KB Home
KB HOME (Form: 10-K, Received: 01/29/2008 16:02:45)
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ   Annual Report Pursuant to Section 13 or 15(d) of     
the Securities Exchange Act of 1934
For the Fiscal Year Ended November 30, 2007
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
(State or other jurisdiction of
incorporation or organization)
  95-3666267
(I.R.S. Employer
Identification No.)
 
10990 Wilshire Boulevard, Los Angeles, California 90024
(Address of principal executive offices)
Registrant’s telephone number, including area code:  (310) 231-4000
 
Securities Registered Pursuant to Section 12(b) of the Act:
 
     
    Name of each exchange
                      Title of each class   on which registered
 
Common Stock (par value $1.00 per share)
  New York Stock Exchange
Rights to Purchase Series A Participating Cumulative Preferred Stock
  New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  o  No  þ   
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.   Yes  o   No  þ  
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer    þ      Accelerated filer    o      Non-accelerated filer    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
 
The aggregate market value of voting stock held by non-affiliates of the registrant on May 31, 2007 was $4,107,806,638, including 12,314,882 shares held by the registrant’s grantor stock ownership trust and excluding 25,358,823 shares held in treasury.
 
The number of shares outstanding of each of the registrant’s classes of common stock on December 31, 2007 was as follows: Common Stock (par value $1.00 per share) 89,525,178 shares, including 12,192,182 shares held by the registrant’s grantor stock ownership trust and excluding 25,451,107 shares held in treasury.
 
Documents Incorporated by Reference
 
Portions of the registrant’s definitive Proxy Statement for the 2008 Annual Meeting of Stockholders (incorporated into Part III).
 
 


 

 
KB HOME
FORM 10-K
FOR THE YEAR ENDED NOVEMBER 30, 2007
 
TABLE OF CONTENTS
 
             
        Page
 
        Number  
 
 
  Business     1  
  Risk Factors     11  
  Unresolved Staff Comments     18  
  Properties     18  
  Legal Proceedings     18  
  Submission of Matters to a Vote of Security Holders     20  
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     22  
  Selected Financial Data     24  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     25  
  Quantitative and Qualitative Disclosures About Market Risk     46  
  Financial Statements and Supplementary Data     47  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     88  
  Controls and Procedures     88  
  Other Information     88  
 
  Directors, Executive Officers and Corporate Governance     89  
  Executive Compensation     89  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     89  
  Certain Relationships and Related Transactions, and Director Independence     90  
  Principal Accountant Fees and Services     90  
 
  Exhibits and Financial Statement Schedules     91  
    95  
  EXHIBIT 10.35
  EXHIBIT 10.36
  EXHIBIT 10.37
  EXHIBIT 10.38
  EXHIBIT 12.1
  EXHIBIT 21
  EXHIBIT 23
  EXHIBIT 31.1
  EXHIBIT 31.2
  EXHIBIT 32.1
  EXHIBIT 32.2


Table of Contents

 
PART I
 
Item 1. BUSINESS
 
General
 
KB Home is a Fortune 500 company listed on the New York Stock Exchange under the ticker symbol “KBH.” We are one of the nation’s largest homebuilders and commemorated our 50th year in the homebuilding industry in 2007. We construct and sell homes through our operating divisions across the United States under the name KB Home. Unless the context indicates otherwise, the terms “the Company,” “we,” “our” and “us” used herein refer to KB Home, a Delaware corporation, and its predecessors and subsidiaries.
 
Beginning in 1957 and continuing until 1986, our business was operated through various subsidiaries of Kaufman and Broad, Inc. (“KBI”) and its predecessors. In 1986, KBI transferred to us the outstanding capital stock of its subsidiaries conducting KBI’s homebuilding and mortgage banking business. Shortly thereafter, we completed an initial public offering of 8% of our common stock and began operating under the name Kaufman and Broad Home Corporation. In 1989, we were spun-off from KBI, which then changed its name to Broad Inc., and operated as an independent company, primarily in California and France. In 2001, we changed our name to KB Home. Since 1989, we have expanded our business in both our existing markets and into new markets through capital investments and acquisitions of a number of other homebuilders. Today, we operate a geographically diverse homebuilding and financial services business serving homebuyers in markets across the United States. We believe our geographic diversity helps to mitigate the effects of local and regional economic cycles, enhancing our long-term growth potential.
 
Our four homebuilding segments offer a variety of homes designed primarily for first-time, first move-up and active adult buyers, including attached and detached single-family homes, townhomes and condominiums. We offer homes in development communities, at urban in-fill locations and as part of mixed-use projects. We use the term “home” to refer to a single-family residence, whether it is a single-family home or other type of residential property, and we use the term “community” to refer to a single development in which homes are constructed as part of an integrated plan.
 
We delivered 23,743 homes in 2007 compared to our record 32,124 homes delivered in 2006. In 2007, our average selling price of $261,600 decreased from $287,700 in 2006. We generated total revenues of $6.42 billion and a loss from continuing operations of $1.41 billion in 2007 compared to total revenues of $9.38 billion and income from continuing operations of $392.9 million in 2006. Our homebuilding revenues, which include revenues from land sales, accounted for 99.8% of our total revenues in both 2007 and 2006. Our results in 2007 reflected the significant market downturn the homebuilding industry experienced throughout the year, and our actions to align our operations with the diminished sales environment and to strengthen our balance sheet.
 
Our financial services segment derives income from mortgage banking, title and insurance services offered to our homebuyers. Mortgage banking services are provided through Countrywide KB Home Loans, a joint venture operated by Countrywide Financial Corporation (“Countrywide”) that offers a variety of loan programs to serve the needs of our homebuyers. Our financial services segment accounted for .2% of our total revenues in both 2007 and 2006.
 
On July 10, 2007, we sold our 49% equity interest in our publicly traded French subsidiary, Kaufman & Broad S. A. (“KBSA”). Accordingly, we now operate our homebuilding and financial services business solely in the United States.
 
Our principal executive offices are located at 10990 Wilshire Boulevard, Los Angeles, California 90024. The telephone number of our corporate headquarters is (310) 231-4000 and our website address is http://www.kbhome.com. Our Spanish-language website is http://www.kbcasa.com. In addition, location and community information is available at (888) KB-HOMES.


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Markets
 
Our homebuilding operations span the United States from coast to coast. Because of the geographic reach of our homebuilding business, we have four homebuilding segments based on the markets in which we construct homes — West Coast, Southwest, Central and Southeast. We operate in the 13 states and 35 major markets shown below:
 
         
Segment   State(s)   Major Market(s)
 
West Coast
  California   Fresno, Los Angeles/Ventura, Oakland, Orange County, Riverside, Sacramento, San Bernardino, San Diego and Stockton
Southwest
  Arizona   Phoenix and Tucson
    Nevada   Las Vegas and Reno
    New Mexico   Albuquerque
Central
  Colorado   Colorado Springs and Denver
    Illinois   Chicago
    Texas   Austin, Dallas/Fort Worth, Houston and San Antonio
Southeast
  Florida   Daytona Beach, Jacksonville, Lakeland, Melbourne, Orlando, Sarasota and Tampa
    Georgia   Atlanta
    Maryland   Washington, D.C.
    North Carolina   Charlotte and Raleigh
    South Carolina   Bluffton/Hilton Head, Charleston and Columbia
    Virginia   Washington, D.C.
 
Segment Operating Information.   The following table sets forth specific operating information for our homebuilding segments for the years ended November 30, 2007, 2006 and 2005:
 
                         
    Years Ended November 30,  
    2007     2006     2005  
West Coast:
                       
Homes delivered
    4,957       7,213       6,624  
Percent of total homes delivered
    21 %     22 %     21 %
Average selling price
  $ 433,600     $ 489,500     $ 460,500  
Total revenues (in millions) (a)
  $ 2,203.3     $ 3,531.3     $ 3,050.5  
Southwest:
                       
Homes delivered
    4,855       7,011       7,357  
Percent of total homes delivered
    20 %     22 %     24 %
Average selling price
  $ 258,500     $ 306,900     $ 265,600  
Total revenues (in millions) (a)
  $ 1,349.6     $ 2,183.8     $ 1,964.5  
Central:
                       
Homes delivered
    6,310       9,613       9,866  
Percent of total homes delivered
    27 %     30 %     32 %
Average selling price
  $ 167,800     $ 159,800     $ 157,600  
Total revenues (in millions) (a)
  $ 1,077.3     $ 1,553.3     $ 1,559.0  
Southeast:
                       
Homes delivered
    7,621       8,287       7,162  
Percent of total homes delivered
    32 %     26 %     23 %
Average selling price
  $ 229,400     $ 244,300     $ 215,100  
Total revenues (in millions) (a)
  $ 1,770.4     $ 2,091.4     $ 1,549.3  
Total:
                       
Homes delivered
    23,743       32,124       31,009  
Average selling price
  $ 261,600     $ 287,700     $ 261,200  
Total revenues (in millions) (a)
  $ 6,400.6     $ 9,359.8     $ 8,123.3  
 
 
(a)  Total revenues include revenues from housing and land sales.
 
Unconsolidated Joint Ventures.   The above tables do not include deliveries from unconsolidated joint ventures. From time to time, we participate in the acquisition, development, construction and sale of residential properties through


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unconsolidated joint ventures. Our unconsolidated joint ventures delivered 127 homes in 2007, 4 homes in 2006 and 83 homes in 2005.
 
Strategy
 
We expect the difficult conditions we experienced in our served markets in 2007 to continue through 2008. Consistent with the general downturn in housing markets across the United States, most of our served markets have faced a persistent oversupply of new and resale homes available for sale, with some areas reaching historically high levels. In these markets, our business has encountered significant challenges from heightened builder and investor efforts to sell homes and land, increased foreclosure activity, consumer reluctance to purchase homes, tighter lending standards due to turmoil in the mortgage finance and credit markets, and reduced home affordability, particularly in areas that experienced rapid sales price increases in the years leading up to and including 2006. These conditions resulted in both lower overall sales in our homebuilding business compared to prior years and downward pressure on our selling prices and margins in 2007, as competition for sales drove marketing expenses higher and increased the need for sales incentives. We do not expect the present business environment in our served markets or these trends to improve in 2008.
 
We believe our continued adherence to the disciplines of our core built-to-order operational business model, KBnxt, will enable us to manage through the current and expected near-term business environment. We believe it will also position us to capitalize on long-term growth opportunities that we expect will arise as housing supply and demand conditions in our served markets begin to stabilize.
 
KBnxt Operational Business Model.   We began operating under the principles of our KBnxt operational business model in 1997. The KBnxt operational business model seeks to generate greater operating efficiencies and return on investment through a disciplined, fact-based and process-driven approach to homebuilding that is founded on a constant and systematic assessment of consumer preferences and market opportunities. The key principles of our KBnxt operational business model include:
 
  •  gaining a detailed understanding of consumer location and product preferences through regular surveys;
 
  •  managing our working capital and reducing our operating risks by acquiring developed and entitled land at reasonable prices in markets with high growth potential, and by disposing of land and interests in land that no longer meet our strategic or investment goals;
 
  •  using our knowledge of consumer preferences to design, construct and deliver the products homebuyers desire;
 
  •  in general, commencing construction of a home only after a purchase contract has been signed;
 
  •  building a backlog of net orders and reducing the time from initial construction to final delivery of homes to customers;
 
  •  establishing an even flow of production of high quality homes at the lowest possible cost; and
 
  •  offering customers affordable base prices and the opportunity to customize their homes through choice of location, floor plans and interior design options.
 
Our KBnxt operational business model is designed to help us achieve a leading position in our existing markets, expand our business into attractive new markets, exit investments that no longer meet our return standards or marketing strategy and calibrate our product lines to consumer preferences in both our existing and new markets. Historically, this focus has allowed us to achieve lower costs and economies of scale with respect to acquiring and developing land, purchasing building materials, subcontracting labor and providing options to customers.
 
Our expansion into new markets will depend on our assessment of a potential new market’s viability and our ability to develop operations in that new market. We will also continue to consider appropriate acquisitions, as market conditions may produce attractive opportunities. However, expansion into new markets and large acquisitions are not a priority for us in the near term.


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Strategic Objectives.   Based on our KBnxt operational business model, and building on initiatives we implemented in 2006 and 2007 as conditions in our served markets became increasingly challenging, our primary strategic objectives include:
 
  •  Maintaining our balanced geographic footprint and focusing on growth opportunities in our existing served markets. We believe this will allow us to efficiently capitalize on the different rates at which our served markets are expected to stabilize. We also believe that our existing served markets offer the most attractive long-term growth prospects.
 
  •  Providing the best value and choice in homes and options for the first-time, first move-up and active adult homebuyer. By promoting value and choice through an affordable base price and product customization, we believe we can stand out from other homebuilders among our core customer base.
 
  •  Generating high levels of customer satisfaction and producing high quality homes. Achieving high customer satisfaction levels is a key driver to our long-term success and delivering quality homes is critical to achieving high customer satisfaction.
 
  •  Maintaining ownership and control over a three-to-four year supply of developable land. Keeping our inventory in line with our future sales expectations maximizes the use of our working capital, enhances our liquidity and helps maintain a strong balance sheet to support long-term strategic investments.
 
  •  Improving the affordability of our homes and lowering our production costs by redesigning and reengineering our products, building smaller homes, reducing production cycle times and direct construction costs, and targeting our pricing to median income levels in our served markets. We believe making our homes more affordable to our core customer base, with corresponding decreases in our production costs, will help us generate revenues and maintain our margins during the current housing market downturn and position us for longer-term profit growth.
 
  •  Continuing to align our cost structure with the expected size and growth of our business, generating free cash flow and maximizing the performance of our invested capital.
 
Marketing Strategy.   Our marketing strategy aims to generate traffic to our communities by promoting our distinct customized homebuying experience. We believe this approach, supported with unique marketing partnerships and consistently applied companywide under one brand, generates a high perceived value for our products and our company among our target customers nationwide.
 
Reflecting this approach, in 2007 we launched a “Built to Order” consumer brand messaging initiative to provide potential homebuyers with a clearer understanding of how our homebuying experience differs from that of other homebuilders and resale homes. The “Built to Order” campaign emphasizes the choices our homebuyers can make in community location, floor plan, exterior architectural style, and interior design options and amenities to create a home built to their individual preferences. In highlighting the choices we make available to our homebuyers and reinforcing our general approach to build homes only after we receive a qualified order, the “Built to Order” campaign serves as the consumer face to core elements of our KBnxt operational business model.
 
During 2007, we also saw the expansion of our successful partnership with Martha Stewart, a leading lifestyle expert. Under this partnership, we offer our homebuyers in selected communities an opportunity to build homes inspired by Martha Stewart’s own residences and to customize them using interior designs that reflect her style. We opened six additional Martha Stewart communities in 2007, bringing the total number to nine. The new Martha Stewart communities included the first in California, Texas, Colorado and Florida, as well as the second in North Carolina and Georgia. Our Martha Stewart communities have generated significant consumer and media interest and traffic, and we expect to open more of them in the future.
 
In September 2007, we announced a high-profile collaboration with The Walt Disney Company to develop exclusive Disney Home product options to be offered to our homebuyers. Options include elements that would normally be built into a home such as lighting fixtures and window coverings and feature some of Disney’s most recognized characters. The first options in the collaboration will be available to our homebuyers in 2008.


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During 2007, we also maintained our focus on the Internet as a key vehicle for reaching homebuyers. We redesigned our primary consumer website, kbhome.com, to be easier to navigate, to better reflect current technologies, and to make “Built to Order” a central message throughout the site.
 
We renewed our emphasis on the first-time, first move-up and active adult homebuyer in 2007. These homebuyers historically have been our core customers and are the buyers we anticipate to have the greatest potential for future home sales. In the present mortgage financing environment, focusing on these types of homebuyers also allows us to offer more homes that fall within conforming loan limits for Fannie Mae, Federal Home Loan Mortgage Corporation (“Freddie Mac”), Federal Housing Administration (“FHA”) and Veterans Administration (“VA”) programs.
 
In 2008, we will continue to implement our “Built to Order” marketing strategy, building on our efforts in 2007.
 
Sales Strategy.   To ensure the consistency of our message and adherence to our KBnxt operational business model, sales of our homes are carried out by in-house teams of sales representatives. Our sales representatives are trained to provide prospective customers with floor plan and design choices, pricing information and tours of fully furnished and landscaped model homes that are decorated to emphasize the distinctive options we offer. We also have Countrywide KB Home Loans representatives available in many of our communities to assist prospective customers with financing questions.
 
To help our homebuyers customize their homes, we operate KB Home Studios in the vast majority of our markets. KB Home Studios are large showrooms where our customers may select from thousands of options to purchase conveniently as part of the original construction of their homes. The coordinated efforts of sales representatives, KB Home Studio consultants and other personnel involved in the customer’s homebuying experience are intended to provide high levels of customer satisfaction and lead to enhanced customer retention and referrals.
 
Customer Service and Quality Control
 
Customer satisfaction is a high priority for us and we are committed to building and delivering quality homes. Our on-site construction supervisors perform regular pre-closing quality checks during the construction process to ensure our homes meet our quality standards and our homebuyers’ expectations. We have customer service personnel who are responsible for responding to homebuyers’ post-closing needs, including warranty claims. We believe prompt and courteous responses to homebuyers’ needs throughout the homebuying process reduces post-closing repair costs, enhances our reputation for quality and service, and may help encourage repeat and referral business from homebuyers and the real estate community. Our goal is for our customers to be 100% satisfied with their new homes. We provide a limited warranty on all of our homes. The specific terms and conditions vary depending on the market where we do business. We generally provide a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home such as appliances.
 
Local Expertise
 
To maximize our KBnxt operational business model’s effectiveness and help ensure its consistent execution, our employees are continuously trained on KBnxt operational principles and evaluated based on their achieving KBnxt operational objectives relevant to their particular job duties. We also believe that our business requires in-depth knowledge of local markets in order to acquire land in desirable locations and on favorable terms, to engage subcontractors, to plan communities based on local demand, to anticipate consumer tastes in specific markets and to assess the local regulatory environments. Accordingly, we operate through local divisions with local market expertise. We have experienced management teams in each of our divisions. Although we have centralized certain functions (such as marketing, advertising, legal, materials purchasing, product development, architecture and accounting) to benefit from economies of scale, our local management exercises considerable autonomy in identifying land acquisition opportunities, developing product and sales strategies, conducting product operations and controlling costs.
 
Community Development and Land Inventory Management
 
Our community development process generally consists of four phases: land acquisition, land development, home construction and sale. Historically, our community development process has ranged from six to 24 months in our


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West Coast segment to a somewhat shorter duration in our other homebuilding segments. The length of the community development process varies based on, among other things, the extent of government approvals required, the overall size of the community, necessary site preparation activities, weather conditions and marketing results.
 
Although they vary significantly, our communities typically consist of 50 to 250 lots ranging in size from 2,000 to 20,000 square feet. Depending on the community, we offer from two to five model home designs with premium lots often containing more square footage, better views or location benefits. Our goal is to own or control enough lots to meet our forecasted production goals over the next three to four years.
 
Land Acquisition and Land Development.   Our current focus is on creating a strong balance sheet and positioning ourselves for future growth. Significant land acquisitions are not currently a priority, but we will consider attractive opportunities as they arise. When we do acquire and develop land, we do so consistent with our KBnxt operational business model, which focuses on obtaining land containing fewer than 250 lots that are entitled and either physically developed (referred to as “finished lots”) or partially finished. Acquiring finished or partially finished lots enables us to construct and deliver homes shortly after the land is acquired with minimal additional development expenditures. This is a more efficient way to use our working capital and reduces the operating risks associated with having to develop and/or entitle land, such as unforeseen improvement costs and/or changes in market conditions. However, depending on market conditions, we may acquire undeveloped and/or unentitled land. We expect that the overall balance of undeveloped, unentitled, entitled and finished lots in our inventory will vary over time.
 
Consistent with our KBnxt operational business model, we target geographic areas for potential land acquisitions and assess the viability of our current inventory based on the results of periodic surveys of both new and resale homebuyers in particular markets. Local, in-house land acquisition specialists conduct site selection research and analysis in targeted geographic areas to identify desirable land or to evaluate whether an existing interest we hold is consistent with our marketing strategy. We also use studies performed by third-party marketing specialists. Some of the factors we consider in evaluating land acquisition targets and assessing current inventory are: consumer preferences; general economic conditions; specific market conditions, with an emphasis on the prices of comparable new and resale homes in the market; expected sales rates; proximity to metropolitan areas and employment centers; population and commercial growth patterns; estimated costs of completing lot development; and environmental matters.
 
We generally structure our land purchases and development activities to minimize, or to defer the timing of cash and capital expenditures, which enhances returns associated with new land investments. While we use a variety of techniques to accomplish this, as further described below, we typically use agreements that give us an option right to purchase land at a future date at a fixed price for a small or no initial deposit payment. Our decision to exercise a particular option right is based on the results of due diligence we conduct after entering into an agreement. In some cases our decision to exercise an option may be conditioned on the land seller obtaining necessary entitlements, such as zoning rights and environmental approvals, and/or physically developing the land by a pre-determined date to allow us to build homes relatively quickly. Depending on the circumstances, our initial deposit payment for an option right may or may not be refundable to us if we do not purchase the underlying land.
 
In addition to acquiring land under option agreements, we may acquire land under agreements that condition our purchase obligation on our satisfaction with the feasibility of developing the land and selling homes on the land by a certain future date. Our option and other purchase agreements may also allow us to phase our land purchases and/or lot development over a period of time and/or upon the satisfaction of certain conditions. We may also acquire land with seller financing that is non-recourse to us, or by working in conjunction with third-party land developers. Our land option contracts generally do not contain provisions requiring our specific performance.
 
As previously noted, under our KBnxt operational business model, we generally attempt to minimize our land development costs by focusing on acquiring finished or partially finished lots. Where we purchase unentitled and unimproved land, we typically use option agreements as described above and during an applicable option period perform technical, environmental, engineering and entitlement feasibility studies, while we seek to obtain necessary governmental approvals and permits. These activities are sometimes done with the seller’s assistance or at the seller’s cost. The use of option arrangements in this context allows us to conduct these development-related activities while minimizing our inventory levels and overall financial commitments, including interest and other carrying costs. It also improves our ability to accurately estimate development costs, an important element in planning communities and pricing homes, prior to incurring them.


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Before we commit to any land purchase or dispose of any interest in land we hold, our senior corporate management carefully evaluates each asset based on the results of our local specialists’ due diligence and a set of strict financial measures, including, but not limited to, gross margin analyses and specific discounted, after-tax cash flow internal rate of return requirements. Potential land acquisition or disposal transactions are subject to review and approval by our corporate land committee, which is composed of senior corporate and regional management. The stringent criteria guiding our land acquisition and disposition decisions have resulted in our maintaining inventory in areas that we believe generally offer better returns for lower risk and lower cash and capital investment.
 
In light of difficult market conditions, we have sold some of our land and interests in land and have abandoned a portion of our options to acquire land. Consistent with our KBnxt operational business model, we determined that these sold or abandoned properties no longer met our strategic needs or our internal investment standards. If market conditions remain challenging, we may sell more of our land and interests in land, and we may abandon or try to sell our options to acquire land.
 
The following table shows the number of lots we owned in various stages of development and under option contracts in our homebuilding segments as of November 30, 2007 and 2006. The table does not include approximately 376 acres optioned as of November 30, 2007 and 393 acres optioned as of November 30, 2006 that have not yet been approved for subdivision into lots.
 
                                                                 
                      Total Lots
 
    Homes/Lots in
    Land Under
    Lots Under
    Owned or
 
    Production     Development     Option     Under Option  
    2007     2006     2007     2006     2007     2006     2007     2006  
 
West Coast
    8,174       10,957       2,961       4,387       3,598       11,762       14,733       27,106  
Southwest
    7,059       9,773       2,866       2,338       5,743       11,101       15,668       23,212  
Central
    9,944       12,799       3,257       6,856       2,472       5,448       15,673       25,103  
Southeast
    7,916       10,576       2,888       6,034       8,830       19,436       19,634       36,046  
                                                                 
Total
    33,093       44,105       11,972       19,615       20,643       47,747       65,708       111,467  
                                                                 
 
Reflecting our geographic diversity and balanced operations, as of November 30, 2007, 22% of the lots we owned or controlled were located in the West Coast reporting segment, 24% were in the Southwest reporting segment, 24% were in the Central reporting segment, and 30% were in the Southeast reporting segment.
 
The following table shows the dollar value of inventory we owned in various stages of development and under option contracts in our homebuilding segments as of November 30, 2007 and 2006 (in thousands):
 
                                                                 
                      Total Lots
 
    Homes/Lots in
    Land Under
    Lots Under
    Owned or
 
    Production     Development     Option     Under Option  
    2007     2006     2007     2006     2007     2006     2007     2006  
 
West Coast
  $ 1,020,637     $ 1,794,320     $ 192,790     $ 432,103     $ 199,396     $ 454,720     $ 1,412,823     $ 2,681,143  
Southwest
    491,098       688,942       161,820       222,011       34,357       202,821       687,275       1,113,774  
Central
    420,811       531,048       59,802       119,649       53,248       85,808       533,861       736,505  
Southeast
    464,922       714,955       131,009       293,891       82,530       211,375       678,461       1,220,221  
                                                                 
Total
  $ 2,397,468     $ 3,729,265     $ 545,421     $ 1,067,654     $ 369,531     $ 954,724     $ 3,312,420     $ 5,751,643  
                                                                 
 
Home Construction and Sale.   Following the purchase of land and, if necessary, the completion of the entitlement process, we typically begin marketing homes and constructing model homes. The time required for construction of our homes depends on the weather, time of year, local labor supply, availability of materials and supplies and other factors. To minimize the costs and risks of standing inventory, we generally begin construction of a home only when we have contracted with a homebuyer. However, cancellations of home purchase contracts prior to the delivery of the underlying homes may cause us to have standing inventory of completed or partially completed homes.
 
We act as the general contractor for the majority of our communities and hire subcontractors for all production activities. The use of subcontractors enables us to reduce our investment in direct labor costs, equipment and facilities. Where practical, we use mass production techniques, and pre-made, standardized components and materials to


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streamline the on-site production process. We have also developed systems for national and regional purchasing of certain building materials, appliances and other items to take advantage of economies of scale and to reduce costs through improved pricing and, where available, participation in manufacturers’ rebate programs. At all stages of production, our administrative and on-site supervisory personnel coordinate the activities of subcontractors and subject their work to quality and cost controls. As part of our KBnxt operational business model, we have also emphasized even-flow production methods to enhance the quality of our homes, minimize production costs and improve the predictability of our revenues and earnings.
 
Backlog
 
We sell our homes under standard purchase contracts, which generally require a customer deposit at the time of signing. The amount of deposit required varies among markets and communities. Homebuyers are also generally required to pay additional deposits when they select options or upgrades for their homes. Most of our sales contracts stipulate that if a homebuyer cancels a contract with us, we have the right to retain the homebuyer’s earnest money and option or upgrade deposits. However, we generally permit customers to cancel their obligations and obtain refunds of all or a portion of their deposit in the event mortgage financing cannot be obtained within a period of time, as specified in their contract.
 
“Backlog” consists of homes that are under contract but have not yet been delivered. Ending backlog represents the number of homes in backlog from the previous period plus the number of net orders (new orders for homes less cancellations) taken during the current period minus the number of homes delivered during the current period. The backlog at any given time will be affected by cancellations. In addition, deliveries of new homes typically increase from the first to the fourth quarter in any year.
 
Our backlog at November 30, 2007, excluding unconsolidated joint ventures, consisted of 6,322 homes, down 40% from the 10,575 homes in backlog at year-end 2006. Our backlog ratio was 68% for the fourth quarter of 2007 and 60% for the fourth quarter of 2006. (Backlog ratio is defined as homes delivered as a percentage of beginning backlog in the quarter.)
 
The significant decrease in backlog levels in 2007 reflected an overall decrease in net orders and lower average selling prices compared to prior years, reflecting the persistently challenging conditions in the housing market that began in 2006. Our net orders declined 13% to 19,490 in 2007 from 22,459 in 2006. Our average cancellation rate in 2007 was 42%, improving from an average of 47% in 2006. During the fourth quarter of 2007, our net orders decreased 32% from the fourth quarter of 2006, reflecting decreases in each of our reporting segments. The fourth quarter 2007 cancellation rate of 58% was the same as the cancellation rate we experienced in the year-earlier quarter, and 8 percentage points higher than the 50% cancellation rate we experienced in the third quarter of 2007.


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The following table sets forth homes delivered, net orders and ending backlog for each quarter during the years ended November 30, 2007 and 2006:
 
                                                 
                                  Unconsolidated
 
    West Coast     Southwest     Central     Southeast     Total     Joint Ventures  
Homes delivered
                                               
2007
                                               
First
    895       1,185       1,427       1,629       5,136       8  
Second
    950       1,061       1,236       1,529       4,776       11  
Third
    1,252       1,133       1,433       1,881       5,699       13  
Fourth
    1,860       1,476       2,214       2,582       8,132       95  
                                                 
Total
    4,957       4,855       6,310       7,621       23,743       127  
                                                 
2006
                                               
First
    1,446       1,552       1,835       1,610       6,443        
Second
    1,579       1,813       2,183       1,827       7,402        
Third
    1,683       1,798       2,489       1,923       7,893       4  
Fourth
    2,505       1,848       3,106       2,927       10,386        
                                                 
Total
    7,213       7,011       9,613       8,287       32,124       4  
                                                 
Net orders
                                               
2007
                                               
First
    1,467       1,108       1,333       1,836       5,744       85  
Second
    1,673       1,437       1,903       2,252       7,265       109  
Third
    713       604       1,370       1,220       3,907       79  
Fourth
    679       482       660       753       2,574       9  
                                                 
Total
    4,532       3,631       5,266       6,061       19,490       282  
                                                 
2006
                                               
First
    1,399       1,492       2,295       1,854       7,040        
Second
    1,628       1,239       2,723       1,899       7,489        
Third
    775       806       1,549       1,037       4,167       24  
Fourth
    772       576       1,156       1,259       3,763       34  
                                                 
Total
    4,574       4,113       7,723       6,049       22,459       58  
                                                 
Ending backlog — homes
                                               
2007
                                               
First
    2,187       2,453       2,961       3,582       11,183       131  
Second
    2,910       2,829       3,628       4,305       13,672       229  
Third
    2,371       2,300       3,565       3,644       11,880       295  
Fourth
    1,190       1,306       2,011       1,815       6,322       209  
                                                 
2006
                                               
First
    4,207       5,368       5,405       5,857       20,837        
Second
    4,256       4,794       5,945       5,929       20,924        
Third
    3,348       3,802       5,005       5,043       17,198       20  
Fourth
    1,615       2,530       3,055       3,375       10,575       54  
                                                 
Ending backlog — value, in thousands
                                       
2007
                                               
First
  $ 1,054,825     $ 640,856     $ 494,429     $ 846,070     $ 3,036,180     $ 42,401  
Second
    1,357,973       733,211       633,775       1,012,098       3,737,057       84,773  
Third
    1,042,194       590,711       599,400       834,588       3,066,893       108,821  
Fourth
    466,726       313,120       312,952       406,037       1,498,835       80,523  
                                                 
2006
                                               
First
  $ 2,059,191     $ 1,690,266     $ 841,504     $ 1,455,301     $ 6,046,262     $  
Second
    2,200,413       1,473,792       947,562       1,499,091       6,120,858        
Third
    1,726,232       1,129,899       802,950       1,295,886       4,954,967       7,748  
Fourth
    819,795       708,206       487,223       811,533       2,826,757       20,292  
                                                 
 
Land and Raw Materials
 
We currently own or control enough land to meet our forecasted production goals for approximately the next three to four years, and we believe that we will be able to acquire land on acceptable terms for future communities as needed. In


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fact, as discussed above, we have recently sold some of our land and abandoned options to purchase land in order to balance our holdings with diminished current and forecasted market conditions. In 2007, our land sales generated $189.0 million of revenues and $74.3 million of pretax losses, including $74.8 million of impairments. Our land option contract abandonments resulted in pretax, non-cash charges of $144.0 million in 2007.
 
The principal raw materials used in the construction of our homes are concrete and forest products. In addition, we use a variety of other construction materials in the homebuilding process, including sheetrock, plumbing and electrical items. We attempt to maintain efficient operations by using standardized materials that are commercially available on competitive terms from a variety of sources. In addition, our centralized or regionalized purchasing of certain building materials, appliances and fixtures allows us to benefit from large quantity purchase discounts and, in some cases, supplier rebates. When possible, we make bulk purchases of these products at favorable prices from suppliers and often instruct subcontractors to submit bids based on these prices.
 
Customer Financing
 
On-site representatives at our communities facilitate sales by offering to arrange financing for prospective customers through Countrywide KB Home Loans. Countrywide KB Home Loans is a retail mortgage banking joint venture that we established with Countrywide in 2005. Although our customers have the choice of obtaining financing elsewhere, we believe that the ability of Countrywide KB Home Loans to offer customers a variety of financing options on competitive terms as a part of the on-site sales process is an important factor in completing sales.
 
Countrywide KB Home Loans provides mortgage banking services to our homebuyers. Leveraging the resources of Countrywide, the joint venture operates with decentralized teams of employees located in all of our markets. Through its relationship with Countrywide, the joint venture offers virtually every loan program in the industry, as well as some products not offered by other lenders. This includes fixed and adjustable rate, conventional, privately-insured mortgages, FHA-insured or VA-guaranteed mortgages and mortgages funded by revenue bond programs of states and municipalities. Countrywide KB Home Loans originated loans for 72% of our customers who obtained mortgage financing in 2007 and 57% in 2006.
 
Discontinued Operations
 
In July 2007, we sold our 49% interest in our French operations. The disposition of the French operations enables us to invest additional resources in our U.S. homebuilding operations. The sale generated total gross proceeds of $807.2 million and a pretax gain of $706.7 million ($438.1 million net of income taxes). As a result of the sale, the French operations, which had previously been presented as a separate reporting segment, are presented as discontinued operations in our consolidated financial statements. All prior period information has been reclassified to be consistent with the current period presentation.
 
Employees
 
We employ a trained staff of land acquisition specialists, architects, planners, engineers, construction supervisors, marketing and sales personnel, and finance and accounting personnel, supplemented as necessary by outside consultants, who guide the development of our communities from their conception through the marketing and sale of completed homes.
 
At December 31, 2007, we had approximately 3,100 full-time employees in our operations, compared to approximately 5,100 at December 31, 2006. None of our employees are represented by a collective bargaining agreement.
 
Competition and Other Factors
 
We believe the use of our KBnxt operational business model, particularly the aspects that involve gaining a deeper understanding of customer interests and needs and offering a wide range of choices to homebuyers, provides us with long-term competitive advantages. The housing industry is highly competitive, and we compete with numerous homebuilders ranging from regional and national firms to small local builders primarily on the basis of price, location, financing, design, reputation, quality and amenities. In addition, we compete with housing alternatives other than new homes,


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including resale homes and rental housing. In certain markets and at times when housing demand is high, we also compete with other builders to hire subcontractors.
 
Financing
 
We do not generally finance the development of our communities with project financing. By “project financing,” we mean proceeds of loans specifically obtained for, or secured by, particular communities. Instead, our operations have been primarily funded by results of operations, public debt and equity financing, and borrowings under our unsecured revolving credit facility with various banks (the “Credit Facility”).
 
Regulation and Environmental Matters
 
As part of our due diligence process for all land acquisitions, our policy is to use third-party environmental consultants to investigate for environmental risks and to require disclosure from land sellers of known environmental risks. Despite these precautions, there can be no assurance that we will avoid material liabilities relating to the removal of toxic wastes, site restoration, monitoring or other environmental matters affecting properties currently or previously owned by us. No estimate of any potential liabilities can be made although we may, from time to time, purchase property that requires modest environmental clean-up costs after appropriate due diligence. In such instances, we take steps prior to acquisition to gain assurance as to the precise scope of work required and the costs associated with removal, site restoration and/or monitoring, using detailed investigations performed by environmental consultants. To the extent contamination or other environmental issues have occurred in the past, we believe we may be able to recover restoration costs from third parties, such as the generators of hazardous waste, land sellers or others in the prior chain of title and/or insurers. Based on these practices, we anticipate that it is unlikely that environmental clean-up costs will have a material effect on our future consolidated financial position or results of operations. We have not been notified by any governmental agency of any claim that any of the properties owned or formerly owned by us are identified by the U.S. Environmental Protection Agency (“EPA”) as being a “Superfund” clean-up site requiring remediation, which could have a material effect on our future consolidated financial position or results of operations. Costs associated with the use of environmental consultants are not material to our consolidated financial position or results of operations.
 
Access to Our Information
 
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Our SEC filings are available to the public over the Internet at the SEC’s website at http://www.sec.gov. The public may also read and copy any document we file at the SEC’s public reference room located at 100 F Street N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room.
 
We encourage the public to read our periodic and current reports. Copies of these filings, as well as any future filings, may be obtained, at no cost, through our website http://www.kbhome.com or by writing to our investor relations department at investorrelations@kbhome.com or at our principal executive offices.
 
Item 1A.  RISK FACTORS  
 
In addition to the risks and the challenging market conditions previously mentioned, the following important factors could adversely impact our business. These factors could cause our actual results to differ materially from the forward-looking and other statements that we make in registration statements, periodic reports and other filings with the SEC, and that we make from time to time in our news releases, annual reports and other written communications, as well as oral forward-looking and other statements made from time to time by our representatives.
 
The homebuilding industry is experiencing a severe downturn that may continue for an indefinite period and adversely affect our business and results of operations compared to prior periods.
 
In 2007, many of our served markets and the U.S. homebuilding industry as a whole continued to experience a significant and sustained decrease in demand for new homes and an oversupply of new and existing homes available for sale, conditions that generally began in 2006. In many markets, a rapid increase in new and existing home prices in the years leading up to and including 2006 reduced housing affordability relative to consumer incomes and tempered buyer


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demand. At the same time, investors and speculators reduced their purchasing activity and instead stepped up their efforts to sell residential property they had earlier acquired. These trends, which were more pronounced in markets that had experienced the greatest levels of price appreciation, resulted in overall fewer home sales, greater cancellations of home purchase agreements by buyers, higher inventories of unsold homes and the increased use by homebuilders, speculators, investors and others of discounts, incentives, price concessions and other marketing efforts to close home sales in 2007 compared to the past several years.
 
Reflecting these demand and supply trends, we, like many other homebuilders, experienced a large drop in net orders, a decline in the selling price of new homes sold and a reduction in our margins in 2007 relative to prior years. We can provide no assurances that the homebuilding market will improve in the near future. In fact, we expect the weakness to continue at least through 2008 and have an adverse effect on our business and our results of operations.
 
Our strategies in responding to the adverse conditions in the homebuilding industry have had limited success, and the continued implementation of these and other strategies may not be successful.
 
While we have been successful in generating positive operating cash flow and reducing our inventories in 2007, we have done so at significantly reduced gross profit levels and have incurred significant asset impairment charges. These contributed to the net loss we recognized in 2007. Also, in 2007, notwithstanding our sales strategies, we continued to experience an elevated rate of sales contract cancellations. We believe that the elevated cancellation rate largely reflects a decrease in homebuyer confidence, with continued price declines and increases in the level of sales incentives for both new and existing homes prompting homebuyers to forgo or delay home purchases. A more restrictive mortgage lending environment and the inability of some buyers to sell their existing homes have also led to cancellations. Many of the factors that affect new orders and cancellation rates are beyond our control. It is uncertain how long the reduced sales levels and the increased level of cancellations will continue.
 
Our business is cyclical and is significantly affected by changes in general and local economic conditions.
 
Our business can be substantially affected by adverse changes in general economic or business conditions that are outside of our control, including changes in:
 
  •  short- and long-term interest rates;
 
  •  the availability of financing for homebuyers;
 
  •  consumer confidence generally and the confidence of potential homebuyers in particular;
 
  •  federal mortgage financing programs and federal and state regulation of lending practices;
 
  •  federal and state income tax provisions, including provisions for the deduction of mortgage interest payments;
 
  •  housing demand from population growth and demographic changes, among other factors;
 
  •  the supply of available new or existing homes and other housing alternatives, such as apartments and other residential rental property;
 
  •  employment levels and job and personal income growth; and
 
  •  real estate taxes.
 
Adverse changes in these conditions may affect our business nationally or may be more prevalent or concentrated in particular regions or localities in which we operate. In 2007, adverse changes in many of these factors affected all of our markets, and we expect the widespread nature of the downturn in the housing market to continue at least through 2008. A downturn in the economy would likely exacerbate the adverse trends the housing market experienced in 2007.
 
Weather conditions and natural disasters, such as earthquakes, hurricanes, tornadoes, floods, droughts, fires and other environmental conditions, can also harm our homebuilding business on a local or regional basis. Civil unrest or acts of terrorism can also have an adverse effect on our business.


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Fluctuating lumber prices and shortages, as well as shortages or price fluctuations in other building materials or commodities, can have an adverse effect on our business. Similarly, labor shortages or unrest among key trades, such as carpenters, roofers, electricians and plumbers, can delay the delivery of our homes and increase our costs.
 
The potential difficulties described above can cause demand and prices for our homes to diminish or cause us to take longer and incur more costs to build our homes. We may not be able to recover these increased costs by raising prices because of market conditions and because the price of each home is usually set several months before the home is delivered, as our customers typically sign their home purchase contracts before construction begins. The potential difficulties described above could cause some homebuyers to cancel or refuse to honor their home purchase contracts altogether. In fact, reflecting the difficult conditions in our served markets, we continued to experience elevated cancellation rates in 2007 and we may experience similar cancellation rates in 2008.
 
Supply shortages and other risks related to demand for building materials and/or skilled labor could increase costs and delay deliveries.
 
The homebuilding industry is highly competitive for skilled labor and building materials. Increased costs or shortages in building materials or skilled labor could cause increases in construction costs and construction delays. We generally are unable to pass on increases in construction costs to customers who have already entered into sales contracts, as the sales contracts generally fix the price of the home at the time the contract is signed, and may be signed well in advance of when construction commences. Sustained increases in construction costs may, over time, erode our margins, and pricing competition for materials and labor may restrict our ability to pass on any additional costs, thereby decreasing our margins.
 
Inflation may adversely affect us by increasing costs that we may not be able to recover, particularly if sales prices decrease.
 
Inflation can have a long-term impact on us because increasing costs of land, materials and labor may call for us to increase sales prices of homes in order to maintain satisfactory margins. However, if the current challenging and highly competitive conditions in the homebuilding market persist, we may be required to decrease prices in an attempt to stimulate sales volume. This potential lowering of sales prices, in addition to impacting our margins on new homes, may also reduce the value of our land inventory and make it more difficult for us to recover the full cost of previously purchased land in new home sales prices or, if we choose, in the disposition of land assets. In addition, depressed land values may cause us to forfeit deposits on land option contracts if we cannot satisfactorily renegotiate the purchase price of the optioned land. We may incur non-cash charges for inventory impairments or land option contract abandonments if the value of our inventory is so reduced or if we choose not to exercise land option contracts.
 
Reduced home sales may impair our ability to recoup development costs or force us to absorb additional costs.
 
We incur many costs even before we begin to build homes in a community. Depending on the stage of development, these include costs of preparing land and installing roads, sewage and other utilities, as well as taxes and other costs related to ownership of the land on which we plan to build homes. Reducing the rate at which we build homes extends the length of time it takes us to recover these costs. Also, we frequently acquire options to purchase land and make deposits that will be forfeited if we do not exercise the options within specified periods. Because of current market conditions, we have had to terminate some of these options, resulting in the forfeiture of deposits and unrecoverable development costs.
 
The value of the land and housing inventory we own or control may fall significantly and our profits may decrease.
 
The value of the land and housing inventory we currently own or control depends on market conditions, including estimates of future demand for, and the revenues that can be generated from, such inventory. The market value of our land inventory can vary considerably because there is often a significant amount of time between our initial acquisition of land and the delivery of homes on that land. The downturn in the housing market has caused the fair market value of certain of our inventory to fall, in some cases well below the estimated fair market value at the time we acquired it. Depending on our assessment of fair market value, we may need to write down the carrying value of certain of our inventory and take corresponding non-cash charges against our earnings to reflect the impaired value. We may also abandon our interests in certain land inventory that no longer meets our internal investment standards, which would also require us to take non-cash charges. If the current downturn in the housing market continues, we may need to take additional charges against


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our earnings for abandonments or inventory impairments, or both. Any such non-cash charges would have an adverse effect on our consolidated results of operations.
 
If new home prices decline, interest rates increase or there is a downturn in the economy, some homebuyers may cancel their home purchases because the required deposits are small and generally refundable.
 
Our backlog numbers reflect the number of homes for which we have entered into a purchase contract with a customer but not yet delivered the home. Our home purchase contracts typically require only a small deposit, and in many states, the deposit is fully refundable at any time prior to closing. If the prices for new homes decline, competitors increase their use of sales incentives, interest rates increase, the availability of mortgage financing diminishes or there is a downturn in local or regional economies or the national economy, homebuyers may terminate their existing home purchase contracts with us in order to negotiate for a lower price or to explore other options. In 2007 and 2006, we experienced elevated cancellation rates, in part because of these reasons. Additional cancellations could have an adverse effect on our business and our results of operations.
 
Our long-term success depends on the availability of improved lots and undeveloped land that meet our land investment criteria.
 
The availability of finished and partially developed lots and undeveloped land for purchase that meet our internal investment criteria depends on a number of factors outside our control, including land availability in general, competition with other homebuilders and land buyers for desirable property, inflation in land prices, zoning, allowable housing density and other regulatory requirements. Should suitable lots or land become less available, the number of homes we may be able to build and sell could be reduced, and the cost of land could increase, perhaps substantially, which could adversely impact our results of operations.
 
Home prices and sales activity in the particular markets and regions in which we do business affect our results of operations because our business is concentrated in these markets.
 
Home prices and sales activity in some of our key markets have declined from time to time for market-specific reasons, including adverse weather, lack of affordability or economic contraction due to, among other things, the failure or decline of key industries and employers. If home prices or sales activity decline in one or more of the key markets in which we operate, particularly in Arizona, California, Florida, Nevada or Texas, our costs may not decline at all or at the same rate and, as a result, our overall results of operations may be adversely affected.
 
Market conditions in the mortgage lending and mortgage finance industries deteriorated significantly in 2007, which adversely affected the availability of credit for some purchasers of our homes, reduced the population of potential mortgage customers and reduced mortgage liquidity. Further tightening of mortgage lending or mortgage financing requirements or further reduced mortgage liquidity could adversely affect the availability of credit for some purchasers of our homes and thereby reduce our sales.
 
During 2007, the mortgage lending and mortgage finance industries experienced significant instability due to, among other things, defaults on subprime loans and a resulting decline in the market value of such loans. In light of these developments, lenders, investors, regulators and other third parties questioned the adequacy of lending standards and other credit requirements for several loan programs made available to borrowers in recent years. This has led to reduced investor demand for mortgage loans and mortgage-backed securities, tightened credit requirements, reduced liquidity, increased credit risk premiums and regulatory actions. Deterioration in credit quality among subprime and other nonconforming loans has caused most lenders to eliminate subprime mortgages and most other loan products that do not conform to Fannie Mae, Freddie Mac, FHA or VA standards. Fewer loan products and tighter loan qualifications in turn make it more difficult for some categories of borrowers to finance the purchase of our homes or the purchase of existing homes from potential move-up buyers who wish to purchase one of our homes. In general, these developments have resulted in a reduction in demand for the homes we sell and have delayed any general improvement in the housing market. Furthermore, they have resulted in a reduction in demand for the mortgage loans that we originate through Countrywide KB Home Loans, our joint venture with Countrywide. These reductions in demand have had, and are expected to continue to have, a materially adverse effect on our business and results of operations in 2008.


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Many of our homebuyers obtain financing for their home purchases from Countrywide KB Home Loans. Countrywide provides the loan products that the joint venture offers to our homebuyers. If Countrywide refuses or is unable to make loan products available to the joint venture to provide to our homebuyers, our results of operations may be adversely affected.
 
Interest rate increases or changes in federal lending programs could lower demand for our homes.
 
Nearly all of our customers finance the purchase of their homes. In recent years, historically low interest rates and the increased availability of specialized mortgage products, including mortgage products requiring no or low down payments, and interest-only and adjustable rate mortgages, had made homebuying more affordable for a number of customers. Increases in interest rates or decreases in the availability of mortgage financing or of certain mortgage programs, as discussed above, may lead to higher down payment requirements or monthly mortgage costs, or both, and could therefore reduce demand for our homes.
 
Increased interest rates can also hinder our ability to realize our backlog because our home purchase contracts provide our customers with a financing contingency. Financing contingencies allow customers to cancel their home purchase contracts in the event they cannot arrange for financing.
 
Because the availability of Fannie Mae, Freddie Mac, FHA and VA mortgage financing is an important factor in marketing and selling many of our homes, any limitations or restrictions in the availability of such government-backed financing could reduce our home sales.
 
Tax law changes could make home ownership more expensive or less attractive.
 
Significant expenses of owning a home, including mortgage interest expense and real estate taxes, generally are deductible expenses for the purpose of calculating an individual’s federal, and in some cases state, taxable income, subject to various limitations, under current tax law and policy. If the federal government or a state government changes income tax laws, as some policy makers have discussed recently, eliminating or substantially reducing these income tax deductions, the after-tax cost of owning a new home would increase substantially. This could adversely impact demand for and/or sales prices of new homes.
 
We are subject to substantial legal and regulatory requirements regarding the development of land, the homebuilding process and protection of the environment, which can cause us to suffer delays and incur costs associated with compliance and which can prohibit or restrict homebuilding activity in some regions or areas.
 
Our homebuilding business is heavily regulated and subject to an increasing amount of local, state and federal regulation concerning zoning, resource protection and other environmental impacts, building design, construction and similar matters. These regulations often provide broad discretion to governmental authorities that oversee these matters, which can result in unanticipated delays or increases in the cost of a specified project or a number of projects in particular markets. We may also experience periodic delays in homebuilding projects due to building moratoria in any of the areas in which we operate.
 
We are also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the environment. These laws and regulations may cause delays in construction and delivery of new homes, may cause us to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas. In addition, environmental laws may impose liability for the costs of removal or remediation of hazardous or toxic substances whether or not the developer or owner of the property knew of, or was responsible for, the presence of those substances. The presence of those substances on our properties may prevent us from selling our homes and we may also be liable, under applicable laws and regulations or lawsuits brought by private parties, for hazardous or toxic substances on properties and lots that we have sold in the past.
 
Further, a significant portion of our business is conducted in California, which is one of the most highly regulated and litigious states in the country. Therefore, our potential exposure to losses and expenses due to new laws, regulations or litigation may be greater than other homebuilders with a less significant California presence.
 
The mortgage banking operations of Countrywide KB Home Loans are heavily regulated and subject to the rules and regulations promulgated by a number of governmental and quasi-governmental agencies. There are a number of


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federal and state statutes and regulations which, among other things, prohibit discrimination, establish underwriting guidelines that include obtaining inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. A finding that we or Countrywide KB Home Loans materially violated any of the foregoing laws could have an adverse effect on our results of operations.
 
We are subject to a Consent Order that we entered into with the Federal Trade Commission in 1979 and related Consent Decrees that were entered into in 1991 and 2005. Pursuant to the Consent Order and the related Consent Decrees, we provide explicit warranties on the quality of our homes, follow certain guidelines in advertising and provide certain disclosures to prospective purchasers of our homes. A finding that we have significantly violated the Consent Order and/or the related Consent Decrees could result in substantial liabilities or penalties and could limit our ability to sell homes in certain markets.
 
Homebuilding and financial services are very competitive, and competitive conditions could adversely affect our business or our financial results.
 
The homebuilding industry is highly competitive. Homebuilders compete not only for homebuyers, but also for desirable land, financing, building materials, skilled management and trade labor. We compete in each of our served markets with other local, regional and national homebuilders, including those with a sales presence on the Internet, often within larger subdivisions containing portions designed, planned and developed by such homebuilders. These homebuilders may also have long-standing relationships with local labor, materials suppliers or land sellers, which may provide an advantage in their respective regions or local markets. We also compete with other housing alternatives, such as existing home sales and rental housing. The competitive conditions in the homebuilding industry can result in:
 
  •  fewer homes delivered;
 
  •  lower selling prices;
 
  •  our offering or increasing sales incentives, discounts or price concessions;
 
  •  lower profit margins;
 
  •  declining new home sales or increasing cancellations by homebuyers of their home purchase contracts with us;
 
  •  impairments in the value of our inventory, goodwill and other assets;
 
  •  difficulty in acquiring desirable land that meets our land buying criteria, and in selling our interests in land that no longer meet our investment return criteria on favorable terms;
 
  •  difficulty in acquiring raw materials and skilled management and labor at acceptable prices; or
 
  •  delays in construction of our homes.
 
Our financial services business competes with other mortgage lenders, including national, regional and local mortgage banks and other financial institutions. Mortgage lenders with greater access to capital or different lending criteria may be able to offer more attractive financing to potential customers.
 
When we are affected by these competitive conditions, our business and financial results can be adversely affected by decreased revenues, increased costs and/or diminished growth in our local or regional homebuilding business. In the current downturn in the homebuilding industry, the reactions of our competitors may be reducing the effectiveness of our efforts to achieve pricing stability and reduce our inventory levels.
 
Homebuilding is subject to warranty and liability claims in the ordinary course of business that can be significant.
 
In the ordinary course of our homebuilding business, we are subject to home warranty and construction defect claims. We record warranty and other reserves for the homes we sell based on historical experience in our markets and our judgment of the qualitative risks associated with the types of homes we build. We have, and require the majority of our subcontractors to have, general liability, property, errors and omissions, workers compensation and other business insurance. These insurance policies protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles, and other coverage limits. Through our captive insurance subsidiary, we reserve for costs to cover our self-


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insured and deductible amounts under these policies and for any costs of claims and lawsuits, based on an analysis of our historical claims, which includes an estimate of claims incurred but not yet reported. Because of the uncertainties inherent to these matters, we cannot provide assurance that our insurance coverage, our subcontractor arrangements and our reserves will be adequate to address all our warranty and construction defect claims in the future. Additionally, the coverage offered by and the availability of general liability insurance for construction defects are currently limited and costly. There can be no assurance that coverage will not be further restricted and become more costly.
 
Because of the seasonal nature of our business, our quarterly operating results fluctuate.
 
We have experienced seasonal fluctuations in quarterly operating results. We typically do not commence significant construction on a home before a home purchase contract has been signed with a homebuyer. Historically, a significant percentage of our home purchase contracts are entered into in the spring and summer months, and a corresponding significant percentage of our deliveries occur in the fall and winter months. Construction of our homes typically requires approximately four months and weather delays that often occur in late winter and early spring may extend this period. As a result of these combined factors, we historically have experienced uneven quarterly results, with lower revenues and operating income generally during the first and second quarters of the year. However, the increasingly challenging market conditions we experienced in 2007 resulted in lower sales in the spring and summer months and correspondingly lower deliveries in the fall and winter months as compared to 2006. With the current difficult market conditions expected to continue through at least 2008, we can make no assurances that our normal seasonal patterns will occur in the near future.
 
Failure to comply with the covenants and conditions imposed by the agreements governing our indebtedness could restrict future borrowing or cause our debt to become immediately due and payable.
 
Our Credit Facility and the indentures governing our outstanding senior and senior subordinated public notes impose restrictions on our operations and activities. The most significant restrictions relate to limits on investments, cash dividends, stock repurchases and other restricted payments, incurrence of indebtedness, creation of liens and asset dispositions, and require maintenance of a maximum debt to equity (or leverage) ratio, a minimum interest coverage ratio, and a minimum level of tangible net worth. If we fail to comply with these restrictions or covenants, the holders of those debt instruments or the banks, as appropriate, could cause our debt to become due and payable prior to maturity or could demand that we compensate them for waiving instances of noncompliance. In addition, a default under the indenture for any of our notes or our Credit Facility could cause a default with respect to our other notes or the Credit Facility, as the case may be, and result in the acceleration of the maturity of all such defaulted indebtedness and our inability to borrow under the Credit Facility. Moreover, we may curtail our investment activities and other uses of cash to maintain compliance with these restrictions and covenants.
 
Our leverage may place burdens on our ability to comply with the terms of our indebtedness, may restrict our ability to operate and may prevent us from fulfilling our obligations.
 
The amount of our debt could have important consequences. For example, it could:
 
  •  limit our ability to obtain future financing for working capital, capital expenditures, acquisitions, debt service requirements or other requirements;
 
  •  require us to dedicate a substantial portion of our cash flow from operations to the payment of our debt and reduce our ability to use our cash flow for other purposes;
 
  •  impact our flexibility in planning for, or reacting to, changes in our business;
 
  •  place us at a competitive disadvantage because we have more debt than some of our competitors; and
 
  •  make us more vulnerable in the event of a downturn in our business or in general economic conditions.
 
Our ability to meet our debt service and other obligations will depend upon our future performance. Our business is substantially affected by changes in economic cycles. Our revenues, earnings and cash flows vary with the level of general economic activity and competition in the markets in which we operate. Our business could also be affected by financial, political and other factors, many of which are beyond our control. Changes in prevailing interest rates may also affect our ability to meet our debt service obligations because borrowings under our Credit Facility bear interest at floating rates. A higher interest rate on our debt could adversely affect our operating results.


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Our business may not generate sufficient cash flow from operations and borrowings may not be available to us under our Credit Facility in an amount sufficient to pay our debt service obligations, fulfill financial or operational guarantees we have provided for certain unconsolidated joint venture transactions, or to fund our other liquidity needs. Should this occur, we may need to refinance all or a portion of our debt on or before maturity, which we may not be able to do on favorable terms or at all.
 
We may have difficulty in continuing to obtain the additional financing required to operate and develop our business.
 
Our homebuilding operations require significant amounts of cash and/or available credit. It is not possible to predict the future terms or availability of additional capital. Moreover, our outstanding public debt and the Credit Facility contain provisions that may restrict the amount and nature of debt we may incur in the future. The Credit Facility limits our ability to borrow additional funds by placing a maximum cap on our leverage ratio. Under the most restrictive of these provisions, at November 30, 2007, we would have been permitted to incur up to $3.56 billion of total consolidated indebtedness, as defined in the Credit Facility. This maximum amount exceeded our actual total consolidated indebtedness at November 30, 2007 by $2.68 billion. In addition, the Credit Facility limits our ability to borrow senior indebtedness, as defined in the Credit Facility, subject to a specified borrowing base. At November 30, 2007, we would have been permitted to incur up to $3.32 billion of senior indebtedness under the Credit Facility. This maximum amount exceeded our actual total senior indebtedness at November 30, 2007 by $1.66 billion. There can be no assurance that we can actually borrow up to these maximum amounts of total consolidated indebtedness or senior indebtedness at any time, as our ability to borrow additional funds, and to raise additional capital through other means, also depends on conditions in the capital markets and our credit worthiness. If conditions in the capital markets change significantly, it could reduce our ability to generate sales and may hinder our future growth and results of operations.
 
We are involved in government investigations and litigation relating to our past stock option grant practices.
 
The SEC and the U.S. Department of Justice (“DOJ”) are conducting investigations into our stock option grant practices. In addition, shareholder derivative lawsuits have been filed in California state and federal courts relating to our stock option grant practices. It is possible that additional lawsuits may be filed. The investigations and lawsuits have resulted in, and will continue to result in, substantial legal and professional fees, and will continue to occupy our time and attention. An adverse outcome to the investigations or one or more of the lawsuits may have a negative effect on our business and our results of operations.
 
Item 1B.  UNRESOLVED STAFF COMMENTS  
 
None.
 
Item 2.  PROPERTIES  
 
We lease our corporate headquarters in Los Angeles, California. Our homebuilding division offices, except for our San Antonio, Texas office, and our KB Home Studios are located in leased space in the markets where we conduct business. Our homebuilding operations in San Antonio, Texas are principally conducted from premises that we own.
 
We believe that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of our businesses.
 
Item 3.  LEGAL PROCEEDINGS  
 
Derivative Litigation
 
On July 10, 2006, a shareholder derivative action, Wildt v. Karatz, et al ., was filed in Los Angeles Superior Court. On August 8, 2006, a virtually identical shareholder derivative lawsuit, Davidson v. Karatz, et al ., was also filed in Los Angeles Superior Court. These actions, which ostensibly are brought on our behalf, allege, among other things, that defendants (various of our current and former directors and officers) breached their fiduciary duties to us by, among other things, backdating grants of stock options to various current and former executives in violation of our shareholder-approved stock option plans. Defendants have not yet responded to the complaints. On January 22, 2007, the Court entered an order, pursuant to an agreement among the parties and us, providing, among other things, that, to preserve the


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status quo without prejudicing any party’s substantive rights, our former Chairman and Chief Executive Officer shall not exercise any of his outstanding options, at any price, during the period in which the order is in effect. Pursuant to further stipulated orders, these terms remain in effect and are now scheduled to expire on February 1, 2008, unless otherwise agreed in writing. The plaintiffs have agreed to stay their cases while the parallel federal court derivative lawsuits discussed below are pursued. A stipulation and order effectuating the parties’ agreement to stay the state court actions was entered by the court on February 7, 2007. The parties may extend the agreement that options will not be exercised by our former Chairman and Chief Executive Officer beyond the current February 1, 2008 expiration date.
 
On August 16, 2006, a shareholder derivative lawsuit, Redfield v. Karatz, et al. , was filed in the United States District Court for the Central District of California. On August 31, 2006, a virtually identical shareholder derivative lawsuit, Staehr v. Karatz, et al ., was also filed in the United States District Court for the Central District of California. These actions, which ostensibly are brought on our behalf, allege, among other things, that defendants (various of our current and former directors and officers) breached their fiduciary duties to us by, among other things, backdating grants of stock options to various current and former executives in violation of our shareholder-approved stock option plans. Unlike Wildt and Davidson , however, these lawsuits also include substantive claims under the federal securities laws. On January 9, 2007, plaintiffs filed a consolidated complaint. All defendants filed motions to dismiss the complaint on April 2, 2007. Subsequently, plaintiffs filed a motion for partial summary judgment against certain of the defendants. Pursuant to stipulated orders, the motions to dismiss and the motion for partial summary judgment have been taken off calendar to permit the parties to explore settlement via mediation. The latest order provides that unless otherwise agreed to by the parties or order by the court, the motions shall be back on calendar as of late March 2008. Discovery has not commenced.
 
Government Investigations
 
In August 2006, we announced that we had received an informal inquiry from the SEC relating to our stock option grant practices. In January 2007, we were informed that the SEC is conducting a formal investigation of this matter. The DOJ is also looking into these practices but has informed KB Home that it is not a target of this investigation. We have cooperated with these government agencies and intend to continue to do so.
 
ERISA Litigation
 
A complaint dated March 14, 2007 in 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. , was filed in the United States District Court for the Central District of California. The action is brought against us, our directors, and certain of our current and former officers. Plaintiffs allege that they are bringing the action on behalf of all participants in the KB Home 401(k) Savings Plan (the “401(k) Plan”). Plaintiffs allege that the defendants breached fiduciary duties owed to members of the 401(k) Plan by virtue of issuing backdated option grants and failing to disclose this information to the 401(k) Plan participants. Plaintiffs claim that this conduct unjustly enriched certain defendants to the detriment of the 401(k) Plan and its participants, and caused the 401(k) Plan to invest in our securities at allegedly artificially inflated prices. The action purports to assert three causes of action for various alleged breaches of fiduciary duty. We have filed a motion to dismiss all claims alleged against us. The Court heard oral argument on the motion on November 19, 2007, after which the Court took the motion under submission. The Court has not yet ruled on the motion, and because of the pendency of the motion, no discovery has been taken in the action.
 
Storm Water Matter
 
In January 2003, we received a request for information from the EPA pursuant to Section 308 of the Clean Water Act. Several other public homebuilders have received similar requests. The request sought information about storm water pollution control program implementation at certain of our construction sites, and we provided information pursuant to the request. In May 2004, on behalf of the EPA, the DOJ tentatively asserted that certain regulatory requirements applicable to storm water discharges had been violated on certain occasions at certain of our construction sites, and civil penalties and injunctive relief might be warranted. The DOJ has also proposed certain steps it would expect us to take in the future relating to compliance with the EPA’s requirements applicable to storm water discharges. We have defenses to the claims that have been asserted and are exploring with the EPA, DOJ and other homebuilders methods of resolving the matter. To resolve the matter, the DOJ will want us to pay civil penalties and sign a consent decree affecting our storm water pollution practices at construction sites.


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Other Matters
 
We are also involved in litigation and governmental proceedings incidental to our business. These cases are in various procedural stages and, based on reports of counsel, we believe that provisions or reserves made for potential losses are adequate and any liabilities or costs arising out of currently pending litigation should not have a materially adverse effect on our consolidated financial position or results of operations.
 
Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted during the fourth quarter of 2007 to a vote of security holders, through the solicitation of proxies or otherwise.


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EXECUTIVE OFFICERS OF THE REGISTRANT
 
The following sets forth certain information regarding our executive officers as of December 31, 2007:  
 
                                     
              Year
    Years
       
              Assumed
    at
  Other Positions and Other
   
          Present Position at
  Present
    KB
  Business Experience within the
   
Name  
Age
    December 31, 2007  
Position
   
Home
  Last Five Years (a)  
From – To
 
Jeffrey T. Mezger
    52    
President and Chief
Executive Officer (b)
    2006       14    
Executive Vice President and Chief Operating Officer
  1999-2006
                                   
Domenico Cecere
    58    
Executive Vice President and
Chief Financial Officer
    2007        6    
Senior Vice President and Chief Financial Officer
  2002-2006
                                   
Wendy C. Shiba
    57    
Executive Vice President, General Counsel and Secretary
    2007       1    
Senior Vice President, Chief Legal Officer and Secretary, Polyone Corporation (specialized polymer materials, services and solutions)
  2006-2007
                               
Vice President, Chief Legal Officer and Secretary, Polyone Corporation
  2001-2006
                                   
Glen Barnard
    63    
Senior Vice President, KBnxt Group
    2006       9    
Regional General Manager (c)
  2004-2006
                               
Chief Executive Officer, Constellation Real Technologies (real estate consortium)
  2001-2003
                                     
                                   
William R. Hollinger
    49    
Senior Vice President and
    2007       20    
Senior Vice President and Controller
  2001-2006
           
  Chief Accounting Officer
                       
                                     
                                   
Kelly Masuda
    40    
Senior Vice President and
Treasurer
    2005       4    
Senior Vice President, Capital Markets and Treasurer
  2005
                               
Vice President, Capital Markets and Treasurer
  2003-2005
                               
Director, Credit Suisse First Boston (investment bank)
  2000-2002
                                     
                                   
John Staines
    45    
Senior Vice President, Human Resources
    2007       1    
Senior Vice President, Human Resources, DaVita, Inc. (kidney dialysis center operator)
  2006
                               
Vice President, Human Resources, Global Supply Chain, The Gap Inc. (clothing retailer)
  2004-2006
                               
Vice President, Human Resources, Mattel, Inc. (toy manufacturer)
  2001-2004
(a)   All positions described were with us, unless otherwise indicated.
 
(b)   Mr. Mezger has served as a director since 2006.
 
(c)   Mr. Barnard was a senior executive with us from 1996-2001, and rejoined us in 2004.
 
There is no family relationship between any of our executive officers or between any of our executive officers and any of our directors.


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PART II
 
Item 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
As of December 31, 2007, there were 880 holders of record of our common stock. Our common stock is traded on the New York Stock Exchange under the ticker symbol “KBH.” The following table sets forth, for the periods indicated, the price ranges of our common stock:
 
                                 
    2007     2006  
    High     Low     High     Low  
 
First Quarter
  $ 56.08     $ 47.69     $ 81.99     $ 64.80  
Second Quarter
    50.90       40.89       69.10       50.40  
Third Quarter
    47.57       28.00       52.65       37.89  
Fourth Quarter
    31.69       18.44       52.18       38.66  
 
 
We paid quarterly cash dividends of $.25 per common share in 2007 and 2006.
 
The declaration and payment of cash dividends on shares of our common stock, whether at current levels or at all, are at the discretion of our board of directors, and depend upon, among other things, our future earnings, cash flows, capital requirements, operational investment strategy, and our general financial condition and general business conditions. In addition, debt instruments to which we are a party contain restrictions on the payment of cash dividends. Based on the most restrictive of these provisions, $283.2 million was available for payment of cash dividends at November 30, 2007.
 
The description of our equity compensation plans required by Item 201(d) of Regulation S-K is incorporated herein by reference to Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Form 10-K.
 
The following table summarizes our purchases of our own equity securities during the three months ended November 30, 2007:
 
                           
                  Maximum
                  Number of Shares
              Total Number of
  That May Yet be
              Shares Purchased as
  Purchased
    Total Number
  Average
    Part of Publicly
  Under the
    of Shares
  Price Paid
    Announced
  Plans or
Period
  Purchased   per Share     Plans or Programs   Programs
 
September 1 - 30
      $           4,000,000
October 1 - 31
    73,049     27.19           4,000,000
November 1 - 30
                  4,000,000
                           
Total
    73,049   $   27.19            
                           
 
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 November 30, 2007, we were authorized to repurchase four million shares under this share repurchase program. During the three months ended November 30, 2007, no shares were repurchased pursuant to this share repurchase program. The 73,049 shares purchased during the three months ended November 30, 2007 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 pursuant to the share repurchase program.


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Stock Performance Graph
 
The graph below compares the cumulative total return of KB Home common stock, the S&P Homebuilding Index, the Dow Jones Home Construction Index and the S&P 500 Index for the last five year-end periods ended November 30.
 
Comparison of Five-Year Cumulative Total Return
Among KB Home, S&P Homebuilding
Index, Dow Jones Home Construction Index and S&P 500 Index
 
COMMON STOCK PRICE PERFORMANCE GRAPH
 
The above graph is based on the KB Home common stock and index prices calculated as of the last trading day before December 1 st of the year-end periods presented. Our November 30, 2007 closing common stock price on the New York Stock Exchange was $20.89 per share. On December 31, 2007, our common stock closed at $21.60 per share. The performance of our common stock depicted in the graphs above represents past performance only and is not indicative of future performance. Total return assumes $100 invested at market close on November 30, 2002 in KB Home common stock, the S&P Homebuilding Index, the Dow Jones Home Construction Index and the S&P 500 Index including reinvestment of dividends.


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Item 6.  SELECTED FINANCIAL DATA
 
The data in this table should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and Notes thereto included later in this report.
 
KB HOME
SELECTED FINANCIAL INFORMATION
(In Thousands, Except Per Share Amounts)
 
                                         
    Years Ended November 30,  
    2007     2006     2005     2004     2003  
 
Homebuilding:
                                       
Revenues
  $ 6,400,591     $ 9,359,843     $ 8,123,313     $ 5,974,496     $ 4,870,522  
Operating income (loss)
    (1,358,335 )     570,316       1,188,935       637,229       469,426  
Total assets
    5,661,564       7,825,339       6,881,486       4,760,288       3,307,164  
Mortgages and notes payable
    2,161,794       2,920,334       2,211,935       1,771,962       1,049,442  
                                         
Financial services:
                                       
Revenues
  $ 15,935     $ 20,240     $ 31,368     $ 44,417     $ 75,125  
Operating income
    11,139       14,317       10,968       8,688       35,777  
Total assets
    44,392       44,024       29,933       210,460       253,113  
Notes payable
                      71,629       132,225  
                                         
Discontinued operations:
                                       
Total assets
  $     $ 1,394,375     $ 1,102,898     $ 1,020,082     $ 810,661  
                                         
Consolidated:
                                       
Revenues
  $ 6,416,526     $ 9,380,083     $ 8,154,681     $ 6,018,913     $ 4,945,647  
Operating income (loss)
    (1,347,196 )     584,633       1,199,903       645,917       505,203  
Income (loss) from continuing operations
    (1,414,770 )     392,947       754,534       430,384       332,610  
Income from discontinued operations, net of income taxes (a)
    485,356       89,404       69,178       43,652       35,311  
Net income (loss)
    (929,414 )     482,351       823,712       474,036       367,921  
Total assets
    5,705,956       9,263,738       8,014,317       5,990,830       4,370,938  
Mortgages and notes payable
    2,161,794       2,920,334       2,211,935       1,843,591       1,181,667  
Stockholders’ equity
    1,850,687       2,922,748       2,773,797       2,039,390       1,592,162  
                                         
                                         
Basic earnings (loss) per share:
                                       
Continuing operations
  $ (18.33 )   $ 4.99     $ 9.21     $ 5.49     $ 4.22  
Discontinued operations
    6.29       1.13       .85       .56       .45  
                                         
Basic earnings (loss) per share
  $ (12.04 )   $ 6.12     $ 10.06     $ 6.05     $ 4.67  
                                         
Diluted earnings (loss) per share:
                                       
Continuing operations
  $ (18.33 )   $ 4.74     $ 8.54     $ 5.10     $ 3.95  
Discontinued operations
    6.29       1.08       .78       .52       .42  
                                         
Diluted earnings (loss) per share
  $ (12.04 )   $ 5.82     $ 9.32     $ 5.62     $ 4.37  
                                         
                                         
Cash dividends per common share
  $ 1.00     $ 1.00     $ .75     $ .50     $ .15  
                                         
 
(a)  Discontinued operations are comprised of our French operations, which have been presented as discontinued operations for all periods presented. Income from discontinued operations, net of income taxes, in 2007 includes a gain of $438.1 million realized on the sale of our French operations.


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Item 7.   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. On July 10, 2007, we sold our 49% equity interest in our publicly traded French subsidiary, KBSA. Accordingly, our French operations are presented as discontinued operations in this report and the financial results of prior periods have been reclassified to conform to the current year presentation. The following table presents a summary of our consolidated results of operations for the years ended November 30, 2007, 2006 and 2005 (in thousands, except per share amounts):
 
                         
    Years ended November 30,  
    2007     2006     2005  
 
Revenues:
                       
Homebuilding
  $ 6,400,591     $ 9,359,843     $ 8,123,313  
Financial services
    15,935       20,240       31,368  
                         
Total
  $ 6,416,526     $ 9,380,083     $ 8,154,681  
                         
Pretax income (loss):
                       
Homebuilding
  $ (1,494,606 )   $ 538,311     $ 1,190,336  
Financial services
    33,836       33,536       11,198  
                         
Income (loss) from continuing operations before income taxes
    (1,460,770 )     571,847       1,201,534  
Income tax benefit (expense)
    46,000       (178,900 )     (447,000 )
                         
Income (loss) from continuing operations
    (1,414,770 )     392,947       754,534  
Income from discontinued operations, net of income taxes
    47,252       89,404       69,178  
Gain on sale of discontinued operations, net of income taxes
    438,104              
                         
Net income (loss)
  $ (929,414 )   $ 482,351     $ 823,712  
                         
Basic earnings (loss) per share:
                       
Continuing operations
  $ (18.33 )   $ 4.99     $ 9.21  
Discontinued operations
    6.29       1.13       .85  
                         
Basic earnings (loss) per share
  $ (12.04 )   $ 6.12     $ 10.06  
                         
Diluted earnings (loss) per share:
                       
Continuing operations
  $ (18.33 )   $ 4.74     $ 8.54  
Discontinued operations
    6.29       1.08       .78  
                         
Diluted earnings (loss) per share
  $ (12.04 )   $ 5.82     $ 9.32  
                         
 
Continuing the downward trends that began in 2006, conditions in the overall housing market were challenging throughout 2007 and became increasingly difficult as the year progressed. Several factors weighed on the housing industry during the year, including a persistent oversupply of new and resale homes available for sale that reached historically high levels; rising foreclosure activity; heightened competition for home sales; reduced home affordability due largely to a record increase in average home prices during the first half of this decade; turmoil in the mortgage finance and credit markets; diminished real estate speculation; and decreased consumer confidence in purchasing homes. Our results for 2007 reflect the impact of these difficult conditions. They also reflect our efforts to reduce inventory investments and community counts to better align our operations with a housing market experiencing significantly reduced activity from the peak levels of a few years ago.
 
With the prolonged market downturn, we have experienced successive negative year-over-year comparisons in our net orders (new orders for homes less cancellations) for the past several quarters. As a result, our current backlog levels are significantly below year-earlier levels and we delivered fewer homes and generated less revenue in 2007 than in 2006. Our revenues in 2007 were also negatively affected by decreases in our average selling prices in three of our four homebuilding segments compared to year-earlier levels due to competitive pressures and changes in our product mix.


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At the same time, intensified competition and pricing pressures, slowing sales rates, and sustained high cancellation rates in many of our markets during 2007 lowered the fair value of certain of our assets and led us to reassess our land positions. This caused us to incur non-cash charges during the year for impairments in the value of our inventory, joint ventures and goodwill and for the abandonment of certain land option contracts. These non-cash charges and lower revenues in 2007 compressed our gross margins compared to the prior year.
 
Further impacting our results for 2007 was a substantial valuation allowance we established in the fourth quarter against certain deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). The deferred tax assets were produced largely from the inventory impairments we took during the year, and the valuation allowance was established in light of the continued downturn of the housing market and uncertainty as to its length and magnitude. To the extent that we generate sufficient taxable income in the future to utilize the tax benefits of the related deferred tax assets, we expect to experience a reduction in our effective income tax rate as the valuation allowance is reversed.
 
We reported a loss from continuing operations in 2007 resulting from the combination of fewer deliveries, lower average selling prices, compressed gross margins, non-cash charges for inventory and joint venture impairments, land option contract abandonments, goodwill impairments and the valuation allowance for deferred tax assets. We do not expect the business climate in most of the markets we serve and the overall housing market to improve in 2008.
 
Our total revenues of $6.42 billion for the year ended November 30, 2007 declined 32% from $9.38 billion in 2006, which had increased 15% from $8.15 billion in 2005. The decrease in total revenues in 2007 was primarily due to a decrease in housing revenues, reflecting fewer homes delivered and lower average selling prices compared to 2006. The increase in our revenues in 2006 was driven by an increase in housing revenues stemming from an increase in homes delivered and higher average selling prices compared to the prior year. Included in our total revenues were financial services revenues of $15.9 million in 2007, $20.2 million in 2006 and $31.4 million in 2005. The decline in financial services revenues in 2007 compared to 2006 was mainly due to fewer homes delivered from our homebuilding operations and the termination of our escrow coordination business in 2007. The decrease in financial services revenues in 2006 compared to 2005 was primarily due to the change in the mortgage banking operations of KB Home Mortgage Company (“KBHMC”) in the fourth quarter of 2005 to an unconsolidated joint venture. On September 1, 2005, we sold substantially all the mortgage banking assets of KBHMC to Countrywide and in a separate transaction established Countrywide KB Home Loans. We and Countrywide each have a 50% ownership interest in Countrywide KB Home Loans, which is accounted for as an unconsolidated joint venture in the financial services reporting segment of our consolidated financial statements.
 
Our continuing operations generated an after-tax loss of $1.41 billion in 2007 due to pretax, non-cash charges of $1.41 billion for inventory and joint venture impairments and the abandonment of land option contracts, and $107.9 million for goodwill impairment recognized during the year. The majority of the inventory and joint venture impairments related to our West Coast and Southwest reporting segments, and the goodwill impairment related solely to our Southwest reporting segment. Our 2007 loss from continuing operations also reflected a non-cash charge of $514.2 million to establish a valuation allowance for certain deferred tax assets. In 2006, we reported after-tax income from continuing operations of $392.9 million, down from $754.5 million in 2005 primarily due to a decrease in the operating margin in our homebuilding operations. Our 2006 results included charges of $431.2 million associated with inventory and joint venture impairments and land option contract abandonments, and a gain of $27.6 million related to the sale of our ownership interest in an unconsolidated joint venture. In 2007, we posted a loss per diluted share from continuing operations of $18.33 compared to earnings per diluted share from continuing operations of $4.74 in 2006 and $8.54 in 2005.
 
Income from discontinued operations, net of income taxes, totaled $485.4 million in 2007, including a $438.1 million after-tax gain on the sale of our French operations. Income from discontinued operations, net of income taxes, totaled $89.4 million in 2006 and $69.2 million in 2005. Discontinued operations are comprised solely of our French operations.
 
Overall, we posted a net loss of $929.4 million, or $12.04 per diluted share (including the French discontinued operations) in 2007. This compares to net income of $482.4 million, or $5.82 per diluted share, in 2006 and $823.7 million, or $9.32 per diluted share, in 2005.


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Our backlog at November 30, 2007 consisted of 6,322 homes, representing future housing revenues of approximately $1.50 billion. These backlog levels decreased 40% and 47%, respectively, from the 10,575 homes in backlog, representing approximately $2.83 billion in future revenues, at November 30, 2006. These decreases were due to the effects of several successive quarters of negative year-over-year net order comparisons and lower average selling prices, reflecting persistently deteriorating housing market conditions. Our homebuilding operations generated 2,574 net orders in the fourth quarter of 2007, down 32% from 3,763 net orders in the fourth quarter of 2006. Net orders in the fourth quarter of 2007 decreased year-over-year in each of our reporting segments. The fourth quarter 2007 cancellation rate of 58% was the same as the cancellation rate we experienced in the fourth quarter of 2006, but was higher than the 50% cancellation rate we experienced in the third quarter of 2007.
 
HOMEBUILDING
 
We have grouped our homebuilding activities into four reportable segments, which we refer to as West Coast, Southwest, Central and Southeast. As of November 30, 2007, our reportable homebuilding segments consisted of operations located in the following states: West Coast — California; Southwest — Arizona, Nevada and New Mexico; Central — Colorado, Illinois and Texas; Southeast — Florida, Georgia, Maryland, North Carolina, South Carolina and Virginia.
 
The following table presents a summary of selected financial and operational data for our homebuilding operations (dollars in thousands, except average selling price):
 
                                 
    Years ended November 30,        
    2007     2006     2005        
 
Revenues:
                               
Housing
  $ 6,211,563     $ 9,243,236     $ 8,099,771          
Land
    189,028       116,607       23,542          
                                 
Total
    6,400,591       9,359,843       8,123,313          
                                 
                                 
Costs and expenses:
                               
Construction and land costs
                               
Housing
    (6,563,082 )     (7,456,003 )     (5,934,948 )        
Land
    (263,297 )     (210,016 )     (19,820 )        
                                 
Total
    (6,826,379 )     (7,666,019 )     (5,954,768 )        
Selling, general and administrative expenses
    (824,621 )     (1,123,508 )     (979,610 )        
Goodwill impairment
    (107,926 )                    
                                 
                                 
Total
    (7,758,926 )     (8,789,527 )     (6,934,378 )        
                                 
                                 
Operating income (loss)
  $ (1,358,335 )   $ 570,316     $ 1,188,935          
                                 
                                 
Homes delivered
    23,743       32,124       31,009          
                                 
Average selling price
  $ 261,600     $ 287,700     $ 261,200          
                                 
Housing gross margin
    (5.7 )%     19.3 %     26.7 %        
                                 
Selling, general and administrative expenses as a percent of housing revenues
    13.3 %     12.2 %     12.1 %        
                                 
Operating income (loss) as a percent of homebuilding revenues
    (21.2 )%     6.1 %     14.6 %        
 
Revenues.   Homebuilding revenues totaled $6.40 billion in 2007, decreasing 32% from $9.36 billion in 2006, which had increased 15% from $8.12 billion in 2005. The decrease in 2007 compared to 2006 reflected lower housing revenues due to fewer homes delivered and a lower average selling price. The increase in 2006 compared to 2005 resulted primarily from higher housing revenues driven by an increase in homes delivered and a higher average selling price.


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Housing revenues totaled $6.21 billion in 2007, $9.24 billion in 2006 and $8.10 billion in 2005. In 2007, housing revenues decreased 33% from the previous year due to a 26% decline in homes delivered and a 9% decrease in the average selling price. In 2006, housing revenues increased 14% from 2005 due to a 4% increase in homes delivered and a 10% increase in the average selling price.
 
We delivered 23,743 homes in 2007, down from 32,124 homes in 2006, reflecting year-over-year decreases in each of our reporting segments. The lower delivery volume in 2007 was due, in part, to our reducing our community count to better align our operations with reduced housing market activity.
 
In 2006, we delivered 32,124 homes, up from 31,009 homes delivered in 2005. The growth in homes delivered in 2006 reflected year-over-year increases of 9% and 16% in our West Coast and Southeast segments, respectively, partially offset by decreases of 5% and 3% in homes delivered from our Southwest and Central segments, respectively.
 
Our average new home selling price decreased 9% in 2007 to $261,600 from $287,700 in 2006. Year-over-year average selling prices declined 11% in our West Coast segment, 16% in our Southwest segment and 6% in our Southeast segment due to weak consumer demand and heightened competition from homebuilders and other sellers, which put downward pressure on home prices. The average selling price in our Central segment increased 5% in 2007 from the previous year, solely due to changes in product mix.
 
Our 2006 average new home price had increased 10% from $261,200 in 2005, primarily due to the delivery in 2006 of homes purchased in the latter half of 2005, when market conditions were more favorable. Increases in our average selling prices in 2006 were more significant in the West Coast, Southwest and Southeast segments, with a slight increase in the Central segment.
 
Land sale revenues totaled $189.0 million in 2007, $116.6 million in 2006 and $23.5 million in 2005. 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. Land sale revenues were more significant in 2007 and 2006 compared to 2005 as deteriorating market conditions caused us to reassess our future sales expectations which resulted in our selling land that no longer fit our marketing strategy rather than holding it for future development.
 
Operating Income.   Our homebuilding operations posted an operating loss of $1.36 billion in 2007, a decrease of $1.93 billion from operating income of $570.3 million in 2006, reflecting losses from both housing operations and land sales. The operating loss in 2007 represented a negative 21.2% of homebuilding revenues. In 2006, operating income as a percent of homebuilding revenues was 6.1%. The 2007 operating loss was due to a decrease in our housing gross margin, which fell to a negative 5.7% in 2007 from a positive 19.3% for the same period of 2006. The change in our housing gross margin was largely the result of pretax non-cash charges of $1.18 billion for inventory impairments and land option contract abandonments in 2007 primarily in our West Coast and Southwest segments. These impairment and abandonment charges resulted from declining market conditions, which depressed new home values and sales rates in certain housing markets across the country. Poor market conditions also depressed land values and led us to terminate our options on projects that no longer met our internal investment standards. Excluding inventory impairment and abandonment charges ($1.18 billion in 2007 and $309.5 million in 2006), our housing gross margin would have been 13.3% in 2007 and 22.7% in 2006.
 
Operating income decreased to $570.3 million in 2006, down from $1.19 billion in 2005. As a percentage of homebuilding revenues, operating income decreased to 6.1% in 2006 from 14.6% in 2005, mainly due to a lower housing gross margin, which decreased to 19.3% in 2006 from 26.7% in 2005. The decrease in housing gross margin was primarily due to a greater use of price concessions and sales incentives to meet competitive conditions and to aggregate charges of $309.5 million associated with inventory impairments and the abandonment of land option contracts we no longer planned to pursue.
 
In 2007, our land sales generated losses of $74.3 million, including impairment charges of $74.8 million relating to future land sales. Our land sales generated losses of $93.4 million in 2006, including impairment charges of $63.1 million relating to future land sales. In 2005, land sales generated profits of $3.7 million, including $9.6 million of impairment charges.


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We evaluate our land and housing inventory for recoverability in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) whenever indicators of potential impairment exist. Based on our evaluations, we recognized non-cash charges for the impairment of inventory of $1.11 billion in 2007, $228.7 million in 2006 and $26.7 million in 2005.
 
The higher impairment charge in 2007 reflects the increasingly challenging housing market conditions that we experienced during the year that lowered the value of certain assets compared to prior periods. These conditions included a significant oversupply of homes available for sale, reduced housing affordability and tighter credit conditions that are keeping prospective buyers from trading up or entering the market, higher foreclosure activity, and heightened competition. As a result, our sales rates, sales prices and gross margins declined in 2007, lowering the fair value of certain inventory positions and resulting in the impairment of inventory. Further deterioration in housing market conditions may lead to additional non-cash impairment charges in the future or cause us to reevaluate our strategy concerning certain assets that could result in future charges associated with the abandonment of land option contracts. In 2006, most of our inventory impairment and abandonment charges were incurred in the fourth quarter, as conditions became more challenging in certain markets, mainly as a result of a growing imbalance between new home supply and demand. These market dynamics caused a decline in the fair value of certain inventory positions and led us to reassess our strategy concerning certain inventory positions.
 
When we determine that we no longer plan to exercise land purchase option contracts due to market conditions and/or changes in market strategy, we write off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. We recognized abandonment charges associated with land option contracts of $144.0 million in 2007, $143.9 million in 2006 and $16.2 million in 2005. The inventory impairment charges and land option contract abandonments are included in construction and land costs in our consolidated statements of operations.
 
Selling, general and administrative expenses totaled $824.6 million in 2007 compared with $1.12 billion in 2006 and $979.6 million in 2005. As a percentage of housing revenues, to which these expenses are most closely correlated, selling, general and administrative expenses were 13.3% in 2007, 12.2% in 2006 and 12.1% in 2005.
 
Goodwill Impairment.   We have recorded goodwill in connection with various acquisitions in prior years. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we test goodwill for potential impairment annually as of November 30 and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During the third quarter of 2007, we determined that it was necessary to evaluate goodwill for impairment due to deteriorating conditions in certain housing markets, the significant inventory impairments we identified and recognized during the quarter in accordance with SFAS No. 144, and the decline in the market price of our common stock to a level below our per share book value. We evaluated goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is to identify potential impairment by comparing the fair value of a reporting unit to the book value, including goodwill. If the fair value of a reporting unit exceeds the book value, goodwill is not considered impaired. If the book value exceeds the fair value, the second step of the process is performed to measure the amount of impairment. Our goodwill evaluations utilized discounted cash flow analyses and market multiple analyses of historical and forecasted operating results of our reporting units. Inherent in our fair value determinations are certain judgments and estimates relating to future cash flows, including the interpretation of current economic indicators and market valuations, and assumptions about our strategic plans with regard to our operations. A change in such assumptions may cause a change in the results of the analyses performed. In addition, to the extent significant changes occur in market conditions, overall economic conditions or our strategic operational plans, it is possible that goodwill not currently impaired may become impaired in the future. Based on the results of our evaluation, we recorded an impairment charge of $107.9 million in the third quarter of 2007 related to our Southwest reporting segment, where the goodwill previously recorded was determined to be impaired. We recorded the charge at our corporate level since all goodwill is carried at that level. The annual impairment test we performed as of November 30, 2007 indicated no additional impairments. The impairment tests we performed as of November 30, 2006 and 2005 indicated no goodwill impairment.
 
Interest Income.   Interest income, which is generated from short-term investments and mortgages and notes receivable, amounted to $28.6 million in 2007, $5.5 million in 2006 and $3.5 million in 2005. Generally, increases and decreases in interest income are attributable to changes in the interest-bearing average balances of our short-term


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investments and our mortgages and notes receivable, as well as fluctuations in interest rates. The increase in interest income in 2007 compared to 2006 reflects a substantial increase in short-term investments due to the higher level of cash generated in 2007.
 
Loss on Early Redemption/Interest Expense, Net of Amounts Capitalized.   In 2007, we completed the early redemption of $650.0 million of debt. On July 27, 2007, we redeemed all $250.0 million of our 9 1 / 2 % senior subordinated notes due in 2011 at a price of 103.167% of the principal amount of the notes, plus accrued interest to the date of redemption. On July 31, 2007, we repaid in full an unsecured $400.0 million term loan (the “$400 Million Term Loan”), together with accrued interest to the date of repayment. The $400 Million Term Loan was scheduled to mature on April 11, 2011. We incurred a loss of $13.0 million associated with the early extinguishment of this debt, primarily due to a call premium on the senior subordinated notes and the write-off of unamortized debt issuance costs.
 
Interest expense results principally from borrowings to finance land purchases, housing inventory and other operating and capital needs. During 2007, all of our interest was capitalized and, consequently, we had no interest expense, net of amounts capitalized. In 2006, interest expense, net of amounts capitalized, totaled $16.7 million. Gross interest incurred during 2007 decreased by $38.2 million, to $199.6 million, from $237.8 million incurred in 2006, mainly due to lower debt levels in 2007. The percentage of interest capitalized in 2007 increased to 100% from 93% in 2006 due to an increase in inventory qualifying for interest capitalization compared to 2006.
 
In 2006, interest expense, net of amounts capitalized, increased to $16.7 million from $16.3 million in 2005. Gross interest incurred in 2006 was $78.7 million higher than the amount incurred in 2005, reflecting higher debt levels in 2006. The percentage of interest capitalized in 2005 was 90%.
 
Equity in Income (Loss) of Unconsolidated Joint Ventures.   Our unconsolidated joint ventures operate in certain markets where our consolidated homebuilding operations are located. These unconsolidated joint ventures posted combined revenues of $662.7 million in 2007, $167.5 million in 2006 and $212.3 million in 2005. The increase in revenues in 2007 over the prior year was primarily due to an increase in the number of lots sold by these unconsolidated joint ventures. The decrease in unconsolidated joint venture revenues in 2006 from 2005 reflected a change in product mix. 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 127 homes in 2007, 4 homes in 2006 and 83 homes in 2005. Unconsolidated joint ventures generated combined losses of $51.6 million in 2007 and $48.6 million in 2006, and combined income of $34.7 million in 2005. In 2007, our equity in loss of unconsolidated joint ventures of $151.9 million included a charge of $156.4 million to recognize the impairment of certain unconsolidated joint ventures mainly in our West Coast, Southwest and Southeast segments. In 2006, our equity in loss of unconsolidated joint ventures of $20.8 million included a charge of $58.6 million to recognize the impairment of certain unconsolidated joint ventures in our West Coast and Southeast segments and a gain of $27.6 million related to the sale of our ownership interest in an unconsolidated joint venture. In 2005, our equity in income from unconsolidated joint ventures totaled $14.2 million.


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HOMEBUILDING SEGMENTS
 
The following table sets forth financial information related to our homebuilding reporting segments for the years indicated (in thousands):
 
                         
    Years Ended November 30,  
    2007     2006     2005  
 
West Coast:
                       
Revenues
  $ 2,203,303     $ 3,531,279     $ 3,050,486  
Operating costs and expenses
    (2,848,548 )     (3,178,973 )     (2,383,112 )
Other, net
    (20,600 )     7,558       13,929  
                         
Pretax income (loss)
  $ (665,845 )   $ 359,864     $ 681,303  
                         
Southwest:
                       
Revenues
  $ 1,349,570     $ 2,183,830     $ 1,964,483  
Operating costs and expenses
    (1,617,395 )     (1,809,930 )     (1,452,272 )
Other, net
    (19,514 )     (8,802 )     1,635  
                         
Pretax income (loss)
  $ (287,339 )   $ 365,098     $ 513,846  
                         
Central:
                       
Revenues
  $ 1,077,304     $ 1,553,309     $ 1,559,067  
Operating costs and expenses
    (1,134,601 )     (1,591,982 )     (1,512,831 )
Other, net
    (6,913 )     (16,076 )     (18,084 )
                         
Pretax income (loss)
  $ (64,210 )   $ (54,749 )   $ 28,152  
                         
Southeast:
                       
Revenues
  $ 1,770,414     $ 2,091,425     $ 1,549,277  
Operating costs and expenses
    (1,932,084 )     (2,036,000 )     (1,392,825 )
Other, net
    (68,750 )     (16,492 )     (3,944 )
                         
Pretax income (loss)
  $ (230,420 )   $ 38,933     $ 152,508  
                         
 
The following table presents information concerning our housing revenues and homes delivered by homebuilding reporting segment:
 
                                         
          Percent
          Percent
       
          of
          of
       
          Total
          Total
    Average
 
    Housing
    Housing
    Homes
    Homes
    Selling
 
Years Ended November 30,
  Revenues     Revenues     Delivered     Delivered     Price  
    (in thousands)                          
 
2007
                                       
West Coast
  $ 2,149,547       35 %     4,957       21 %   $ 433,600  
Southwest
    1,254,932       20       4,855       20       258,500  
Central
    1,058,985       17       6,310       27       167,800  
Southeast
    1,748,099       28       7,621       32       229,400  
                                         
Total
  $ 6,211,563       100 %     23,743       100 %   $ 261,600  
                                         
2006
                                       
West Coast
  $ 3,530,679       38 %     7,213       22 %   $ 489,500  
Southwest
    2,151,908       23       7,011       22       306,900  
Central
    1,536,075       17       9,613       30       159,800  
Southeast
    2,024,574       22       8,287       26       244,300  
                                         
Total
  $ 9,243,236        100 %     32,124        100 %   $ 287,700  
                                         


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          Percent
          Percent
       
          of
          of
       
          Total
          Total
    Average
 
    Housing
    Housing
    Homes
    Homes
    Selling
 
Years Ended November 30,
  Revenues     Revenues     Delivered     Delivered     Price  
    (in thousands)                          
 
2005
                                       
West Coast
  $ 3,050,486       38 %     6,624       21 %   $ 460,500  
Southwest
    1,954,196       24       7,357       24       265,600  
Central
    1,554,863       19       9,866       32       157,600  
Southeast
    1,540,226       19       7,162       23       215,100  
                                         
Total
  $ 8,099,771       100 %     31,009       100 %   $ 261,200  
                                         
 
West Coast  — Housing revenues in our West Coast segment decreased 39% to $2.15 billion in 2007 from $3.53 billion in 2006 due to a 31% decrease in homes delivered and an 11% decrease in the average selling price. Homes delivered in this segment decreased to 4,957 in 2007 from 7,213 in 2006 primarily due to a 10% decrease in active communities. We have decreased our active communities to match reduced levels of demand in this segment compared to prior periods. The average selling price fell to $433,600 in 2007 from $489,500 in 2006 due to pricing pressure stemming from highly competitive conditions and weak demand. Our lower average selling price in 2007 also reflects our efforts to redesign and reengineer our products to improve their affordability, particularly in light of tighter mortgage financing requirements applicable to loans above conforming limits. The West Coast segment generated a pretax loss of $665.8 million in 2007, down from pretax income of $359.9 million in 2006. This decrease was principally due to charges of $716.4 million for inventory and joint venture impairments and the abandonment of land option contracts in 2007, and a lower housing gross margin stemming from lower sales prices and more frequent use of price concessions and sales incentives.
 
In 2006, West Coast segment housing revenues increased 16%, from $3.05 billion in 2005, due to a 9% increase in homes delivered and a 6% increase in the average selling price. We delivered 7,213 homes with an average selling price of $489,500 in 2006, up from 6,624 homes with an average selling price of $460,500 in 2005. Pretax income decreased to $359.9 million in 2006 from $681.3 million in 2005. As a percentage of total revenues, pretax income decreased to 10.2% in 2006 from 22.3% in 2005. This decrease was principally due to $213.1 million of inventory and joint venture impairment charges and land option contract abandonments in 2006, and a lower housing gross margin stemming from greater use of price concessions and sales incentives as a result of increasing competition.
 
Southwest  — Housing revenues in the Southwest segment decreased 42% to $1.25 billion in 2007, from $2.15 billion in 2006, due to a 16% decrease in the average selling price, and a 31% decrease in homes delivered. The average selling price decreased to $258,500 in 2007 from $306,900 in 2006 due to pricing pressure stemming from a persistent oversupply of new and resale homes in certain markets within this segment coupled with declining demand. We delivered 4,855 homes in the Southwest segment in 2007, down from 7,011 homes in 2006 primarily due to a 24% decrease in active communities, principally in Las Vegas, reflecting our efforts to align our operations with relatively lower levels of demand. The Southwest segment generated a pretax loss of $287.3 million in 2007 compared to pretax income of $365.1 million in 2006. The decrease was primarily due to $385.4 million of inventory and joint venture impairment charges and land option contract abandonments in 2007, and a lower housing gross margin resulting from ongoing weakness in market conditions, greater competition, and the increased use of price concessions and sales incentives to stimulate sales.
 
In 2006, Southwest segment housing revenues increased 10% from $1.95 billion in 2005, due to a 16% increase in the average selling price, partly offset by a 5% decrease in homes delivered. We delivered 7,011 homes in this segment in 2006 at an average selling price of $306,900 compared to 7,357 homes delivered in 2005 at an average selling price of $265,600. Pretax income decreased to $365.1 million in 2006 from $513.8 million in 2005. As a percentage of total revenues, pretax income decreased to 16.7% in 2006 from 26.2% in 2005. The decrease was primarily due to a lower housing gross margin, reflecting moderating market conditions, greater competition, and the increased use of price concessions and sales incentives.
 
Central  — Housing revenues in the Central segment of $1.06 billion in 2007 decreased 31% from $1.54 billion in 2006, reflecting a year-over-year decrease of 34% in homes delivered, partially offset by a 5% increase in the average

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selling price. In this segment, homes delivered decreased to 6,310 in 2007 from 9,613 in 2006 primarily due to a 26% decrease in active communities, principally in Texas and Indiana, due to our exiting smaller submarkets and realigning our operations with our reduced sales expectations in these states. The average selling price increased to $167,800 in 2007 from $159,800 in 2006 due to a change in product mix. This segment generated a pretax loss of $64.2 million in 2007, down from a pretax loss of $54.7 million in 2006. The 2007 loss included $38.9 million of inventory and joint venture impairment and land option contract abandonment charges.
 
In 2006, Central segment housing revenues were essentially flat with 2005, reflecting a 3% decrease in homes delivered offset by a slight increase in the average selling price. Homes delivered in this segment decreased to 9,613 in 2006 from 9,866 in 2005 while the average selling price increased to $159,800 in 2006 from $157,600 in 2005. This segment generated a pretax loss of $54.7 million in 2006, down from pretax income of $28.2 million in 2005 primarily due to $48.8 million of inventory impairments and land option contract abandonments in 2006 and a slightly lower housing gross margin.
 
Southeast  — Housing revenues in the Southeast segment decreased 14% to $1.75 billion in 2007 from $2.02 billion in 2006 due to decreases of 8% in homes delivered and 6% in the average selling price. Homes delivered decreased to 7,621 in 2007 from 8,287 in 2006 reflecting the difficult conditions in many Southeast markets. The average selling price decreased to $229,400 in 2007 from $244,300 in 2006 as highly competitive conditions exerted downward pressure on home prices, primarily in Florida. The Southeast segment generated a pretax loss of $230.4 million in 2007, including charges of $269.6 million for inventory and joint venture impairments and the abandonment of land option contracts, compared to pretax income of $38.9 million in 2006. The Southeast segment impairment and abandonment charges were principally in Florida.
 
In 2006, Southeast segment housing revenues rose 31% to $2.02 billion from $1.54 billion in 2005 as a result of a 16% increase in homes delivered and a 14% increase in the average selling price. Homes delivered in this segment increased to 8,287 in 2006 from 7,162 in 2005, while the average selling price increased to $244,300 in 2006 from $215,100 in 2005. Pretax income decreased to $38.9 million in 2006 from $152.5 million in 2005. As a percentage of total revenues, pretax income decreased to 1.9% in 2006 from 9.8% in 2005 principally due to $129.9 million of inventory impairment charges and land option contract abandonments in 2006.
 
FINANCIAL SERVICES SEGMENT
 
Our financial services segment provides title and insurance services to our homebuyers and provided escrow coordination services until 2007, when we terminated our escrow coordination business. This segment also provides mortgage banking services to our homebuyers indirectly through Countrywide KB Home Loans. On September 1, 2005, we completed the sale of substantially all the mortgage banking assets of KBHMC to Countrywide and in a separate transaction established Countrywide KB Home Loans, a joint venture with Countrywide. Countrywide KB Home Loans began making loans to our homebuyers on September 1, 2005 and essentially replaced the mortgage banking operations of KBHMC, our wholly owned financial services subsidiary which had provided mortgage banking services to our homebuyers in the past. We and Countrywide each have a 50% ownership interest in the joint venture with Countrywide providing management oversight of the joint venture’s operations. Countrywide KB Home Loans is accounted for as an unconsolidated joint venture in the financial services reporting segment of our consolidated financial statements.


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The following table presents a summary of selected financial and operational data for our financial services segment (dollars in thousands):
 
                         
    Years Ended November 30,  
    2007     2006     2005  
 
Revenues
  $ 15,935     $   20,240     $ 31,368  
Expenses
    (4,796 )     (5,923 )     (20,400 )
Equity in income of unconsolidated joint venture
    22,697       19,219       230  
                         
Pretax income
  $ 33,836     $ 33,536     $ 11,198  
                         
                         
Total originations (a):
                       
Loans
    16,869       15,740       15,325  
Principal
  $ 3,934,336     $ 3,843,793     $ 2,789,818  
Retention rate
    72 %     57 %     48 %
Loans sold to third parties (a):
                       
Loans
    16,909       15,613       12,045  
Principal
  $ 3,969,827     $ 3,787,597     $ 1,910,153  
 
 
(a)  Includes combined Countrywide KB Home Loans and KBHMC results for 2005.
 
Revenues.   Our financial services operations generated revenues primarily from the following sources: interest income; title services; insurance commissions; escrow coordination fees; and sales of mortgage loans and servicing rights. Financial services revenues included interest income of $.2 million in 2007, $.2 million in 2006 and $8.2 million in 2005, which was earned primarily from first mortgages and mortgage-backed securities held for long-term investment as collateral. Interest income decreased in 2007 and 2006 mainly due to the wind-down of the mortgage banking operations of KBHMC. Financial services revenues also included revenues from title services, insurance commissions and escrow coordination fees of $15.7 million in 2007, $20.0 million in 2006, and $17.3 million in 2005. The decrease in financial services revenues in 2007 compared to 2006 was due to the lower number of homes delivered by our homebuilding operations and the termination of our escrow coordination business in 2007. The increases in revenues related to these services in 2006 correlated with the increase in the number of homes delivered from our homebuilding operations. Financial services revenues included mortgage and servicing rights income of $5.9 million in 2005. Due to the sale of KBHMC’s mortgage banking operations in the fourth quarter of 2005, the financial services segment did not generate any mortgages and servicing rights income in 2006 or 2007.
 
Expenses.   Financial services expenses in 2007, 2006 and 2005 were comprised of interest expense, general and administrative expenses, and other income and expense items. Interest expense decreased to a nominal amount in 2007 and 2006 from $5.2 million in 2005 due to the wind-down of KBHMC’s mortgage banking operations in late 2005. General and administrative expenses totaled $4.8 million in 2007, $5.9 million in 2006 and $22.0 million in 2005. The decrease in general and administrative expenses in 2007 was primarily due to the termination of our escrow coordination business in 2007. In 2006, the decrease in general and administrative expenses was primarily due to the wind-down of KBHMC’s mortgage banking operations in the fourth quarter of 2005 and the change in the mortgage banking operations of KBHMC to an unconsolidated joint venture structure. In 2005, financial services expenses included other items aggregating to income of $6.8 million. These other items included a $26.6 million gain recorded in connection with the sale of assets to Countrywide. The gain represented the cash received over the sum of the book value of the assets sold and certain nominal costs associated with the disposal. In addition, financial services expenses in 2005 included $19.8 million of expenses accrued for various regulatory and other contingencies.
 
Equity in income of unconsolidated joint venture.   The equity in income of unconsolidated joint venture of $22.7 million in 2007, $19.2 million in 2006 and $.2 million in 2005 relates to our 50% interest in the Countrywide KB Home Loans joint venture. The increase in unconsolidated joint venture income in 2007 compared to 2006 reflected a 7% increase in the number of loans originated by the Countrywide KB Home Loans joint venture, reflecting a higher retention rate (the percentage of our homebuyers using Countrywide KB Home Loans as their loan originator). The overall retention rate increase during 2007 reflected the continuing maturation of the joint venture, which began in late 2005. In 2006, the increase in unconsolidated joint venture income reflected the joint venture’s first full year of operation.


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INCOME TAXES
 
We recognized an income tax benefit from continuing operations of $46.0 million in 2007 and income tax expense from continuing operations of $178.9 million in 2006 and $447.0 million in 2005. These amounts represent an effective tax rate on the pretax loss from continuing operations for 2007 of 3% and effective tax rates on pretax income from continuing operations of 31% for 2006 and 37% for 2005. The decrease in our effective tax rate in 2007 from 2006 was primarily due to a non-cash valuation allowance recorded as a reserve against deferred tax assets. Excluding the impact of the valuation allowance, our effective tax rate for 2007 would have been 38%. The decrease in our effective tax rate in 2006 from 2005 was primarily due to the release of excess state tax accruals, tax benefits from the manufacturing deduction created by the American Jobs Creation Act of 2004, and a reduction in the disallowance of stock-based compensation deductions and related expenses, partially offset by a reduction in available tax credits and a 25% phase-out of these credits.
 
We generated significant deferred tax assets in 2007 largely due to the inventory impairments we incurred during the year. We evaluate our deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. In accordance with SFAS No. 109, we assess whether a valuation allowance should be established based on our determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. In light of the continued downturn in the housing market and the uncertainty as to its length and magnitude, we anticipate being in a three-year cumulative loss position during fiscal year 2008. According to SFAS No. 109, a three-year cumulative loss is significant negative evidence in considering whether deferred tax assets are realizable, and also generally precludes relying on projections of future taxable income to support the recovery of deferred tax assets. Therefore, during the fourth quarter of 2007, we recorded a valuation allowance totaling approximately $522.9 million against our deferred tax assets. The valuation allowance was reflected as a non-cash charge of $514.2 million to income tax expense and $8.7 million to accumulated other comprehensive loss (as a result of an adjustment made in accordance with Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans, an amendment of FASB Statement No. 87, 88, 106 and 132(R)” (“SFAS No. 158”)). The deferred tax assets, for which there is no valuation allowance, relate to amounts that can be realized through future reversals of existing taxable temporary differences or through carrybacks to the 2006 and 2007 years. The majority of the tax benefits associated with our deferred tax assets can be carried forward for 20 years. To the extent we generate sufficient taxable income in the future to fully utilize the tax benefits of the related deferred tax assets, we expect our effective tax rate to decrease as the valuation allowance is reversed.
 
During 2007, 2006 and 2005, we made investments that resulted in benefits in the form of synthetic fuel tax credits. During 2005, a small portion of these tax credits were forfeited as part of an Internal Revenue Service (“IRS”) settlement. Additionally, these tax credits are subject to a phase-out provision that gradually reduces the tax credits if the annual average price of domestic crude oil increases to a stated phase-out range. We currently estimate the phase-out percentage for 2007 to be 65%. In 2006, there was a 25% reduction in tax credits and in 2005 there was no reduction in tax credits.
 
DISCONTINUED OPERATIONS
 
Discontinued operations are comprised solely of our French operations, which were sold on July 10, 2007. We sold our 49% equity interest in KBSA for total gross proceeds of $807.2 million, and a pretax gain of $706.7 million ($438.1 million, net of income taxes) was recognized in the third quarter of 2007 related to the transaction. The sale was made pursuant to a share purchase agreement dated May 22, 2007 (the “Share Purchase Agreement”), among us, Financière Gaillon 8 SAS (the “Purchaser”), an affiliate of PAI partners, a European private equity firm, and three of our wholly owned subsidiaries: Kaufman and Broad Development Group, International Mortgage Acceptance Corporation, and Kaufman and Broad International, Inc. (collectively, the “Selling Subsidiaries”). Under the Share Purchase Agreement, the Purchaser agreed to acquire our 49% equity interest (representing 10,921,954 shares held collectively by the Selling Subsidiaries) at a price of 55.00 euros per share. The purchase price consisted of 50.17 euros per share paid by the Purchaser in cash, and a cash dividend of 4.83 euros per share paid by KBSA.
 
In 2007, income from discontinued operations, net of income taxes, totaled $485.4 million, or $6.29 per diluted share, including the gain realized on the sale of these operations. Income from discontinued operations, net of income taxes, totaled $89.4 million, or $1.08 per diluted share, in 2006 and $69.2 million, or $.78 per diluted share, in 2005.


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LIQUIDITY AND CAPITAL RESOURCES
 
Overview.   We historically have funded our homebuilding and financial services operations with internally generated cash flows and external sources of debt and equity financing. We also have the Credit Facility under which we may borrow funds from time to time as needed.
 
In light of the deteriorating market conditions in 2007, we took several decisive actions during the year to generate cash flow, reduce debt levels and strengthen our balance sheet. These actions included reducing inventory and community counts, trimming our workforce, consolidating or exiting underperforming markets and selling our French operations. Due to the strategies we employed, we reduced our debt by $758.5 million and increased our cash balance by $625.2 million in 2007.
 
In 2007, we completed the early redemption of $650.0 million of debt. On July 27, 2007, we completed the redemption of all $250.0 million of our 9 1 / 2 % senior subordinated notes due in 2011 at a price of 103.167% of the principal amount of the notes, plus accrued interest to the date of redemption. On July 31, 2007, we repaid in full our $400 Million Term Loan, together with accrued interest to the date of repayment. The $400 Million Term Loan was scheduled to mature on April 11, 2011. We incurred a loss of $13.0 million associated with the early extinguishment of this debt, primarily due to a call premium on the senior subordinated notes and the write-off of unamortized debt issuance costs.
 
Our financial leverage, as measured by the ratio of debt to total capital, was 53.9% at the end of 2007 and 50.0% at the end of 2006. The year-over-year increase in this ratio reflected lower retained earnings in 2007 primarily due to substantial non-cash charges recorded during the year for the impairment of inventory, joint ventures and goodwill; the abandonment of land option contracts; and the valuation allowance recorded on certain deferred tax assets. Our ratio of net debt to net total capital at November 30, 2007 was 31.1%, representing an improvement of 12.1 percentage points from our 43.2% ratio at November 30, 2006. Net debt to net total capital is calculated by dividing mortgages and notes payable, net of homebuilding cash, by net total capital (mortgages and notes payable, net of homebuilding cash, plus stockholders’ equity). We believe the ratio of net debt to net total capital is useful in understanding the leverage employed in our operations and comparing us with others in the homebuilding industry.
 
Capital Resources.   External sources of financing for our homebuilding activities include our Credit Facility, third-party secured financings, and the public debt and equity markets. Substantial unused lines of credit remain available for our future use, if required, principally through our Credit Facility. Interest on the Credit Facility is payable monthly at the London Interbank Offered Rate plus an applicable spread on amounts borrowed. At November 30, 2007, we had $296.8 million of outstanding letters of credit and no outstanding borrowings, leaving approximately $1.20 billion available for our future use under the Credit Facility. (This amount is based on the $1.50 billion aggregate commitment under the Credit Facility at November 30, 2007. On January 25, 2008, the Credit Facility was amended and the aggregate commitment was reduced to $1.30 billion as disclosed in Note 22. Subsequent Event in the Notes to Consolidated Financial Statements in this Form 10-K. If the $1.30 billion had been in effect at November 30, 2007, approximately $1.00 billion would have been available for our future use at that date.)
 
On August 17, 2007, we entered into a third amendment (the “Revolver Amendment”) to the Credit Facility. The Revolver Amendment allows for a reduction of the minimum interest coverage ratio (the “Coverage Ratio”) otherwise required under the Credit Facility for a period of up to nine consecutive quarters (the “Reduction Period”). The Coverage Ratio is the ratio of our consolidated EBITDA to consolidated interest expense (as defined under the Credit Facility). During the Reduction Period, the interest rates applied to borrowings and the unused line fee under the Credit Facility, and the maximum ratio of our consolidated total indebtedness to consolidated tangible net worth, are subject to adjustment. The Revolver Amendment also permits us to eliminate any minimum Coverage Ratio requirement during the Reduction Period, for a period of up to four quarters, if certain financial criteria are met, and makes permanent amendments to certain other provisions of the Credit Facility. Consenting lenders to the Revolver Amendment received a fee in connection with this amendment.
 
The Credit Facility, as amended, contains covenants that require us to stay within certain specified financial ratios. The non-cash charges associated with inventory and joint venture impairments, land option contract abandonments, goodwill impairment and the valuation allowance on deferred tax assets in 2007 negatively affected our ability to comply at November 30, 2007 with a covenant in the Credit Facility that requires us to maintain a certain consolidated tangible


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net worth. As a result, on January 7, 2008, we obtained a waiver of compliance under this covenant. To address our covenant compliance for future periods, we entered into a fourth amendment to the Credit Facility on January 25, 2008 that amended the minimum consolidated tangible net worth we are required to maintain.
 
Depending on available terms and our negotiating leverage related to specific market conditions, we also finance certain land acquisitions with purchase-money financing from land sellers or with other forms of financing from third parties. At November 30, 2007, we had outstanding seller-financed notes payable of $19.1 million secured primarily by the underlying property, which had a carrying value of $48.0 million.
 
Consolidated Cash Flows.   Operating, investing and financing activities provided net cash of $539.6 million in 2007 and $479.2 million in 2006. These activities used net cash of $66.0 million in 2005.
 
Operating Activities.   Continuing operations provided net operating cash of $896.9 million during 2007 and $480.2 million during 2006. The year-over-year change in operating cash flow primarily reflected a net decrease in inventories stemming from our curtailment of inventory investments in light of challenging housing market conditions and our diminished future sales expectations. Our sources of operating cash in 2007 included a net decrease in inventories of $779.9 million (excluding inventory impairments and land option contract abandonments, $4.1 million of inventories acquired through seller financing and a decrease of $409.5 million in consolidated inventories not owned), other operating sources of $17.4 million, and various non-cash items added to the loss from continuing operations. Partially offsetting the cash provided was a loss from continuing operations of $929.4 million and a decrease in accounts payable, accrued expenses and other liabilities of $340.6 million. Our French discontinued operations provided net cash from operating activities of $297.4 million in 2007.
 
In 2006, sources of operating cash from our continuing operations included earnings of $482.4 million, an increase in accounts payable, accrued expenses and other liabilities of $205.7 million, other operating sources of $7.2 million and various non-cash items deducted from net income. Our sources of operating cash in 2006 were partially offset by an increase in inventories of $356.3 million (excluding inventory impairments and land option contract abandonments, $128.7 million of inventories acquired through seller financing and a decrease of $18.1 million in consolidated inventories not owned) and an increase in receivables of $23.5 million. Our French discontinued operations provided net cash from operating activities of $229.5 million in 2006.
 
In 2005, uses of operating cash by our continuing operations included net investments in inventories of $1.81 billion (excluding inventory impairments and land option contract abandonments, $36.8 million of inventories acquired through seller financing and an increase of $120.7 million in consolidated inventories not owned). The cash used was partially offset by earnings of $823.7 million, an increase in accounts payable, accrued expenses and other liabilities of $697.5 million, a decrease in receivables of $50.1 million, other operating sources of $55.7 million and various non-cash items deducted from net income. Our French discontinued operations provided net cash from operating activities of $86.7 million in 2005.
 
Investing Activities.   Continuing operations provided net cash from investing activities of $498.9 million in 2007 and used $196.9 million in the year-earlier period. In 2007, $739.8 million was provided from the sale of our French discontinued operations, net of cash divested and $.7 million was provided from net sales of property and equipment. Partially offsetting the cash provided was $241.6 million used for investments in unconsolidated joint ventures. Our French discontinued operations used net cash for investing activities of $12.1 million in 2007.
 
In 2006, $237.8 million was used by continuing operations for investments in unconsolidated joint ventures and $17.6 million was used for net purchases of property and equipment. The cash used was partially offset by proceeds of $57.8 million from the sale of our investment in an unconsolidated joint venture and $.7 million from other investing activities. In 2006, our French discontinued operations used net cash of $4.5 million for investing activities.
 
In 2005, $117.6 million was used by continuing operations for investments in unconsolidated joint ventures and $22.1 million was used for net purchases of property and equipment. The cash used was partially offset by proceeds of $42.4 million from the sale of substantially all of the mortgage banking assets of KBHMC and $1.3 million provided from other investing activities. Our French discontinued operations used net cash of $1.9 million for investing activities in 2005.


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Financing Activities.   Continuing operations used net cash of $835.0 million for financing activities in 2007 and provided net cash of $185.9 million for financing activities in 2006. In 2007, cash was used for the redemption of the $400 Million Term Loan, which was scheduled to mature on April 11, 2011, and $250.0 million of 9 1 / 2 % senior subordinated notes due in 2011, net payments on short-term borrowings of $114.1 million, dividend payments of $77.2 million and repurchases of common stock of $6.9 million in connection with the satisfaction of employee withholding taxes on vested restricted stock. These uses of cash were partly offset by $12.3 million from the issuance of common stock under employee stock plans and $.9 million of excess tax benefit associated with the exercise of stock options. Our French discontinued operations used net cash of $306.5 million for financing activities in 2007.
 
In 2006, sources of cash from our continuing operations included proceeds from the $400 Million Term Loan, $298.5 million in total proceeds from the issuance of $300.0 million of 7 1 / 4 % senior notes due 2018 (the “$300 Million 7 1 / 4 % Senior Notes”), $65.1 million from the issuance of common stock under employee stock plans and $15.4 million of excess tax benefits associated with the exercise of stock options. Partially offsetting the sources of cash were $394.1 million used for repurchases of common stock, net payments of $120.7 million on short-term borrowings and dividend payments of $78.3 million. On December 8, 2005, our board of directors increased the annual cash dividend on our common stock to $1.00 per share from $.75 per share. In 2006, our French discontinued operations used net cash of $215.0 million for financing activities.
 
In 2005, financing activities provided $747.6 million in total proceeds from the issuance of $300.0 million of 5 7 / 8 % senior notes due 2015 (the “$300 Million 5 7 / 8 % Senior Notes”) and $450.0 million of 6 1 / 4 % senior notes due 2015 (the “$450 Million Senior Notes”), and $101.8 million from the issuance of common stock under employee stock plans. Partially offsetting the cash provided were $417.7 million of net payments on short-term borrowings, $134.7 million used for repurchases of common stock and $61.6 million for cash dividend payments. On December 2, 2004, our board of directors increased the annual cash dividend on our common stock to $.75 per share from $.50 per share. Our French discontinued operations used net cash of $119.2 million for financing activities in 2005.
 
Shelf Registration Statement.   At November 30, 2007, $450.0 million of capacity remained available under our universal shelf registration statement filed with the SEC on November 12, 2004 (the “2004 Shelf Registration”).
 
Changes in Capital Structure.   At November 30, 2007, we were authorized to repurchase four million shares of our common stock under a board-approved share repurchase program. We did not repurchase any shares of our common stock under this program in 2007.
 
We continually consider various options for the use of our cash, including internal capital investments, investments to grow our business and additional debt reductions. Based on our current capital position, we believe we have adequate resources and sufficient credit facilities to satisfy our current and reasonably anticipated future requirements for funds to acquire capital assets and land, 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.
 
OFF-BALANCE SHEET ARRANGEMENTS
 
We conduct a portion of our land acquisition, development and other homebuilding activities through participation in unconsolidated joint ventures in which we hold less than a controlling interest. These unconsolidated joint ventures operate in certain markets where our consolidated homebuilding operations are located. Through unconsolidated joint ventures, we reduce and share our risk and also reduce the amount invested in land, while increasing our access to potential future homesites. The use of unconsolidated joint ventures also, in some instances, enables us to acquire land which we might not otherwise obtain or have access to on as favorable terms without the participation of a strategic partner. Our partners in these unconsolidated joint ventures are unrelated homebuilders, land developers and other real estate entities, or other commercial enterprises. While we view our participation in unconsolidated joint ventures as beneficial to our homebuilding activities, we do not view them as essential to those activities.
 
We and/or our joint venture partners sometimes obtain certain options or enter into other arrangements to purchase portions of the land held by the unconsolidated joint ventures. These land option prices are generally negotiated prices that approximate fair value. We do not include in our income from unconsolidated joint ventures our pro rata share of unconsolidated joint venture earnings resulting from land sales 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 ventures.


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Our investments in unconsolidated joint ventures totaled $297.0 million at November 30, 2007 and $381.2 million at November 30, 2006. These unconsolidated joint ventures had total assets of $2.51 billion at November 30, 2007 and $2.40 billion at November 30, 2006 and outstanding secured construction debt of approximately $1.54 billion at November 30, 2007 and $1.45 billion at November 30, 2006. In certain instances, we provide varying levels of guarantees on the debt of unconsolidated joint ventures. When we provide a guarantee, the unconsolidated joint venture generally receives more favorable terms from lenders than would otherwise be available to it. At November 30, 2007, we had payment guarantees related to the third-party debt of two of our unconsolidated joint ventures. One of these unconsolidated joint ventures had aggregate third-party debt of $320.4 million at November 30, 2007, of which each of the joint venture partners guaranteed its pro rata share. Our share of the payment guarantee, which is triggered only in the event of bankruptcy of the joint venture, was 49% or $155.2 million. The other unconsolidated joint venture had total third-party debt of $6.2 million at November 30, 2007, of which each of the joint venture partners guaranteed its pro rata share. Our share of this guarantee was 50% or $3.1 million. Our pro rata share of limited maintenance guarantees of unconsolidated entity debt totaled $103.8 million at November 30, 2007. The limited maintenance guarantees apply only if the value of the collateral (generally land and improvements) is less than a specific percentage of the loan balance. If we are required to make a payment under a limited maintenance guarantee to bring the value of the collateral above the specified percentage of the loan balance, the payment would constitute a capital contribution and/or loan to the affected unconsolidated joint venture.
 
In the ordinary course of business, we enter into land option contracts in order to procure land for the construction of homes. The use of such option agreements allows us to reduce the risks associated with land ownership and development, reduce our financial commitments, including interest and other carrying costs, and minimize land inventories. Under such land option contracts, we will fund a specified option deposit or earnest money deposit in consideration for the right to purchase land in the future, usually at a predetermined price. Under the requirements of FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities” (“FASB Interpretation No. 46(R)”), certain of our land option contracts may create a variable interest for us, with the land seller being identified as a variable interest entity (“VIE”).
 
In compliance with FASB Interpretation No. 46(R), we analyze our land option contracts and other contractual arrangements when they are entered into or upon a reconsideration event, and have consolidated the fair value of certain VIEs from which we are purchasing land under option contracts. Although we do not have legal title to the optioned land, FASB Interpretation No. 46(R) requires us to consolidate the VIE if we are determined to be the primary beneficiary. The consolidation of these VIEs, where we were determined to be the primary beneficiary, increased our inventories, with a corresponding increase to accrued expenses and other liabilities, on our consolidated balance sheets by $19.0 million at November 30, 2007 and $215.4 million at November 30, 2006. The significant decrease in 2007 from the previous year resulted from our abandonment of certain land option contracts due to challenging market conditions in 2007 and exercising options to purchase land from VIEs that were previously consolidated. The liabilities related to our consolidation of VIEs from which we are purchasing land under option contracts represent the difference between the purchase price of optioned land not yet purchased and our cash deposits. Our cash deposits related to these land option contracts totaled $4.7 million at November 30, 2007 and $41.9 million at November 30, 2006. Creditors, if any, of these VIEs have no recourse against us. As of November 30, 2007, excluding consolidated VIEs, we had cash deposits totaling $54.6 million that were associated with land option contracts having an aggregate purchase price of $979.1 million.
 
We also evaluate land option contracts in accordance with Statement of Financial Accounting Standards No. 49, “Accounting for Product Financing Arrangements” (“SFAS No. 49”), and increased inventories, with a corresponding increase to accrued expenses and other liabilities, on our consolidated balance sheets by $221.1 million at November 30, 2007 and $434.2 million at November 30, 2006, as a result of our evaluations. The decrease in the 2007 amount compared to the previous year is due to the exercise of land option contracts and the abandonment of certain land option contracts.


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CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
 
The following table summarizes our future cash requirements under contractual obligations as of November 30, 2007 (in thousands):
 
                                         
    Payments due by Period  
    Total     2008     2009-2010     2011-2012     Thereafter  
 
Contractual obligations:
                                       
Long-term debt
  $ 2,161,794     $ 1,909     $ 515,504     $ 348,549     $ 1,295,832  
Interest
    815,262       144,688       243,996       179,554       247,024  
Operating lease obligations
    79,603       21,926       34,696       14,689       8,292  
                                         
Total
  $ 3,056,659     $ 168,523     $ 794,196     $ 542,792     $ 1,551,148  
                                         
 
We are often required to obtain bonds and letters of credit in support of our obligations to various municipalities and other government agencies in connection with subdivision improvements such as roads, sewers and water. At November 30, 2007, we had approximately $1.08 billion of performance bonds and $296.8 million of letters of credit outstanding. At November 30, 2006, we had approximately $1.24 billion of performance bonds and $464.2 million of letters of credit outstanding. We do not believe that any currently outstanding bonds or letters of credit will be called. The expiration dates of letters of credit coincide with the expected completion dates of the related projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. Performance bonds do not have stated expiration dates. Rather, we are released from the bonds as the contractual performance is completed.
 
We have, and require the majority of the subcontractors we use to have, general liability insurance (including construction defect coverage) and workers’ compensation insurance. These insurance policies protect us against a portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles and other coverage limits. We self-insure a portion of our overall risk through the use of a captive insurance subsidiary.
 
We record expenses and liabilities related to the costs to cover our self-insured and deductible amounts under our insurance policies and for any estimated costs of potential claims and lawsuits (including expected legal costs) in excess of our coverage limits or not covered by our policies, based on an analysis of our historical claims, which includes an estimate of construction defect claims incurred but not yet reported. We engage a third-party actuary that uses our historical claim data to estimate our unpaid claims, claim adjustment expenses and incurred but not reported claims reserves for the risks that we are assuming under the general liability. Projection of losses related to these liabilities is subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to our markets and the types of products we build, claim settlement patterns, insurance industry practices and legal interpretations, among others. Because of the high degree of judgment required in determining these estimated liability amounts, actual future costs could differ significantly from our currently estimated amounts.
 
CRITICAL ACCOUNTING POLICIES
 
Listed below are accounting policies that we believe are critical because of the significance of the activity or because they require the use of significant judgment in their application.
 
Homebuilding Revenue Recognition.   As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, revenues from housing and other real estate sales are recognized in accordance with Statement of Financial Accounting Standards No. 66, “Accounting for Sales of Real Estate” (“SFAS No. 66”), when sales are closed and title passes to the buyer. Sales are closed when all of the following conditions are met: a sale is consummated, a significant down payment is received, the earnings process is complete and the collection of any remaining receivables is reasonably assured.
 
Inventories and Cost of Sales.   As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, inventories are stated at cost, unless the carrying amount of the parcel or community is determined not to be recoverable, in which case the inventories are written down to fair value in accordance with SFAS No. 144. Fair value is determined based on estimated future cash flows discounted for inherent risks associated


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with the real estate assets, or other valuation techniques. Due to uncertainties in the estimation process, it is possible that actual results could differ from those estimates. Our inventories typically do not consist of completed projects.
 
We rely on certain estimates to determine construction and land costs and resulting gross margins associated with revenues recognized. Our construction and land costs are comprised of direct and allocated costs, including estimated future costs for warranties and amenities. Land, land improvements and other common costs are generally allocated on a relative fair value basis to homes within a parcel or community. Land and land development costs include related interest and real estate taxes.
 
In determining a portion of the construction and land costs for each period, we rely on project budgets that are based on a variety of assumptions, including future construction schedules and costs to be incurred. It is possible that actual results could differ from budgeted amounts for various reasons, including construction delays, labor or materials shortages, increases in costs that have not yet been committed, changes in governmental requirements, unforeseen environmental hazard discoveries or other unanticipated issues encountered during construction that fall outside the scope of contracts obtained. While the actual results for a particular construction project are accurately reported over time, variances between the budgeted and actual costs of a project could result in the understatement or overstatement of construction and land costs and homebuilding gross margins in a specific reporting period. To reduce the potential for such distortion, we have set forth procedures that collectively comprise a “critical accounting policy.” These procedures, which we have applied on a consistent basis, include updating, assessing and revising project budgets on a monthly basis, obtaining commitments from subcontractors and vendors for future costs to be incurred, reviewing the adequacy of warranty accruals and historical warranty claims experience, and utilizing the most recent information available to estimate construction and land costs to be charged to expense. The variances between budgeted and actual amounts identified by us have historically not had a material impact on our consolidated results of operations. We believe that our policies provide for reasonably dependable estimates to be used in the calculation and reporting of construction and land costs.
 
Warranty Costs.   As discussed in Note 12. Commitments and Contingencies in the Notes to Consolidated Financial Statements in this Form 10-K, we provide a limited warranty on all of our homes. The specific terms and conditions of warranties vary depending upon the market in which we do business. We generally provide a structural warranty of 10 years, a warranty on electrical, heating, cooling and 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 such as appliances. We estimate the costs that may be incurred under each limited warranty and record a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect our warranty liability include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary. While we believe the warranty accrual reflected in the consolidated balance sheets to be adequate, actual warranty costs in the future could differ from our current estimates.
 
Stock-Based Compensation.   As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, effective December 1, 2005, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which requires that companies measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements. We provide compensation benefits by issuing stock options, restricted stock, phantom shares and stock appreciation rights (“SARs”). Determining the fair value of share-based awards at the grant date requires judgment to identify the appropriate valuation model and develop the assumptions, including the expected term of the stock options, expected stock-price volatility and dividend yield, to be used in the calculation. Judgment is also required in estimating the percentage of share-based awards that are expected to be forfeited. We estimated the fair value of stock options granted using the Black-Scholes option-pricing model with assumptions based primarily on historical data. In addition, we estimated the fair value of certain restricted common stock that is subject to a market condition (“Performance Shares”) using a Monte Carlo simulation model. If actual results differ significantly from these estimates, stock-based compensation expense and our consolidated results of operations could be materially impacted. Prior to December 1, 2005, we accounted for stock option grants under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and related interpretations.


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Goodwill.   As disclosed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, we have recorded goodwill in connection with various acquisitions in prior years. In accordance with SFAS No. 142, we test goodwill for potential impairment annually as of November 30 and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The process of evaluating goodwill for impairment involves the determination of the fair value of our reporting units. Inherent in such fair value determinations are certain judgments and estimates relating to future cash flows, including the interpretation of current economic indicators and market valuations, and assumptions about our strategic plans with regard to our operations. To the extent additional information arises, market conditions change or our strategies change, it is possible that our conclusion regarding goodwill impairment could change and result in a material effect on our consolidated financial position or results of operations.
 
Income Taxes.   As discussed in Note 1. Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Form 10-K, income taxes are accounted for in accordance with SFAS No. 109. The provision for, or benefit from, income taxes is calculated using the asset and liability method, under which deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We evaluate our deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. In accordance with SFAS No. 109, we assess whether a valuation allowance should be established based on our determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends primarily on the generation of future taxable income during the periods in which those temporary differences become deductible. Judgment is required in determining the future tax consequences of events that have been recognized in our consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations. Further discussion of the valuation allowance recorded in 2007 is included in Note 17. Income Taxes in the Notes to Consolidated Financial Statements in this Form 10-K.
 
SUBSEQUENT EVENT
 
On January 25, 2008, we entered into the fourth amendment to the Credit Facility. The fourth amendment amends the minimum consolidated tangible net worth we are required to maintain under the Credit Facility and reduces the aggregate commitment under the Credit Facility from $1.50 billion to $1.30 billion.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109” (“FASB Interpretation No. 48”). FASB Interpretation No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FASB Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FASB Interpretation No. 48 are effective for our first quarter ending February 29, 2008. We are in the process of evaluating the potential impact of adopting FASB Interpretation No. 48, but do not expect the interpretation to have a material impact on our consolidated financial position or results of operations.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. We are currently evaluating the potential impact of adopting SFAS No. 157 on our consolidated financial position and results of operations.
 
In November 2006, the Emerging Issues Task Force (“EITF”) ratified EITF Issue No. 06-8, “Applicability of the Assessment of a Buyer’s Continuing Investment under SFAS No. 66 for Sales of Condominiums” (“EITF 06-8”). EITF 06-8 states that adequacy of the buyer’s investment under SFAS No. 66 should be assessed in determining whether to recognize profit under the percentage-of-completion method on the sale of individual units in a condominium project. EITF 06-8 could require that additional deposits be collected by developers of condominium projects that wish to recognize profit during the construction period under the percentage-of-completion method. EITF 06-8 is effective for


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fiscal years beginning after March 15, 2007. We are currently evaluating the potential impact of adopting EITF 06-8 on our consolidated financial position and results of operations.
 
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits entities to choose to measure certain financial assets and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are currently evaluating the potential impact of the adoption of SFAS No. 159; however, we do not expect it to have a material impact on our consolidated financial position or results of operations.
 
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) amends Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS No. 141”), and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. It is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively. We are currently evaluating the potential impact of adopting SFAS No. 141(R) on our consolidated financial position and results of operations.
 
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. We are currently evaluating the potential impact of adopting SFAS No. 160 on our consolidated financial position and results of operations.
 
OUTLOOK
 
At November 30, 2007, we had 6,322 homes in backlog, a decrease of 40% from the 10,575 homes in backlog at November 30, 2006. Our backlog at November 30, 2007 represented future housing revenues of approximately $1.50 billion, down 47% from approximately $2.83 billion at November 30, 2006. The reduction in our backlog reflects several successive quarters of year-over-year decreases in net orders. In the fourth quarter of 2007, our homebuilding operations generated 2,574 net orders, down 32% from the 3,763 net orders generated in the final quarter of 2006. The year-over-year decline in our fourth quarter net orders was due, in part, to a 22% decrease in the number of active communities, consistent with our efforts to adjust our homebuilding operations to the market environment. Our fourth quarter 2007 cancellation rate of 58% was unchanged from the cancellation rate we experienced in the fourth quarter of 2006, but was higher than the 50% rate reported in the third quarter of 2007.
 
We expect the negative operational and financial pressures the homebuilding industry and our business experienced in 2007 to continue and possibly even intensify in 2008 as the housing market contraction, which gained momentum throughout 2007, looks to extend well into the year ahead. While affordability constraints and declining buyer confidence were key factors driving the downturn in the housing market in 2006, they were joined in 2007 by tighter credit standards and disrupted mortgage markets. These factors are causing many potential homebuyers to forgo or defer home purchases because they are unable to obtain adequate financing, are concerned that they cannot sell their existing home at a fair price or at a price that covers their existing mortgage, and/or are expecting home prices to fall further. This demand-side dynamic is a key reason there were in 2007, and there continues to be, a considerable number of new and existing homes available for sale in housing markets across the country. The oversupply of homes available for sale relative to demand created the extremely challenging conditions we experienced in 2007 and its persistence and depth suggest there will be little, if any, improvement in the near-term future.
 
As housing industry conditions became increasingly difficult in 2007, we continued to execute on a number of strategies that we adopted in 2006 to solidify our financial position and to reposition our business with the present market environment and our future expectations. We made strengthening our balance sheet one of our highest priorities


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during the year and focused on reducing our debt levels and generating cash through greater conversion of our backlog into revenue and strategically converting operating assets into cash, including the sale of our interest in our French operations. From our efforts in 2007, we enter 2008 with a cash balance of $1.33 billion, no borrowings outstanding under our Credit Facility and a debt balance that is $758.5 million lower than at the beginning of 2007. We believe our substantial cash position and reduced leverage provide us with an opportunity to strategically reload our land pipeline for higher margin deliveries in future periods.
 
We also reviewed our market positions, community counts and overhead requirements during the year, and curtailed our investments where it made financial or strategic sense to do so. Based in part on this review and the conversion of our backlog, we have reduced the number of lots we own or control by 65% since February 28, 2006 from approximately 186,000 to 66,000 at November 30, 2007. We also reduced our community counts in weaker markets, and exited certain underperforming markets altogether. We anticipate further reducing our active communities in 2008, which will likely have a negative impact on our year-over-year net order results compared to 2007.
 
In positioning our business for the future, we intensified our focus in 2007 on our core customer base — the first-time, first move-up and active adult homebuyer — and further refined our “Built to Order” operating disciplines. During 2007, we introduced newly designed, smaller, more affordable homes in our active communities at price points calibrated to median income levels to attract our core customers. We also reengineered our home designs to lower production costs and cycle times, while continuing to invest in our KB Home Studios to provide our customers with a customized choice/value proposition that we believe uniquely differentiates us from other builders in the marketplace.
 
Based on our efforts in 2007, we believe we are well positioned financially and strategically to navigate through the current housing market downturn and have set a foundation for future growth. However, we believe 2008 will be another tough year for the homebuilding industry and see no indication that housing markets struggling with a significant oversupply of homes available for sale are stabilizing. We believe the moderating sales activity and significant pricing and margin pressures that affected the homebuilding industry throughout 2007 will continue, and may deepen, until current new and resale home inventory levels are in better balance with demand, and it is not clear when this may occur. As a result, we do not expect our delivery volume and related revenues to improve in 2008, and we may need to take additional charges for inventory impairments in the future. In addition, our 2008, and possibly 2009, results may be negatively affected if there is a downturn in the general economy, a decrease in job growth and/or a decline in overall consumer confidence that further prolongs the recovery of the housing markets.
 
As we move ahead, we expect to continue our efforts from the past year to maintain a strong financial position, sharpen our focus on our core customer base and our “Built to Order” business model, and to align our cost structure and operations with market conditions. Longer term, we expect favorable demographics and continuing population growth in our served markets to drive demand for new homes, and believe that our operating approach and financial resources will allow us to capitalize on improvements in these housing markets as they occur.
 
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, 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.


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Actual events and results may differ materially from those expressed or forecasted in the 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 and business conditions; material prices and availability; labor costs and availability; changes in interest rates; our debt level; declines in consumer confidence; increases in competition; weather conditions, significant natural disasters and other environmental factors; government regulations; the availability and cost of land in desirable areas; government investigations and shareholder lawsuits regarding our past stock option grant practices and the restatement of certain of our financial statements; other legal or regulatory proceedings or claims; conditions in the capital, credit (including consumer mortgage lending standards) and homebuilding markets; and the other risks discussed above in Item 1A. Risk Factors.


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Item 7A.  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 and senior subordinated notes. For fixed rate debt, changes in interest rates generally affect the fair market 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 interest rate changes.
 
The following table sets forth principal cash flows by scheduled maturity, weighted average interest rates and the estimated fair market value of our long-term debt obligations as of November 30, 2007 (dollars in thousands):
 
                                                                 
                                              Fair Value at
 
    Years Ended November 30,           November 30,
 
    2008     2009     2010     2011     2012     Thereafter     Total     2007  
 
Long-term debt (a)
                                                               
Fixed Rate
  $     $ 200,000     $ 298,273     $ 348,549     $     $ 1,295,832     $ 2,142,654       $1,921,042  
Weighted Average Interest Rate
    %     8.6 %     7.8 %     6.4 %     %     6.3 %                
(a) Includes senior subordinated and senior notes.


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Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
KB HOME
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
         
    Page
   
Number
 
Consolidated Statements of Operations for the Years Ended November 30, 2007, 2006 and 2005
    48  
Consolidated Balance Sheets as of November 30, 2007 and 2006
    49  
Consolidated Statements of Stockholders’ Equity for the Years Ended November 30, 2007, 2006 and 2005
    50  
Consolidated Statements of Cash Flows for the Years Ended November 30, 2007, 2006 and 2005
    51  
Notes to Consolidated Financial Statements
    52-85  
Reports of Independent Registered Public Accounting Firm
    86-87  
 
 
Separate combined financial statements of our unconsolidated joint venture activities have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary as defined by Rule 3-09 of Regulation S-X.


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KB HOME
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
 
                         
    Years Ended November 30,  
    2007     2006     2005  
 
Total revenues
  $ 6,416,526     $ 9,380,083     $ 8,154,681  
                         
Homebuilding:
                       
Revenues
  $ 6,400,591     $ 9,359,843     $ 8,123,313  
Construction and land costs
    (6,826,379 )     (7,666,019 )     (5,954,768 )
Selling, general and administrative expenses
    (824,621 )     (1,123,508 )     (979,610 )
Goodwill impairment
    (107,926 )            
                         
Operating income (loss)
    (1,358,335 )     570,316       1,188,935  
Interest income
    28,636       5,503       3,529  
Loss on early redemption/interest expense, net of amounts capitalized
    (12,990 )     (16,678 )     (16,343 )
Equity in income (loss) of unconsolidated joint ventures
    (151,917 )     (20,830 )     14,215  
                         
Homebuilding pretax income (loss)
    (1,494,606 )     538,311       1,190,336  
                         
Financial services:
                       
Revenues
    15,935       20,240       31,368  
Expenses
    (4,796 )     (5,923 )     (20,400 )
Equity in income of unconsolidated joint venture
    22,697       19,219       230  
                         
Financial services pretax income
    33,836       33,536       11,198  
                         
Income (loss) from continuing operations before income taxes
    (1,460,770 )     571,847       1,201,534  
Income tax benefit (expense)
    46,000       (178,900 )     (447,000 )
                         
Income (loss) from continuing operations
    (1,414,770 )     392,947       754,534  
Income from discontinued operations, net of income taxes
    47,252       89,404       69,178  
Gain on sale of discontinued operations, net of income taxes
    438,104              
                         
Net income (loss)
  $ (929,414 )   $ 482,351     $ 823,712  
                         
Basic earnings (loss) per share:
                       
Continuing operations
  $ (18.33 )   $ 4.99     $ 9.21  
Discontinued operations
    6.29       1.13       .85  
                         
Basic earnings (loss) per share
  $ (12.04 )   $ 6.12     $ 10.06  
                         
Diluted earnings (loss) per share:
                       
Continuing operations
  $ (18.33 )   $ 4.74     $ 8.54  
Discontinued operations
    6.29       1.08       .78  
                         
Diluted earnings (loss) per share
  $ (12.04 )   $ 5.82     $ 9.32  
                         
 
See accompanying notes.


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KB HOME
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Shares)
 
                 
    November 30,  
    2007     2006  
 
Assets
               
Homebuilding:
               
Cash and cash equivalents
  $ 1,325,255     $ 700,041  
Receivables
    295,739       224,077  
Inventories
    3,312,420       5,751,643  
Investments in unconsolidated joint ventures
    297,010       381,242  
Deferred income taxes
    222,458       430,806  
Goodwill
    67,970       177,333  
Other assets
    140,712       160,197  
                 
      5,661,564       7,825,339  
Financial services
    44,392       44,024  
Assets of discontinued operations
          1,394,375  
                 
Total assets
  $ 5,705,956     $ 9,263,738  
                 
                 
                 
                 
Liabilities and stockholders’ equity
               
Homebuilding:
               
Accounts payable
  $ 699,851     $ 626,243  
Accrued expenses and other liabilities
    975,828       1,600,617  
Mortgages and notes payable
    2,161,794       2,920,334  
                 
      3,837,473       5,147,194  
                 
Financial services
    17,796       26,276  
Liabilities of discontinued operations
          1,167,520  
Stockholders’ equity:
               
Preferred stock — $1.00 par value; authorized, 10,000,000 shares; none issued
           
Common stock — $1.00 par value; authorized, 290,000,000 shares at November 30, 2007 and 2006; 114,976,285 and 114,648,604 shares issued at November 30, 2007 and 2006, respectively
    114,976       114,649  
Paid-in capital
    851,628       825,958  
Retained earnings
    1,968,881       2,975,465  
Accumulated other comprehensive income (loss)
    (22,923 )     63,197  
Grantor stock ownership trust, at cost: 12,203,282 and 12,345,182 shares at November 30, 2007 and 2006, respectively
    (132,608 )     (134,150 )
Treasury stock, at cost: 25,451,107 and 25,274,482 shares at November 30, 2007 and 2006, respectively
    (929,267 )     (922,371 )
                 
Total stockholders’ equity
    1,850,687       2,922,748  
                 
Total liabilities and stockholders’ equity
  $ 5,705,956     $ 9,263,738  
                 
 
See accompanying notes.


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KB HOME
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In Thousands)
 
                                                                                         
    Years Ended November 30, 2007, 2006 and 2005  
    Number of Shares                       Accumulated
                         
          Grantor
                            Other
          Grantor
             
          Stock
                            Comprehensive
          Stock
          Total
 
    Common
    Ownership
    Treasury
    Common
    Paid-in
    Retained
    Income
    Deferred
    Ownership
    Treasury
    Stockholders’
 
    Stock     Trust     Stock     Stock     Capital     Earnings     (Loss)     Compensation     Trust     Stock     Equity  
 
Balance at November 30, 2004
    110,273       (14,755 )     (16,896 )   $ 110,273     $ 610,333     $ 1,818,774     $ 59,968     $ (6,046 )   $ (160,334 )   $ (393,578 )   $ 2,039,390  
                                                                                         
Comprehensive income:
                                                                                       
Net income
                                  823,712                               823,712  
Foreign currency translation
                                        (31,264 )                       (31,264 )
                                                                                         
Total comprehensive income
                                                                792,448  
Dividends on common stock 
                                  (61,577 )                             (61,577 )
Exercise of employee stock options
    3,632       950             3,632       91,072       (1,301 )                 10,323             103,726  
Restricted stock awards
          149                   7,940                   (9,555 )     1,615              
Restricted stock amortization
                                              1,996                   1,996  
Stock-based compensation
                            5,809                                     5,809  
Grantor stock ownership trust
          656                   27,824                         7,130             34,954  
Treasury stock
                (2,125 )                                         (134,713 )     (134,713 )
French share transfer
                                  (8,236 )                             (8,236 )
                                                                                         
Balance at November 30, 2005
    113,905       (13,000 )     (19,021 )     113,905       742,978       2,571,372       28,704       (13,605 )     (141,266 )     (528,291 )     2,773,797  
                                                                                         
Comprehensive income:
                                                                                       
Net income
                                  482,351                               482,351  
Foreign currency translation
                                        34,493                         34,493  
                                                                                         
Total comprehensive income
                                                                516,844  
Dividends on common stock 
                                  (78,258 )                             (78,258 )
Exercise of employee stock options
    744                   744       34,723                                     35,467  
Restricted stock awards
          537                   32,726                         5,839             38,565  
Restricted stock amortization
                            4,649                                     4,649  
Stock-based compensation
                            19,358                                     19,358  
Grantor stock ownership trust
          118                   5,129                         1,277             6,406  
Treasury stock
                (6,253 )                                         (394,080 )     (394,080 )
Reclass due to SFAS No. 123(R) implementation
                            (13,605 )                 13,605                    
                                                                                         
Balance at November 30, 2006
    114,649       (12,345 )     (25,274 )     114,649       825,958       2,975,465       63,197             (134,150 )     (922,371 )     2,922,748  
                                                                                         
Comprehensive loss:
                                                                                       
Net loss
                                  (929,414 )                             (929,414 )
Foreign currency translation
                                        (63,197 )                       (63,197 )
                                                                                         
Total comprehensive loss
                                                                (992,611 )
Postretirement benefits adjustment
                                        (22,923 )                       (22,923 )
Dividends on common stock 
                                  (77,170 )                             (77,170 )
Exercise of employee stock options
    327                   327       9,718                                     10,045  
Restricted stock amortization
                            4,993                                     4,993  
Stock-based compensation
                            9,354                                     9,354  
Grantor stock ownership trust
          142                   1,605                         1,542             3,147  
Treasury stock
                (177 )                                         (6,896 )     (6,896 )
                                                                                         
Balance at November 30, 2007
    114,976       (12,203 )     (25,451 )   $ 114,976     $ 851,628     $ 1,968,881     $ (22,923 )   $     $ (132,608 )   $ (929,267 )   $ 1,850,687  
                                                                                         
 
See accompanying notes.


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KB HOME
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
 
                         
    Years Ended November 30,  
    2007     2006     2005  
Cash flows from operating activities:
                       
Net income (loss)
  $ (929,414 )   $ 482,351     $ 823,712  
Income from discontinued operations, net of income taxes
    (47,252 )     (89,404 )     (69,178 )
Gain on sale of discontinued operations, net of income taxes
    (438,104 )            
Adjustments to reconcile net income (loss) to net cash provided (used) by
operating activities:
                       
Equity in (income) loss of unconsolidated joint ventures
    129,220       1,611       (14,445 )
Distributions of earnings from unconsolidated joint ventures
    42,356       13,553       11,973  
Gain on sale of investment in unconsolidated joint venture
          (27,612 )      
Gain on sale of mortgage banking assets
                (26,647 )
Amortization of discounts and issuance costs
    2,478       2,441       1,550  
Depreciation and amortization
    17,274       18,091       17,546  
Provision for deferred income taxes
    208,348       (189,047 )     3,150  
Excess tax benefit associated with exercise of stock options
    (882 )     (15,384 )      
Stock option income tax benefits
                36,930  
Stock-based compensation expense
    9,354       19,358       5,809  
Inventory and joint venture impairments and land option contract abandonments
    1,410,345       431,239       42,922  
Goodwill impairment
    107,926              
Changes in assets and liabilities:
                       
Receivables
    (71,406 )     (23,529 )     50,146  
Inventories
    779,875       (356,342 )     (1,807,593 )
Accounts payable, accrued expenses and other liabilities
    (340,630 )     205,707       697,484  
Other, net
    17,409       7,182       55,679  
                         
Net cash provided (used) by operating activities — continuing operations
    896,897       480,215       (170,962 )
Net cash provided by operating activities — discontinued operations
    297,397       229,505       86,715  
                         
Net cash provided (used) by operating activities
    1,194,294       709,720       (84,247 )
                         
Cash flows from investing activities:
                       
Sale of discontinued operations, net of cash divested
    739,764              
Sale of investment in unconsolidated joint venture
          57,767        
Sale of mortgage banking assets
                42,396  
Investments in unconsolidated joint ventures
    (241,551 )     (237,786 )     (117,633 )
Purchases of property and equipment, net
    685       (17,638 )     (22,059 )
Other, net
          772       1,260  
                         
Net cash provided (used) by investing activities — continuing operations
    498,898       (196,885 )     (96,036 )
Net cash used by investing activities — discontinued operations
    (12,112 )     (4,477 )     (1,938 )
                         
Net cash provided (used) by investing activities
    486,786       (201,362 )     (97,974 )
                         
Cash flows from financing activities:
                       
Net payments on credit agreements and other short-term borrowings
          (84,100 )     (378,529 )
Proceeds from (redemption of) term loan
    (400,000 )     400,000        
Redemption of senior subordinated notes
    (250,000 )            
Proceeds from issuance of senior notes
          298,458       747,591  
Payments on mortgages, land contracts and other loans
    (114,119 )     (36,595 )     (39,119 )
Issuance of common stock under employee stock plans
    12,310       65,052       101,749  
Excess tax benefit associated with exercise of stock options
    882       15,384        
Payments of cash dividends
    (77,170 )     (78,258 )     (61,577 )
Repurchases of common stock
    (6,896 )     (394,080 )     (134,713 )
                         
Net cash provided (used) by financing activities — continuing operations
    (834,993 )     185,861       235,402  
Net cash used by financing activities — discontinued operations
    (306,527 )     (215,010 )     (119,213 )
                         
Net cash provided (used) by financing activities
    (1,141,520 )     (29,149 )     116,189  
                         
Net increase (decrease) in cash and cash equivalents
    539,560       479,209       (66,032 )
Cash and cash equivalents at beginning of year
    804,182       324,973       391,005  
                         
Cash and cash equivalents at end of year
  $ 1,343,742     $ 804,182     $ 324,973  
                         
See accompanying notes.


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KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1.   Summary of Significant Accounting Policies
 
Operations.   KB Home is a builder of single-family homes, townhomes and condominiums. The Company operates in Arizona, California, Colorado, Florida, Georgia, Illinois, Maryland, Nevada, New Mexico, North Carolina, South Carolina, Texas and Virginia. The Company also offers mortgage services through Countrywide KB Home Loans, a joint venture with Countrywide. Countrywide KB Home Loans, which is accounted for as an unconsolidated joint venture within the Company’s financial services reporting segment, began offering loans to the Company’s homebuyers on September 1, 2005. Through its financial services subsidiary, KBHMC, the Company provides title and insurance services to its homebuyers. The Company previously offered mortgage banking services directly through KBHMC until September 1, 2005 when substantially all of KBHMC’s mortgage banking assets were sold to Countrywide.
 
Basis of Presentation.   The consolidated financial statements include the accounts of the Company and all significant subsidiaries and joint ventures in which a controlling interest is held, as well as certain VIEs required to be consolidated pursuant to FASB Interpretation No. 46(R). All intercompany transactions have been eliminated. Investments in unconsolidated joint ventures in which the Company has less than a controlling interest are accounted for using the equity method.
 
In July 2007, the Company sold its 49% equity interest in its publicly traded French subsidiary, KBSA. Therefore, for the years ended November 30, 2007, 2006 and 2005, the French operations have been presented as discontinued operations in the consolidated financial statements.
 
Use of Estimates.   The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and, as such, include amounts based on informed estimates and judgments of management. Actual results could differ from these estimates.
 
Cash and Cash Equivalents.   The Company considers all highly liquid debt instruments and other short-term investments, purchased with a maturity of three months or less, to be cash equivalents. The Company’s cash equivalents totaled $1.11 billion at November 30, 2007 and $371.0 million at November 30, 2006.
 
Goodwill.   The Company has recorded goodwill in connection with various acquisitions in prior years. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. In accordance with SFAS No. 142, the Company tests goodwill for potential impairment annually as of November 30 and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company evaluates goodwill for impairment using the two-step process prescribed in SFAS No. 142. The first step is to identify potential impairment by comparing the fair value of a reporting unit to the book value, including goodwill. If the fair value of a reporting unit exceeds the book value, goodwill is not considered impaired. If the book value exceeds the fair value, the second step of the process is performed to measure the amount of impairment.
 
Property and Equipment and Depreciation.   Property and equipment are recorded at cost and are depreciated over their estimated useful lives, which generally range from two to 10 years, using the straight-line method. Repair and maintenance costs are charged to earnings as incurred. Property and equipment are included in other assets on the consolidated balance sheets and totaled $32.7 million, net of accumulated depreciation of $61.3 million, at November 30, 2007 and $50.7 million, net of accumulated depreciation of $55.2 million, at November 30, 2006. Depreciation expense totaled $17.3 million in 2007, $17.2 million in 2006, and $17.4 million in 2005.
 
Foreign Currency Translation.   Results of operations for KBSA were translated to U.S. dollars using the average exchange rates during the period. Assets and liabilities were translated using the exchange rates in effect at the balance sheet date. Resulting translation adjustments were recorded in stockholders’ equity as foreign currency translation adjustments. Cumulative translation adjustments of $63.2 million related to the Company’s French operations were recognized in 2007 in connection with the sale of those operations.
 
Homebuilding Operations.   Revenues from housing and other real estate sales are recognized in accordance with SFAS No. 66 when sales are closed and title passes to the buyer. Sales are closed when all of the following conditions are met: a sale is consummated, a significant down payment is received, the earnings process is complete and the collection of any remaining receivables is reasonably assured.


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Construction and land costs are comprised of direct and allocated costs, including estimated future costs for warranties and amenities. Land, land improvements and other common costs are generally allocated on a relative fair value basis to homes within a parcel or community. Land and land development costs include related interest and real estate taxes.
 
Inventories are stated at cost unless the carrying amount of the parcel or community is determined not to be recoverable, in which case the inventories are written down to fair value in accordance with SFAS No. 144. SFAS No. 144 requires that real estate assets be tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to the undiscounted future net cash flows expected to be generated by the asset. These evaluations for impairment are significantly impacted by estimates of revenues, costs and expenses, and other factors. If real estate assets are considered to be impaired, the impairment to be recognized is measured by the amount which the carrying value of the assets exceeds the fair value of the assets. Fair value is determined based on estimated future cash flows discounted for inherent risks associated with the real estate assets, or other valuation techniques.
 
Financial Services Operations.   Revenues are generated primarily from the following sources: interest income; title services; and insurance commissions. Interest income is accrued as earned. Title services revenues are recognized as closing services are rendered and title insurance policies are issued, both of which generally occur simultaneously at the time each home is closed. Insurance commissions are recognized when policies are issued. The financial services segment also generated revenues from escrow coordination services until the escrow coordination business was terminated in 2007. Escrow coordination fees were recognized at the time the home was closed.
 
Prior to September 1, 2005, the Company also directly generated revenues from loan originations and sales of mortgage loans and servicing rights through KBHMC. Since September 1, 2005, these mortgage banking activities have been performed by Countrywide KB Home Loans, an unconsolidated joint venture.
 
Stock-Based Compensation.   Effective December 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123(R), which requires that companies measure and recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements. The Company provides compensation benefits by issuing stock options, restricted stock, phantom shares and SARs. Prior to December 1, 2005, the Company accounted for its stock option grants under the recognition and measurement provisions of APB Opinion No. 25 and related interpretations.
 
The Company adopted SFAS No. 123(R) using the modified prospective transition method. Under that transition method, the provisions of SFAS No. 123(R) apply to all awards granted or modified after the date of adoption. In addition, compensation expense must be recognized for any unvested stock option awards outstanding as of the date of adoption on a straight-line basis over the remaining vesting period. The fair value of stock options is estimated on the date of grant using the Black-Scholes option-pricing model. In addition, SFAS No. 123(R) requires the tax benefit resulting from tax deductions in excess of the compensation expense recognized for those options to be reported in the statement of cash flows as an operating cash outflow and a financing cash inflow rather than as an operating cash inflow as previously reported.
 
SFAS No. 123(R) requires disclosure of pro forma financial information for periods prior to adoption. The following table sets forth the effect on net income and earnings per share as if the fair value recognition provisions of SFAS


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No. 123(R) had been applied to all outstanding and unvested awards in the year ended November 30, 2005 (in thousands, except per share amounts):
 
                 
Net income, as reported
  $ 823,712          
Add: Stock-based compensation expense included in net income, net of related tax effects
    4,309          
Deduct: Stock-based compensation expense determined using the fair value method, net of related tax effects
    (19,462 )        
                 
Pro forma net income
  $ 808,559          
                 
Earnings per share:
               
Basic — as reported
  $ 10.06          
Basic — pro forma
    9.87          
Diluted — as reported
    9.32          
Diluted — pro forma
    9.21          
                 
 
Advertising Costs.   The Company expenses advertising costs as incurred. The Company incurred advertising costs of $68.0 million in 2007, $107.0 million in 2006 and $78.6 million in 2005.
 
Insurance.   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, subject to certain self-insured retentions, deductibles and other coverage limits. The Company records expenses and liabilities for self-insured and deductible amounts, based on an analysis of its historical claims, which includes an estimate of claims incurred but not yet reported. The Company self-insures a portion of its overall risk through a captive insurance subsidiary.
 
Income Taxes.   Income taxes are accounted for in accordance with SFAS No. 109. The provision for, or benefit from, income taxes is calculated using the asset and liability method, under which deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are evaluated on a quarterly basis to determine whether a valuation allowance is required. In accordance with SFAS No. 109, the Company assesses whether a valuation allowance should be established based on its determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends primarily on the generation of future taxable income during the periods in which those temporary differences become deductible. Judgment is required in determining the future tax consequences of events that have been recognized in the Company’s consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on the Company’s consolidated financial position or results of operations.
 
Other Comprehensive Income (Loss).   The accumulated balance of other comprehensive loss in the consolidated balance sheet as of November 30, 2007 is comprised solely of an adjustment of $22.9 million recorded directly to accumulated other comprehensive loss at the end of 2007 to initially apply SFAS No. 158, which requires an employer to recognize the funded status of a defined postretirement benefit plan as an asset or liability on the balance sheet and requires any unrecognized prior service costs and actuarial gains/losses to be recognized in accumulated other comprehensive income (loss). The accumulated balance of other comprehensive income in the consolidated balance sheet as of November 30, 2006 is comprised solely of cumulative foreign currency translation adjustments of $63.2 million related to the Company’s French operations, which were sold in 2007.
 
Earnings (Loss) Per Share.   Basic earnings (loss) per share is calculated by dividing net income (loss) by the average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the average number of shares outstanding including all potentially dilutive shares issuable under outstanding stock options. All outstanding stock options were excluded from the diluted earnings (loss) per share calculations for the year ended November 30, 2007 because they were antidilutive due to the loss from continuing operations. For the years ended November 30, 2006 and 2005, options to purchase 597,100 shares and 5,700 shares, respectively, were excluded from the computations of diluted earnings per share because the exercise price was greater


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than the average market price of the common stock and their effect would have been antidilutive. The following table presents a reconciliation of average shares outstanding (in thousands):
 
                         
    Years Ended November 30,  
    2007     2006     2005  
 
Basic average shares outstanding
    77,172       78,829       81,888  
Net effect of stock options assumed to be exercised
          4,027       6,537  
                         
Diluted average shares outstanding
    77,172       82,856       88,425  
                         
 
Recent Accounting Pronouncements.   In July 2006, the FASB issued FASB Interpretation No. 48, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FASB Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FASB Interpretation No. 48 are effective for the Company’s first quarter ending February 29, 2008. The Company is in the process of evaluating the potential impact of adopting FASB Interpretation No. 48, but does not expect the interpretation to have a material impact on its consolidated financial position or results of operations.
 
In September 2006, the FASB issued SFAS No. 157, which provides guidance for using fair value to measure assets and liabilities, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. The Company is currently evaluating the potential impact of adopting SFAS No. 157 on its consolidated financial position and results of operations.
 
In November 2006, the EITF ratified EITF 06-8, which states that adequacy of the buyer’s investment under SFAS No. 66 should be assessed in determining whether to recognize profit under the percentage-of-completion method on the sale of individual units in a condominium project. EITF 06-8 could require that additional deposits be collected by developers of condominium projects that wish to recognize profit during the construction period under the percentage-of-completion method. EITF 06-8 is effective for fiscal years beginning after March 15, 2007. The Company is currently evaluating the potential impact of adopting EITF 06-8 on its consolidated financial position and results of operations.
 
In February 2007, the FASB issued SFAS No. 159, which permits entities to choose to measure certain financial assets and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the potential impact of the adoption of SFAS No. 159; however, it is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
 
In December 2007, the FASB issued SFAS No. 141(R), which amends SFAS No. 141, and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively. The Company is currently evaluating the potential impact of adopting SFAS No. 141(R) on its consolidated financial position and results of operations.
 
In December 2007, the FASB issued SFAS No. 160, which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated. SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 160 on its consolidated financial position and results of operations.
 
Reclassifications.   Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to the 2007 presentation.


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Note 2.   Segment Information
 
As of November 30, 2007, the Company has identified five reporting segments, comprised of four homebuilding reporting segments and one financial services reporting segment, within its consolidated operations in accordance with Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The homebuilding reporting segments have operations in the following states:
 
West Coast: California
Southwest: Arizona, Nevada and New Mexico
Central: Colorado, Illinois and Texas
Southeast: Florida, Georgia, 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, first move-up and active adult buyers.
 
The Company’s homebuilding reporting segments were identified based primarily on similarities in economic and geographic characteristics, as well as similar product type, regulatory environments, methods used to sell and construct homes and land acquisition characteristics. The Company evaluates segment performance primarily based on segment pretax income.
 
The Company’s financial services reporting segment provides mortgage banking, title and insurance services to the Company’s homebuyers. This segment also provided escrow coordination services to the Company’s homebuyers until the escrow coordination business was terminated in 2007. Mortgage banking services were provided directly by KBHMC prior to September 1, 2005. From and after that date, mortgage banking services have been provided through Countrywide KB Home Loans. The Company’s financial services segment operates 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 as described in Note 1. Summary of Significant Accounting Policies. Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent, stand-alone entity during the periods presented.
 
The following tables present financial information relating to the Company’s reporting segments (in thousands):
 
                         
    Years Ended November 30,  
    2007     2006     2005  
Revenues:
                       
West Coast
  $ 2,203,303     $ 3,531,279     $ 3,050,486  
Southwest
    1,349,570       2,183,830       1,964,483  
Central
    1,077,304       1,553,309       1,559,067  
Southeast
    1,770,414       2,091,425       1,549,277  
                         
Total homebuilding revenues
    6,400,591       9,359,843       8,123,313  
Financial services
    15,935       20,240       31,368  
                         
Total revenues
  $ 6,416,526     $ 9,380,083     $ 8,154,681  
                         
Income (loss) from continuing operations before income taxes:
                       
West Coast
  $ (665,845 )   $ 359,864     $ 681,303  
Southwest
    (287,339 )     365,098       513,846  
Central
    (64,210 )     (54,749 )     28,152  
Southeast
    (230,420 )     38,933       152,508  
Corporate and other (a)
    (246,792 )     (170,835 )     (185,473 )
                         
Total homebuilding income (loss) from continuing operations before income taxes
    (1,494,606 )     538,311       1,190,336  
Financial services
    33,836       33,536       11,198  
                         
Total income (loss) from continuing operations before income taxes
  $ (1,460,770 )   $ 571,847     $ 1,201,534  
                         


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    Years Ended November 30,  
    2007     2006     2005  
Interest cost:
                       
West Coast
  $ 63,902     $      20,160     $    16,970  
Southwest
    45,827       49,622       27,912  
Central
    21,184       37,518       41,046  
Southeast
    44,364       31,850       14,150  
Corporate and other
    9,209       20,777       17,236  
                         
Total (b)
  $ 184,486     $ 159,927     $ 117,314  
                         
Equity in income (loss) of unconsolidated joint ventures:
                       
West Coast
  $ (64,886 )   $ (25,732 )   $ 13,287  
Southwest
    (15,734 )     (26 )     112  
Central
    (6,916 )     (3,829 )     (2 )
Southeast
    (64,381 )     (12,290 )     (319 )
Corporate and other
          21,047       1,137  
                         
Total
  $ (151,917 )   $ (20,830 )   $ 14,215  
                         
Inventory impairments:
                       
West Coast
  $ 631,399     $ 113,022     $  
Southwest
    337,889       17,343        
Central
    24,662       30,592       23,743  
Southeast
    116,023       67,808       2,981  
                         
Total
  $ 1,109,973     $ 228,765     $ 26,724  
                         
Inventory abandonments: