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, 2008

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

 

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(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  þ  No  o   

 

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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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, 2008 was $1,837,819,039, including 12,091,182 shares held by the registrant’s grantor stock ownership trust and excluding 25,483,921 shares held in treasury.

 

The number of shares outstanding of each of the registrant’s classes of common stock on December 31, 2008 was as follows: Common Stock (par value $1.00 per share) 89,607,919 shares, including 11,891,482 shares held by the registrant’s grantor stock ownership trust and excluding 25,512,386 shares held in treasury.

 

Documents Incorporated by Reference

 

Portions of the registrant’s definitive Proxy Statement for the 2009 Annual Meeting of Stockholders (incorporated into Part III).

 

 

 

KB HOME

FORM 10-K

FOR THE YEAR ENDED NOVEMBER 30, 2008

 

TABLE OF CONTENTS

 

 

PART I

 

 

Segment Operating Information.   The following table presents specific operating information for our homebuilding segments for the years ended November 30, 2008, 2007 and 2006:

 

 

 

 

Unconsolidated Joint Ventures.   The above table does not include homes delivered from our unconsolidated joint ventures. From time to time, we participate in the acquisition, development, construction and sale of residential properties through unconsolidated joint ventures. Our unconsolidated joint ventures delivered 262 homes in 2008, 127 homes in 2007 and 4 homes in 2006.

 

Strategy

 

Major housing markets across the United States began declining in mid-2006. Most of our served markets have progressively weakened since then. Over the two-and-a-half year period, an increasing oversupply of new and resale homes, exacerbated more recently by rising foreclosure activity, drove home prices steadily lower. In 2008, weakening economic activity and rising job losses prompted a historic decline in consumer confidence that further discouraged home purchases. In this environment, our business has confronted fierce competition from heightened homebuilder, financial institution and investor efforts to sell homes and land, declining demand for new homes, and tighter lending standards due to turmoil in mortgage finance and credit markets. We expect housing market and general economic conditions to remain difficult and possibly worsen in 2009. And, while we believe that long-term fundamentals for the housing sector remain strong, and that current negative conditions will stabilize over time, we cannot predict when a meaningful recovery in the housing market will occur.

 

We recognized early in 2006 that housing markets were slowing after several years of record growth. In response, we shifted our strategic focus from expansion to an emphasis on capital preservation, inventory, overhead and debt reduction, and cash generation. Entering fiscal 2009, with housing markets still in turmoil, we continue to emphasize three priorities: maintaining a strong financial position; restoring the profitability of our homebuilding operations; and positioning our business for an eventual housing market recovery, while adhering to the disciplines of our core operational business model, KBnxt.

 

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:

 

 

Our KBnxt operational business model is designed to help us accomplish several objectives in a disciplined manner: build and maintain 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; calibrate our product lines to consumer preferences in both our existing and new markets; and achieve lower costs and economies of scale in acquiring and developing land, purchasing building materials, subcontracting trade 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 sustainable operations in that new market. We will also continue to consider potential asset acquisitions, as market conditions may produce attractive opportunities. However, expansion into new markets and large acquisitions are not a strategic priority for us in the near term.

Strategic Objectives.   Guided by the disciplines of our KBnxt operational business model and building on the initiatives we have implemented in response to increasingly challenging market conditions, our primary strategic objectives include:

 

 

Marketing Strategy.   Our marketing strategy focuses on differentiating the KB Home brand from resale homes and from homes sold through foreclosures and by other builders. We believe that our Built to Order ^TM message generates a high perceived value for our products and our company among consumers. Built to Order emphasizes our unique process of partnering with our homebuyers to create a home built to their individual preferences as to a home design, layout, square footage and homesite location, and to personalize their home interiors with features and amenities that meet their needs and interests. Built to Order serves as the consumer face of core elements of our KBnxt operational business model and ensures that our marketing strategy and advertising campaigns are closely aligned with our overall operational focus.

 

Our KB Home Studios are integral to our Built to Order approach to homebuying. These large showrooms allow our homebuyers to select from thousands of product and design options available for purchase as part of the original construction of their homes. The coordinated efforts of our sales representatives and KB Home Studio consultants are intended to provide high levels of customer satisfaction and lead to enhanced customer retention and referrals.

 

We are further differentiating the KB Home brand with an industry-leading environmental commitment. In 2008, we launched our My Home. My Earth. ^® environmental initiative that is focused on the challenge of becoming a leading environmentally friendly national company and issued our first sustainability report. In 2008, we were the first national homebuilder to commit to installing exclusively ENERGY STAR ^TM appliances in all of our new homes. We also offer our homebuyers an extensive line of high-value, low-cost products through our KB Home Studios that can help minimize the environmental impact of the homes they purchase.

 

During 2008, we continued to focus our marketing initiatives on first-time, first move-up and active adult homebuyers. These historically have been our core customers and it is among these groups that we see the greatest potential for future home sales.

In 2009, our efforts to differentiate the value proposition of the KB Home Built to Order homebuying experience will continue with the introduction of new home designs that meet evolving market trends. We also will continue to develop and promote our environmental sustainability initiatives.

 

Sales Strategy.   To ensure the consistency of our message and adherence to our Built to Order approach, sales of our homes are carried out by in-house teams of sales representatives who work personally with each homebuyer to create a one-of-a-kind home that meets the homebuyer’s style and budget.

 

Customer Service and Quality Control

 

Customer satisfaction is a high priority for us. 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 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 helps 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 a home.

 

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 achievement of relevant KBnxt operational objectives. 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 that meet local demand, to anticipate consumer tastes in specific markets and to assess local regulatory environments. Accordingly, we operate our business through local divisions with trained personnel who have 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, purchasing administration, 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, the completion time of our community development process has ranged from six to 24 months in our 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 1,300 to 20,000 square feet. Depending on the community, we offer from two to five model home designs and 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.   We are currently focused on maintaining a strong balance sheet and positioning ourselves for future growth. Significant land acquisitions are not currently a strategic 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 and continued market viability analysis 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, consistent with our investment standards. 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 the 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 and/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 prior to incurring them, an important element in planning communities and pricing homes.

 

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 properties no longer met our strategic needs or our internal investment standards. If market conditions remain challenging, as we expect, we may sell more of our land and interests in land, and we may abandon or try to sell more options to acquire land.

 

The following table shows the number of inventory lots we owned, in various stages of development, or controlled under option contracts in our homebuilding segments as of November 30, 2008 and 2007. The table does not include approximately 316 acres optioned as of November 30, 2008 and 376 acres optioned as of November 30, 2007 that had not yet been approved for subdivision into lots.

 

 

Reflecting our geographic diversity and balanced operations, as of November 30, 2008, 22% of the lots we owned or controlled were located in the West Coast reporting segment, 22% were in the Southwest reporting segment, 25% were in the Central reporting segment, and 31% were in the Southeast reporting segment.

 

The following table shows the dollar value of inventory we owned in various stages of development or controlled under option contracts in our homebuilding segments as of November 30, 2008 and 2007 (in thousands):

 

 

Home Construction and Sale.   Following the purchase of land and, if necessary, the completion of the entitlement process, we typically begin marketing homes for sale 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 signed a purchase contract 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 streamline the on-site production process. We have also developed programs 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’ or suppliers’ rebate programs. As part of our My Home. My Earth. environmental initiative, we have begun to integrate products, materials and construction practices into our home building process in certain areas to reduce the environmental impact of our operations and the homes we build. 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 also emphasize even-flow production methods to enhance the quality of our homes and minimize production costs.

 

Backlog

 

We sell our homes under standard purchase contracts, which generally require a customer deposit at the time of signing. The amount of the 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 home purchase contracts stipulate that if a homebuyer cancels a contract with us, we have the right to retain the homebuyer’s deposits. However, we generally permit homebuyers to cancel their obligations and obtain refunds of all or a portion of their deposits 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, 2008, excluding unconsolidated joint ventures, consisted of 2,269 homes, down 64% from the 6,322 homes in backlog at year-end 2007. Our backlog represented future housing revenues of approximately $521.4 million at November 30, 2008 and $1.50 billion at November 30, 2007. Our backlog ratio was 82% for the fourth quarter of 2008 and 68% for the fourth quarter of 2007, as we experienced fewer cancellations in the fourth quarter of 2008. (Backlog ratio is defined as homes delivered as a percentage of beginning backlog in the quarter.)

 

The significant decrease in backlog levels in 2008 reflects the aggregate impact over the past several quarters of successive negative year-over-year net order results, lower average selling prices, and our strategic initiatives to reduce our inventory and active community counts to align with reduced housing market activity. Our net orders declined 58% to 8,274 in 2008 from 19,490 in 2007. Our average cancellation rate based on net orders in 2008 was 41%, compared to an average of 42% in 2007. During the fourth quarter of 2008, our net orders decreased 50% from the fourth quarter of 2007, with decreases occurring in each of our homebuilding segments. The lower level of net orders reflects our reduced active community counts compared to the year-earlier fourth quarter, as well as our strategic decisions to wind down or exit certain communities as backlog is delivered and to discontinue product in particular communities as part of a product transition initiative.

The following table shows homes delivered, net orders, cancellation rates (based on gross orders) and ending backlog by reporting segment and with respect to our unconsolidated joint ventures for each quarter during the years ended November 30, 2008 and 2007:

 

 

 

 

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 believe that we will be able to acquire land on acceptable terms for our anticipated future needs. However, as discussed above, we have recently sold some of our land and abandoned options to purchase land in order to balance our holdings with current and forecasted market conditions and we may sell additional land or land interests in 2009. In 2008, our land sales generated $82.9 million of revenues and $82.8 million of pretax losses, including $86.2 million of impairments. Our land option contract abandonments resulted in pretax, noncash charges of $40.9 million in 2008.

 

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 pre-made, 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, manufacturer or supplier rebates. When possible, we make bulk purchases of these products at favorable prices from manufacturers and 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 mortgage financing for prospective homebuyers through our Countrywide KB Home Loans retail mortgage banking joint venture. Although our homebuyers may obtain financing from any qualified lender, 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. This includes both fixed and adjustable rate mortgages under conventional, FHA-insured and VA-guaranteed mortgages, and mortgages through revenue bond programs sponsored by states and municipalities. Countrywide KB Home Loans originated loans for 80% of our customers who obtained mortgage financing in 2008 and 72% in 2007.

 

Discontinued Operations

 

In July 2007, we sold our 49% interest in our publicly traded French subsidiary, Kaufman and Broad, S.A. (“KBSA”). The disposition of the French operations enabled us to invest additional resources in our domestic homebuilding operations and we have since operated exclusively in the United States. 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 are presented as discontinued operations in our consolidated financial statements in 2007 and 2006.

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, 2008, we had approximately 1,600 full-time employees in our operations, compared to approximately 3,100 at December 31, 2007. 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, including resale homes, foreclosed homes and rental housing. In certain markets and at times when housing demand is high, we also compete with other builders to hire subcontractors.

 

During 2008, difficult operating conditions prevailed across most U.S. housing markets. The supply of unsold homes in the marketplace increased substantially, exacerbated by record-high mortgage defaults and foreclosures. Many consumers were no longer able to afford their mortgage payments or were unable to refinance homes when their principal payments became due. Meanwhile, demand for new homes was constrained by weak consumer confidence, a downturn in the general economy and job markets, and tightening consumer mortgage lending standards. This protracted supply/demand imbalance intensified competition among homebuilders for orders throughout the year and produced relentless downward pressure on home prices. We expect this tough market environment to continue, and possibly worsen, in 2009.

 

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 will attempt 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 their 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”). We make our public SEC filings available, at no cost, through our website http://www.kbhome.com, as soon as reasonably practicable after the report is electronically filed with, or furnished to, the SEC. We will also provide these reports in electronic or paper format free of charge upon request made to our investor relations department at investorrelations@kbhome.com or at our principal executive offices. Our SEC filings are also 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.

Item 1A.  RISK FACTORS  

 

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 (i) we make in registration statements, periodic reports and other filings with the SEC and from time to time in our news releases, annual reports and other written reports or communications, and (ii) made orally from time to time by our representatives.

 

The homebuilding industry is experiencing a prolonged and severe downturn that may continue for an indefinite period and adversely affect our business and results of operations compared to prior periods.

 

In 2008 and 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 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 2008 and 2007 compared to the past several years. In 2008 and 2007, these negative supply and demand trends were exacerbated by increasing foreclosure activity that reached successive record highs, a severe downturn in general economic conditions, weakening employment trends, turmoil in credit and consumer lending markets and tighter lending standards.

 

Reflecting the impact of this difficult environment, we, like many other homebuilders, experienced a large drop in net orders, a decline in the average selling price of new homes sold and a reduction in our margins in 2008 and 2007 relative to prior years, and generated operating losses. We can provide no assurances that the homebuilding market will improve in the near future. In fact, we expect the weakness to continue, and possibly worsen, in 2009 and have a corresponding adverse effect on our business and our results of operations, including, but not limited to, lower home sales and revenues.

 

Further tightening of mortgage lending or mortgage financing requirements or further turmoil in credit and mortgage lending markets could adversely affect the availability of credit for some potential purchasers of our homes and thereby reduce our sales.

 

During 2008 and 2007, the mortgage lending and mortgage finance industries experienced significant instability due to, among other things, delinquencies, defaults and foreclosures on home loans and a resulting decline in their market value, particularly subprime and adjustable-rate loans. A number of providers, purchasers and insurers of such loans have gone out of business or exited the market. In light of these developments, lenders, investors, regulators and others 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, adjustable-rate and other nonconforming loans has caused most lenders to stop offering such loan products. Fewer loan products and providers 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 our homes and slowed any general improvement in the housing market. Furthermore, they have resulted in a reduction in demand for the mortgage loans originated through our Countrywide KB Home Loans joint venture. 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 2009.

 

Many of our homebuyers obtain financing for their home purchases from Countrywide KB Home Loans. Our partner, a Bank of America, N.A. subsidiary, provides the loan products that the joint venture offers to our homebuyers. If our partner 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.

 

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 2008 and 2007, we have done so at significantly reduced gross profit levels and have incurred significant asset impairment charges. Moreover, many of our strategic initiatives to generate cash and reduce our inventories have involved lowering overhead through workforce reductions, for which we incurred significant costs, and reducing our active community counts through strategic wind downs or market exits, curbs in development and sales of land interests. These strategic steps have resulted in our generating successively fewer net orders, homes delivered and revenues compared to prior periods, and contributed to the net losses we recognized in 2008 and 2007. Also, in 2008, notwithstanding our sales strategies, we continued to experience volatility in cancellations of home purchase contracts. We believe that the volatile cancellation rates largely reflected a decrease in homebuyer confidence based on sustained home price declines, increased offerings of sales incentives in the marketplace for both new and existing homes and generally poor economic conditions, all of which prompted homebuyers to forgo or delay home purchases. The more restrictive mortgage lending environment and the inability of some buyers to sell their existing homes have also led to lower demand for new homes and higher cancellations. Many of these factors affecting new orders and cancellation rates are beyond our control. It is uncertain how long these factors, and the reduced sales levels and volatility in cancellations we have experienced will continue. To the extent that they do, we expect that they will have a negative effect on our business and our results of operations.

 

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:

 

 

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 2008 and 2007, unfavorable changes in many of these factors negatively affected all of our served markets, and we expect the widespread nature of the downturn in the housing market to continue in 2009. A continued downturn in the economy would likely worsen the unfavorable trends the housing market experienced in 2008 and 2007.

 

Weather conditions and natural disasters, such as earthquakes, hurricanes, tornadoes, floods, droughts, fires and other environmental conditions, can also impair our homebuilding business on a local or regional basis. Civil unrest or acts of terrorism can also have a negative effect on our business.

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 we sell 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 volatile home purchase contract cancellation rates in 2008 and we may experience similar volatility in 2009.

 

Supply shortages and other risks related to demand for building materials and/or skilled labor could increase costs and delay deliveries.

 

There is a high level of competition in the homebuilding industry 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 home purchase contracts, as the purchase 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. Further, we may not be able to pass on increases in construction costs because of market conditions. Sustained increases in construction costs due, among other things, to pricing competition for materials and skilled labor may, over time, decrease 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 skilled 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 further decrease prices in an attempt to stimulate sales volume. Our 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 with new home sales prices or, if we choose, in disposing 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 noncash charges for inventory impairments if the value of our owned inventory is reduced or for land option contract abandonments 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, finishing and entitling lots, 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 may be forfeited if we do not exercise the options within specified periods. Because of current market conditions, we have strategically terminated some of these options, resulting in the forfeiture of deposits and unrecoverable due diligence and 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 or optioning of land and the delivery of homes on that land. The downturn in the housing market has caused the fair value of certain of our owned or controlled inventory to fall, in some cases well below the estimated fair value at the time we acquired it. Because of our assessments of fair value, we have been required to write down the carrying value of certain of our inventory, including certain inventory that we have previously written down, and take corresponding noncash charges against our earnings to reflect the impaired value. We have also abandoned our interests in certain land inventory that no longer meets our internal investment standards, which also required us to take noncash charges. If the current downturn in the housing market continues, we may need to take additional charges against our earnings for inventory

impairments or land option contract abandonments, or both. Any such noncash charges would have an adverse effect on our consolidated results of operations.

 

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 further 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, explore other options or because they cannot, or become reluctant to, complete the purchase. In 2008, 2007 and 2006, we experienced elevated and volatile cancellation rates, in part because of these reasons. Continued elevated and volatile cancellation rates due to these conditions, or otherwise, 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 standards depends on a number of factors outside of 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 attractive land could increase, perhaps substantially, which could adversely impact our results of operations including, but not limited to, our margins.

 

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 served 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 our key served markets, 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.

 

Interest rate increases or changes in federal lending programs or regulation could lower demand for our homes.

 

Nearly all of our customers finance the purchase of their homes. Prior to 2006, 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 and more available to customers with lower credit scores. Increases in interest rates or decreases in the availability of mortgage financing or of certain mortgage programs, as discussed above, may lead to fewer mortgage loans being provided, higher down payment requirements or monthly mortgage costs, or a combination of the foregoing, and, as a result, 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 adequate financing.

 

Because the availability of Fannie Mae, Freddie Mac, FHA- and VA-backed 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 and adversely affect our results of operations. This may occur as a result of the federal government’s conservatorship of Fannie Mae and Freddie Mac in 2008.

 

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, by eliminating or substantially reducing these income tax

benefits, 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 and permitting requirements 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, and recently entered into a consent decree with the EPA and certain states concerning our storm water pollution prevention practices. These laws and regulations and the consent decree 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, 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 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 (including existing homes sold through foreclosures) and rental housing. The competitive conditions in the homebuilding industry can result in:

 

 

 

These competitive conditions may adversely affect our business and financial results by decreasing our revenues, increasing our costs and/or diminishing growth in our local or regional homebuilding business. In the current downturn in the homebuilding industry, the reactions of our new home and housing alternative competitors are reducing the effectiveness of our efforts to achieve pricing stability, generate home sales, 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 served markets and our judgment of the 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-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, or that any potential inadequacies will not have an adverse affect on our results of operations. 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, increasing our risks, and become more costly.

 

Because of the seasonal nature of our business, our quarterly operating results fluctuate.

 

We have experienced seasonal fluctuations in our 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 2008 resulted in lower sales in the spring and summer months and correspondingly lower deliveries in the fall and winter months as compared to 2007. With the current difficult market conditions expected to continue into 2009, 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 indenture governing our outstanding public notes impose restrictions on our operations and activities. The restrictions primarily relate to cash dividends, stock repurchases, incurrence of indebtedness, creation of liens and asset dispositions, defaults with respect to other debt obligations 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, which would have a

significant adverse effect on our ability to invest in and grow our business. Moreover, we may curtail our investment activities and other uses of cash to maintain compliance with these restrictions and covenants.

 

We participate in certain unconsolidated joint ventures where we may be adversely impacted by the failure of the unconsolidated joint venture or the other partners in the unconsolidated joint venture to fulfill their obligations.

 

We have investments in and commitments to certain unconsolidated joint ventures with unrelated strategic partners to acquire and develop land and, in some cases, build and deliver homes. To finance these activities, our unconsolidated joint ventures often obtain loans from third-party lenders that are secured by the unconsolidated joint venture’s assets. In certain instances, we and the other partners in an unconsolidated joint venture provide guarantees and indemnities to lenders with respect to the unconsolidated joint venture’s debt, which may be triggered under certain conditions when the unconsolidated joint venture fails to fulfill its obligations under its loan agreements. Because we do not have a controlling interest in these unconsolidated joint ventures, we depend heavily on the other partners in each unconsolidated joint venture to both (i) cooperate and make mutually acceptable decisions regarding the conduct of the business and affairs of the unconsolidated joint venture and (ii) ensure that they, and the unconsolidated joint venture, fulfill their respective obligations to us and to third parties. If the other partners in our unconsolidated joint ventures do not provide such cooperation or fulfill these obligations due to their financial condition, strategic business interests (which may be contrary to ours), or otherwise, we may be required to spend additional resources (including payments under the guarantees we have provided to the unconsolidated joint ventures’ lenders) and suffer losses, each of which could be significant. Moreover, our ability to recoup such expenditures and losses by exercising remedies against such partners may be limited due to potential legal defenses they may have, their respective financial condition and other circumstances.

 

The downturn in the housing market and the continuation of the disruptions in the credit markets could limit our ability to access capital and increase our costs of capital or stockholder dilution.

 

We have historically funded our homebuilding and financial services operations with internally generated cash flows and external sources of debt and equity financing. However, during this downturn in the housing market, we have relied primarily on the positive operating cash flow we have generated to meet our working capital needs and repay outstanding indebtedness. While we anticipate generating positive operating cash flow in 2009, principally through the receipt of federal income tax refunds and from home and land sales, the prolonged downturn in the housing markets and the disruption in the credit markets have reduced the availability to us of other sources of liquidity.

 

As of November 30, 2008, we had $200.0 million of 8 5 / 8 % senior subordinated notes (the “$200 Million Senior Subordinated Notes”) outstanding, which matured on December 15, 2008. We had sufficient cash on hand and redeemed these notes upon their scheduled maturity. However, current market conditions would significantly limit our ability to replace this indebtedness if we chose to do so, particularly due to the lowering of our senior debt ratings by three rating agencies during 2008. Pricing in the public debt markets has increased substantially, and the indenture terms available in these markets are generally more restrictive than those in our current indentures. Moreover, due to the deterioration in the credit markets and the uncertainties that exist in the general economy and for homebuilders in particular, we cannot be certain that we would be able to replace existing financing or secure additional sources of financing. In addition, the significant decline in our stock price, the ongoing volatility in the stock markets and the reduction in our stockholders’ equity relative to our debt could also impede our access to the equity markets or increase the amount of dilution our stockholders would experience should we seek or need to raise capital through issuance of equity.

 

While we believe we can meet our forecasted capital requirements from our cash resources, future cash flow and the sources of financing that we anticipate will be available to us, we can provide no assurance that we will be able to do so, particularly if current difficult housing or credit market or economic conditions continue or deteriorate further. The effects on our business, liquidity and financial results of these conditions could be material and adverse to us.

 

Our net operating loss carryforwards could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.

 

Since the end of our 2007 fiscal year, we have generated significant net operating losses, (“NOLs”), and we may generate additional NOLs in 2009. Under federal tax laws, we can use our NOLs (and certain related tax credits) to offset ordinary income tax on our future taxable income for up to 20 years, after which they expire for such purposes. Until they expire, we can carry forward our NOLs (and certain related tax credits) that we do not use in any particular year to offset income tax in future years.

The benefits of our NOLs would be reduced or eliminated if we experience an “ownership change,” as determined under Section 382 of the Internal Revenue Code. A Section 382 “ownership change” occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an “ownership change” occurs, Section 382 would impose an annual limit on the amount of NOLs we can use to offset income tax equal to the product of the total value of our outstanding equity immediately prior to the “ownership change” (reduced by certain items specified in Section 382) and the federal long-term tax-exempt interest rate in effect for the month of the “ownership change.” A number of special rules apply to calculating this annual limit.

 

While the complexity of Section 382’s provisions and the limited knowledge any public company has about the ownership of its publicly-traded stock make it difficult to determine whether an “ownership change” has occurred, we currently believe that an “ownership change” has not occurred. However, if an “ownership change” were to occur, the annual limit Section 382 may impose could result in a material amount of our NOLs expiring unused. This would significantly impair the value of our NOL assets and, as a result, have a negative impact on our financial position and results of operations.

 

A decline in our tangible net worth and the resulting increase in our leverage ratio 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:

 

 

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.

 

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. In fact, the total commitment available under our Credit Facility was reduced in 2008. Should we not generate sufficient cash flow from operations or have borrowings available to us under our Credit Facility, 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, or through equity issuances that would dilute existing stockholders’ interests. However, we currently do not anticipate a need to borrow under the Credit Facility through its November 2010 maturity.

 

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, 2008, we would have been permitted to incur up to $1.55 billion of consolidated total indebtedness, as defined in the Credit Facility. This maximum amount exceeded our actual consolidated total indebtedness at November 30, 2008 by $814.5 million. 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, 2008, we would have been permitted to incur up to

$2.47 billion of senior indebtedness under the Credit Facility. This maximum amount exceeded our actual total senior indebtedness at November 30, 2008 by $825.0 million. 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 perceived credit worthiness, as discussed above. 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.

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. We own the premises for our San Antonio, Texas office.

 

We believe that such properties, including the equipment located therein, are suitable and adequate to meet the needs of our businesses.

Item 3.  LEGAL PROCEEDINGS  

 

Derivative Litigation

 

In the summer of 2006, four shareholder derivative lawsuits were filed, ostensibly on our behalf, alleging, among other things, that the 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 stockholder-approved stock option plans. Two of the lawsuits were state court actions filed in Los Angeles County Superior Court, and two were federal actions filed in the United States District Court for the Central District of California. The two federal lawsuits also included substantive claims under the federal securities laws.

 

We recently reached a tentative global settlement with the parties in the four actions. The settlement also includes a resolution of all issues with our former Chairman and Chief Executive Officer, Bruce Karatz. On December 9, 2008, the parties to the federal court actions submitted the proposed settlement to the court, and the plaintiffs in those actions concurrently filed an unopposed motion seeking preliminary approval of the proposed settlement. On December 15, 2008, the court granted preliminary approval of the proposed settlement and scheduled a hearing for February 9, 2009 to determine whether the settlement should be finally approved by the court. If it is finally approved, the federal litigation will be dismissed, and all parties have agreed that the state court litigation will be dismissed as well. If the settlement is not approved, the federal and state court litigation will continue.

 

ERISA Litigation

 

On March 16, 2007, plaintiffs Reba Bagley and Scott Silver filed an action brought under Section 502 of the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1132, Bagley et al., v. KB Home, et al., in the United States District Court for the Central District of California. The action was brought against us, our directors, and certain of our current and former officers. After the court allowed leave to file an amended complaint, on April 3, 2008, plaintiffs filed an amended complaint adding Tolan Beck and Rod Hughes as additional plaintiffs and dismissing certain individuals as defendants. All four plaintiffs claim to be former employees of KB Home who participated in the KB Home 401(k) Savings Plan (the “Plan”). Plaintiffs allege on behalf of themselves and on behalf of all others similarly situated that all defendants breached fiduciary duties owed to plaintiffs and purported class members under ERISA by failing to disclose information to and providing misleading information to participants in the Plan about our alleged prior stock option backdating practices and by failing to remove our stock as an investment option under the Plan. Plaintiffs allege that this breach of fiduciary duties caused plaintiffs to earn less on their Plan accounts than they would have earned but for defendants’ alleged breach of duties. Plaintiffs seek unspecified money damages and injunctive and other equitable relief. On May 16, 2008, we filed a motion to dismiss on the ground that plaintiffs’ allegations fail to state a claim against us. Plaintiffs filed an opposition to the motion on June 20, 2008. The hearing on the motion was held on September 8, 2008. On October 6, 2008, the court issued its order. The court denied our motion to dismiss the plaintiffs’ claims for breach of fiduciary duty and breach of the duty to monitor and granted our motion to dismiss the plaintiffs’ claims for breach of the fiduciary duty of disclosure. The court also denied a separate motion to dismiss filed by the

individual defendants based on the standing of plaintiffs to sue. We filed our answer to the first amended complaint on November 5, 2008. On November 24, 2008, the court approved a stipulation to stay all discovery and other proceedings through February 6, 2009, in order to allow the parties time to attempt to settle the plaintiffs’ claims through mediation.

 

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 2008 to a vote of security holders, through the solicitation of proxies or otherwise.

 

 

 

 

There is no family relationship between any of our executive officers or between any of our executive officers and any of our directors.

 

Stock Performance Graph

 

The graph below compares the cumulative total return of KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index for the last five year-end periods ended November 30.

 

Comparison of Five-Year Cumulative Total Return
Among KB Home, S&P 500 Index, S&P Homebuilding
Index and Dow Jones Home Construction Index

 

 

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. As of November 30, 2008, the closing common stock price on the New York Stock Exchange was $11.63 per share. On December 31, 2008, our common stock closed at $13.62 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, 2003 in KB Home common stock, the S&P 500 Index, the S&P Homebuilding Index and the Dow Jones Home Construction Index including reinvestment of dividends.

 

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 the Notes thereto. Both are included later in this report.

 

 

 

asset valuation allowances. Our year-over-year results for 2008 were also affected by our providing targeted price reductions and sales incentives in certain communities in response to competitive conditions, or to facilitate our exit from specific markets, projects or product types.

 

Despite the difficult housing market conditions and our year-over-year declines in homes delivered and revenues generated, our net loss in 2008 was smaller than our loss from continuing operations in 2007. This improvement was principally due to the substantially lower asset impairment and abandonment charges we incurred in 2008 compared to the previous year. Our financial results in 2008 were also helped by strategic adjustments we have made in response to the changing operating environment. Since 2006, we have implemented a series of aggressive actions focused on generating and preserving cash, lowering our direct building costs, gaining operational efficiencies, lowering overhead, developing new product to compete with resales and foreclosures, and restoring profitability. Specific strategic actions taken during 2008 included calibrating our business to market conditions by consolidating certain operating divisions, reducing our workforce by 57%, and transitioning to new, value-engineered homes that are less expensive to build and can be offered to homebuyers at more affordable prices and with greater design choices. These actions had a positive impact on our results for the year, particularly in the fourth quarter, creating a foundation we intend to build on as we enter 2009.

 

Our total revenues of $3.03 billion for the year ended November 30, 2008 decreased 53% from $6.42 billion in 2007, which had decreased 32% from $9.38 billion in 2006. Revenues declined in 2008 and 2007 primarily due to decreases in our housing revenues corresponding to fewer homes delivered and lower average selling prices. Included in our total revenues were financial services revenues of $10.8 million in 2008, $15.9 million in 2007 and $20.2 million in 2006. Financial services revenues decreased in both 2008 and 2007 primarily due to our delivering fewer homes and the termination of our escrow coordination business in 2007.

 

We incurred a net loss of $976.1 million, or $12.59 per diluted share in 2008, largely due to pretax, noncash charges of $748.6 million for inventory and joint venture impairments and the abandonment of land option contracts, and $68.0 million for goodwill impairments. These charges reflected the deterioriating housing market conditions, which exerted downward pressure on asset values. The bulk of these charges were associated with our West Coast, Southwest and Southeast reporting segments. The goodwill impairment charges in 2008 related to our Central and Southeast reporting segments, and resulted in our having no remaining goodwill company-wide at November 30, 2008. The net loss in 2008 also reflected a $355.9 million valuation allowance charge taken against net deferred tax assets to fully reserve the tax benefits generated from our pretax loss for the year in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). In 2007, our continuing operations generated an after-tax loss of $1.41 billion, or $18.33 per diluted share, due to pretax, noncash charges of $1.41 billion for inventory and joint venture impairments and the abandonment of land option contracts, and $107.9 million for goodwill impairments recognized during the year. The majority of the inventory-related charges in 2007 related to our West Coast and Southwest reporting segments, and the goodwill impairments related solely to our Southwest reporting segment. Our 2007 loss from continuing operations also reflected a noncash charge of $514.2 million to establish a valuation allowance for our net deferred tax assets. In 2006, we reported after-tax income from continuing operations of $392.9 million or $4.74 per diluted share.

 

Income from our French discontinued operations, net of income taxes, totaled $485.4 million in 2007, including a $438.1 million after-tax gain on the sale of these operations. Income from our French discontinued operations, net of income taxes, totaled $89.4 million in 2006.

 

Overall, we posted a net loss of $929.4 million, or $12.04 per diluted share (including the discontinued operations) in 2007. This compares to net income of $482.4 million, or $5.82 per diluted share, in 2006.

 

Our backlog at November 30, 2008 was comprised of 2,269 homes, representing future housing revenues of approximately $521.4 million. These backlog measures decreased 64% and 65%, respectively, from the 6,322 homes in backlog, representing approximately $1.50 billion in future housing revenues, at November 30, 2007. These decreases were due to the combined impact over the past several quarters of negative year-over-year net order results, lower average selling prices, and our strategic initiatives to reduce our inventory and community count to better align with reduced housing market activity. Our homebuilding operations generated 8,274 net orders in 2008, down 58% from 19,490 net orders in 2007. The decrease in net orders in 2008 reflected our year-over-year reduction in community counts, the gradual winding down of certain communities as backlog was delivered, and our discontinuation of product in particular communities as part of our product transition strategy. Order cancellations as a percentage of gross orders improved slightly to 41% in 2008 from 42% in 2007.

We generated $341.3 million of positive cash flow from operating activities in 2008 and ended the year with cash and cash equivalents and restricted cash totaling $1.25 billion. Our total debt at year-end stood at $1.94 billion, down $220.3 million from $2.16 billion at November 30, 2007, mainly due to the early redemption of our $300.0 million of 7 3 / 4 % senior subordinated notes due in 2010 (the “$300 Million Senior Subordinated Notes”) partially offset by increased mortgages and land contracts due to land sellers. We ended 2008 with no cash borrowings outstanding under our Credit Facility. As of November 30, 2008, our ratio of debt to total capital, net of cash and cash equivalents and restricted cash, was 45.4%, within our targeted range of 40%-50%. Restricted cash consists of an interest reserve account established with the Credit Facility’s administrative agent (the “Interest Reserve Account”), as discussed below. Our liquidity, including the available capacity under our Credit Facility, was approximately $1.84 billion at November 30, 2008. Our inventory balance of $2.10 billion at November 30, 2008 was 36% lower than the $3.31 billion balance at November 30, 2007. We ended 2008 with what we believe is an attractive, geographically diverse land portfolio of approximately 47,000 lots owned or controlled. We ended 2007 with approximately 66,000 lots owned or controlled. We believe our solid financial position and fewer, well-situated lot positions give us a distinct competitive advantage relative to other homebuilding companies and should allow us to capitalize on opportunities as housing markets stabilize. However, it is uncertain when meaningful stabilization will occur.

 

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, 2008, our reportable homebuilding segments consisted of ongoing operations located in the following states: West Coast — California; Southwest — Arizona and Nevada; Central — Colorado and Texas; Southeast — Florida, North Carolina and South Carolina.

 

The following table presents a summary of certain financial and operational data for our homebuilding operations (dollars in thousands, except average selling price):