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Inventory Impairments and Land Option Contract Abandonments

3 Months Ended

Feb. 29, 2012

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: significant decreases in sales rates, average selling prices, volume of homes delivered, gross profit margins on homes delivered or projected gross profit 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 37 land parcels or communities for recoverability during the three months ended February 29, 2012, and evaluated 31 land parcels or communities for recoverability during the three months ended February 28, 2011.

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 the 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. 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 periods ended February 29, 2012 and February 28, 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 2011 and into 2012, with no significant deterioration or improvement identified as to revenue and cost drivers. In the Company’s assessments during the first quarter of 2012, the Company determined that the year-over-year decline in net orders in the period did not reflect a sustained change in market conditions preventing recoverability. Rather, the Company considered that the decline primarily reflected higher home purchase contract cancellation rates stemming from period-specific residential consumer mortgage loan funding issues, which the Company believes will be mitigated in future periods with a new preferred mortgage lender relationship it established in March 2012. In addition, with respect to recoverability, the impact of the decline in net orders was generally offset by a higher average selling price. Based on this experience, and taking into account the signs of stability in certain markets for new home sales, the Company’s inventory assessments as of February 29, 2012 considered an expected steady, if slightly improved, overall sales pace for the remainder of 2012.

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 significant sustained deterioration or improvement, or other changes, in such conditions. Therefore, the Company’s inventory assessments, at the time made, anticipate sales rates, average selling prices and costs to generally continue at or near then-current levels through the affected asset’s estimated remaining life. Inventory assessments for the Company’s land held for future development also incorporate highly subjective forecasts for future performance, including the timing and projected costs of development and construction, the product to be offered, and the sales rates and selling prices of the product when an associated community is anticipated to open for sales. The Company evaluates various factors to develop these forecasts, including the availability of and demand for homes and finished lots within the relevant marketplace; historical, current and future sales trends for the marketplace; and third-party data, if available. Based on these factors, the Company formulates assumptions for future performance that it believes are reasonable. These various estimates, trends and expectations used in the Company’s inventory assessments are specific to each land parcel or community and may vary among land parcels or communities.

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 rate used in the Company’s estimated discounted cash flows was 17% during the three-month periods ended February 29, 2012 and February 28, 2011. The discount rate used and related 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 $6.6 million in the three months ended February 29, 2012 associated with two communities with a post-impairment fair value of $12.2 million. In the three months ended February 28, 2011, the Company recognized $1.0 million of pretax, noncash inventory impairment charges associated with three land parcels or communities with a post-impairment fair value of $1.2 million. As of February 29, 2012, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $341.7 million, representing 52 land parcels or communities. As of November 30, 2011, the aggregate carrying value of the Company’s inventory that had been impacted by pretax, noncash inventory impairment charges was $338.5 million, representing 53 land parcels or communities.

The Company’s inventory controlled under land option contracts 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 optioned land parcel on a quarterly basis and are affected by the following factors, among others: 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 and other similar contracts due to market conditions and/or changes in its marketing strategy, the Company writes off the related inventory costs, including non-refundable deposits and pre-acquisition costs. Based on the results of its assessments, the Company recognized no pretax, noncash land option contract abandonment charges in the three months ended February 29, 2012. In the three months ended February 28, 2011, the Company recognized $.8 million of such charges corresponding to 141 lots. 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 five years.

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