Implementation Strategy.  Through the continued growth through the execution of our KBnxt operational business model, we have concentrated on achieving a leading position in our existing markets, expanding our business into attractive new markets through de novo entry or acquisitions, and expanding our product lines in both our existing and new markets. We believe that thisThis focus has allowed us to achieve lower costs and improved profitability through economies of scale with respect to acquiring land, acquisitions, purchasing building materials, subcontracting labor and providing options to customers.

We will continue to adhere to the disciplines of our KBnxt operational business model in 2007, a year that is likely to present operating challenges similar to those that developed in 2006. We do not expect the difficult conditions currently present in the U.S. housing market, including an oversupply of new and resale home inventories in certain markets, lack of affordability in certain areas and greater competition, to improve significantly, or at all, in 2007. Accordingly, in the short-term, we are focused on aligning the size of our organization with the lower unit volume expected this year and preserving our currentstrong financial condition. We also believe, however, that the general health of the U.S. economy, including historically low interest rates and high employment levels, bodes well for the recovery of the homebuilding industry and our company. Our long-term focus remains the profitable growth strategy, in 2005 we pursued organic growth inof our existing markets andhomebuilding business.

Any expansion into new markets such as Washington, D.C. and downtown Los Angeles, through de novo entry. We also expanded our product line to include high density and mixed use products, such as condominium complexes and commercial/residential projects, supplementing our existing entry-level, move-up, luxury and active adult products. Generally, we expect to follow a similar approach in 2006. Organic growth in existing markets will be driven primarily by increasing the average number of communities we operate. De novo expansion will depend on our assessment of a potential new market’s viability and our ability to develop operations in any new market we decide to enter. The extension of our product line into new product types and with respect to the products we make available in specific markets will be driven by our assessment of consumer preferences and fit within our existing business operations. We also will continue to explore appropriate acquisition opportunities to supplement organic and de novo growthacquisitions as market conditions may result in our business.attractive opportunities.

Marketing Strategy.In 2005,2006, we continued our efforts to buildmarketing strategy of building a national brand that stands out from othersother homebuilders by combining a consistently executed marketing program with nationwide promotions and partnerships. We believe this approach has yielded results. In 2006, a study we conducted in each of our industry. To advance this strategy,markets across the United States found that KB Home is the best known homebuilding brand in both aided and unaided awareness.

Our brand recognition continues to benefit from our high-profile partnership with Martha Stewart. In addition to the opening of the first two Martha Stewart communities in 2006, we entered into a licensing and co-marketing agreementpartnered with Martha Stewart Living Omnimedia underon Martha’s Ultimate KB Home Giveaway, a month-long national promotion in conjunction with her syndicated daytime TV show,Martha. The promotion gave viewers a chance to win a Martha Stewart home in their choice of our first two Martha Stewart communities located in North Carolina and Georgia.

A key marketing focus in 2006 was the creation of new marketing tools to reach out to some of our most essential audiences, including real estate brokers, online home shoppers and our current homeowners. These tools include an emphasis on new broker programs and materials for our local markets, as well as an expanded focus on market-specific online advertising. We launched a new email strategy to more effectively communicate timely messages to our prospective homebuyers. We designed a new web site, http://www.kbhomeowner.com, to provide a post-sale service to our homeowners, including information on services in their new neighborhood and a place to store their most important homeowner information online. The http://www.kbhomeowner.com web site, which we launched in January 2007, is

In 2007, we plan to launch “KB Home’s Twin Lakes: New Homes Created with Martha Stewart” in March 2006. Located near Raleigh, North Carolina, Twin Lakes will offer customerscontinue to focus on improving the opportunityeffectiveness of our marketing programs and the promotion of a single brand across the United States. We also plan to purchase homes inspired by several of Martha Stewart’s personal residences that embody her unique aesthetic and classic approach to design. In 2006, we hopecontinue to expand this collaborationour Martha Stewart communities to our communities in other areas of the country.

To help our homebuyers customize their homes, we operate KB Home Studios in many of our markets. KB Home Studios are large showrooms where our customers may select from thousands of options to have a profound impact on the way people shop for homes today. Our consumer website, http://www.kbhome.com, includes features and tools to benefit visitors, including a Spanish-language versionconveniently purchase as part of the entire site, a video touroriginal construction of thetheir homes. The coordinated efforts of sales representatives, KB Home Studio consultants and other personnel in the customer’s homebuying experience are intended to convey allprovide high levels of customer satisfaction and lead to enhanced customer retention and referrals.

In France, we introduced the choicesAmerican concept of a master bedroom suite, as well as walk-in closets, built-in kitchen cabinetry and products availabletwo-car garages. We believe that our value engineering allows us to offer appealing and well-designed homes at competitive prices. Our French operations offer a broad choice of options to customers through new home studios in our retail design environment, a calculatorParis, Lyon, Marseille and Nice that demonstratesare similar to first-time buyers the financial impact of owning a home with a savings estimate versus their current rent, streaming video testimonials from actualourU.S.-based KB homeowners and an online customer care area to support our homeowners. We continue to expand our online efforts and anticipate adding new features to the website in 2006.Home Studios.

We believe that our business requires in-depth knowledge of local markets in order to acquire land in desirable locations and on favorable terms, to engage subcontractors, to plan communities keyed to local demand, to anticipate customerconsumer tastes in specific markets and to assess the local regulatory environment.environments. Accordingly, our divisional structure is designedwe operate through local divisions that we establish to utilizetake advantage of our local market expertise. We have experienced management teams in each of our divisions. Although we have centralized certain functions, such as marketing, advertising, legal, materials purchasing, product development, architecture and accounting, to benefit from economies of scale, our local management continues to exerciseexercises considerable autonomy in identifying land acquisition opportunities, developing product and sales strategies, conducting productionproduct operations and controlling costs. We seek to operate at optimal volume levels in each of our markets in order to maximize our competitive advantages and the benefits of the KBnxt operational business model.

Our new home community development process generally consists of threefour phases: land acquisition, land development, and home construction and sale. Historically, our community development process has ranged from six to 24 months in our West Coast region to a somewhat shorter duration in our other domestic regions. In France, the community development process has historically ranged from 12 to 30 months. The length of the community development process varies based on, among other things, the extent of government approvals required, the overall size of the community, necessary site preparation activities, weather conditions and marketing results.

Although they vary significantly, our domestic new home communities typically consist of 50 to 250 lots ranging in size from 2,000 to 20,000 square feet on which we build homes for our customers.feet. Depending on the community, we offer from two to five model home design options to customers, with premium lots often containing more square footage, better views or orientationlocation benefits. In France, our single-family home developments typically consist of 50 to 150 lots, with average lot sizes of 5,500 square feet. Our goal is to own or control enough lots to meet our forecasted production goals in the United States and France over the next three to five years.

Land Acquisition and Development.  Prior to our adoption of our KBnxt operational business model in 1997, we typically acquired undeveloped and/or unentitled land on which significantly more than 250 lots could be developed. Since we adopted our KBnxt operational business model, we have focused on obtaining land containing less than 250 lots and have substantially reduced our acquisition of undeveloped and/or unentitled land. Instead, we have focused on

Consistent with our KBnxt operational business model, we target geographic areas for potential land acquisitions based on the results of periodic surveys of both new and resale homebuyers in particular markets. Local,in-house land acquisition specialists conduct site selection research and analysis in targeted geographic areas to identify desirable land consistent with our marketing strategy. Studies performed by third-party marketing specialists are also utilized. Some of the factors we consider in evaluating land acquisition targets areare: consumer preferences; general economic conditions; specific market conditions, with an emphasis on the prices of comparable new and resale homes in the market; expected sales rates; proximity to metropolitan areas and employment centers; population and commercial growth patterns; estimated costs of completing lot development; and environmental matters. Extensive due diligence is also performed for each land acquisition with the results reported as part of the presentation to senior management prior to acquisition decisions.

We generally structure our land purchases and development activities to minimize, or to defer the timing of, cash and capital expenditures, which enhances returns associated with new land investments. While we use a variety of techniques to accomplish this, as further described below, we typically use agreements that give us an option right to purchase land at a future date at a fixed price for a small or no initial deposit payment. Our decision to exercise a particular option right is based on the results of the due diligence we conduct after entering into an agreement. In some cases our decision to exercise an option may be conditioned on the land seller’s obtaining necessary entitlements, such as zoning rights and environmental approvals, and/or physically developing the land by a pre-determined date to allow us to build homes relatively quickly. Depending on the circumstances, our initial deposit payment for an option right may or may not be fully or substantially refundable to us if we do not actually purchase the underlying land.

In addition to acquiring land under option agreements, we may acquire land under agreements that condition our purchase obligation on our satisfaction by a certain future date with the feasibility of developing and selling homes on the land.land by a certain future date. Our option and other purchase agreements may also allow us to phase our land purchase and/or lot development obligations over a period of time and/or subject toupon the satisfaction of certain conditions. We may also acquire land with seller financing that is non-recourse to us, or by working in conjunction with third-party land developers.

As previously noted, under our KBnxt operational business model, we generally attempt to minimize our land development costs by focusing on acquiring finished or partially finished lots. Where we purchase unentitled and unimproved land, we typically use option agreements as described above and perform during an applicable option period technical, environmental, engineering and entitlement feasibility studies, while we seek to obtain necessary governmental approvals and permits. These activities are sometimes done with a seller’s assistance or at the seller’s cost. The use of option arrangements in this context allows us to conduct these development-related activities while minimizing our overall financial commitments, including interest and other carrying costs, and land inventories. It also improves our ability to accurately estimate development costs, an important element in planning communities and pricing homes, prior to incurring them.

Before we commit to any land purchase, our senior corporate management carefully evaluates each acquisition opportunity based on the results of our local specialists’ due diligence and a set of strict financial measures, including, but not limited to, gross margin analyses and specific discounted after tax cash flow internal rate of return requirements. Prior to 2006, a single “Land Committee,” comprised of several of our highest-ranking executives, reviewed and approved or disapproved all domestic land acquisitions. In 2006, we have implemented a revised land acquisition review and approval process. Potential transactions involving significant financial commitments or that are outside the ordinary course of our business are subject to review and approval by our investment committee, which is composed of our senior executive officers. Smaller but still sizeable potential transactions are subject to review and approval by our corporate land committee, which is composed of senior management experienced in land acquisitions. The smallest potential transactions for the release of non-refundable deposits and the expenditure of entitlement costs are subject to review and approval by our divisional land committees, which are composed of senior divisional and regional management, with further development expenditures subject to prior ratification by our corporate land committee. The stringent criteria guiding our land acquisition decisions has resulted in our geographic expansion to areas which generally offer better returns for lower

The following table shows the number of lots we owned in various stages of development and under option contracts in our principal marketsconstruction segments as of November 30, 20052006 and 2004.2005. The table does not include approximately 479393 acres and 1,818479 acres optioned in the United States in 20052006 and 2004,2005, respectively, which have not yet been approved for subdivision into lots.

Reflecting our geographic diversity and balanced operations, as a result of our extensive domestic expansion outside of the West Coast region and across the United States. As of November 30, 2005, 22%2006, 21% of the lots we owned or controlled were located in the West Coast region, 17%reporting segment, 18% were in the Southwest region, 24%reporting segment, 19% were in the Central region, 32%reporting segment, 27% were in the Southeast regionreporting segment and 5%15% were in France.

Home Construction and Sale.  Following the purchase of land and, if necessary, the completion of the entitlement process, we typically begin marketing homes and constructing model homes. The time required for construction of our homes depends on the weather, time of year, local labor supply, availability of materials and supplies and other factors. The construction of our homes is generally contingent upon customer orders to minimize the costs and risks of standing inventory. As a resultHowever, cancellations of our implementing the KBnxt operational business model, the percentage of sold inventory in production in our domestic operations has increased dramatically and was 88% as of November 30, 2005. At year-end 1996,home purchase contracts prior to the implementationdelivery of our KBnxt operational business model, the percentageunderlying units may cause us to have standing inventory of sold inventory in production was 44%.completed or partially completed units.

We act as the general contractor for the majority of our communities and hire subcontractors for all production activities. The use of subcontractors enables us to reduce our investment in direct labor costs, equipment and facilities. Where practical, we use mass production techniques, and prepackaged, standardized components and materials to streamline the on-site production phase. We have also developed systems for national and regional purchasing of certain building materials, appliances and other items to take advantage of economies of scale and to reduce costs through improved pricing and, where available, participation in national manufacturers’ rebate programs. At all stages of production, our own administrative and on-site supervisory personnel coordinate the activities of subcontractors and subject their work to quality and cost controls. As part of our KBnxt operational business model, we have also emphasized even flow production methods to enhance the quality of our homes, minimize production costs and improve the predictability of our revenues and earnings.

      Our division personnel provide assistance to homebuyers during all phases of the homebuying process and after the home is sold. The coordinated efforts of sales representatives, KB Home Studio consultants, on-site construction superintendents and post-closing customer service personnel in the customer’s homebuying experience is intended to provide high levels of customer satisfaction and lead to enhanced customer retention and referrals. In our domestic homebuilding operations, we provide customers with a limited home warranty program administered by personnel in each of our divisions. This arrangement is designed to give our customers prompt and efficient post-delivery service. For homes sold in the United States, we generally provide a structural warranty of 10 years, a warranty on electrical, heating,

Sales of our homes are made pursuant to standard salespurchase contracts, which generally require a customer deposit at the time of execution and an additional payment upon mortgage approval.execution. We generally permit customers to cancel their obligations and obtain refunds of all or a portion of their depositsdeposit in the event mortgage financing cannot be obtained within a period of time, as specified in the contract. Once mortgage financing approval is obtained, we generally require an additional deposit.

“Backlog” consists of homes which are under contract but have not yet been delivered. Ending backlog represents the number of units in backlog from the previous period plus the number of net orders (sales made less cancellations) taken during the current period minus unit deliveries made during the current period. The backlog at any given time will be affected by cancellations. In addition, deliveries of new homes typically increase from the first to the fourth quarter in any year.

Our backlog at November 30, 2005,2006, excluding the effects of unconsolidated joint ventures, reached 25,722totaled 17,384 units, up 27%down 32% from the 20,28025,722 backlog units at year-end 2004.2005. Our backlog ratio was 53% for the fourth quarter of 2006 and 43% for the fourth quarter of 2005 and 47% for the fourth quarter of 2004.2005. (Backlog ratio is defined as unit deliveries as a percentage of beginning backlog in the quarter.) Domestically, unit backlog of 10,575 units at November 30, 2006 decreased by 48% compared to 20,240 units at November 30, 2005 increased by2005. Unit backlog of 6,809 in France was 24% compared to 16,357 unitshigher at November 30, 2004. Our overall expansion of operations and continued emphasis onpre-sales contributed2006 compared to the increase5,482 unit backlog at November 30, 2005.

The significant decrease in domestic backlog levels. Netlevels in 2006 resulted from a decrease in net orders due in part to increased home purchase contract cancellations. Our net orders declined 28% to 30,675 in 2006 from 42,405 in 2005. Our average cancellation rate in 2006 was 42%, up from an average of 27% in 2005. During the fourth quarter of 2006, our net orders decreased 38% from the fourth quarter of 2005, reflecting a 50% decline in net orders generated by our U.S. operations totaled 9,747to 3,763 from 7,510, partially offset by a 3% increase in net orders in France to 2,296 from 2,237 in the year-earlier quarter. During the fourth quarter of 2005, up 14%2006, our cancellation rate rose to 48% from 8,516 in the fourth quarter of 2004. Net orders in France totaled 2,237 in the fourth quarter of 2005, up 30% from 1,71631% in the year-earlier quarter. Unit backlogquarter and improved from 53% in the third quarter of 5,482 in France was 40% higher at November 30, 2005 compared to the 3,923 unit backlog at November 30, 2004.2006.

The following table sets forth unit deliveries, net orders and ending backlog relating to sales of homes and homes under contract for each quarter during the years ended November 30, 20052006 and 2004.2005: