Inventory Impairments and Land Option Contract Abandonments

Each land parcel or community in the Company’s owned inventory is assessed to determine if indicators of potential impairment exist. Impairment indicators are assessed separately for each land parcel or community on a quarterly basis and include, but are not limited to: significant decreases in sales rates, average selling prices, volume of homes delivered, gross margins on homes delivered or projected margins on homes in backlog or future housing sales; significant increases in budgeted land development and construction costs or cancellation rates; or projected losses on expected future land sales. If indicators of potential impairment exist for a land parcel or community, the identified asset is evaluated for recoverability in accordance with Accounting Standards Codification Topic No. 360, “Property, Plant, and Equipment” (“ASC 360”). The Company evaluated 33 land parcels or communities and 28 land parcels or communities for recoverability during the three months ended May 31, 2011 and 2010, respectively. The Company evaluated 64 land parcels or communities and 55 land parcels or communities for recoverability during the six months ended May 31, 2011 and 2010, respectively.

When an indicator of potential impairment is identified for a land parcel or community, the Company tests the asset for recoverability by comparing the carrying value of the asset to the undiscounted future net cash flows expected to be generated by the asset. The undiscounted future net cash flows are impacted by then-current conditions and trends in the market in which an asset is located as well as factors known to the Company at the time the cash flows are calculated. The undiscounted future net cash flows consider recent trends in the Company’s sales, backlog and cancellation rates. Among the trends considered with respect to the three-month and six-month periods ended May 31, 2011 and 2010 was the impact on demand of the April 30, 2010 expiration of the federal homebuyer tax credit, as discussed further below under “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Also taken into account are the Company’s future expectations related to the following: market supply and demand, including estimates concerning average selling prices; sales and cancellation rates; and anticipated land development, construction and overhead costs to be incurred. With respect to the three-month and six-month periods ended May 31, 2011, these expectations have reflected the Company’s experience that market conditions for its assets in inventory where impairment indicators are identified have been generally stable in 2010 and into 2011, with no significant deterioration or improvement identified as to revenue and cost drivers, excluding the temporary, though significant impact of the expiration of the federal homebuyer tax credit. The Company’s inventory assessments therefore considered an expected improved sales pace as the Company moves through the remainder of 2011. The Company’s considerations in this regard took into account that, on a sequential basis, net orders for the second quarter of 2011 increased 53% from the first quarter of 2011.

Given the inherent challenges and uncertainties in forecasting future results, the Company’s inventory assessments at the time they are made generally assume the continuation of then-current market conditions, subject to identifying information suggesting a sustained deterioration or improvement in such conditions or other significant changes. Therefore, for most of its assets in inventory where impairment indicators are identified, the Company’s quarterly inventory assessments in 2011 will, at the time they are made, anticipate sales rates, average selling prices and costs to generally continue at or near then-current levels through an affected asset’s estimated remaining life. These estimates, trends and expectations are specific to each land parcel or community and may vary among land parcels or communities.

In its inventory assessments during the second quarter of 2011, the Company determined that the declines in its sales and backlog levels that it experienced in the third and fourth quarters of 2010 did not reflect a sustained change in market conditions preventing recoverability. Rather, they reflected the effects of the temporary surge in demand motivated by the April 30, 2010 expiration of the federal homebuyer tax credit. Also contributing to these declines in the Company’s sales and backlog levels were strategic reductions the Company made in selected communities in previous quarters.

A real estate asset is considered impaired when its carrying value is greater than the undiscounted future net cash flows the asset is expected to generate. Impaired real estate assets are written down to fair value, which is primarily based on the estimated future cash flows discounted for inherent risk associated with each asset. The discount rates used in the Company’s estimated discounted cash flows ranged from 17% to 20% during the three-month and six-month periods ended May 31, 2011 and the six-month period ended May 31, 2010. These discounted cash flows are impacted by: the risk-free rate of return; expected risk premium based on estimated land development, construction and delivery timelines; market risk from potential future price erosion; cost uncertainty due to development or construction cost increases; and other risks specific to the asset or conditions in the market in which the asset is located at the time the assessment is made. These factors are specific to each land parcel or community and may vary among land parcels or communities.

Based on the results of its evaluations, the Company recognized pretax, noncash inventory impairment charges of $20.1 million in the three months ended May 31, 2011 associated with five land parcels or communities with a post-impairment fair value of $27.6 million. These charges reflect an $18.1 million adjustment to the fair value of real estate collateral in the Company’s Southwest reporting segment that the Company took back on a note receivable. There were no such charges in the three months ended May 31, 2010. In the six months ended May 31, 2011, the Company recognized pretax, noncash inventory impairment charges of $21.1 million associated with eight land parcels or communities with a post-impairment fair value of $28.8 million. In the six months ended May 31, 2010, the Company recognized $6.8 million of such charges associated with four land parcels or communities. The inventory impairments the Company recorded during the three-month and six-month periods ended May 31, 2011 and the six-month period ended May 31, 2010 reflected declining asset values in certain markets due to unfavorable economic and competitive conditions.

As of May 31, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $391.6 million, representing 59 communities and various other land parcels. As of November 30, 2010, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $418.5 million, representing 72 communities and various other land parcels.

The Company’s optioned inventory is assessed to determine whether it continues to meet the Company’s internal investment and marketing standards. Assessments are made separately for each optioned land parcel on a quarterly basis and are affected by, among other factors: current and/or anticipated sales rates, average selling prices and home delivery volume; estimated land development and construction costs; and projected profitability on expected future housing or land sales. When a decision is made not to exercise certain land option contracts due to market conditions and/or changes in marketing strategy, the Company writes off the costs, including non-refundable deposits and pre-acquisition costs, related to the abandoned projects. Based on the results of its assessments, the Company recognized pretax, noncash land option contract abandonment charges of $.5 million corresponding to 117 lots in the three months ended May 31, 2011. There were no such charges in the three months ended May 31, 2010. In the six months ended May 31, 2011 and 2010, the Company recognized pretax, noncash land option contract abandonment charges of $1.3 million corresponding to 258 lots and $6.5 million corresponding to 401 lots, respectively.