Meritage Homes plans to become profitable again next year, even if current conditions continue and sales prices stay the same, CEO Steve Hilton told analysts during the public builder's second quarter conference call on Tuesday, July 28.

The company’s ink will change from red to black, Hilton says, because Meritage is getting better at building smaller homes faster and for less and the land they’ll be building on will be considerably cheaper.

For the second quarter, though, the company still logged a loss of $74 million, $2.37 a share. That includes sizeable impairments of $64 million, most of which were related to terminating an option contract on 1,200 lots outside of Phoenix.

New orders were off, too, from last year’s second quarter, but at 1,147, they still increased from the first quarter’s 987.

In other metrics, Meritage has managed to reduce its general and administrative expenses by 33% in the past year, maintain a gross margin of 12.3% excluding impairments, and increase its cash to $385 million. Its net debt/capital, at 32.6%, was also an improvement. The builder's cancellation rate of 23% was the lowest it has been since 2005.

That might be partially due to Meritage's increased number of spec home sales, which have climbed to nearly half of all the houses it sold in the quarter. Part of the company’s strategy is to increase the number of speculative homes it has to four or five in each community, but the sales have been happening so quickly that the Meritage has only been able to keep about two per community. “These homes are getting sold almost as quickly as they are getting started,” said Hilton, who believes the $8,000 federal housing tax credit "is driving demand for entry-level buyers.”

He said he hopes the credit, which expires Nov. 30, gets expanded.

In terms of markets, entry-level and first-time move up buyers have become Meritage’s current mainstays, accounting for the majority of its sales as its new smaller, less costly homes resonate with these buyers. The downside is that Meritage has seen its average selling price decline slightly as a result.

Another contributing factor to Meritage's sales numbers is is community count, which has fallen by 16% from a year ago to 178. But the company will be bringing on more developments by the year's end with higher profit margins, thanks to purchasing the land at distressed prices in various markets.

Some of this new land is being bought at between two-thirds and three-fourths of what it sold for previously, according to Hilton. “We have a few deals in Florida, several in Phoenix, a couple in California, one or two in Colorado,” Hilton said. “We’re not doing anything in Vegas. We see the market there continuing to do worse. And not much in Texas, the opportunities are not as interesting yet.”

And the company is shopping for more land, particularly in California, Colorado, and Florida, where Meritage says it has shortages. Meritage is running into competition in the land bargain bin from other public builders, which are also looking to pick up deals.

“There are seven to eight public builder competitors competing for finished lots,” said Hilton. “There’s definitely competition today for lots, and it’s a little different than it was a few months back when we were competing with the investors. There is no question that public builders are back buying lots again. A lot of transactions have not closed yet, but I do see the land departments of our competitors being pretty active.”

Meritage also did some work in the first half of the year on its debt, choosing to retire $24 million in bond debt by buying the notes back at an average of 41 cents on the dollar. The company issued 783,000 shares of common stock to fund the repurchase. By paying it off early, the company gained $9 million in savings. “It would be like issuing stock in the high $20s or $30s per share,” said Hilton of the value gained. “We thought it was a pretty fair trade.”

It also has decided to eliminate its $150 million revolving credit facility, which will free Meritage from various covenants and restrictions and save the company roughly $2 million a year. It plans to establish a new source for its letters of credit.

Teresa Burney is a senior editor at BUILDER and BIG BUILDER magazines.

Learn more about markets featured in this article: Phoenix, AZ.