Inventory Impairments and Land Option Contract Abandonments

9 Months Ended

Aug. 31, 2011

Inventory Impairments and Land Option Contract Abandonments [Abstract]

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 the following: 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 for recoverability during each of the three-month periods ended August 31, 2011 and 2010. The Company evaluated 97 land parcels or communities and 88 land parcels or communities for recoverability during the nine months ended August 31, 2011 and 2010, respectively. Some of these land parcels or communities evaluated during the nine months ended August 31, 2011 and 2010 were evaluated in more than one quarterly period.

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 nine-month periods ended August 31, 2011 and 2010 were the after effects of a temporary surge in demand in the first two quarters of 2010 that was motivated by 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 were 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 nine-month periods ended August 31, 2011, these expectations reflected the Company’s experience that market conditions for its assets in inventory where impairment indicators were 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. Based on this experience, and taking into account the year-over-year increase in net orders in the third quarter of 2011 and the year-over-year increase in the number of new home communities, the Company’s inventory assessments considered an expected improved sales pace for the remainder 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 for the remainder of 2011, at the time made, will 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 third 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, the Company considered that they reflected the after effects of a temporary surge in demand in the first two quarters of 2010 that was 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 community count reductions the Company made in select markets in prior periods to align its operations with market activity levels.

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 were 17% and 18% during the three months ended August 31, 2011 and 2010, respectively, and ranged from 17% to 20% during the nine-month periods ended August 31, 2011 and 2010. These discounted cash flows are impacted by the following: 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 $.3 million in the three months ended August 31, 2011 associated with one community with a post-impairment fair value of $1.1 million. In the three months ended August 31, 2010, the Company recognized $1.4 million of pretax, noncash inventory impairment charges associated with one community with a post-impairment fair value of $2.7 million. In the nine months ended August 31, 2011, the Company recognized pretax, noncash inventory impairment charges of $21.4 million associated with nine land parcels or communities with a post-impairment fair value of $29.9 million. These charges included an $18.1 million adjustment to the fair value of real estate collateral in the Company’s Southwest homebuilding reporting segment that the Company took back on a note receivable in the second quarter of 2011. In the nine months ended August 31, 2010, the Company recognized $8.2 million of pretax, noncash inventory impairment charges associated with five land parcels or communities with a post-impairment fair value of $6.6 million. The inventory impairments the Company recorded during the three-month and nine-month periods ended August 31, 2011 and 2010 reflected declining asset values in certain markets due to unfavorable economic and competitive conditions.

As of August 31, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $366.8 million, representing 56 land parcels or communities. 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 land parcels or communities.

The Company’s inventory held under land option and other similar contracts is assessed to determine whether it continues to meet the Company’s internal investment and marketing standards. Assessments are made separately for each such land parcel on a quarterly basis and are affected by the following, 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 to not exercise certain land option and other similar 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 $.8 million corresponding to 209 lots in the three months ended August 31, 2011 and $1.9 million of such charges corresponding to 284 lots in the three months ended

August 31, 2010. In the nine months ended August 31, 2011 and 2010, the Company recognized pretax, noncash land option contract abandonment charges of $2.1 million corresponding to 467 lots and $8.5 million corresponding to 685 lots, respectively. The charges for land option contract abandonments reflected the Company’s termination of land option contracts on projects that no longer met its investment standards or marketing strategy.

Inventory impairment and land option contract abandonment charges are included in construction and land costs in the Company’s consolidated statements of operations.

The estimated remaining life of each land parcel or community in the Company’s inventory depends on various factors, such as the total number of lots remaining; the expected timeline to acquire and entitle land and develop lots to build homes; the anticipated future sales and cancellation rates; and the expected timeline to build and deliver homes sold. While it is difficult to determine a precise timeframe for any particular inventory asset, the Company estimates its inventory assets’ remaining operating lives under current and expected future market conditions to range generally from one year to in excess of 10 years. Based on current market conditions and expected delivery timelines, the Company expects to realize, on an overall basis, the majority of its current inventory balance within three to five years.

Due to the judgment and assumptions applied in the estimation process with respect to inventory impairments, land option contract abandonments and the remaining operating lives of the Company’s inventory assets, it is possible that actual results could differ substantially from those estimated.