500 units had to be built -- by the factory, not 500 with whatever mods you care to put on your bike. In other words, a true "production" bike. But once you've got it -- bore/stroke it to the maximum allowed in the class that the factory version would be (i.e., the Kawasaki 636 could be opened to 649.9 cc, as could a 599 cc Honda, and so on). Airbox and exhaust have to look precisely like stock -- from the outside. You're welcome to gut the muffler, though, although you'd better be sure to save the factory outlet parts and put them back. I don't know exactly how picky the impound inspectors would be if you opened up the exhaust canister to remove stuff and then put it back together with a patchy-looking job (poor rivets, lousy welded up seam, etc. Make it look exactly like it came from the factory!).
You wonder why there's so much allowed in the "production" class? Don't spend too much time wondering -- just go ahead and do whatever you want, asking for guidance from us as you go. Have fun at it while you're at it, too.