Instead of focusing on evidence of a deteriorating housing market during an Oct. 26 conference call with investors, executives at Scottsdale, Ariz.-based Meritage Homes underscored the fact that it is operating much more conservatively through a dedicated focus on the operational-objective improvements the company laid out in its previous quarter. "We are focused on things we can control and have been proactive on strengthening our balance sheet," said Steven Hilton, Meritage chairman and CEO.

A conservative approach to operations paid off for the company, which was able to show positive cash flow of $5 million this quarter, posting an $88 million turnaround in cash flow from the previous quarter. In fact, the company even beat its own projections for achieving positive cash flow from operations.

"We liquidated over 11% of our spec inventory this quarter, renegotiated or opted out of about 6,000 lot purchases under option contracts, and reduced our total lot supply by 20%," Hilton said. Leveraging the company's lot-option model, Meritage has reduced its lot supply by 43% from the peak in September of '05.

Meritage joined several other public companies releasing quarterly results for the period ending Sept. 30, 2007. Despite the progress on the cash-flow front, the company's executives also discussed their quarterly loss and 23% drop in orders.

Though Meritage maintained operating profitability before real estate charges and goodwill writeoffs, earnings took a huge hit over the previous quarter. Exceeding most analysts' expectations, earnings were down a whopping 299% over the second quarter as Meritage posted a net loss of $119 million or $4.52 per share, after $217 million of primarily non-cash charges ($132 million after tax). Even after the charges, adjusted net earnings fell 79% over 2Q07 to nearly $14 million.

Softer demand, coupled with higher cancellation rates, reduced net orders to 1,435 homes with a total value of $390 million in the third quarter of 2007, compared to 1,870 orders valued at $581 million in 2006. The company's order cancellation rate in the third quarter of 2007 rose to approximately 41% of gross orders, from 37% in both the third quarter 2006 and the second quarter 2007. According to Hilton, the company's average can rate typically runs between 20% and 25%.

Hilton said they are witnessing national builders in some markets that have no-bid communities stop lowering their prices and, instead, decide to mothball the project. "We think this is a step toward bringing back consumer confidence," he added.

In order to preserve and eventually strengthen profitability, the company is working to "get buyers back into the market in ways other than continuing to reduce prices," said Hilton, who noted that, "The current pricing is pretty competitive. We are looking at the way we package our incentives, we market our product, we train our sales people. We are fine-tuning our product. We are honing our skills and focusing on doing a better job of selling houses."

Third-quarter home-closing revenue was $575 million in 2007, compared to $876 million in 2006. The 34% revenue decline reflects a 9% reduction in the average selling price on 28% fewer home closings. The largest year-over-year (YOY) declines in closing revenue occurred in Nevada (-65%), Arizona (-58%), and California (-50%). In contrast, third quarter revenue from Texas closings increased 6%, and Meritage's Colorado market increased 73% YOY as that operation continued to grow from its startup in early 2006.

Still, the company's efforts to gain more financial flexibility during the quarter manifested themselves in a variety of ways:

- By slashing $13 million in compensation expenses and other cost reductions, the company reduced general and administrative expenses by 38% YOY to reflect 3.7% of home closing revenue.

- Spec inventory dropped, and the number of the most critical of those--the unsold completed homes--was down 15%.

- As it became more apparent that the deterioration of the overall home building market would not be recessitated by year's end, Meritage joined several other public companies by proactively amending its revolving credit agreement to reduce the potential pressure on needed cash flow. "This amendment is a preemptive measure that provides us additional operating flexibility," Hilton said.

The amendment also permanently decreases the borrowing capacity under the credit agreement, which matures in 2011, by $50 million to $800 million and modifies the applicable interest rate depending on the leverage ratio.