SecProbe.io

CORRESP
1
filename1.htm

corresp

KB HOME

10990 Wilshire Boulevard

Los Angeles, California 90024

November 23, 2005

United States Securities and Exchange Commission

450 Fifth Street

Washington, D.C. 20549

Attention: John Cash, Accounting Branch Chief

    Re:

    File No. 1-09195

    KB Home

    Form 10-K for Fiscal Year Ended November 30, 2004

    Form 10-Q for Fiscal Quarter Ended August 31, 2005

Dear Mr. Cash:

This letter responds to the comments of the Securities and Exchange Commission (the “Commission”)
staff contained in your letter dated November 9, 2005 regarding the reports listed above filed by
KB Home (the “Company”).

Set forth below are the Commission’s comments, followed by the Company’s responses.

Form 10-K for fiscal year ended November 30, 2004

Note 5 — Consolidation of Variable Interest Entities

    1.

    We acknowledge that we have previously requested information about this subject. Since you
have had more time to apply this guidance, we have further comments. Please provide for us a
more comprehensive analysis of how you have applied FIN 46(R) regarding your land option
contracts. In particular:

    •

    Provide a description of how your various option contracts are structured;

    •

    Tell us how you define whether a land option contract is a VIE;

    •

    Provide an example of a land option contract (if determined to be a VIE) requiring
consolidation and one not requiring consolidation, with emphasis on the various
distinguishing elements.

Please accompany your analysis with direct reference to accounting guidance and/or details
concerning how you have interpreted this guidance.

Response

The Company’s implementation of FASB Interpretation No. 46(R), “Consolidation of Variable
Interest Entities,” (“FIN 46(R)”) has evolved since the Company’s prior response to the
Commission dated January 8, 2004. In that regard, the Company completed the full
implementation of FIN 46(R) for variable interest entities (“VIEs”) created on or before

January 31, 2003 as required during the quarter ended May 31, 2004. The Company has also
continued to closely follow developments related to FIN 46(R), which was issued in December
2003 and replaced FIN 46 in its entirety. The Company continues to regularly consult with its
independent registered public accounting firm, Ernst & Young LLP, and other sources of
expertise, and to apply the latest generally accepted guidance available in analyzing land
option contracts, including Ernst & Young’s recently updated (May 2005) guidance concerning the
application of FIN 46(R) to land option contracts. (“Appendix E—Application of FASB
Interpretation No. 46 to the Homebuilder Industry” to Ernst & Young’s publication “Financial
Reporting Developments: FASB Interpretation No. 46, Consolidation of Variable Interest
Entities.”)

The Company’s application of FIN 46(R) to land option contracts continues to involve the
following steps described in the Company’s January 8, 2004 response letter:

    (a)

    determining whether the entity being considered for consolidation
is a VIE;

    (b)

    determining whether the Company holds a variable interest in the VIE;

    (c)

    considering Paragraphs 13 and 16 of FIN 46(R) if the variable
interest is in specific assets of the entity; and

    (d)

    evaluating whether the Company is the primary beneficiary of the
VIE and thus is required to consolidate the VIE.

The Company consistently applies its understanding of FIN 46(R) to its land option contracts to
evaluate whether a land seller is a VIE and whether consolidation is required.

Provide a description of how your various option contracts are structured;

The Company enters into a number of land option contracts with a wide variety of structures.
For example, the Company often enters into contracts in which it pays an initial deposit for
the right to purchase land in a specified condition (raw land or developed lots) at a future
date for a fixed price. Typically that deposit is fully or substantially refundable while the
Company performs due diligence. If the results of the Company’s due diligence are favorable,
the deposit becomes non-refundable.

In certain transactions, the Company’s decision on whether to exercise its option to purchase a
particular property may be conditioned on a land seller’s obtaining during the contract period
all necessary entitlements, such as zoning rights and environmental approvals, and/or
physically developing the property to enable the Company to commence the construction of
residences thereon. In some cases, if the land seller is unable to obtain the necessary
entitlements and/or complete the development work by a pre-determined outside date, the Company
may have a right to recover all or a portion of its deposit and the contract may be terminated.
However, the Company’s total exposure is limited to the deposit and any due diligence costs
incurred. A contract may also provide that the Company purchase all of the land in one
takedown or may permit the Company to acquire the land over time, in phases. The contract will
generally provide that if the Company fails to purchase the property under the terms of the
land option contract, the land seller’s sole remedy for the Company’s default is to retain the
deposit as liquidated damages.

A variation on the contract structure described above includes contracts under which the
Company, rather than the land seller, seeks the entitlements and/or develops the land during
the term of the land option contract on behalf of the land seller. The Company is typically
not obligated to purchase the property if it is unable to obtain the entitlements. In some
instances,

the land seller is entitled to retain some or all of the deposit even if the Company is not
able to obtain the entitlements. In cases where the Company is developing the property prior
to closing, contracts vary as to whether the Company or the land seller has to pay for
entitlement or development costs (a) if the closing does not occur or (b) if the costs are
higher than anticipated.

Other contracts allow the Company to purchase the property, in its condition at the time the
contract is entered into, over time in phases. The Company again generally has only a modest
deposit which it would lose if it elects not to proceed with the transaction, or elects to stop
its takedowns before acquiring all lots under contract.

There are literally dozens of permutations of these factors imbedded into the hundreds of land
option contracts that the Company enters into each year. However, in evaluating land option
contracts under FIN 46(R) to determine whether or not to consolidate, the Company consistently
applies a formal evaluation process that begins with determining whether the land option
contract is with a VIE.

Tell us how you define whether a land option contract is a VIE;

The Company’s initial determination of whether a particular land option contract is with a VIE
is generally made at the time the contract is executed. This timing is consistent with
Paragraph 6 of FIN 46(R) which states: “The initial determination of whether an entity is a
variable interest entity shall be made on the date at which an enterprise becomes involved with
the entity.” VIE status is reevaluated if any reconsideration events, such as a contract
amendment, occur. The Company’s determination of whether a land option contract is with a VIE
is made by evaluating the land option contract and the relevant land seller entity in relation
to the conditions in Paragraph 5 of FIN 46(R).1

Based on Paragraph 3 of FIN 46(R), which states that the term “entity” is used “to refer to any
legal structure used to conduct activities or to hold assets,” the Company has determined that
any land option contract with a land seller that holds the land as an individual rather than
through an entity is outside the scope of FIN 46(R) and is assumed not to be with a VIE.

    1 FIN 46(R) Paragraph 5 states that a VIE exists when one of the following conditions exist:

    a.

    The total equity investment at risk is not sufficient to permit
the entity to finance its activities without additional
subordinated financial support provided by any parties, including
equity holders.

    b.

    As a group the holders of the equity investment at risk lack any
one of the following three characteristics of a controlling
financial interest:

    1.

    The direct or indirect ability through voting or similar
rights to make decisions about an entity’s activities
that have a significant effect on the success of the entity.

    2.

    The obligation to absorb the expected losses of the entity.

    3.

    The right to receive the expected residual returns of the
entity.

    c.

    The equity investors as a group also are considered to lack
characteristic (b)(1) if (i) the voting rights of some investors are not
proportional to their obligations to absorb the expected losses of the entity,
their rights to receive the expected residual returns of the entity, or both
and (ii) substantially all of the entity’s activities either involve or
are conducted on behalf of an investor that has disproportionately few voting
rights.

For land option contracts in which the land seller is not an individual, the Company applies
the provisions of and applicable guidance for Paragraph 5 of FIN 46(R) to determine whether the
land seller entity is a VIE as follows:

The total equity investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support provided by any parties, including
equity holders (FIN 46(R) Paragraph 5a).

In order to evaluate the sufficiency of the equity investment at risk, it is necessary to
understand the structure of the land seller entity and judgment may be required. For example,
if a land seller entity with which the Company enters into a land option contract is
capitalized with equity and/or nonrecourse debt or debt that is recourse only to the land and
equity, the land seller entity has demonstrated that it can finance its activities without
additional subordinated financial support and, as such, is not a VIE based on Paragraph 5a of
FIN 46(R). However, if the land seller entity is capitalized with debt that is guaranteed by
the equity holders of the land seller entity, then the amount of equity invested in the land
seller entity is compared to an estimate of the entity’s expected losses based on reasonable
quantitative evidence. If such evaluation discloses that the equity investment at risk is
sufficient to permit the land seller entity to finance its activities without additional
subordinated financial support, the land seller entity is determined not to be a VIE. If such
equity investment at risk is determined to not be sufficient to permit the land seller entity
to finance its activities without additional subordinated financial support, the land seller
entity is determined to be a VIE.

The direct or indirect ability through voting or similar rights to make decisions about an
entity’s activities that have a significant effect on the success of the entity (FIN 46(R)
Paragraph 5b.1).

In applicable contracts, the land seller entity is typically the sole decision maker for
deciding (a) the capital structure of the land seller entity, (b) which assets are to be
included in the land seller entity, and (c) the terms of any financing, including whether to
refinance any debt. The Company typically does not have decision making ability over the land
seller entity’s activities, and while it may have certain rights pursuant to the lot option
contract, the Company typically does not have substantive participating rights, as they are
defined in EITF Issue No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a
Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain
Approval or Veto Rights.” Accordingly, the holder of the equity investment at risk in the land
seller entity will generally have sufficient decision making ability for the land seller entity
not to be a VIE. This determination is made, however, after consideration of all of the
individual facts and circumstances

The obligation to absorb the expected losses of the entity (FIN 46(R) Paragraph 5b.2).

As a group, the holders of the equity investment at risk must have the obligation to absorb the
expected losses of the land seller entity for the entity not to be a VIE. The investor or
investors do not have that obligation if they are directly or indirectly protected from the
expected losses or are guaranteed a return by the entity itself or by other parties involved
with the land seller entity. Losses by the land seller entity may arise from a significant
decline in the value of the property and/or the land seller entity incurring substantial cost
overruns in the development of the property.

While a land seller entity is exposed to these significant risks of loss, if the Company’s land
option contract provides the land seller entity with first dollar risk of loss protection, the
land option contract is determined to establish a variable interest in the land seller entity.
The land option contract written by the land seller entity to the Company is an “in the money”
option contract if the deposit placed by the Company is non-refundable. This non-refundable
portion represents the protection that the land seller entity has from first dollar risk of
loss in the event that market prices decline and the Company exercises its right to forfeit the
option deposit and terminate the option agreement. Although there are potential outcomes in
which the land seller entity and/or the lender(s) may incur losses (for example, a steep
decline in the market value of the property below the protection provided by the Company’s
option deposit), because the land seller entity is not exposed to all of the first dollar risk
of loss in the entity, the land seller entity will generally be considered a VIE.

The right to receive the expected residual returns of the entity (FIN 46(R) Paragraph 5b.3).

FIN 46(R) requires that the equity holders, as a group, have the right to receive the expected
residual returns of the entity for the entity not to be considered a VIE. FIN 46(R) states
that investors do not have that right if their return is capped by the entity’s governing
documents or arrangements with other variable interest holders or the entity. In applying this
provision to a typical land option structure of the Company, if the land seller entity writes
an option on land granting the Company a right to purchase the land at a specific price, by
design, the land option contract explicitly caps the return of the equity holders. As a
result, the land seller entity would be considered a VIE.

In summary, the Company initially evaluates all of its land option contracts in accordance with
FIN 46(R) at the time each land option contract is executed to determine whether they are with
VIEs. Land option contacts with land sellers who are individuals do not meet the definition of
an “entity” under FIN 46(R) and therefore are not VIEs. Generally, the land option contracts
which the Company determines to be VIEs meet the conditions in Paragraph 5b.2 or 5b.3 of FIN
46(R). If the land option contract is determined to be with a VIE, the Company analyzes the
contract further to determine whether it is the primary beneficiary and, thus, whether it is
required to consolidate the land option contract.

Provide an example of a land option contract (if determined to be a VIE) requiring
consolidation and one not requiring consolidation, with emphasis on the various distinguishing
elements.

The following examples are derived from actual land option contracts entered into by the
Company:

Example #1: Land option contract requiring consolidation

The Company entered into a land option contract with a land seller entity that i