Given its unique position with respect to land under control, Meritage differs from its competitors in several important respects. However, they don't differ as far as facing significant challenges navigating the current housing market.

As many already know, Meritage claimed in their earnings release that they believed the worst was over for home builders. "Trends may be indicating an inflection point" they claim. They cited improvements in cancellation rates, improving sales, reductions in inventories, decreasing impairments and land prices, as well as stabilization in incentives.

But improvement relative to what?

In fact, they have used only the previous two quarters as a basis for comparison, which were unusual for many reasons, not least of which is the seasonal weakness in fall and winter. Rather CEO Hilton has ignored those characteristics in formulating his assumptions, and if the housing market does not improve dramatically, it is likely they will have to begin looking for a new "inflection point".

Because of their small ratio of lots owned versus optioned, Meritage has not had to take significant land impairment charges as compared to other builders. But that doesn't mean they don't have significant investments in optioned land. Indeed, they plan to convert a number of options through the remainder of fiscal '07, bringing their percentage of lots owned from 20% to 30%.

And that takes cash. Indeed, compared to other builders who are currently reporting losses while generating cash flow from existing land holdings, Meritage has been cash flow negative so far this year, and will continue to be cash flow negative.

They admitted that gross margins will continue to "compress" this year (they currently stand at 15.6%). But yet again, they rely on rosy assumptions in claiming that they should return to their "historic" 19-20% range. For this historical basis, they use the last ten years of operations, a time which saw unprecedented growth in home building in the U.S. What if, instead of a quick return to those conditions, the new home market continues to contract?

They also claim that they will not need to take goodwill impairment charges. Again, this assumes a bottom is in and the home market will boom rather than bust. They currently have $129M in goodwill on their balance sheet, a significant percentage of which is in places like FLA, CA, AZ and NV. Stay tuned as they may need to revise this claim before the year is over.

Meritage also admitted that their debt-to-capitalization ratio will likely grow toward the higher end of their targeted 40-50% range (right now it at 43%, up from 40.5% last year). That's because they will continue to accumulate debt as they exercise options on land. This, indeed, is what distinguishes them from other builders. While their competitors are reducing land positions, generating cash, and reporting losses, Meritage is deferring charges, increasing debt and land owned.

Meritage is, in fact, delaying their day of reckoning.

Another item that stuck out for me was their claim that their exposure to sub-prime was "less than 10%". And they couldn't answer a question about their exposure to Alt-A. They also admitted that the average loan used by customers had an LTV of 85%. Given that most buyers need to take second mortgages to buy homes at today's inflated prices, the CLTV for those same buyer is likely higher than 95%.

Another sign of things to come is the number of unsold homes Meritage is carrying, down 12% from its peak last quarter, but still 22% higher than last year. That won't decrease very much as they will continue to build spec homes on those lots they'll be buying. In fact, it may actually grow over the next two quarters.

Finally, Meritage confirmed that orders in April have dropped off sharply from March, and that the decline was nationwide.