book entries or electronic registration evidencing shares of Restricted Stock must include an appropriate legend referring to the terms, conditions, and restrictions applicable to such Restricted Stock, and the Company may, in it sole discretion, retain physical possession of any stock certificate until such time as all applicable restrictions lapse.
8.6 Section  83(b) Election . If a Holder makes an election under Section 83(b) of the Code to be taxed with respect to the Restricted Stock as of the date of transfer of the Restricted Stock rather than as of the date or dates upon which the Holder would otherwise be taxable under Section 83(a) of the Code, the Holder shall be required to deliver a copy of such election to the Company promptly after filing such election with the Internal Revenue Service.
ARTICLE 9.
AWARD OF PERFORMANCE AWARDS, STOCK
PAYMENTS AND RESTRICTED STOCK UNITS
9.1 Performance Awards .
(a) The Committee is authorized to grant Performance Awards to any Eligible Individual and to determine whether such Performance Awards shall be Performance-Based Compensation. The number of Shares subject to a Performance Award and the value of a Performance Award may be linked to any one or more of the Performance Criteria or other specific criteria determined by the Committee, in each case on a specified date or dates or over any period or periods determined by the Committee. Performance Awards may be paid in cash, Shares, or both, as determined by the Committee.
(b) Without limiting Section 9.1(a), the Committee may grant Performance Awards to any Eligible Individual in the form of a cash bonus payable upon the attainment of objective Performance Goals, or such other criteria, whether or not objective, which are established by the Committee, in each case on a specified date or dates or over any period or periods determined by the Committee. Any such bonuses paid to a Holder that are intended to be Performance-Based Compensation shall be based upon objectively determinable bonus formulas established in accordance with the provisions of Article 5.

 

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9.2 Stock Payments . The Committee is authorized to make Stock Payments to any Eligible Individual. The number or value of Shares of any Stock Payment shall be determined by the Committee and may be based upon one or more Performance Criteria or any other specific criteria, including service to the Company or any Affiliate, determined by the Committee. Shares underlying a Stock Payment that is subject to a vesting schedule or other restrictions, conditions or criteria set by the Committee will not be issued until the restrictions, conditions or criteria have been satisfied. Unless otherwise provided in the applicable Award Agreement, a Holder of a Stock Payment shall have no rights as a Company stockholder with respect to such Stock Payment until such time as the Stock Payment has vested and the Shares underlying the Award have been issued to the Holder. Stock Payments may, but are not required to, be made in lieu of base salary, bonus, fees or other cash compensation otherwise payable to such Eligible Individual.
9.3 Restricted Stock Units . The Committee is authorized to grant Restricted Stock Units to any Eligible Individual. The number and terms and conditions of Restricted Stock Units shall be determined by the Committee. The Committee shall specify the date or dates on which the Restricted Stock Units shall become fully vested and nonforfeitable, and may specify such vesting restrictions, conditions or criteria as it deems appropriate, including, without limitation, conditions based on one or more Performance Criteria or other specific criteria, including service to the Company or any Affiliate, in each case on a specified date or dates or over any period or periods, as the Committee determines. The Company Stock Administrator shall specify, or permit the Holder to elect, the conditions and dates upon which the Shares underlying the Restricted Stock Units that shall be issued, if applicable, subject to the requirements of Section 409A of the Code. Restricted Stock Units may be paid in cash, Shares, or both, as determined by the Committee. On the distribution dates, the Company shall issue to the Holder one unrestricted, fully transferable Share (or the Fair Market Value of one such Share in cash) for each vested and nonforfeitable Restricted Stock Unit.
9.4 Term . The term of a Performance Award, Stock Payment award and/or Restricted Stock Unit award shall be set by the Committee in its sole discretion.
9.5 Exercise or Purchase Price . The Committee may establish an exercise or purchase price for a Performance Award, Shares distributed as a part of a Stock Payment or Shares distributed pursuant to a Restricted Stock Unit Award.
ARTICLE 10.
AWARD OF STOCK APPRECIATION RIGHTS
10.1 Grant of Stock Appreciation Rights .
(a) The Committee is authorized to grant Stock Appreciation Rights to Eligible Individuals on such terms and conditions as it may determine that are not inconsistent with the Plan; provided, however , that no Stock Appreciation Right shall be granted to any Employee or Consultant of an Affiliate unless the Company is an “eligible issuer of service recipient stock” with respect to such person within the meaning of Section 409A of the Code.

 

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(b) A Stock Appreciation Right shall entitle the Holder (or other person entitled to exercise the Stock Appreciation Right) to exercise all or a specified portion of the Stock Appreciation Right (to the extent then exercisable pursuant to its terms) and to receive from the Company an amount determined by multiplying the difference obtained by subtracting the exercise price of the Stock Appreciation Right from the Fair Market Value of a Share on the date of exercise of the Stock Appreciation Right, and multiplying the difference, if positive, by the number of Shares with respect to which the Stock Appreciation Right shall have been exercised, subject to any limitations the Committee may impose. Except as described in Section 10.1(c) below, the exercise price of each Stock Appreciation Right shall be set by the Committee, but shall not be less than 100% of the Fair Market Value of a Share on the date the Stock Appreciation Right is granted (or on the date the Stock Appreciation Right is modified, extended or renewed for purposes of Section 409A of the Code).
(c) Notwithstanding the foregoing provisions of Section 10.1(b) to the contrary, in the case of a Stock Appreciation Right that is a Substitute Award, the exercise price of such Stock Appreciation Right may be less than 100% of the Fair Market Value of a Share on the date of grant; provided , that the excess of: (a) the aggregate Fair Market Value (as of the date such Substitute Award is granted) of the Shares subject to the Substitute Award, over (b) the aggregate exercise price thereof does not exceed the excess of: (x) the aggregate fair market value (as of the time immediately preceding the transaction giving rise to the Substitute Award, such fair market value to be determined by the Committee) of the shares of the predecessor entity that were subject to the grant assumed or substituted for by the Company, over (y) the aggregate exercise price of such shares, and that the grant of the Substitute Award otherwise satisfies the requirements of Section 1.409A-1(b)(5)(v)(D) of the Treasury Regulations.
10.2 Stock Appreciation Right Term . The term of each Stock Appreciation Right shall be set by the Committee in its sole discretion; provided , however , that the term shall not be more than ten (10) years from the date the Stock Appreciation Right is granted. The Committee shall determine the time period, including the time period following a Termination of Service, during which the Holder has the right to exercise a vested Stock Appreciation Right, which time period may not extend beyond the term of the Stock Appreciation Right.
10.3 Stock Appreciation Right Vesting . Subject to Section 4.6, the Committee shall determine the period of time and other conditions that must be satisfied before the Holder’s right to exercise a Stock Appreciation Right, in whole or in part, shall vest. Such vesting may be based on service with the Company or an Affiliate, any of the Performance Criteria, or any other criterion or condition determined by the Committee. No portion of a Stock Appreciation Right that cannot be exercised at the Holder’s Termination of Service shall thereafter become exercisable.
10.4 Manner of Exercise . All or a portion of an exercisable Stock Appreciation Right shall be deemed exercised upon delivery of all of the following to the Company Stock Administrator, or such other person or entity designated by the Committee, or his, her or its office, as applicable:
(a) A written or electronic notice complying with the applicable rules established by the Company Stock Administrator stating that the Stock Appreciation Right, or a

 

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portion thereof, is exercised. The notice must be signed in writing or electronically by the Holder or other person then entitled to exercise the Stock Appreciation Right or such portion of the Stock Appreciation Right;
(b) Such representations and documents as the Company Stock Administrator, in its sole discretion, deems necessary or advisable to effect compliance with applicable laws and regulations. The Company Stock Administrator may, in its sole discretion, also take whatever additional actions it deems appropriate to effect such compliance; and
(c) In the event that the Stock Appreciation Right shall be exercised pursuant to this Section 10.4 by any person or persons other than the Holder, appropriate proof of the right of such person or persons to exercise the Stock Appreciation Right.
10.5 Payment . Payment of the amounts payable with respect to Stock Appreciation Rights pursuant to this Article 10 shall be in cash, Shares (based on their Fair Market Value as of the date the Stock Appreciation Right is exercised), or a combination of both, as determined by the Committee.
ARTICLE 11.
ADDITIONAL TERMS OF AWARDS
11.1 Payment . The Committee shall determine the methods by which payments by any Holder with respect to any Awards granted under the Plan shall be made, including, without limitation: (a) cash or check, (b) Shares (including, in the case of payment of the exercise price of an Award, Shares issuable pursuant to the exercise of the Award) or Shares not subject to any pledge or security interest and held for such period of time as may be required by the Committee, in each case, having a Fair Market Value on the date of delivery equal to the aggregate payments required, (c) delivery of a written or electronic notice that the Holder has placed a market sell order with a broker with respect to Shares then issuable upon exercise or vesting of an Award, and that the broker has been directed to pay a sufficient portion of the net proceeds of the sale to the Company in satisfaction of the aggregate payments required; provided , that payment of such proceeds is then made to the Company upon settlement of such sale, or (d) other property or legal consideration acceptable to the Committee. The Committee shall also determine the methods by which Shares shall be delivered or deemed to be delivered to Holders. Notwithstanding any other provision of the Plan to the contrary, no Holder who is a Director or an “executive officer” of the Company within the meaning of Section 13(k) of the Exchange Act shall be permitted to make payment with respect to any Awards granted under the Plan, or continue any extension of credit with respect to such payment, with a loan from the Company or a loan arranged by the Company to the extent it would violate Section 13(k) of the Exchange Act.
11.2 Tax Withholding . The Company and any Affiliate shall have the authority and the right to deduct or withhold, or require a Holder to remit to the Company, an amount sufficient to satisfy federal, state, local and foreign taxes (including the Holder’s FICA or employment tax obligation) required by law to be withheld with respect to any taxable event concerning a Holder arising as a result of the Plan. The Committee may, in its sole discretion and in satisfaction of the foregoing requirement, allow a Holder to elect to have the Company withhold Shares

 

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otherwise issuable under an Award (or allow the surrender of Shares). The number of Shares which may be so withheld or surrendered shall be limited to the number of Shares which have a Fair Market Value on the date of withholding or repurchase equal to the aggregate amount of such liabilities not to exceed the minimum statutory withholding rates for federal, state, local and foreign income tax and payroll tax purposes that are applicable to such supplemental taxable income. The Company Stock Administrator shall determine the Fair Market Value of the Shares, consistent with applicable provisions of the Code, for tax withholding obligations due in connection with a broker-assisted cashless Option exercise or a Stock Appreciation Right exercise involving the sale of Shares to pay the Option or Stock Appreciation Right exercise price or any tax withholding obligation.
11.3 Transferability of Awards .
(a) Except as otherwise provided in Section 11.3(b):
(i) No Award under the Plan may be sold, pledged, assigned or transferred in any manner other than to a Permitted Transferee by will or the laws of descent and distribution or, subject to the consent of the Committee, pursuant to a QDRO, unless and until and to the extent such Award has been exercised, or the Shares underlying such Award have been issued, and all restrictions applicable to such Shares have lapsed;
(ii) No Award or interest or right therein shall be liable for the debts, contracts or engagements of the Holder or the Holder’s successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, hypothecation, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted imposition of liability thereon or disposition thereof shall be null and void and of no effect, except to the extent that such disposition is permitted hereunder; and
(iii) During the lifetime of the Holder, only the Holder (or the personal representative of an incompetent Holder) may exercise an Award (or any portion thereof) granted to such Holder under the Plan, unless it has been disposed of pursuant to a QDRO, in which case the beneficiary of the QDRO may exercise the Award; after the death of the Holder, any exercisable portion of an Award may be exercised by a Permitted Transferee, but only prior to the time when such portion expires or becomes unexercisable under the Plan or the applicable Program or Award Agreement.
(b) Notwithstanding Section 11.3(a), the Committee, in its sole discretion and subject to such terms and conditions as it may impose, may permit a Holder to transfer an Award other than an Incentive Stock Option to any one or more Permitted Transferees, subject to any state, federal, local or foreign tax and securities laws applicable to transferable Awards.
(c) A Holder may, in the manner determined by the Committee, designate a Permitted Transferee to exercise the rights of the Holder as his or her beneficiary and to receive any distribution with respect to any Award upon the Holder’s death. Such person shall be subject to all terms and conditions of the Plan and any Program or Award Agreement applicable to the

 

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Holder, except to the extent the Plan, the Program, the Award Agreement or applicable law otherwise provide, and to any additional restrictions deemed necessary or appropriate by the Committee. If the Holder is married and resides in a community property state, a designation of a person other than the Holder’s spouse as his or her beneficiary with respect to more than 50% of the Holder’s interest in the Award shall not be effective without the prior written or electronic consent of the Holder’s spouse. Subject to the foregoing, a beneficiary designation may be changed or revoked by a Holder at any time provided the change or revocation is filed with the Committee prior to the Holder’s death. If no beneficiary has been designated in this manner or the beneficiary does not survive the Holder, the rights of the Holder shall be exercisable by the Holder’s executor or administrator.
11.4 Conditions to Issuance of Shares .
(a) Notwithstanding anything herein to the contrary, the Company shall not be required to issue or deliver any certificates or make any book entries evidencing Shares pursuant to the exercise or vesting of any Award, unless and until the Board or the Committee has determined, with advice of counsel, that the issuance of such Shares is in compliance with all applicable laws and regulations and, if applicable, the requirements of any Securities Exchange, and the Shares are covered by an effective registration statement or applicable exemption from registration. In addition to the terms and conditions provided herein, the Board or the Committee may require that a Holder make such reasonable covenants, agreements, and representations as the Board or the Committee, in its discretion, deems advisable in order to comply with any such laws, regulations, or requirements.
(b) All certificates evidencing Shares delivered pursuant to the Plan and all Shares issued pursuant to book entry procedures are subject to any stop-transfer orders and other restrictions as the Committee or the Company Stock Administrator deems necessary or advisable to comply with applicable laws and regulations and the rules of any Securities Exchange.
(c) The Company Stock Administrator shall have the right to require any Holder to comply with any timing or other restrictions with respect to the settlement, vesting, distribution or exercise of any Award, including a window-period limitation, as may be imposed in the sole discretion of the Company Stock Administrator, or because of any other requirement arising from compliance with any applicable laws or regulations, as determined by the Company Stock Administrator, in its sole discretion.
(d) No fractional Shares shall be issued and the Company Stock Administrator shall determine, in its sole discretion, whether cash shall be given in lieu of fractional Shares or whether such fractional Shares shall be eliminated by rounding.
(e) Notwithstanding any other provision of the Plan, unless otherwise determined by the Company Stock Administrator or required by any applicable laws or regulations, the Company shall not deliver to any Holder certificates evidencing Shares issued in connection with any Award and instead such Shares shall be recorded in the books of the Company (or, as applicable, its transfer agent or the Company Stock Administrator).

 

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11.5 Forfeiture Provisions . Pursuant to its general authority to determine the terms and conditions applicable to Awards under the Plan, the Committee shall have the right to provide, in the terms or conditions of Programs or Awards made under the Plan or in any policy with respect to the recovery or recoupment of compensation or benefits in the event of financial restatements or the occurrence of other events that are inconsistent with the payment of compensation, as determined by the Committee, or to require a Holder to agree by separate written or electronic instrument, that: (a)(i) any proceeds, gains or other economic benefit actually or constructively received by the Holder upon any receipt or exercise of the Award, or upon the receipt or resale of any Shares underlying the Award, must be paid to the Company, and (ii) the Award shall terminate and any unexercised portion of the Award (whether or not vested) shall be forfeited, if (b)(i) a Termination of Service occurs prior to a specified date, or within a specified time period following receipt or exercise of the Award, (ii) the Holder at any time, or during a specified time period, engages in any activity in competition with the Company, or which is inimical, contrary or harmful to the interests of the Company, as further defined by the Committee, (iii) the Holder incurs a Termination of Service for “cause” (as such term is defined in the sole discretion of the Committee, or as set forth in a written agreement relating to such Award between the Company and the Holder) or (iv) the Company’s financial results are restated and such proceeds, gains or other economic benefit actually or constructively received by the Holder would have been lower had they been calculated based on such restated results.
11.6 Prohibition on Repricing . Except as provided in Section 13.2, the Committee shall not, without the approval of the stockholders of the Company, (i) authorize the amendment of any outstanding Option or Stock Appreciation Right to reduce its exercise price, except with respect to any Substitute Award, or (ii) cancel any outstanding Option or Stock Appreciation Right in exchange for cash or another Award that has a lower exercise price or that provides additional value to the Holder, except with respect to any Substitute Award.
11.7 Permitted Replacement Awards . The Committee shall have the authority, without the approval of the stockholders of the Company, to amend any outstanding Award (or any award granted under another Company plan, subject to the terms of such other plan) to increase the exercise price or to cancel and replace an Award (or any award granted under another Company plan, subject to the terms of such other plan) with the grant of an Award having an exercise price that is greater than or equal to the original price per share and having vesting schedule and term equal to the remaining vesting schedule and term of the Award (or award granted under another Company plan) being replaced.
11.8 Shareholder Approval of Certain Accelerations . The Committee shall not, without the approval of the stockholders of the Company, accelerate the vesting of any Awards except (a) in connection with the death or disability of a Holder or the Retirement of a Holder who is an Employee, or (b) in accordance with Section 13.2(h).
ARTICLE 12.
ADMINISTRATION
12.1 Committee . The Committee shall administer the Plan (except as otherwise permitted herein) and shall consist solely of two or more Non-Employee Directors appointed by and holding office at the pleasure of the Board, each of whom is intended to qualify as a “non-

 

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employee director” as defined by Rule 16b-3 of the Exchange Act or any successor rule, an “outside director” for purposes of Section 162(m) of the Code and an “independent director” under the rules of any Securities Exchange; provided , that any action taken by the Committee shall be valid and effective, whether or not members of the Committee at the time of such action are later determined not to have satisfied the requirements for membership set forth in this Section 12.1 or otherwise provided in any charter of the Committee.
12.2 Duties and Powers of Committee . It shall be the duty of the Committee to conduct the general administration of the Plan in accordance with its provisions, subject to the Committee’s power to delegate duties under Section 12.6. The Committee shall have the power to interpret the Plan, the Program and any Award Agreement, and to adopt such rules for the administration, interpretation and application of the Plan as are not inconsistent therewith, to interpret, amend or revoke any such rules and to amend any Program or Award Agreement in any manner not inconsistent with the Plan; provided that the rights of the Holder of an Award that is the subject of any such Program or Award Agreement are not affected adversely by such amendment, unless the consent of the Holder is obtained or such amendment is otherwise permitted under Section 13.9. Any such Award under the Plan need not be the same with respect to each Holder. Any such interpretations and rules with respect to Incentive Stock Options shall be consistent with the provisions of Section 422 of the Code. In its sole discretion, the Board may at any time and from time to time exercise any and all rights and duties of the Committee under the Plan except with respect to matters which under Rule 16b-3 under the Exchange Act, Section 162(m) of the Code or the rules of any Securities Exchange require otherwise.
12.3 Action by the Committee . Unless otherwise established by the Board or in any charter of the Committee, a majority of the Committee shall constitute a quorum and the acts of a majority of the members present at any meeting at which a quorum is present, and acts approved in writing by all members of the Committee in lieu of a meeting, shall be deemed the acts of the Committee for purposes of the Plan. Each member of the Committee is entitled to, in good faith, rely or act upon any report or other information furnished to that member by any officer or other employee of the Company or any Affiliate, the Company’s independent certified public accountants, or any compensation consultant, attorney or other professional retained by the Company to assist in the administration of the Plan.
12.4 Authority of Committee . Subject to any specific designation in the Plan or any applicable Program, the Committee has the exclusive power, authority and sole discretion to:
(a) Designate Eligible Individuals to receive Awards;
(b) Determine the type or types of Awards to be granted to each Eligible Individual;
(c) Determine the number of Awards to be granted and the number of Shares to which an Award will relate;
(d) Determine the terms and conditions of any Award granted pursuant to the Plan, including, but not limited to: the exercise price, grant price, or purchase price; any Performance Criteria; any restrictions or limitations on the Award; any schedule for vesting;

 

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lapse of forfeiture restrictions or restrictions on the exercisability of an Award and accelerations or waivers thereof; and any provisions related to non-competition and recapture of gain on an Award, based in each case on such considerations as the Committee in its sole discretion determines;
(e) Determine whether, to what extent, and pursuant to what circumstances (i) an Award may be settled in, or the exercise price of an Award may be paid in cash, Shares, other Awards, or other property (subject to the requirements of Section 409A of the Code), or (ii) an Award may be canceled, forfeited, or surrendered;
(f) Prescribe the form of each Award Agreement, which need not be identical for each Holder;
(g) Decide all other matters that must be determined in connection with an Award;
(h) Establish, adopt, or revise any rules and regulations as it may deem necessary or advisable to administer the Plan;
(i) Interpret the terms of, and any matter arising pursuant to, the Plan, any Program or any Award Agreement; and
(j) Make all other decisions and determinations that may be required pursuant to the Plan or as the Committee deems necessary or advisable to administer the Plan.
12.5 Decisions Binding . The Committee’s interpretation of the Plan, any Awards granted pursuant to the Plan, any Program, any Award Agreement and all decisions and determinations by the Committee with respect to the Plan are final, binding, and conclusive on all parties.
12.6 Delegation of Authority . The Board or Committee may from time to time delegate (a) to a committee of one or more members of the Board the authority to grant or amend Awards and (b) to a committee of one or more members of the Board or to one or more officers of the Company the authority to take administrative actions pursuant to Article 12; provided that any delegation of authority shall only be permitted to the extent it is permissible under Section 162(m) of the Code, applicable securities laws, the rules of any applicable Securities Exchange and any Company policy governing the grant of equity-based awards. Any delegation hereunder shall be subject to the restrictions and limits that the Board or Committee specifies at the time of such delegation, and the Board may at any time rescind the authority so delegated or appoint a new delegate. At all times, the delegatee appointed under this Section 12.6 shall serve in such capacity at the pleasure of the Board and the Committee.
ARTICLE 13.
MISCELLANEOUS PROVISIONS
13.1 Amendment, Suspension or Termination of the Plan . Except as otherwise provided in this Section 13.1, the Plan and any Award Agreement may be wholly or partially amended or otherwise modified, suspended or terminated at any time or from time to time by the

 

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Board or the Committee. However, without approval of the Company’s stockholders, no action of the Committee may, except as provided in Section 13.2, (i) increase the limits imposed in Section 3.1 on the maximum number of Shares that may be issued under the Plan, (ii) take any action described in Section 11.6 above, (iii) materially modify the requirements for eligibility to participate in the Plan, (iv) materially increase the benefits accruing to participants in the Plan, or (v) take any other action that requires the approval of the Company’s stockholders under the rules of any applicable Securities Exchange. Except as provided in Section 13.9, no amendment, suspension or termination of the Plan shall, without the consent of the Holder, adversely affect the rights of the Holder under any Award theretofore granted to such Holder, unless the Award itself otherwise expressly so provides.
13.2 Changes in Common Stock or Assets of the Company, Acquisition or Liquidation of the Company and Other Corporate Events.
(a) In the event of any stock dividend, stock split, combination or exchange of shares, merger, consolidation or other distribution (other than normal cash dividends) of Company assets to stockholders, or any other change affecting the Shares or the Share price other than an Equity Restructuring, the Committee shall make equitable adjustments, if any, to reflect such change with respect to (i) the aggregate number and kind of securities that may be issued under the Plan (including, but not limited to, adjustments of the limitations in Section 3.1 on the maximum number and kind of securities that may be issued under the Plan, adjustments of the Award Limit, and adjustments of the manner in which securities subject to Full Value Awards will be counted); (ii) the number and kind of securities (or other property) subject to outstanding Awards; (iii) the terms and conditions of any outstanding Awards (including, without limitation, any applicable performance targets or criteria with respect thereto); and (iv) the grant or exercise price per share for any outstanding Awards under the Plan.
(b) In the event of any transaction or event described in Section 13.2(a) or any unusual or nonrecurring transactions or events affecting the Company, any Affiliate of the Company, or the financial statements of the Company or any Affiliate, or of changes in applicable laws, regulations or accounting principles, the Committee, in its sole discretion, and on such terms and conditions as it deems appropriate, either by the terms of the Award or by action taken prior to the occurrence of such transaction or event and either automatically or upon the Holder’s request, is hereby authorized to take any one or more of the following actions whenever the Committee determines that such action is appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan or with respect to any Award under the Plan, to facilitate such transactions or events or to give effect to such changes in laws, regulations or principles:
(i) To provide for either (A) termination of any such Award in exchange for an amount of cash, if any, equal to the amount that would have been attained upon the exercise of such Award or realization of the Holder’s rights (and, for the avoidance of doubt, if as of the date of the occurrence of the transaction or event described in this Section 13.2 the Committee determines in good faith that no amount would have been attained upon the exercise of such Award or realization of the Holder’s rights, then such Award may be terminated by the Company without payment) or (B) the replacement of such Award with other rights or property selected by the Committee in its sole discretion having an aggregate value not exceeding the

 

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amount that could have been attained upon the exercise of such Award or realization of the Holder’s rights had such Award been currently exercisable or payable or fully vested;
(ii) To provide that such Award be assumed by the successor or survivor corporation, or a parent or subsidiary thereof, or shall be substituted for by similar options, rights or awards covering the stock of the successor or survivor corporation, or a parent or subsidiary thereof, with appropriate adjustments as to the number and kind of shares and prices;
(iii) To make adjustments in the number and type of securities (or other property) subject to outstanding Awards, and in the number and kind of outstanding Restricted Stock and/or in the terms and conditions of (including the grant or exercise price), and the criteria included in, outstanding Awards and Awards which may be granted in the future;
(iv) To provide that such Award shall be exercisable or payable or fully vested with respect to all Shares covered thereby, notwithstanding anything to the contrary in the Plan or the applicable Program or Award Agreement; and/or
(v) To provide that the Award cannot vest, be exercised or become payable after such event.
(c) In connection with the occurrence of any Equity Restructuring, and notwithstanding anything to the contrary in Sections 13.2(a) and 13.2(b):
(i) The number and type of securities subject to each outstanding Award and the exercise price or grant price thereof, if applicable, shall be equitably adjusted; and/or
(ii) The number and kind of securities that may be issued under the Plan pursuant to new Awards shall be equitably adjusted.
(d) The Committee may, in its sole discretion, include such further provisions and limitations in any Award, Program, Award Agreement or certificate or book-entry evidencing Shares, as it may deem equitable and in the best interests of the Company that are not inconsistent with the provisions of the Plan.
(e) No adjustment or action described in this Section 13.2 or in any other provision of the Plan, any applicable Program or the Award Agreement shall be authorized to the extent that such adjustment or action would cause such Award to violate the requirements of Section 409A of the Code. With respect to any Award which is granted to a Covered Employee and is intended to qualify as Performance-Based Compensation, no adjustment or action described in this Section 13.2 or in any other provision of the Plan, any applicable Program or the Award Agreement shall be authorized to the extent that such adjustment or action would cause such Award to fail to so qualify as Performance-Based Compensation, unless the Committee determines that the Award should not so qualify. No adjustment or action described in this Section 13.2 or in any other provision of the Plan shall be authorized to the extent that such adjustment or action would cause the Plan to violate Section 422(b)(1) of the Code, unless the Committee determines that Options granted under the Plan are not to qualify as “incentive

 

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stock options”. Furthermore, no such adjustment or action shall be authorized to the extent such adjustment or action could result in short-swing profits liability under Section 16 or violate the exemptive conditions of Rule 16b-3 unless the Committee determines that the Award is not to comply with such exemptive conditions.
(f) The existence of the Plan, any Program, any Award Agreement and any Awards granted hereunder shall not affect or restrict in any way the right or power of the Company or the stockholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other change in the Company’s capital structure or its business, any merger or consolidation of the Company, any issue of stock or of options, warrants or rights to purchase stock or of bonds, debentures, preferred or prior preference stocks whose rights are superior to or affect the Common Stock or the rights thereof or which are convertible into or exchangeable for Common Stock, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.
(g) In the event of any pending stock dividend, stock split, combination or exchange of shares, merger, consolidation or other distribution (other than normal cash dividends) of Company assets to stockholders, or any other change affecting the Shares or the Share price, including any Equity Restructuring, for reasons of administrative convenience, the Company in its sole discretion may refuse to permit the exercise of any Award during a period of thirty (30) days prior to the consummation of any such transaction.
(h) Without limiting the generality of the foregoing, the vesting of an Award will not automatically accelerate upon the occurrence of a Change of Ownership; provided, however, the Committee may determine that upon the occurrence of a Change of Ownership, (i) the acquirer or surviving entity shall be required to assume an Award or substitute a comparable award with respect to the equity of the acquirer or surviving entity, (ii) the vesting of all or any portion of the Award will accelerate to the time immediately prior to the consummation of the Change of Ownership, or, in the case of an Option or Stock Appreciation Right, all or any portion of the Award shall become immediately exercisable so that the Holder will have the opportunity to exercise the Award (or portion thereof) immediately prior to consummation of the Change of Ownership, and/or (iii) all or any portion of the Award, including any unvested portion should the Committee so determine, shall be purchased for (x) in the case of an Option or Stock Appreciation Right, cash in an amount equal to the excess of the aggregate Fair Market Value of the Shares subject to the Award to be purchased over the aggregate exercise price for such Shares, net of tax withholding, and (y) in the case of any other Award, such consideration as the Committee may in good faith determine to be equitable under the circumstances; provided, further, that any determination of the Committee in this regard shall comply with Sections 409A and 424 of the Code.
13.3 No Stockholder Rights . Except as otherwise provided herein, a Holder shall have none of the rights of a stockholder with respect to Shares subject to any Award until the Holder becomes the record owner of such Shares.
13.4 Paperless Administration . In the event that the Company Stock Administrator establishes, for the Company or using the services of a third party, an automated system for the

 

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documentation, granting or exercise of Awards, such as a system using an internet website or interactive voice response, then the paperless documentation, granting or exercise of Awards by a Holder may be permitted through the use of such an automated system.
13.5 Effect of Plan upon Other Compensation Plans . The adoption of the Plan shall not affect any other compensation or incentive plans in effect for the Company or any Affiliate, except as described in Section 3.1(a) above with respect to the Company’s 2001 Stock Incentive Plan. Nothing in the Plan shall be construed to limit the right of the Company or any Affiliate: (a) to establish any other forms of incentives or compensation for Employees, Directors or Consultants of the Company or any Affiliate, or (b) to grant or assume options or other rights or awards otherwise than under the Plan in connection with any proper corporate purpose including without limitation, the grant or assumption of options in connection with the acquisition by purchase, lease, merger, consolidation or otherwise, of the business, stock or assets of any corporation, partnership, limited liability company, firm or association.
13.6 Compliance with Laws . The Plan, the granting and vesting of Awards under the Plan and the issuance and delivery of Shares and the payment of money under the Plan or under Awards granted or awarded under the Plan are subject to compliance with all applicable laws and regulations, the rules of any Securities Exchange, and to such approvals by any listing, regulatory or governmental authority as may, in the opinion of counsel for the Company, be necessary or advisable in connection therewith. Any securities delivered under the Plan shall be subject to such restrictions, and the person acquiring such securities shall, if requested by the Company, provide such assurances and representations to the Company as the Company may deem necessary or desirable to assure compliance with all applicable legal requirements. To the extent permitted by applicable law, the Plan, any Program and any Awards granted or awarded hereunder shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.
13.7 Titles and Headings, References to Sections of the Code, the Securities Act or Exchange Act . The titles and headings of the Sections in the Plan are for convenience of reference only and, in the event of any conflict, the text of the Plan, rather than such titles or headings, shall control. References to sections of the Code, the Securities Act or the Exchange Act shall include any amendment or successor thereto.
13.8 Governing Law . The Plan, any Program and any agreements hereunder shall be administered, interpreted and enforced under the internal laws of the State of Delaware without regard to conflicts of laws thereof.
13.9 Section 409A .
(a) To the extent that the Committee determines that any Award granted under the Plan is subject to Section 409A of the Code, the Program pursuant to which such Award is granted and the Award Agreement evidencing such Award shall incorporate the terms and conditions required by Section 409A of the Code. To the extent applicable, the Plan, the Program and any Award Agreements shall be interpreted in accordance with Section 409A of the Code. Notwithstanding any provision of the Plan or the applicable Program or Award Agreement to the contrary, in the event that following the Effective Date the Committee

 

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determines that any Award may be subject to Section 409A of the Code, the Committee may adopt such amendments to the Plan and the applicable Program and Award Agreement or adopt other policies and procedures (including amendments, policies and procedures with retroactive effect), or take any other actions, that the Administrator determines are necessary or appropriate to (i) exempt the Award from Section 409A of the Code and/or preserve the intended tax treatment of the benefits provided with respect to the Award, or (ii) comply with the requirements of Section 409A of the Code and related Department of Treasury guidance and thereby avoid the application of any penalty taxes under such Section.
(b) If, at the time of a Holder’s “separation from service” (within the meaning of Section 409A of the Code), (i) such Holder is a “specified employee” (within the meaning of Section 409A of the Code as determined annually by the Committee in accordance with the methodology specified by resolution of the Board or the Committee and in accordance with Section 1.409A-1(i) of the Treasury Regulations) and (ii) the Committee shall make a good-faith determination that an amount payable pursuant to an Option or Award constitutes “deferred compensation” (within the meaning of Section 409A of the Code) the payment of which is required to be delayed pursuant to the six-month delay rule set forth in Section 409A of the Code in order to preserve the tax treatment intended for such payment or to avoid additional tax, interest, or penalties under Section 409A of the Code, then the Company shall not pay such amount on the otherwise scheduled payment date but shall instead pay it on the first business day after such six-month period. Such amount shall be paid without interest, unless otherwise determined by the Committee, in its sole discretion, or as otherwise provided in any applicable agreement between the Company and the relevant Holder.
(c) The Holder shall be solely responsible and liable for the satisfaction of all taxes, interest, and penalties that may be imposed on such Holder or for such Holder’s account in connection with any Award (including any taxes, interest, and penalties under Section 409A of the Code), and neither the Company nor its Affiliates shall have any obligation to reimburse, indemnify or otherwise hold such Holder harmless from any or all of such taxes, interest, or penalties.
13.10 No Rights to Awards . No Eligible Individual or other person shall have any claim to be granted any Award pursuant to the Plan, and neither the Company nor the Committee is obligated to treat Eligible Individuals, Holders or any other persons uniformly.
13.11 Unfunded Status of Awards . The Plan is intended to be an “unfunded” plan for incentive compensation. With respect to any payments not yet made to a Holder pursuant to an Award, nothing contained in the Plan or any Program or Award Agreement shall give the Holder any rights that are greater than those of a general creditor of the Company or any Affiliate.
13.12 Indemnification . To the extent allowable pursuant to applicable law, each member of the Committee or of the Board shall be indemnified and held harmless by the Company from any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by such member in connection with or resulting from any claim, action, suit, or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action or failure to act pursuant to the Plan and against and from any and all amounts paid by him or her in satisfaction of judgment in such action, suit, or proceeding against him or her. The

 

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foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such persons may be entitled pursuant to the Company’s Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless.
13.13 Term . The ability to grant new awards under this Plan shall terminate on the tenth (10 th ) anniversary of the Effective Date.
# # #

 

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Exhibit 31.1
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Jeffrey T. Mezger, certify that:
1.  
I have reviewed this quarterly report on Form 10-Q of KB Home;
2.  
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.  
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.  
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a)  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
  b)  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
  c)  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
  d)  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.  
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  a)  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
  b)  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
Dated April 8, 2010  /s/ JEFFREY T. MEZGER    
  Jeffrey T. Mezger   
  President and Chief Executive Officer
(Principal Executive Officer) 
 
 

 

 

Exhibit 31.2
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William R. Hollinger, certify that:
1.  
I have reviewed this quarterly report on Form 10-Q of KB Home;
2.  
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.  
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.  
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a)  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
  b)  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
  c)  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
  d)  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.  
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  a)  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
  b)  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
Dated April 8, 2010  /s/ WILLIAM R. HOLLINGER    
  William R. Hollinger   
  Senior Vice President and Chief Accounting Officer
(Principal Financial Officer) 
 
 

 

 

Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of KB Home (the “Company”) on Form 10-Q for the period ended February 28, 2010 (the “Report”), I, Jeffrey T. Mezger, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)  
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)  
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
Dated April 8, 2010  /s/ JEFFREY T. MEZGER    
  Jeffrey T. Mezger   
  President and Chief Executive Officer
(Principal Executive Officer) 
 

 

 

         
Exhibit 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of KB Home (the “Company”) on Form 10-Q for the period ended February 28, 2010 (the “Report”), I, William R. Hollinger, Senior Vice President and Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)  
The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)  
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
         
Dated April 8, 2010  /s/ WILLIAM R. HOLLINGER    
  William R. Hollinger   
  Senior Vice President and Chief Accounting Officer
(Principal Financial Officer)