UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended May 31, 2006.

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

For the transition period from [               ] to [               ].

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(Exact name of registrant as specified in its charter)

Delaware (State of incorporation)		95-3666267 (IRS employer identification number)

10990 Wilshire Boulevard
Los Angeles, California 90024
(310) 231-4000

(Address and telephone number of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ       No o

Indicate by check mark whether the registrant 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. (check one):

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of May 31, 2006.

Common stock, par value $1.00 per share, 91,318,327 shares outstanding, including 12,412,982 shares held by the Registrant’s Grantor Stock Ownership Trust and excluding 23,183,707 shares held in treasury.

 

 

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FORM 10-Q
INDEX

		Page
		Number(s)
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income — Six Months and Three Months Ended May 31, 2006 and 2005		3
Consolidated Balance Sheets — May 31, 2006 and November 30, 2005		4
Consolidated Statements of Cash Flows — Six Months Ended May 31, 2006 and 2005		5
Notes to Consolidated Financial Statements		6-18
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk		31
Item 4. Controls and Procedures		31
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		32
Item 4. Submission of Matters to a Vote of Security Holders		32
Item 6. Exhibits		33
SIGNATURES		34
INDEX OF EXHIBITS		35
EXHIBIT 3.9
EXHIBIT 10.28
EXHIBIT 10.29
EXHIBIT 10.30
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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(In Thousands, Except Per Share Amounts — Unaudited)

		Six Months Ended May 31,								Three Months Ended May 31,
		2006				2005				2006				2005
Total revenues		$	4,783,721			$	3,766,446			$	2,592,071			$	2,130,326
Construction:
Revenues		$	4,774,537			$	3,748,806			$	2,587,213			$	2,120,313
Construction and land costs			(3,539,504	)			(2,764,651	)			(1,921,189	)			(1,552,276	)
Selling, general and administrative expenses			(619,079	)			(493,783	)			(324,237	)			(273,285	)
Operating income			615,954				490,372				341,787				294,752
Interest income			2,293				1,771				1,113				791
Interest expense, net of amounts capitalized			(15,019	)			(6,417	)			(10,266	)			(4,001	)
Minority interests			(29,846	)			(33,426	)			(18,129	)			(19,066	)
Equity in pretax income (loss) of unconsolidated joint ventures			5,437				7,779				(318	)			2,162
Construction pretax income			578,819				460,079				314,187				274,638
Financial services:
Revenues			9,184				17,640				4,858				10,013
Expenses			(3,237	)			(16,662	)			(1,490	)			(9,638	)
Equity in pretax income of unconsolidated joint venture			3,867				—				2,717				—
Financial services pretax income			9,814				978				6,085				375
Total pretax income			588,633				461,057				320,272				275,013
Income taxes			(207,600	)			(156,800	)			(113,700	)			(93,500	)
Net income		$	381,033			$	304,257			$	206,572			$	181,513
Basic earnings per share		$	4.75			$	3.76			$	2.60			$	2.22
Diluted earnings per share		$	4.48			$	3.47			$	2.46			$	2.06
Basic average shares outstanding			80,268				80,938				79,522				81,665
Diluted average shares outstanding			85,112				87,750				83,978				88,044
Cash dividends per common share		$	.5000			$	.3750			$	.2500			$	.1875

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(In Thousands — Unaudited)

		May 31,				November 30,
		2006				2005
Assets
Construction:
Cash and cash equivalents		$	9,680			$	144,783
Trade and other receivables			573,219				580,931
Inventories			7,568,977				6,128,342
Investments in unconsolidated joint ventures			386,312				275,378
Deferred income taxes			201,278				220,814
Goodwill			247,171				242,589
Other assets			155,193				124,150
			9,141,830				7,716,987
Financial services			46,746				29,933
Total assets		$	9,188,576			$	7,746,920
Liabilities and Stockholders’ Equity
Construction:
Accounts payable		$	935,110			$	892,727
Accrued expenses and other liabilities			1,464,126				1,338,626
Mortgages and notes payable			3,581,484				2,463,814
			5,980,720				4,695,167
Financial services			54,080				55,131
Minority interests			159,455				144,951
Common stock			114,502				113,905
Paid-in capital			828,776				771,973
Retained earnings			2,961,558				2,620,251
Accumulated other comprehensive income			52,612				28,704
Deferred compensation			—				(13,605	)
Grantor stock ownership trust, at cost			(134,887	)			(141,266	)
Treasury stock, at cost			(828,240	)			(528,291	)
Total stockholders’ equity			2,994,321				2,851,671
Total liabilities and stockholders’ equity		$	9,188,576			$	7,746,920

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(In Thousands — Unaudited)

		Six Months Ended May 31,
		2006				2005
Cash flows from operating activities:
Net income		$	381,033			$	304,257
Adjustments to reconcile net income to net cash used by operating activities:
Equity in pretax income of unconsolidated joint ventures			(9,304	)			(7,779	)
Distributions of earnings from unconsolidated joint ventures			5,847				4,407
Minority interests			29,846				33,426
Amortization of discounts and issuance costs			2,075				1,941
Depreciation and amortization			9,832				10,160
Provision for deferred income taxes			19,536				898
Excess tax benefit from stock-based compensation			(9,876	)			—
Change in assets and liabilities:
Receivables			9,021				130,543
Inventories			(1,181,383	)			(795,139	)
Accounts payable, accrued expenses and other liabilities			52,020				38,381
Other, net			6,838				(37,455	)
Net cash used by operating activities			(684,515	)			(316,360	)
Cash flows from investing activities:
Investments in unconsolidated joint ventures			(111,344	)			(32,905	)
Net sales of mortgages held for long-term investment			2				188
Payments received on first mortgages and mortgage-backed securities			32				213
Purchases of property and equipment, net			(10,546	)			(11,533	)
Net cash used by investing activities			(121,856	)			(44,037	)
Cash flows from financing activities:
Net proceeds from (payments on) credit agreements and other short term borrowings			334,258				(17,131	)
Proceeds from term loan			400,000				—
Proceeds from issuance of senior notes			298,458				298,071
Payments on collateralized mortgage obligations			(28	)			(135	)
Payments on mortgages, land contracts and other loans			(65,604	)			(47,807	)
Issuance of common stock under employee stock plans			65,183				68,846
Payments to minority interests			(15,342	)			(34,002	)
Excess tax benefit from stock-based compensation			9,876				—
Payments of cash dividends			(39,726	)			(30,514	)
Repurchases of common stock			(299,949	)			(5,013	)
Net cash provided by financing activities			687,126				232,315
Net decrease in cash and cash equivalents			(119,245	)			(128,082	)
Cash and cash equivalents at beginning of period			153,990				234,196
Cash and cash equivalents at end of period		$	34,745			$	106,114
Summary of cash and cash equivalents:
Construction		$	9,680			$	76,279
Financial services			25,065				29,835
Total cash and cash equivalents		$	34,745			$	106,114
Supplemental disclosures of cash flow information:
Interest paid, net of amounts capitalized		$	10,436			$	4,154
Income taxes paid		$	232,300			$	47,474
Supplemental disclosures of noncash activities:
Cost of inventories acquired through seller financing		$	134,536			$	113,931
Inventory of consolidated variable interest entities		$	124,716			$	42,495

See accompanying notes.

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(Unaudited)

1. Basis of Presentation and Significant Accounting Policies

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

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s financial position as of May 31, 2006, the results of its consolidated operations for the six months and three months ended May 31, 2006 and 2005, and its consolidated cash flows for the six months ended May 31, 2006 and 2005. The results of operations for the six months and three months ended May 31, 2006 are not necessarily indicative of the results to be expected for the full year. The consolidated balance sheet at November 30, 2005 has been taken from the audited financial statements as of that date. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended November 30, 2005, which are contained in the Company’s 2005 Annual Report to Stockholders on Form 10-K.

Segment information

The Company has identified two reportable segments: construction and financial services. Information for the Company’s reportable segments is presented in its consolidated statements of income, consolidated balance sheets and related notes to consolidated financial statements included herein. The Company’s reporting segments follow the same accounting policies used for the Company’s consolidated financial statements. Management evaluates a segment’s performance based upon a number of factors, including pretax results.

Earnings per share

Basic earnings per share is calculated by dividing net income by the average number of common shares outstanding for the period. Diluted earnings per share is calculated by dividing net income by the average number of common shares outstanding including all dilutive potentially issuable shares under various stock option plans and stock purchase contracts.

The following table presents a reconciliation of average shares outstanding (in thousands):

		Six Months Ended May 31,								Three Months Ended May 31,
		2006				2005				2006				2005
Basic average shares outstanding			80,268				80,938				79,522				81,665
Net effect of stock options assumed to be exercised			4,844				6,812				4,456				6,379
Diluted average shares outstanding			85,112				87,750				83,978				88,044

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

Comprehensive Income

The following table presents the components of comprehensive income (in thousands):

		Six Months Ended May 31,								Three Months Ended May 31,
		2006				2005				2006				2005
Net income		$	381,033			$	304,257			$	206,572			$	181,513
Foreign currency translation adjustment			23,908				(19,480	)			20,821				(20,333	)
Comprehensive income		$	404,941			$	284,777			$	227,393			$	161,180

The accumulated balances of other comprehensive income in the balance sheets as of May 31, 2006 and November 30, 2005 are comprised solely of cumulative foreign currency translation adjustments of $52.6 million and $28.7 million, respectively.

Reclassifications

Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to the 2006 presentation.

2. Stock-Based Compensation

The Company has stock-based employee compensation plans. Under the Company’s current plans, stock options, associated limited appreciation rights, restricted shares of common stock, stock units, other equity-based awards and other incentive awards may be granted to eligible individuals. Stock option awards granted under the plans typically expire 10-15 years after the date of grant. Among other features, the plans contain provisions which are designed to enable the Company to maintain federal tax deductibility for its payment of annual compensation in excess of $1.0 million to certain participating executive officers.

Prior to December 1, 2005, the Company accounted for its stock-based compensation plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and related interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Accordingly, no stock-based compensation expense was recognized in the consolidated income statement for the three months or six months ended May 31, 2005, as all options granted under the Company’s stock-based employee compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective December 1, 2005, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (“SFAS No. 123(R)”) using the modified prospective transition method. Under that transition method, compensation cost recognized in the three months and six months ended May 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to December 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). The fair value for each option was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants during the quarter ended May 31, 2006: a risk free interest rate of 4.84%; an expected volatility factor for the market price of the Company’s common stock of 41.06%; a dividend yield of 1.95%; and an expected life of five years. The weighted average fair value of each option granted during the quarter ended May 31, 2006 was $24.82. In accordance with the modified prospective transition method, results for prior periods have not been

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2. Stock-Based Compensation (continued)

restated. As a result of adopting SFAS No. 123(R) on December 1, 2005, the Company’s pretax income and net income for the three months ended May 31, 2006 were $4.0 million and $2.6 million lower, respectively, and its basic and diluted earnings per share for the period were $.03 and $.02 lower, respectively, than if it had continued to account for stock-based compensation under APB Opinion No. 25. The Company’s pretax income and net income for the six months ended May 31, 2006 were $8.8 million and $5.7 million lower, respectively, and its basic and diluted earnings per share for the period were $.07 and $.05 lower, respectively, than if it had continued to account for stock-based compensation under APB Opinion No. 25.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. SFAS No. 123(R) requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (“excess tax benefits”) to be classified and reported as both an operating cash outflow and a financing cash inflow upon adoption. As a result, the Company classified $9.9 million of excess tax benefits as an operating cash outflow and a financing cash inflow for the six months ended May 31, 2006.

The following table illustrates the effect (in thousands, except per share amounts) on net income and basic and diluted earnings per share if the fair value recognition provisions of SFAS No. 123(R) had been applied to all outstanding and unvested awards in the six months and three months ended May 31, 2005. For purposes of this pro forma disclosure, the value of the options was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants during the quarter ended May 31, 2005: a risk free interest rate of 3.85%; an expected volatility factor for the market price of the Company’s common stock of 43.60%; a dividend yield of 1.11%; and an expected life of seven years. The weighted average fair value of each option granted during the quarter ended May 31, 2005 was $27.07.

		Six Months Ended				Three Months Ended
		May 31,				May 31,
		2005				2005
Net income-as reported		$	304,257			$	181,513
Deduct stock-based compensation expense determined using the fair value method, net of related tax effects			(9,763	)			(5,229	)
Pro forma net income		$	294,494			$	176,284
Earnings per share:
Basic-as reported		$	3.76			$	2.22
Basic-pro forma			3.64				2.16
Diluted-as reported			3.47				2.06
Diluted-pro forma			3.42				2.02

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2. Stock-Based Compensation (continued)

The following table summarizes the stock options outstanding as of May 31, 2006 as well as activity during the six months then ended:

										Weighted				Aggregate
						Weighted				Average				Intrinsic
						Average				Remaining				Value as of
						Exercise				Contractual				May 31, 2006
		Options				Price				Term				(in thousands)
Options outstanding at beginning of period			9,176,253			$	28.16
Granted			82,069				68.19
Exercised			(596,911	)			24.16
Cancelled			(60,585	)			38.20
Options outstanding at end of period			8,600,826			$	28.75				11.6			$	200,586
Options exercisable at end of period			6,245,467			$	23.76				11.3			$	172,993

As of May 31, 2006, there was $16.1 million of total unrecognized compensation cost related to unvested stock option awards.

3. Financial Services

Financial information related to the Company’s financial services segment is as follows (in thousands):

		Six Months Ended May 31,								Three Months Ended May 31,
		2006				2005				2006				2005
Revenues:
Interest income		$	117			$	5,050			$	62			$	2,501
Title services			3,168				2,161				1,907				1,245
Insurance commissions			4,419				4,066				2,146				1,901
Escrow coordination fees			1,480				1,394				743				752
Mortgage and servicing rights income			—				4,969				—				3,614
Total revenues			9,184				17,640				4,858				10,013
Expenses:
Interest			(29	)			(3,129	)			(14	)			(1,446	)
General and administrative			(3,208	)			(13,533	)			(1,476	)			(8,192	)
			5,947				978				3,368				375
Equity in pretax income of unconsolidated joint venture			3,867				—				2,717				—
Pretax income		$	9,814			$	978			$	6,085			$	375

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Financial Services (continued)

		May 31,				November 30,
		2006				2005
Assets
Cash and cash equivalents		$	25,065			$	9,207
First mortgages held under commitments of sale and other			1,995				3,338
Investment in unconsolidated joint venture			19,097				15,230
Other assets			589				2,158
Total assets		$	46,746			$	29,933
Liabilities
Accounts payable and accrued expenses		$	53,520			$	54,543
Collateralized mortgage obligations secured by mortgage- backed securities			560				588
Total liabilities		$	54,080			$	55,131

4. Inventories

Inventories consist of the following (in thousands):

		May 31,				November 30,
		2006				2005
Homes, lots and improvements in production		$	5,026,763			$	4,215,488
Land under development			2,542,214				1,912,854
Total inventories		$	7,568,977			$	6,128,342

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

		Six Months Ended May 31,								Three Months Ended May 31,
		2006				2005				2006				2005
Capitalized interest, beginning of period		$	228,163			$	167,249			$	251,563			$	189,966
Interest incurred			113,610				85,367				62,044				44,171
Interest expensed			(15,019	)			(6,417	)			(10,266	)			(4,001	)
Interest amortized			(53,111	)			(38,379	)			(29,698	)			(22,316	)
Capitalized interest, end of period		$	273,643			$	207,820			$	273,643			$	207,820

5. Consolidation of Variable Interest Entities

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (as amended, “FASB Interpretation No. 46(R)”), to clarify the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities (referred to as “variable interest entities” or “VIEs”) in which equity investors do not have the characteristics of a controlling interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Pursuant to FASB Interpretation No. 46(R), an enterprise that absorbs a majority of a VIE’s expected losses, receives a majority of a VIE’s expected residual

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.		Consolidation of Variable Interest Entities (continued)
		returns, or both, is determined to be the primary beneficiary of the VIE and must consolidate the entity in its financial statements. In the ordinary course of its business, the Company enters into land option contracts in order to procure land for the construction of homes. Under such land option contracts, the Company 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), certain of the Company’s land option contracts may create a variable interest for the Company, with the land seller being identified as a VIE.
		In compliance with FASB Interpretation No. 46(R), the Company analyzed its land option contracts and other contractual arrangements and has consolidated the fair value of certain VIEs from which the Company is purchasing land under option contracts. The consolidation of these VIEs, where the Company was determined to be the primary beneficiary, added $358.3 million to inventory and other liabilities in the Company’s consolidated balance sheet at May 31, 2006. The Company’s cash deposits related to these land option contracts totaled $49.7 million at May 31, 2006. Creditors, if any, of these VIEs have no recourse against the Company. As of May 31, 2006, excluding consolidated VIEs, the Company had cash deposits totaling $154.3 million which were associated with land option contracts having an aggregate purchase price of $4.20 billion.
6.		Goodwill
		The changes in the carrying amount of goodwill for the six months ended May 31, 2006, are as follows (in thousands):

		2006
Balance, beginning of period		$	242,589
Goodwill acquired			—
Foreign currency translation			4,582
Balance, end of period		$	247,171

7.		Mortgages and Notes Payable
		On April 3, 2006, pursuant to its universal shelf registration statement filed with the Securities and Exchange Commission on November 12, 2004 (the “2004 Shelf Registration”), the Company issued $300.0 million of 7 1/4% Senior Notes (the “$300 Million Senior Notes”) at 99.486% of the principal amount of the notes. The notes, which are due June 15, 2018 with interest payable semi-annually, represent senior unsecured obligations and rank equally in right of payment with all of the Company’s existing and future senior unsecured indebtedness and are guaranteed by certain of the Company’s domestic subsidiaries (“Guarantor Subsidiaries”). The $300 Million Senior Notes may be redeemed, in whole at any time or from time to time in part, at a price equal to the greater of (1) 100% of their principal amount and (2) the sum of the present values of the remaining scheduled payments of principal and interest on the notes to be redeemed discounted at a defined rate, plus in each case, accrued and unpaid interest to the applicable redemption date. The Company used all of the proceeds from the $300 Million Senior Notes to repay borrowings under its $1.50 billion unsecured revolving credit facility (the “$1.5 Billion Credit Facility”).
		On April 12, 2006, the Company entered into an unsecured $400.0 million term loan (the “$400 Million Term Loan”), which provides for interest to be paid quarterly at the London Interbank Offered Rate plus an applicable spread. The principal balance of the $400 Million Term Loan is due and payable in full on April 11, 2011.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.		Mortgages and Notes Payable (continued)
		Under the $400 Million Term Loan agreement, the Company is required, among other things, to maintain certain financial statement ratios and a minimum net worth and is subject to limitations on acquisitions, inventories and indebtedness. The Company believes that it is in compliance with these requirements and is not aware of any covenant violations. The Company used all of the proceeds from the $400 Million Term Loan to repay borrowings under the $1.5 Billion Credit Facility.
8.		Commitments and Contingencies
		The Company provides a limited warranty on all of its homes. The specific terms and conditions of warranties vary depending upon the market in which the Company does business. For homes sold in the United States, the Company generally provides a structural warranty of 10 years, a warranty on electrical, heating, cooling, plumbing and other building systems each varying from two to five years based on geographic market and state law, and a warranty of one year for other components of the home such as appliances. The Company estimates the costs that may be incurred under each limited warranty and records a liability in the amount of such costs at the time the revenue associated with the sale of each home is recognized. Factors that affect the Company’s warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
		Changes in the Company’s warranty liability are as follows (in thousands):

		Six Months Ended May 31,
		2006				2005
Balance, beginning of period		$	131,875			$	99,659
Warranties issued			35,067				35,918
Payments and adjustments			(31,680	)			(25,210	)
Balance, end of period		$	135,262			$	110,367

		In the normal course of its business, the Company issues certain representations, warranties and guarantees related to its home sales, land sales and commercial construction that may be affected by FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Based on historical evidence, the Company does not believe any of these representations, warranties or guarantees would result in a material effect on its consolidated financial position or results of operations.
		The Company is often required to obtain bonds and letters of credit in support of its obligations to various municipalities and other government agencies with respect to subdivision improvements, including roads, sewers and water, among other things. At May 31, 2006, the Company had outstanding approximately $1.21 billion and $437.1 million of performance bonds and letters of credit, respectively. In the event any such bonds or letters of credit are called, the Company would be obligated to reimburse the issuer of the bond or letter of credit. However, the Company does not believe that any currently outstanding bonds or letters of credit will be called.
		Borrowings outstanding and letters of credit issued under the Company’s $1.5 Billion Credit Facility are guaranteed by the Guarantor Subsidiaries.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.		Commitments and Contingencies (continued)
		The Company conducts a portion of its land acquisition, development and other residential and commercial activities through unconsolidated joint ventures. These unconsolidated joint ventures had total assets of $2.47 billion and outstanding secured construction debt of approximately $1.39 billion at May 31, 2006. In certain instances, the Company provides varying levels of guarantees on the debt of unconsolidated joint ventures. When the Company or its subsidiaries provide a guarantee, the unconsolidated joint venture generally receives more favorable terms from lenders than would otherwise be available to it. At May 31, 2006, the Company had payment guarantees related to the third-party debt of three of its unconsolidated joint ventures. One of the joint ventures had aggregate third-party debt of $439.6 million at May 31, 2006, of which each of the joint venture partners guaranteed its pro rata share. The Company’s share of the payment guarantee, which is triggered only in the event of bankruptcy of the joint venture, was 49% or $213.2 million. The remaining two unconsolidated joint ventures had total third-party debt of $7.9 million at May 31, 2006, of which each of the joint venture partners guaranteed its pro rata share. The Company’s share of this guarantee was 50% or $4.0 million. The Company’s pro rata share of limited maintenance guarantees of unconsolidated entity debt totaled $176.9 million at May 31, 2006. 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 the Company is 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 and increase the Company’s share of any funds such unconsolidated joint venture distributes.
		In January 2003, the Company received a request for information from the U.S. Environmental Protection Agency (“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 discharge practices at certain of the Company’s construction sites, and the Company provided information pursuant to the request. In May 2004, on behalf of the EPA, the U.S. Department of Justice (“DOJ”) tentatively asserted that certain regulatory requirements applicable to storm water discharges were violated at certain of the Company’s construction sites, and civil penalties and injunctive relief might be warranted. The DOJ has also proposed certain steps it would expect the Company to take in the future relating to compliance with the EPA’s requirements applicable to storm water discharges. The Company has defenses to the claims that have been asserted and is exploring methods of resolving the matter. The Company believes that the costs associated with the claims are not likely to be material to its consolidated financial position or results of operations.
9.		Stockholders’ Equity
		On December 8, 2005, the Company’s board of directors increased the annual cash dividend on the Company’s common stock to $1.00 per share from $.75 per share. The first quarterly dividend at the increased rate of $.25 per share was paid on February 23, 2006 to stockholders of record on February 9, 2006.
		The Company’s board of directors also authorized a share repurchase program on December 8, 2005 under which the Company may repurchase up to 10 million shares of its common stock. Acquisitions under the share repurchase program may be made in open market or private transactions and will be made from time to time at management’s discretion based on its assessment of market conditions and buying opportunities. During the six months ended May 31, 2006, the Company repurchased four million shares of its common stock under the share repurchase program at an aggregate price of $287.4 million. In addition to the share repurchases in the first half of 2006, which consisted of open market transactions, the Company also retired $12.5 million of common stock obtained in connection with the satisfaction of employee withholding taxes on vested restricted stock.
10.		Recent Accounting Pronouncements
		In December 2004, the FASB issued Staff Position 109-1 (“FSP 109-1”), “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” The American Jobs Creation Act provides a 3% deduction on “qualified

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.		Recent Accounting Pronouncements (continued)
		domestic production activities income,” subject to certain limitations and is effective for the Company’s fiscal year ending November 30, 2006. This deduction provides a tax savings against income attributable to domestic production activities, including the construction of real property. When fully phased-in, the deduction will be 9% of “qualified domestic production activities income,” subject to certain limitations. Based on the guidance provided by FSP 109-1, this deduction was accounted for as a special deduction under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” and reduced income tax expense. An estimate of the tax benefit resulting from the new deduction is reflected in the Company’s effective income tax rate for the three months and six months ended May 31, 2006. The Company currently estimates the reduction in its effective income tax rate for the year ending November 30, 2006 to be approximately .8%.
		In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections,” (“SFAS No. 154”) which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes” and Statement of Financial Accounting Standards No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
		In June 2005, the Emerging Issues Task Force (“EITF”) released Issue No. 04-5 “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” (“EITF 04-5”). EITF 04-5 provides guidance in determining whether a general partner controls a limited partnership and therefore should consolidate the limited partnership. EITF 04-5 states that the general partner in a limited partnership is presumed to control that limited partnership and that the presumption may be overcome if the limited partners have either (1) the substantive ability to dissolve or liquidate the limited partnership or otherwise remove the general partner without cause, or (2) substantive participating rights. The effective date for applying the guidance in EITF 04-5 was (1) June 29, 2005 for all new limited partnerships and existing limited partnerships for which the partnership agreement was modified after that date, and (2) no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005 for all other limited partnerships. Implementation of EITF 04-5 is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
11.		Supplemental Guarantor Information
		The Company’s obligations to pay principal, premium, if any, and interest under certain debt instruments are guaranteed on a joint and several basis by the Guarantor Subsidiaries. The guarantees are full and unconditional and the Guarantor Subsidiaries are 100% owned by KB Home. The Company has determined that separate, full financial statements of the Guarantor Subsidiaries would not be material to investors and, accordingly, supplemental financial information for the Guarantor Subsidiaries is presented.

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11.

Supplemental Guarantor Information (continued) Condensed Consolidating Income Statements Six Months Ended May 31, 2006 (in thousands)

										Non-
		KB Home				Guarantor				Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	3,256,116			$	1,527,605			$	—			$	4,783,721
Construction:
Revenues		$	—			$	3,256,116			$	1,518,421			$	—			$	4,774,537
Construction and land costs			—				(2,372,085	)			(1,167,419	)			—				(3,539,504	)
Selling, general and administrative expenses			(77,685	)			(313,315	)			(228,079	)			—				(619,079	)
Operating income (loss)			(77,685	)			570,716				122,923				—				615,954
Interest expense, net of amounts capitalized			104,786				(80,991	)			(38,814	)			—				(15,019	)
Minority interests			(20,760	)			(230	)			(8,856	)			—				(29,846	)
Other income			45				2,540				5,145				—				7,730
Construction pretax income			6,386				492,035				80,398				—				578,819
Financial services pretax income			—				—				9,814				—				9,814
Total pretax income			6,386				492,035				90,212				—				588,633
Income taxes			(2,300	)			(173,200	)			(32,100	)			—				(207,600	)
Equity in earnings of subsidiaries			376,947				—				—				(376,947	)			—
Net income		$	381,033			$	318,835			$	58,112			$	(376,947	)		$	381,033

Six Months Ended May 31, 2005 (in thousands)

										Non-
		KB Home				Guarantor				Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	2,403,884			$	1,362,562			$	—			$	3,766,446
Construction:
Revenues		$	—			$	2,403,884			$	1,344,922			$	—			$	3,748,806
Construction and land costs			—				(1,713,879	)			(1,050,772	)			—				(2,764,651	)
Selling, general and administrative expenses			(61,993	)			(235,771	)			(196,019	)			—				(493,783	)
Operating income (loss)			(61,993	)			454,234				98,131				—				490,372
Interest expense, net of amounts capitalized			87,380				(59,069	)			(34,728	)			—				(6,417	)
Minority interests			(10,810	)			(13,090	)			(9,526	)			—				(33,426	)
Other income			247				5,012				4,291				—				9,550
Construction pretax income			14,824				387,087				58,168				—				460,079
Financial services pretax income			—				—				978				—				978
Total pretax income			14,824				387,087				59,146				—				461,057
Income taxes			(5,000	)			(131,600	)			(20,200	)			—				(156,800	)
Equity in earnings of subsidiaries			294,433				—				—				(294,433	)			—
Net income		$	304,257			$	255,487			$	38,946			$	(294,433	)		$	304,257

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11.

Supplemental Guarantor Information (continued) Condensed Consolidating Income Statements Three Months Ended May 31, 2006 (in thousands)

										Non-
		KB Home				Guarantor				Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	1,770,934			$	821,137			$	—			$	2,592,071
Construction:
Revenues		$	—			$	1,770,934			$	816,279			$	—				2,587,213
Construction and land costs			—				(1,293,095	)			(628,094	)			—				(1,921,189	)
Selling, general and administrative expenses			(38,424	)			(171,015	)			(114,795	)			—				(324,234	)
Operating income (loss)			(38,424	)			306,824				73,390				—				341,790
Interest expense, net of amounts capitalized			51,675				(41,570	)			(20,371	)			—				(10,266	)
Minority interests			(12,942	)			(214	)			(4,973	)			—				(18,129	)
Other income (expense)			21				(57	)			828				—				792
Construction pretax income			330				264,983				48,874				—				314,187
Financial services pretax income			—				—				6,085				—				6,085
Total pretax income			330				264,983				54,959				—				320,272
Income taxes			(100	)			(94,100	)			(19,500	)			—				(113,700	)
Equity in earnings of subsidiaries			206,342				—				—				(206,342	)			—
Net income		$	206,572			$	170,883			$	35,459			$	(206,342	)		$	206,572

Three Months Ended May 31, 2005 (in thousands)

										Non-
		KB Home				Guarantor				Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Revenues		$	—			$	1,369,596			$	760,730			$	—			$	2,130,326
Construction:
Revenues		$	—			$	1,369,596			$	750,717			$	—			$	2,120,313
Construction and land costs			—				(970,477	)			(581,799	)			—				(1,552,276	)
Selling, general and administrative expenses			(33,982	)			(131,811	)			(107,492	)			—				(273,285	)
Operating income (loss)			(33,982	)			267,308				61,426				—				294,752
Interest expense, net of amounts capitalized			43,985				(29,918	)			(18,068	)			—				(4,001	)
Minority interests			(6,261	)			(6,921	)			(5,884	)			—				(19,066	)
Other income			130				1,211				1,612				—				2,953
Construction pretax income			3,872				231,680				39,086				—				274,638
Financial services pretax income			—				—				375				—				375
Total pretax income			3,872				231,680				39,461				—				275,013
Income taxes			(1,300	)			(78,800	)			(13,400	)			—				(93,500	)
Equity in earnings of subsidiaries			178,941				—				—				(178,941	)			—
Net income		$	181,513			$	152,880			$	26,061			$	(178,941	)		$	181,513

KB HOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11. Supplemental Guarantor Information (continued)

Condensed Consolidating Balance Sheets
May 31, 2006 (in thousands)

		KB Home				Guarantor				Non-Guarantor				Consolidating
		Corporate				Subsidiaries				Subsidiaries				Adjustments				Total
Assets
Construction:
Cash and cash equivalents		$	30,931			$	(84,337	)		$	63,086			$	—			$	9,680
Trade and other receivables			4,405				172,129				396,685				—				573,219
Inventories			—				5,472,949				2,096,028				—				7,568,977
Other assets			448,256				236,013				305,685				—				989,954
			483,592				5,796,754				2,861,484				—				9,141,830
Financial services			—				—				46,746				—				46,746
Investment in subsidiaries			312,309				—				—				(312,309	)			—
Total assets		$	795,901			$	5,796,754			$	2,908,230			$	(312,309	)		$	9,188,576
Liabilities and stockholders’ equity
Construction:
Accounts payable, accrued expenses and other liabilities		$	104,193			$	1,423,699			$	871,344			$	—			$	2,399,236
Mortgages and notes payable			3,206,828				110,549				264,107				—				3,581,484
			3,311,021				1,534,248				1,135,451				—				5,980,720
Financial services			—				—				54,080				—				54,080
Minority interests			132,643				155				26,657				—				159,455
Intercompany			(5,642,084	)			4,262,351				1,379,733				—				—
Stockholders’ equity			2,994,321				—				312,309				(312,309	)			2,994,321
Total liabilities and stockholders’ equity		$	795,901			$	5,796,754			$	2,908,230			$	(312,309	)		$	9,188,576