Employee Benefit and Stock Plans

Most of our employees are eligible to participate in the KB Home 401(k) Savings Plan (the “401(k) Plan”) under which contributions by employees are partially matched by us. The aggregate cost of the 401(k) Plan to us was $2.6 million in 2012, $2.8 million in 2011 and $3.2 million in 2010. The assets of the 401(k) Plan are held by a third-party trustee. The 401(k) plan participants may direct the investment of their funds among one or more of the several fund options offered by the 401(k) Plan. A fund consisting of our common stock is one of the investment choices available to participants. As of November 30, 2012, 2011 and 2010, approximately 7%, 4% and 5%, respectively, of the 401(k) Plan’s net assets were invested in the fund consisting of our common stock.

At our Annual Meeting of Stockholders held on April 1, 2010, our stockholders approved the KB Home 2010 Equity Incentive Plan (the “2010 Plan”), authorizing, among other things, the issuance of up to 3,500,000 shares of our common stock for grants of stock-based awards to our employees, non-employee directors and consultants. This pool of shares includes all of the shares that were available for grant as of April 1, 2010 under our 2001 Stock Incentive Plan, under which no new awards may be made. Accordingly, as of April 1, 2010, the 2010 Plan became our only active equity compensation plan. Under the 2010 Plan, grants of stock options and other similar awards reduce the 2010 Plan’s share capacity on a 1-for-1 basis, and grants of restricted stock and other similar “full value” awards reduce the 2010 Plan’s share capacity on a 1.78-for-1 basis. In addition, subject to the 2010 Plan’s terms and conditions, a stock-based award may also be granted under the 2010 Plan to replace an outstanding award granted under another of our plans (subject to the terms of such other plan) with terms substantially identical to those of the award being replaced.

At our Annual Meeting of Stockholders held on April 7, 2011, our stockholders approved an amendment to the 2010 Plan (the “Plan Amendment”) to increase the number of shares of our common stock that may be issued under the 2010 Plan by an additional 4,000,000 shares.

The 2010 Plan provides that stock options, performance stock, restricted stock and stock units may be awarded for periods of up to 10 years. The 2010 Plan also enables us to grant cash bonuses, SARs and other stock-based awards. In addition to awards outstanding under the 2010 Plan, we have awards outstanding under our Amended and Restated 1999 Incentive Plan (the “1999 Plan”), which provided for generally the same types of awards as the 2010 Plan. We also have awards outstanding under our 1988 Employee Stock Plan and our Performance-Based Incentive Plan for Senior Management, each of which provides for generally the same types of awards as the 2010 Plan, but stock option awards granted under these plans have terms of up to 15 years.

Stock Options. Stock option transactions are summarized as follows:



	Years Ended November 30,
	2012				2011				2010
	Options		Weighted Average Exercise Price		Options		Weighted Average Exercise Price		Options		Weighted Average Exercise Price
Options outstanding at beginning of year	10,160,396		$	21.27	8,798,613		$	24.19	5,711,701		$	27.39
Granted	30,000		9.08		1,716,000		6.36		3,572,237		18.71
Exercised	(7,494	)	13.93		—		—		(28,281	)	13.00
Cancelled	(77,356	)	17.96		(354,217	)	21.47		(457,044	)	22.05
Options outstanding at end of year	10,105,546		$	21.27	10,160,396		$	21.27	8,798,613		$	24.19
Options exercisable at end of year	8,533,224		$	23.76	7,142,568		$	26.43	6,146,605		$	28.73
Options available for grant at end of year	1,721,847				2,477,219				21,703

The total intrinsic value of stock options exercised was less than $.1 million for the year ended November 30, 2012 and was $.1 million for the year ended November 30, 2010. There were no stock options exercised during the year ended November 30, 2011. The aggregate intrinsic value of stock options outstanding was $18.2 million, $1.7 million and $.3 million at November 30, 2012, 2011 and 2010, respectively. The intrinsic value of stock options exercisable was $7.8 million at November 30, 2012. Stock options exercisable had no intrinsic value at November 30, 2011 and an intrinsic value of less than $.1 million at November 30, 2010. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the price of the option.

On August 13, 2010, we consummated an exchange offer (the “August 2010 Exchange Offer”) pursuant to which eligible employees had the opportunity to exchange their outstanding cash-settled SARs granted on October 2, 2008 and January 22, 2009 for non-qualified options to purchase shares of our common stock granted under the 2010 Plan. On November 9, 2010, we consummated a separate exchange offer (the “November 2010 Exchange Offer”) pursuant to which eligible employees had the opportunity to exchange their outstanding cash-settled SARs granted on July 12, 2007 and October 4, 2007 for non-qualified options to purchase shares of our common stock granted under the 2010 Plan.

Pursuant to both the August 2010 Exchange Offer and the November 2010 Exchange Offer, each stock option granted in exchange for a SAR had an exercise price equal to the SAR’s exercise price and the same number of underlying shares, vesting schedule and expiration date as each such SAR. The August 2010 Exchange Offer and the November 2010 Exchange Offer did not include a re-pricing or any other changes impacting the value to the employees. We conducted the August 2010 Exchange Offer and November 2010 Exchange Offer in an effort to reduce the overall degree of variability in the expense recorded for employee equity-based compensation by replacing the SARs, which are accounted for as liability awards, with stock options, which are accounted for as equity awards.

Pursuant to the August 2010 Exchange Offer, 19 eligible employees returned a total of 1,116,030 SARs to us, and those SARs were cancelled on August 13, 2010 in exchange for corresponding grants of stock options to 18 of those employees to purchase an aggregate of 1,073,737 shares of our common stock at $19.90 per share and one grant of stock options to one employee to purchase 42,293 shares of our common stock at $11.25 per share.

Pursuant to the November 2010 Exchange Offer, nine eligible employees returned a total of 925,705 SARs to us, and those SARs were cancelled on November 9, 2010 in exchange for corresponding grants of stock options to those nine employees to purchase an aggregate of 732,170 shares of our common stock at $28.10 per share and grants of stock options to seven of those employees to purchase an aggregate of 193,535 shares of our common stock at $36.19 per share.

The stock options granted pursuant to the August 2010 Exchange Offer and the November 2010 Exchange Offer are included in the stock options granted total in the above table.

On October 6, 2011, our president and chief executive officer was granted an award of performance-based stock options to purchase an aggregate of 365,000 shares of our common stock at the purchase price of $6.32 per share. The performance-based stock options shall vest and become exercisable if our president and chief executive officer does not experience a termination of service prior to the applicable dates described in his performance option agreement, and if the performance goal, as set forth in that agreement, has been satisfied. The number of performance-based stock options that ultimately vest depends on the achievement of one of the following three performance metrics: positive cumulative operating margin; relative operating margin; and customer satisfaction, as set forth in the agreement. In accordance with ASC 718, we used the Black-Scholes option-pricing model to estimate the grant date fair value per performance-based stock option of $2.54.

On October 7, 2010, our president and chief executive officer was granted an award of performance-based stock options to purchase an aggregate of 260,000 shares of our common stock at the purchase price of $11.06 per share. The performance-based stock options shall vest and become exercisable if our president and chief executive officer does not experience a termination of service prior to the applicable dates described in his performance option agreement, and if the performance goal, as set forth in that agreement, has been satisfied. The number of performance-based stock options that ultimately vest depends on the achievement of one of the following three performance metrics: positive cumulative operating margin; relative operating margin; and relative customer satisfaction, as set forth in the agreement. In accordance with ASC 718, we used the Black-Scholes option-pricing model to estimate the grant date fair value per performance-based stock option of $4.59.

Stock options outstanding and stock options exercisable at November 30, 2012 are as follows:



	Options Outstanding				Options Exercisable
Range of Exercise Price	Options	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Options	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
$ 6.32 to $10.54	1,704,998	$	6.43	8.8	567,674	$	6.44
$10.55 to $14.96	2,030,550	12.07		6.6	1,595,552	12.34
$14.97 to $20.08	2,211,772	17.69		6.3	2,211,772	17.69
$20.09 to $33.92	2,024,721	27.35		5.1	2,024,721	27.35
$33.93 to $69.63	2,133,505	39.81		5.4	2,133,505	39.81
$ 6.32 to $69.63	10,105,546	$	21.27	6.3	8,533,224	$	23.76	5.9

The weighted average grant date fair value of stock options granted in 2012, 2011 and 2010 was $4.18, $2.56 and $2.81, respectively. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:



	Years Ended November 30,
	2012		2011		2010
Risk-free interest rate	.7	%	.9	%	.7	%
Expected volatility factor	65.6	%	65.6	%	61.7	%
Expected dividend yield	1.9	%	3.9	%	2.2	%
Expected term	5 years		5 years		3 years

The risk-free interest rate assumption is determined based on observed interest rates appropriate for the expected term of our stock options. The expected volatility factor is based on a combination of the historical volatility of our common stock and the implied volatility of publicly traded options on our stock. The expected dividend yield assumption is based on our history of dividend payouts. The expected term of employee stock options is estimated using historical data.

Our stock-based compensation expense related to stock option grants was $5.0 million in 2012, $5.9 million in 2011 and $5.8 million in 2010. As of November 30, 2012, there was $1.7 million of total unrecognized stock-based compensation expense related to unvested stock option awards. This expense is expected to be recognized over a weighted average period of 1.3 years.

We record proceeds from the exercise of stock options as additions to common stock and paid-in capital. The tax shortfalls of $.3 million in 2012, $1.0 million in 2011 and $2.8 million in 2010 resulting from the cancellation of stock awards, were reflected in paid-in capital. In 2012 and 2011, the consolidated statement of cash flows reflected no excess tax benefit associated with the exercise of stock options since December 1, 2005, in accordance with the cash flow classification requirements of ASC 718. In 2010, the consolidated statement of cash flows reflected $.6 million of excess tax benefit associated with the exercise of stock options.

Other Stock-Based Awards. From time to time, we grant restricted stock to various employees as a compensation benefit. During the restriction periods, these employees are entitled to vote and to receive cash dividends on such shares. The restrictions imposed with respect to the shares granted lapse over periods of three years if certain conditions are met.

Restricted stock transactions are summarized as follows:



	Years Ended November 30,
	2012				2011
	Shares		Weighted Average per Share Grant Date Fair Value		Shares		Weighted Average per Share Grant Date Fair Value
Outstanding at beginning of year	338,912		$	15.03	402,477		$	15.09
Granted	207,617		16.23		—		—
Vested	(176,135	)	14.25		(10,930	)	13.49
Cancelled	(140,670	)	15.44		(52,635	)	15.44
Outstanding at end of year	229,724		$	15.81	338,912		$	15.03

As of November 30, 2012, we had $3.3 million of total unrecognized compensation cost related to restricted stock awards that will be recognized over a weighted average period of approximately three years.

On November 8, 2012, we granted PSUs to certain employees. Each PSU grant corresponds to a target amount of our common stock (the “Award Shares”). Each PSU entitles the recipient to receive a grant of between 0% and 200% of the recipient’s Award Shares, and will vest based on our achieving, over a three-year period commencing on December 1, 2012 and ending on November 30, 2015, specified levels of (a) average return on equity performance and (b) revenue growth relative to a peer group of high-production homebuilding companies, subject to the recipient’s continued employment with us through to and including the date on which the management development and compensation committee of our board of directors determines performance for each of the measures. The grant date fair value of each such PSU was $16.23. As of November 30, 2012, there were 227,049 PSUs outstanding. The number of shares of our common stock actually granted to a recipient, if any, when a PSU vests will depend on the degree of achievement of the applicable performance measures during the three-year performance period. Compensation cost for PSUs is initially estimated based on target performance achievement and adjusted as appropriate throughout the performance period. Accordingly, future compensation costs associated with outstanding PSUs may increase or decrease based on the probability of our achievement with respect to the applicable performance measures. At November 30, 2012, we had $3.6 million of total unrecognized compensation cost related to unvested PSUs, which is expected to be recognized over a weighted-average period of approximately three years.

In 2009 and 2008, we granted phantom shares to various employees. In 2008, we also granted SARs to various employees. These cash-settled awards have been accounted for as liabilities in our consolidated financial statements. Each phantom share represented the right to receive a cash payment equal to the closing price of our common stock on the applicable vesting date. Each SAR represents a right to receive a cash payment equal to the positive difference, if any, between the grant price and the market value of a share of our common stock on the date of exercise. The phantom shares vested in full at the end of three years, while the SARs vested in equal annual installments over three years. There were no phantom shares outstanding as of November 30, 2012, compared to 5,556 and 268,762 phantom shares outstanding as of November 30, 2011 and 2010, respectively. We had 29,939 SARs outstanding at both November 30, 2012 and 2011, compared to 37,517 SARs outstanding as of November 30, 2010. The year-over-year decrease in the number of outstanding SARs in 2011 from 2010 reflects the impact of the August 2010 Exchange Offer and the November 2010 Exchange Offer.

We recognized total compensation expense of $1.7 million in 2012, $1.2 million in 2011 and $.7 million in 2010 related to restricted stock, PSUs, phantom shares and SARs.

Grantor Stock Ownership Trust. On August 27, 1999, we established a grantor stock ownership trust (the “Trust”) into which certain shares repurchased in 2000 and 1999 were transferred. The Trust, administered by a third-party trustee, holds and distributes the shares of common stock acquired to support certain employee compensation and employee benefit obligations under our existing stock option, the 401(k) Plan and other employee benefit plans. The existence of the Trust has no impact on the amount of benefits or compensation that is paid under these plans.

For financial reporting purposes, the Trust is consolidated with us, and therefore any dividend transactions between us and the Trust are eliminated. Acquired shares held by the Trust remain valued at the market price on the date of purchase and are shown as a reduction to stockholders’ equity in the consolidated balance sheets. The difference between the Trust share value and the market value on the date shares are released from the Trust is included in paid-in capital. Common stock held in the Trust is not considered outstanding in the computations of earnings (loss) per share. The Trust held 10,615,934 and 10,884,151 shares of common stock at November 30, 2012 and 2011, respectively. The trustee votes shares held by the Trust in accordance with voting directions from eligible employees, as specified in a trust agreement with the trustee.