Hovnanian Enterprises Inc (HOVNP) 2004 Q2 法說會逐字稿

Good morning. Thank you for joining us today for Hovnanian Enterprises fiscal 2004 second quarter earnings conference call. By now, you should have all received a copy of the earnings press release. However, if anybody is missing a copy and would like one, please contact Dana Almack at 732-747-7800.

We will send you a copy of the release and ensure that you are on the company's distribution list. There will be a replay of today's call. This replay will be available one hour after the completion of the call and run for 12 months. Replay can be accessed by dialing 1-800-428-6051 with a pass code of 357879. Again, the replay number is 1-800-428-6051 with a pass code of 357879. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode.

Management will make some opening remarks about the second quarter results, then open up the line for questions. The company will also be webcasting this live presentation along with the opening comments from management. Slides are available on the Investors Page of the company's website at www.khov.com. Those listeners who would like to follow along should log onto the website at this time.

Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements contained in the press release also applies to any comments made during this conference call and to the information in the slide presentation. I would now like to turn the conference over to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara please go ahead.

Good morning. And thank you for participating in today's call to review the results of our second quarter. Joining me today from the company are Larry Sorsby, Executive Vice President and Chief Financial Officer, Paul Buchanan, Senior Vice President and Corporate Controller and Brian Cheripka, Assistant Director of Investor Relations. We're pleased to report another record financial performance for the second quarter of fiscal 2004 which ended on April 30th.

We set all time second quarter records for our company in home deliveries, revenues and net income far exceeding last year's record levels in these category. While the overall housing industry continues to perform exceptionally well, the largest builders, including our company, are exhibiting particularly strong growth as we increasingly dominate the regional markets across the country. The home building industry's returns are among the strongest among all industries on Wall Street and our company's returns particularly in year over year earnings growth, return on capital and return on equity, probably some of the key measures, continues to be among the highest of the industry.

The stock market is valuing our stock as if earnings are expected to decline precipitously this year. Yet we sold more homes in the second quarter than in any other quarter in our company's history, with the dollar value of net contracts exceeding last year's record results by 62%. Our net sales contracts and backlog for the second quarter represent all time records for any quarter in our company's history.

These sales contracts will be converted to home deliveries and earnings over the next few quarters, leading to continued strong performance. In fact, we currently have well over 85% of this year's projected deliveries either delivered or in backlog. With our current sales backlog and our strong land position in each of our most highly regulated markets, we are well positioned to continue our strong earnings growth and excellent financial performance all the way through fiscal 2004 and 2005 and hopefully into subsequent years as well.

The increase in our net contracts for the quarter demonstrates our ability to continue achieving substantial organic growth. We are also expanding our geographic footprint through entry into new markets. Largely through acquisitions of smaller builders, as we participate in the significant level of industry consolidation that is occurring amidst the increasing dominance in competitive advantages of the larger builders. We expect to continue gaining market share from other smaller builders, regardless of whether the national housing starts go up or down by 5 or 10% next quarter, next month or next year.

But many stock market participants just seem to-- just don't seem to grasp that fact. The market share gains we have achieved particularly as a result of industry consolidation trends have been one of the primary drivers of our strong financial performance over the last several years. Before I talk more about our future prospects, I would like to review some of the highlights for our second quarter.

For those of you that are viewing the slides on the investor page of our website at www.khov.com, you may now begin with slide #3. We have significantly exceeded last year's second quarter earnings by reporting net income of $1.06 per fully diluted share for the second quarter ended April 30th. This represents a 33% increase in earnings per share from the prior record earnings of 80 cents per share achieved last year.

Our ability to achieve price increases in selected communities across the country continued in the second quarter and that allowed us to exceed our prior earnings projection for the quarter. As shown on slide #4, net income of 70.5 million after tax increased by 34% over last year's second quarter income of $52.6 million.

Slide #5, we continue to generate excellent returns for our shareholders, far exceeding the average return for the S&P 500 companies and ahead of nearly all the companies in the Fortune 1000. The company's after tax return on beginning capital for the trailing 12 months ended April was a strong 24.8%. And our after tax return on beginning equity for the trailing 12 months ended April was also extremely high at 44%. Slide 6, our return on capital and return on equity continued to rank among the best in the industry.

Go to slide 7, total revenues for the three months ended April 30 increased 35% to 919 million from $680 million last year. Setting a new record for our second quarter. Slide 8, including unconsolidated joint ventures, deliveries increased 35% to 3 ,372 homes, also a new record for the quarter. This pace of activity far surpassed '03's second quarter record of 2 ,507. Go to slide 5.

Net contracts for the period rose to an all time record of 4 ,911, including about 138 homes from unconsolidated joint ventures, with a total value of $1.5 billion, representing an increase I alluded to earlier of 62% in dollar value from last year's results. Our consolidated number of net contracts increased 45% from last year's second quarter. That's a number of homes versus dollar value.

Our organic growth from operations that have been with us for multiple years continues at a rapid pace, as indicated by the considerable increases in the net contracts in markets unaffected by acquisitions. The dollar value of our net contracts in the Northeast increased 48% for the second quarter, excluding the effect of Summit Homes in Ohio.

The dollar value of net contracts increased 22% in the Southeast, excluding the Windward homes acquisition in Tampa. In the West, which was not effected by any acquisitions, the dollar value of our net contracts for the second quarter increased 71%. Again, this is all organic growth.

In certain of our California communities, recent sales of new homes have outpaced our ability to start and construct them. So in order to keep our new starts at a pace equal to the high volume of contracts in these communities, we have decided to consciously slow our sales pace in some of our California communities between now and September. This decision will better allow us to manage our inventory of approved lots and help ensure we get timely coordination of sales and construction.

It may make some tougher sales comparison for the next few months, particularly in California, but given that we are 76% ahead in California this last quarter compared to the prior one and this most recent month was also a very strong month, we're quite comfortable and we're not at all concerned about that possibility for the next few months. Despite an increase of over 100 basis points in long-term mortgage rates since the middle of March, our net contracts for the month of April were up 39% over the prior year.

Results for our April new sales certainly did not exhibit the decline that was reported last week in the national new home sales for April. Interest rates remain at an absolute low level relative to historic averages and we feel comfortable that the Federal Reserve will manage any increases in rates in a steady fashion as the economy gains strength. If you look at slide 10, this is a particularly powerful slide.

Frankly, I think it's hard to recall a time when the national economy was strengthening as it is now and housing did not perform well. If you look at this chart, we've crosshatched the periods when the country was in a national recession and as you might expect, historically, housing slowed down during that period, except in the most recent period where it held relatively stable. If you look at the periods when we came out of recession, we have always had strong housing conditions.

That's obviously quite relevant right now, since we have officially come out of a recession, yet everyone is concerned, I guess, that we will buck the trend that has been with us and housing for some reason will not do well in a strong economy, notwithstanding the fact that it has done that for decade upon decade. Although rising rates will undoubtly impact affordability, we expect consumers will adjust by purchasing smaller, less expensive model types or by buying fewer features or upgrades. We don't expect the industry to experience a material dropoff in overall demand as the economy is gaining strength.

Keep in mind we need to build about 1.6 million net additional new homes on average during this decade just to meet the projected needs of household formation in our growing population. The steady underlying demand for housing based on demographics, along with the increasing regulatory constraints that limit the supply of lots to build new homes will continue to drive a healthy level of new home sales in most of our markets.

The combination of these market conditions with our market share gains and our wide range of product offerings, especially including the focus on the active adult segment, will continue to allow our company to achieve the growth objectives we set out for the next several years. We expect to release our net contracts for the month of May tomorrow morning. The four weeks ended Sunday, May 30th, will show that we've experienced some strong double-digit increases again in the case of our year over year net contracts.

Slide 11, contract backlog at April 30th reached 8,093 homes with a sales value of $2.4 billion. That includes 237 homes from unconsolidated joint ventures. The number of homes in backlog in the dollar value of backlog are both all time records for any quarter in our history. The value of contract backlog represents a 69% increase over the end of April 2003.

Although the adverse weather we have experienced has delayed our ability to start and complete homes in several markets in the Northeast and Southeast, and by the way, it has sprinkled over the last few days again each day, we are on track to exceed last year's results for our remaining two quarters in fiscal '04. [sound cuts out]- the weather will result in a greater number of homes being delivered the latter half of the year than we would have liked. We are continuously seeking to improve our operating efficiency, reduce overall costs and identify new ways to create sustainable competitive advantages.

One area that we began to focus on a little bit more lately is our brand identity. To capitalize on our increased size, geographic diversification and marketing power, particularly in today's age of internet-based marketing, we have recently made a decision to change the name under which we operate in several of our markets to K. Hovnanian Homes over the next 12 months.

Turn to slide 12. This will effect operations in several markets, including California where we currently sell under the Forecast Homes name in many areas throughout the state. As well as our operations in Ohio, Maryland, Virginia, Arizona and North Carolina where we currently sell under the names of Summit Homes, Washington Homes, Great Western Homes, Westminster Homes and Fortis Homes as well. The strength in K. Hovnanian Homes brand identity is consistent with our focus on being recognized as a major builder with a national reputation for quality in each of our markets.

Our strong brand will ultimately lead to greater advantages in terms of market share, land acquisition, pricing power and customer satisfaction. However, we are likely to continue to make additional acquisitions and we remain committed to being flexible regarding our branding strategies, particularly with new acquisitions in each of our new markets. Which allows us to maintain the brands of acquired builders with strong local identities. Each of these operations where we are now changing the brand to K Hovnanian Homes has independently made the determination that this will be a positive branding change and they have transitioned this change over time using the tag line of K. Hovnanian Company in conjunction with their current brand.

We also continue to be focused on growth. Our two-pronged strategy for growth seeks to expand our geographic footprint into new markets by selectively acquiring smaller builders that fit our parameters and doing occasional start ups on top of achieving 15-20% organic growth and earnings in our current markets. We achieved this targeted growth in our existing markets by increasing our community count and further deploying our broad product array.

As an example of the latter strategy, our number of deliveries from active adult communities is expected to triple by 2006 as we expand this segment of our business across the country. We use an acquisition strategy to expand our market position in our current market or as a means to enter a new market with a significant market position. If there is a good strategic fit, a top management team that is committed to remaining with our company and appropriate return can be achieved.

We remain disciplined in achieving our targeted returns as we make acquisitions and our track record over the past six years plus speaks for itself. Integration and management retention in acquisitions has become one of our core strengths. Slide 13, in March, we announced our entry into the Minneapolis/St. Paul housing market.

We hired Tom Santy, as Senior Manager with more than 24 years of experience in that marketplace. Tom has the proves experience to operate a division dlefering more than a thousand homes annually in this top 20 market. While we have typically entered new markets through acquisition, we are confident that this extensive experience of our new management team will provide us with the same advantages of market knowledge and local relationships that we have been able to achieve through acquisition of local home building companies in other markets.

The Twin Cities Metropolitan Area is a vibrant housing market with more than 18,000 new housing permits in '03 and a wide variety of price points for both attached and detached housing. This market breadth will allow our company to employe our diverse product strategy to achieve growth and market penetration. We are excited to begin establishing the Hovnanian name as a leader in building quality homes in the Twin Cities market and we expect to deliver our first homes in this market during fiscal 2005.

We anticipate that significant consolidation in our industry nationwide as larger home builders like our company continue to exert greater leverage over smaller builders. Even without any further acquisitions, our focus on organic growth and on being a dominant builder in each of our markets is yielding noticeable advantages in terms of land acquisition, pricing power, and cost efficiency. Our strong contract backlog and the recent pricing power in many of our communities gives us confidence that we will meet or exceed our earnings targets for fiscal '04 and increased optimism about our fiscal '05 growth prospects.

Not only do we have more than 85% of the projected deliveries already closed or in backlog but we have almost 2000 homes in contract backlog for fiscal '05 deliveries. Turn to slide 14. Therefore, we are increasing our projection for our current fiscal year to exceed $5 per fully diluted share, a 25 cent per share increase from our prior projection.

This revised projection represents over a 27% increase from last year's record earnings of $3.93 per share, and is on top of the 59% compounded annual growth rate in earnings that we've achieved over each of the last five years. Our 2004 earnings projection is net of all non-cash charges and ongoing amortization of definite life intangibles. This includes a charge of 8 cents per fully diluted share for the early retirement of debt which we will now incur in the third quarter. And an additional 15 cents per fully diluted share in amortization of itangibles which we will incur in the third and fourth quarters as a result of our decision to change the Forecast brand name in California to K. Hovnanian Homes.

Excluding the 23 cents per share of additional charges, we would have projected EPS in excess of $5.23, up from our previous projection of $4.75 per share. Despite these additional charges, we expect our earnings to grow nearly 30% over last year's record results. Fiscal '04 total revenue is now expected to climb more than 28% to $4.1 billion on deliveries of more than 14,400 homes.

Net income is expected to grow by at least 30% to in excess of $333 million after tax. If market conditions remain stable, we remain on track to achieve our target of at least 15% earnings growth in fiscal '05 beginning with a strong first quarter which once again, we're beginning to develop a strong backlog position for. Details on our updated summary projections for fiscal '04 are available on our Financial Information Page of the Investor Relations Section of our company's website at www.khov.com. I'll now turn it over to Larry Sorsby to discuss our financial performance in greater detail.

Thank you, Ara. A summary of our six-month results is displayed on slide 15, showing a strong performance for the first half of the year. Total revenues increased from 1.3 billion to 1.7 billion and net income increased 32% from 97.3 million to 128.2 million. Earnings for the first half of the year increased from $1.48 per diluted share in fiscal 2003 to $1.93 per fully diluted share over the same six-month period in fiscal 2004.

Ara already reviewed the highlights of our results for the second quarter, so I'll now get into some of the specifics. Turning to slide 16, the company's consolidated home building gross margin for the second quarter excluding land sales was 25.2%, a decline of 40 basis points from the second quarter of fiscal 2003. The decline was caused primarily by recent company acquisitions and by increases in material costs, including commodities such as lumber.

Due in part to our conservative purchase accounting approach where we step up inventories and amortize intangibles, recent company acquisitions increased the number of deliveries in the quarter from markets that have lower average gross margins than our consolidated average gross margins. If we would have excluded the impact of our Tampa and Arizona acquisitions, our second quarter gross margins would have actually increased from 25.6% last year to 26% this year.

The fact that our gross margins for the second quarter is only 40 basis points lower than last year's is even more impressive given that our margins have also been under pressure as a result of increases in material costs. The price of lumber and certain other construction materials has risen rapidly since the start of the year. Although we attempt to lock in pricing by purchasing materials 3-6 months into the future, the cost increases have adversely impacted our margin.

To assess the magnitude of this impact specific to lumber prices, we calculated the variance in gross margin being achieved on homes that we closed during the second quarter versus what the margin would have been if lumber prices had held constant at the level they were in the second quarter of 2003. On a consolidated basis, the average impact to gross margin was approximately 150 basis points lower for homes closed during the second quarter of '04.

However, we believe that the vast majority of these increased costs have been offset by the increases in average selling prices that we have been able to achieve over that same period of time. When we started the year, we projected that our consolidated gross margins would decline by approximately 100 basis points this year when compared with the full fiscal 2003 results. We expect margins to decline as a result of acquisitions and higher land and material costs and the fact that our projections assume zero home price aappreciation from current levels.

Since our projections do assume zero, further price or cost increases anywhere, we projected that our margins would fall by as much as 100 basis points at the beginning of this year. However, instead of zero price appreciation across the board, we have continued to achieve significant price increases in a number of our communities throughout the U.S.. Thus, our margins were only 40 basis points lower than last year's second quarter. And we are now projecting our gross margins for the full year fiscal in 2004 to be about 20 basis points lower than last year's, despite the effect of the acquisitions and land and material price increases.

If home prices continue to appreciate, there is the potential for upside in our home building gross margins in fiscal '04. Many investors and anayists have been concerned with increasing land prices. However, as illustrated on slide 17, our developed lot costs have remained relatively flat since 1999 at around 26% of revenues.

During this same timeframe, direct and indirect construction costs have declined as a percent of revenues and our home building gross margins actually increased from 21% to 25.5%. Since 1999, our average per developed lot cost has increased from 62,400 to 69,100, a compounded annual growth rate of only 2.6%, while our average sales prices grew at a compounded annual growth rate of 3%. Turning to slide 18, total selling, general and administrative expense, including corporate expense as a percent of total revenues was 10.4% in the second quarter of '04, a 30-basis point reduction from 10.7% in last year's second quarter.

We anticipate that our total SG&A expense ratio will represent about 9.4% of total revenues for the full year in fiscal '04, down 60 basis points from 10% in fiscal '03. Turning to slide 19, the average sales price for home delivered company-wide for the three months ended April 30th was 269,700, a 1.1% increase from the average sales price of $266,745 in the prior year's second quarter. These prices include the impact of our unconsolidated joint ventures.

The average sales price in our markets increased as a result of the variation in our mix of communities We expect our average sales price to be in the range of 275,000-285,000 for the remainder of this fiscal year. Turning to slide 20, EBITDA for the second quarter rose 36% to 139.4 million from 102.8 million in the second quarter of '03. EBITDA represents earnings before interest expense, income taxes, depreciation, amortization and other non-cash, non-recurring write offs and charges.

The reconciliation of our company's EBITDA to net income can be found as an attachment to the quarterly earnings release. EBITDA covered the amount of interest incurred in the quarter by 6.3 times and total debt EBITDA was 1.9 times, reflecting the company's ability to more than adequately service its debt requirements. During the quarter, both Moody's Investor Service and Standard&Poors, increased the company's rating outlook from stable to positive, validating the strength of our credit profile.

Turning to slide 21, our net recourse debt to capitalization at April 30th 2004 was 48.9% compared with a ratio of 51.3% at the end of the second quarter in 2003. We anticipate that the company's average net debt to capitalization ratio for fiscal 2004 will be at or below 50% and line with our targets. We continue to have ample liquidity on our balance sheet to meet our growth objectives for the future.

There was no outstanding balance on the company's $590 million unsecured revolving credit facility at the end of the quarter, and we had approximately $123 million in cash. After the close of the second quarter, we redeemed all of our 9 1/8% senior notes through 2009 resulting in a 8-cent non-cash charge per share that would be taken in our fiscal third quarter. However, this refinancing will result in annual interest savings of approximately 4 cents per diluted share going forward.

This charge has been factored into the updated earnings projections for fiscal 2004. In accordance with FASB Interpretation Number 46, Consolidation of Variable Interest Entities, we have now applied the consolidation provisions to all of our VIEs in existence as of 4-30-2004. Previously we had only been allowed to apply 1046 to all VIEs established since January 31, 2003.

The full application of FIN-46 has resulted in the consolidation of a total of approximately 260 million in land inventory and 33 VIE entities. These consolidations have also added net of our option deposits, 238 million of minority interest ownership in those entities to the company's balance sheet as of April 30th, 2004. There were no additional liabilities added to the balance sheet as a result of these variable interest entities.

For each of the entities, the company holds a lot option contract for either all of the lots or a majority of the lots. Turning to slide 22, shareholder's equity grew 8% to $970.2 million as of April 30, '04 from 898.9 million at the end of the first quarter. Based our revised earnings projection for 2004, we now expect shareholders equity to grow to about 1.15 billion by October 31, 2004.

Turning to slide 23, we have seen a steady rise in home buyers choosing to use adjustable rate mortgages, otherwise known as ARMS over the past six months. For the first six months of fiscal 2004, ARMS represented 39% of all of our origination volume, versus 23% ARM origination volume in fiscal 2003. Most of our home buyers that are choosing to use this product are selecting 3 or five-year ARMS. We believe the shift to adjustable rate mortgages is partially the result of more sophisticated home buyers who recognize the financial advantages of this product relative to the time they expect to stay in their new home.

In some higher priced markets, affordability is effecting some customers decision to utilize ARMS. The credit qaument of the our home buyers remains very strong. In fact, our average loan to value ratio decreased to 77% for the first six months of fiscal 2004 compared to 78% for the full year of fiscal 2003. In the first half of fiscal 2004, our average FICO company scores remained quite high at 711, relatively flat with the score of 713 for the full year in fiscal 2003. Both are higher than national averages for mortgage originations. Our mortgage capture rate for the second quarter declined to 66% from 74% in the second quarter of '03, primarily due to the impact of recent acquisitions.

We expect our aggregate capture rate to improve as we expand our operations to all of our housing markets. We are currently originating mortgages in all of our markets except Florida, Arizona, and a portion of our Houston operations. Although we expect our mortgage operations contributions to the company's profitability to continue to grow at double-digit rates, our mortgage margins are under pressure.

Margins may fall due to the increased popularity of ARMS, which historically are less profitable to originate and due to competitive pressures related to the significant falloff in the mortgage refinance business. Turning to slide 24, we have a total of nearly 86,000 lots controlled for future development company wide. This is one of the longest controlled land positions in the industry, representing nearly a six-year supply based on our '04 projected the deliveries.

Most of the lots for our future communities are already owned by the company or controlled under options. So our lot costs are locked in, providing greater forward earnings visibility and increasing our confidence in our financial projections. 71% of our lots are controlled under option contracts, which greatly minimizes our risk exposure to land. We are continuing to employ a strategy of using land and lot option contracts wherever possible to minimize our land risks and give us the flexibility to renegotiate those contracts if there is a slow down in our sales within a particular community or a particular market.

Turning to slide 25, this shows our aggregate option position for all of our lot options and the amount of aggregate deposits we have at risk, which are only 6.3% of the total purchase price to the lots. We believe that this strategy maximizes our ability to reduce risks associated with land ownership. Turning to slide 26, we have 291 communities open companywide as of April 30th, a 19% increase over the prior year.

Our current plans project about 300 communities open at our fiscal 2004 year end. This represents a 17% increase from the 257 communities open at the end of fiscal 2003. Turning to slide 27, looking ahead, we are projecting earnings in the range of $1.25-1.30 per fully diluted share for the third quarter.

This represents a significant increase in earnings per share over last year's third quarter earnings of $1.06 per diluted share. We expect to incur 15 cents per fully diluted share of additional amortization of intangibles in the third and fourth quarters of fiscal 2004 as a result of a decision we made in May to change our Forecast Homes brand name in California to K Hovnanian Homes. Including a charge of 8 cents per fully diluted share for the early retirement of debt, which we will incur in the third quarter, these additional charges will have a combined impact of 23 cents on our earnings per fully diluted share for fiscal 2004.

These additional charges have been factored into our updated financial projections. By amortizing the intangibles associated with our Forecast Homes name, we will eliminate 50 million of intangibles from our balance sheet. We-- in fact, we plan to amortize about 80% of that 50 million, or $40 million of these intangibles over the next 18 months. At October 31, 2004, we expect that our combined balance sheet of good will and indefinite life intangibles will be approximately 32.7 million, or only 1.2% of projected total assets at year end.

These are the categories that cannot be amortized. They will be $50 million lower that the 10-31-04 compared to 10-31-03 because of our decision to change the Forecast name and begin the amortizing the intangible amount associated with that name. Now I'll turn it back to Ara for some closing comments.

Thanks, Larry. Our exceptional team of Hovnanian associates continues to put forth an outstanding effort in executing business strategies and we're very proud of our record financial performance again for the second quarter. Our company continues to achieve financial results that places us near the top of the industry in terms of earnings growth and return on investment.

In this year's Fortune 500 rankings, the home building industry and Hovnanian in particular significantly outperformed the median Fortune 500 company. We see that on slide 28. While total shareholder returns for the median Fortune 500 company was 32% over one year and 4% over five years, the home building industry returned 105% and 29% respectively over the same periods. At the same time, Hovnanian generated one and five-year returns of 175 and 59% returns. Return on average equity for the median Fortune 500 company was 13% in '03. Homebuilders, again, outpaced the group and achieved a return on equity of 23%.

We significantly outperformed both Fortune 500 and the home building industry by achieving a 38% return on average equity. Obviously, much higher on beginning equity. The same holds true for growth and revenues and growth and profit over one and five-year periods. Needless to say, with these historic returns, and the prospect for continued healthy returns given our backlog and continued strong sales pace, all of the senior executives of the large public builders are frustrated with our recent stock performance.

Home building stocks currently trade at a significant discount to the industries that are not producing even close to comparable returns and don't have nearly the opportunities in consolidation that we do. The industry average PE multiple of only 7.3 times projected '04 earnings already less than half the equivalent PE of the S&P 500 is frustrating. Many investors have tied that future performance of homebuilders to nothing more than interest rate concerns.

Yet quarter after quarter, including last quarter with 100 basis points increase in mortgage rates, for at least the last five years, home builders have demonstrated an ability to achieve significant double-digit growth in earnings even in an environment where interest rates were consistently above 8% as they were in the year 2000. As I've shown you earlier and mentioned, it will be an odd circumstance if housing does poorly when we come out of the recession, which we seem to have done.

Our closing share price on Tuesday of $35.07 represents a low multiple of only 7 times our revised projection for fiscal '04 earnings this for a company that has achieved a 59% compounded growth in earnings over the past five years. We remain focused on achieving our growth objectives and are confident that our actions have again positioned us for double-digit increase in earnings in physical '05. That concludes our presentation. And we'll now open it up to questions.

Thank you. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the hand set before pressing any numbers. Should you have a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star-two. Your questions will be taken in the order they are received. Please stand by for your first question. Our first question comes from Ivy Zelman from CSFB. Please state your question.

Good morning, gentlemen. Actually, it's Dennis [McGom] on behalf of Ivy. Larry, just a couple quick points on the model with the increased amortization, can you break out that 15 cents by the quarters, maybe give us an idea of what total amortization will be on a dollar basis?

Yeah, the amortization will be about 5 million in the third quarter and about 10 million in the fourth quarter.

That's the additional.

Yeah.

Additional.

There will be 5 cents in the third and 10 cents in the fourth.

Okay. And total amortization for '05, what are you assuming? Would that be the remaining 35 million net?

Hold on and I'll pull it.

We're talking-- we're talking about total amortization? That is about 35 million. Larry, pretty sure it's $35 million, or 35 cents for the year.

Okay. Total '05?

Oh, '05?

Yeah.

I'm sorry. I thought you were asking about '04.

'05's amortization is about $43 million. That's what we have in our budget approximately.

And then how about on the JV income, I notice you obviously with your backlog increasing there. What should we expect the final two quarters of next year?

We've not made any public projections on that at this stage. I don't think it's going to be all that material, but it's cooked into our projection.

We would see it accelerate though obviously with that backlog?

Yes, it will begin to accelerate.

Okay. And then just lastly, if you were to compare apples to apples your price increases and deliveries the last year and a half or so, what would that number be?

Well I gave you a pretty good chart on our average sales praise increases. Obviously there is a mix issue there, so it's not apples to apples on a price increase. I don't have a projection, or, you know, or a wild best guess that I could give you. It really various greatly from community to community, market by market.

I guess that's why I'm trying to strip out the mix impact. I understand how much you may be raising prices, but if we looked at '03 reported being 5% increase, would it be--

It's all a mix related. We simply do not track, so we won't be able to give you just, you know, how much it was a pure apples to apples, same model same location price increase. It's just not something we track across the company.

Okay, well what if maybe I phrase the question a different way, if we see-

If I could go back for one second. In markets like Ohio, North Carolina, Dallas, Houston, those markets even Arizona, there have been price increases, but they are quite moderate. Then if you look at markets like Southern California, in the Inland area, on the Coastal area, in Northern California, in the DC market, in the Northeast market, the New York, Pennsylvania, Philadelphia suburbs, there they have been much more significant. So I can't even give you a meaningful-- even if we tracked it, the number would not be meaningful on a national basis because the conditions are so very different across the country.

Okay. If we looked at the national number, which let's say is around 5-6% and that came down to a more normalized level of 2-3%, maybe 4%--

The national number of 5% you're referring to is--

Price increases, let's say on a national level prices are up 5-6%.

For us or you're saying in general in the market?

No, the national.

Okay.

And that returns to a 2-3% type number, maybe a little bit above 3% and your prices came down, you know, on par with that, what kind of impact would that have on your margin?

Well, our projections assume less than that. We assume zero price appreciation. So the guidance we're giving you going forward the guidance for '05 assumes far more conservative than even those numbers. We assume zero.

Okay. Following up on that, haven't you sold pretty much all of the homes you're going to sell in the third, or close in the third and fourth quarter already?

Almost, but it varies by market. In the Northeast market, Ohio, in, in the DC markets, we are virtually 100% sold out for the remaining quarters. In certain markets in Northern California, parts of Southern California, in parts of Houston, and parts of Dallas, we tend to sell-- we tend to start construction before sale and sell during construction. So in those markets we still have sales that we need to book for the fourth quarter.

Okay. Very good. Thanks, guys.

Thank you. Our next question comes from Stephen Kim from Smith Barney. Please state your question.

Thanks very much. Congratulations on a good quarter and lot of good information you guys gave in your opening remarks.

Thank you.

I had a couple of questions, if I could. Ara specifically, I was wondering if you could address how you think you are faring relative to the competition out there? In your remark, you mentioned several several times that, you know, despite 100-basis point increase in rates, but the demand continues to be extremely good. You have indicated that, you know, your orders were fairly recently and you talked about coming out of prior recession, the industry has generally done well. I was wondering if you could differentiate though between whether you are seeing just general strength for everybody in the home building business and the real estate markets, notwithstanding the 100-point basis point increase? Or are you saying that you are actually because of certain things Hovnanian is doing, actually doing much better than the competition who may have seen some weakness?

No. Well, a little bit of both, but the competition I would say, particularly the larger public builders, I would not say are seeing weakness. I would say there is strength across the board including in our competition. However, I would also say that, and that's pretty clear and evident from our returns on capital, returns on equity, our year over year earnings growth, we are outperforming even the best of our competitors. I think there is only one that we don't -- only one home builder that we don't outperform on virtually every measure.

Yeah and you've been doing that for a awhile.

Yes it, will be several years now.

But Stephen, in terms of recent sales pace, I believe that most, if not all of the top public builders, are going to be reporting year over year positive comparisons and orders. I don't think our order patterns are far disparate from what others are going to be reporting. I think the small to medium size homebuilders maybe continuing to lose share, I mean consolidation is continuing. And even if the overall market slows a little bit, I think the top 10 builders including ourselves, will continue to show positive year over year results in order patterns.

Frankly, I can't make heads or tails and I rarely can over the month by month national new home sales figures. Frankly, I don't pay much attention to them because they revise them 95% of the time anyway, and some cases, quite significantly. I can tell you that, you know, in numerous times when the national figures are strong, ours might have been a little weak and when the national figures are weak, ours may have been a little strong.

Most of the periods I talked to sales continue at a solid, steady pace. Ours, we are tending to grow more, more rapidly than our peers who are registering some very significant gains and part of that is we've had, I think, stronger organic growth and we supplement through acquisitions as well.

Right, and, yeah, I mean he agree with your new home sales comment. We actually wroke about and that and I think that's a pretty terrible statistic. As the follow-up to that first question, then, it would seem that from a longer term or medium term extra strategic standpoint, home builder executives are sort of faced with a choice. They can either pursue the traditional route, which is brace for a downturn if one were to come, and outperform in a tough market because of some defensive actions that were taken. Which it probably manifests itself in decisions being made now with respect to home price, type of product you would be introducing, maybe, you know, compensation programs getting ready to sort of tweak them if necessary, land investments, et cetera. Or if you anticipate and are convinced that demand will remain strong, it would seem that if you took a defensive posture, you might actually leave some money on the table. You might actually miss an opportunity to grow and continue to gain ground relative to the largest builders in the industry. Can you talk about sort of how Hovnanian, which is not one of the very largest builders, but is growing very rapidly, and has also seen a lot of downturns in the past and you've managed to navigate those, how do you strategically position your company at this point?

Well, what we're doing Stephen, and your questions are certainly questions that are on our minds all the time. What we are doing, first of all, is making certain we have the right capital structure to withstand any reasonable fluctuations in market conditions. We're absolutely targeting to a one-to-one or better debt to equity ratio, or said another way, 50% debt to total cap, and on top of that, we're making sure that we're maintaining more than adequate excess availability through our bank lines. In fact, we reported we have nothing drawn on at quarter end.

In fact, have had excess cash on our $590 million line. Now, having said that, you would think it's kind of silly for what I'm about to tell you, which is that we're talking with our banks right now and we're in the process of increasing that line significantly. Part of the increase just has to do with your general growth, to have that availability. But we don't plan to use much of it. But we want to have that availability both in case the economy does slow down, although frankly we think that's not particularly likely at the moment.

Again, because of the slide we showed you, we're fairly bullish that as we come out of a recession, as you look back historically, housing has fared quite well. And we don't see that as an exception, even with slightly raising rates. The primary reason we're doing that really is to take advantage of opportunities that come up. But we really, even with the credit availability, we are tempering our actions to stay in line with our debt to equity targets/ Because, you know, of decades past, home builders have gotten into trouble as they overleveraged. And we think staying nice and conservative in the 50% level or less is the way to go.

Okay. Great.

I will add, it is very helpful to be having, again, for yet another year, post, you know, higher than 40% after tax returns on beginning equity. Because that allows us to significantly increase our investments as our equity is growing that much and still maintain conservative leverage. It gives us a lot of capital to grow and both organic growth, but the capital growth, the capital availability we have, because we're earning so much and generating so much cash flow is more than even our stronger organic growth can absorb. Snd that's allowing us to supplement with acquisitions right now.

Great. Thanks Ara.

Okay.

Thank you. Our next question comes from Craig [Casara] from Friedman Billings Ramsey. Please state your question.

Hi. Yes, good morning. Thanks for the additional disclosure today. Could you give me an update kind of on your specs, where they were at the end of the quarter.

Yes, as you know, we report those every quarter in our 10-Q. They have been relatively steady for the last few years based on the number of started and unsold homes on a per community basis. Not going to be any different this quarter end either. We have 1,036 started and unsold homes as of the end of the April quarter, and 306 model homes for a total of 1,342 total started and unsold including models.

Now, does your guidance of delivering more than 14,400 homes, does that assume any spec deliveries or is that what you plan to have working on your backlog and your additional sales in third quarter?

In terms of '04?

Yes.

I mean as Ara mentioned earlier, certain of our markets, Houston being a simple example, North Carolina being another traditionally sell some of their homes based on them already being started. And certainly we are still able to deliver homes to customers that have not yet been sold in those markets because we have some that are started. So there will be some component of these thousand homes that will deliver in '04.

Mm-hmm. Okay. Thanks. One thing I wanted to ask is you've had a pretty descent slow down sort of in your conversion of your backlog, say from one quarter and what you're actually delivering, you know, it looks to me like it's off maybe about 10% from last year. Can you give a little color on why is that occurring, is that markets based event or is that-?

One of the things we were talking about is the really challenging weather conditions along the entire East Coast and certainly the Northeast and our Southeast markets are a very significant part of our business. It's frustrating. It's not just the rain days that prevent you from, you know, framing a house or putting a roof on, but even the dry days, unless you've got four or five consistent ones, they prevent you from doing site development work. So that is part of the reason you are seeing and that that's a pretty good pickup. It really has to do with site development that is pushing more of our activity to the fourth quarter, which we don't like. There is not much we can do about it.

And the other issue, in certain communities that we've had extraordinarily strong demand for, we're sold further out than we would normally be sold. In fact, as Ara mentioned in the conference call script, the market in California, we're actually consciously going to slow down sales because we're sold too far out in advance of starts, so that's another reason that that conversion rate might be declining.

Right, right.

Interesting today and yesterday, rather we had only small periods this morning, it just rained briefly and yesterday only for an hour or two, if that. But basically the next four days, the site-- housing construction can start, can continue, but the next four days, land development is going to slow down dramatically.

Okay. Thanks. I guess also I wanted to ask, you know, I've heard from a lot of the builders that deal flow as far as potential acquisitions is as strong as it's ever been, but pricing expectations have also been quite exorbitant . Can you comment on maybe what you're seeing in the market? Are you still seeing those kind of issues as pricing maybe come in a bit over the last couple of months?

We continue to see a lot of opportunity, I agree, there is more deal flow than ever. You're talking about company acquisitions versus land acquisitions?

Correct, correct, acquisitions for the builders.

Yes,-- yes, but-- there certainly are some that have inflated expectations, but we feel quite optimist that we're going to be able to match up, you know, the right opportunities with the right pricing expectations. And you know, we are continuing to see good opportunities in that regard. I will say that, you know, I think we have a bit more of an advantage vis-a-vis our peers in this regard because of our track record. I think we are the only home builder that has kept virtually every single manager, you know, I would say the senior level of all the acquisitions we've been doing.

And that is a huge leg up on attracting future and additional companies. It does absolutely separate us from the rest of the pack in acquisitions. And I think-- I'm quite certain there are cases where we will, are not necessarily the highest priced bidder on a company. And the sellers, if they are staying, would prefer to work with us because of our track record of keeping management and working well in a more entrepreunerial, yet systemized manner. Kind of a good blend of big company and entrepreneurship at the same time.

And given that you seem to think that you are undervalued, and I tend to agree, do you have any thoughts about being a-- a bit more aggressive in the buy back market?

You know, it's awfully tempting and we certainly consider it. On the other hand we are earning 42% after tax on beginning equity. This is not the first quarter we're doing that. It's yet another year of doing that, and we are planning to grow aggressively. We see many opportunities there. There is still a lot of geographic footprint that we haven't covered in the country at this point.

So at the moment, we are authorized and have been buyers over the last several years of millions of shares. But we don't-- you know, we're not aggressive buyers at this moment. You know, we see a lot of growth coming right now and we just want to make sure we're maintaining a strong capitalization and, again, we're earning great returns on our equity right now.

Okay. Thanks a lot.

Thank you. Our next question comes from Margaret [Waling] from UBS. Please state your question.

Good morning, guys.

Good morning.

Nice quarter. Two questions, if I may. The first one is you gave a lot of detail in your prepared comments, which is very useful about the call, what's working for and against you. I'm wondering if you can give us maybe specifics as you break out your regions, what's the range in the margins and the return on capital? The peak to trough versus the average currency? Could you give us that?

We just don't give public information broken out market by market, but I'll give you just a highlight.

Yeah.

That is that the more heavily regulated markets that are more constrained in terms of supply of land, we get our highest margins. That would include all of California. That would include our New Jersey and Eastern Pennsylvania operation. That would include our Washington DC markets, including both Virginia and Maryland.

Our weakest market has been the same for the last four years, that's North Carolina. Although we've seen some encouraging signs in North Carolina with some very, very minor price increases and a little pickup in sales, the returns on capital deployed still is the weak of any of our operations. And the others, Arizona, Florida, and Texas, if you exclude the purchase accounting adjustments are all earning solid returns. Just not at the same level that we're able to get in the heavily regulated markets.

Okay. What I'm trying to figure out is that, you know, the very regulated markets you're getting better pricing power because there is a supply constraint. So are there more goods which would have a more normalized supply environment recognizing that it's constrained virtually everywhere relative to demand, but are there markets where you just have much more efficient operators?

Yes, yes, because for example, in Dallas, which does not have the highly regulated market, I think we are much more efficient than our competitors. Frankly our peers are concerned and complaining about their margins. We're earning excellent returns in Dallas right now.

And--

And Houston which is a more medium-size return market, our returns don't quite match some of our very highly regulated markets, But they are very strong and I think it's because we have two very efficient operations in those markets.

How do you measure the efficiency?

Let me give you an insight, Margaret. We see a lot of acquisition opportunities.

Yeah.

And, you know, for example, in Houston, we saw numerous opportunities and picked the two that we ended actually acquiring out of the pack. The returns that Park Side Homes and Brighton Homes were generating compared to the other companies that we looked at in Houston, they were generating significantly higher returns than many of the other competitors that we looked at in that marketplace. So we know that efficient operators, you know, that just from comparing and contrasting acquisitions. And then once the company is actually join our team after an acquisition, we do a number of things, national contracts being an easy example, to enhance their returns even further.

Now, when we refer to efficiency, it's not always just pure efficiency from the cost perspective. You know, it's really the ability of a management team to detect the sweet spots in the marketplace.

Yeah.

You know, is the sweet spot in active adult, is it low end? Is it farther out fringe part or the heart of the market, is it in multi family? It is an art form to really detect the sweet spots and consistently be able to outperform the competitors. And I'm pleased to say the team we have has been able to do that.

So, you know, I think every question I get from investors comes down to one and that is what happens to the home building earnings power in the event that we lose home price inflation,. Which is highly unusual if and when we get wage inflation. But in that unlikely event, can you take wholesale quickly more quickly than you're losing home pricing. And it sounds like if you have some of these markets where you're being more proactive and really identifying your customer, you can do that.

Frankly, I think we-- as an industry and as a company, I think we have just begun to scratch the surface on opportunities to take the cost out of the market. Out of the system.

In terms of the process

Terms of the process, yeah.

More than the procurement?

The home building industry, I mean it's essentially a manufacturing industry, but compared with the state of the art manufacturing techniques of other industries, we are rather primitive. I think that's changing. It's been primitive because it's been smaller companies. Now we have got, you know, a dozen multi-billion dollar companies and we are advancing as an industry. We simply are, and it's inevitable and it's happening right now in terms of companies getting more cost efficient.

Okay.

We talked about some of those ways in our other conference calls. We talked about the fact that Summit Homes acquisition, we are actually buying direct and distributing through our own warehouse. That's yielding some efficiencies. We're actually doing some vertical integration. We're actually doing some of the contracting ourselves as opposed to subcontracting out everything.

We're looking at even flow production techniques. And in the Northeast about half of our construction is now utilizing these even flow construction techniques that we think are yielding some efficiencies. We're looking at very sophisticated CAD programs, computer aided design programs that are absolutely helping us become more efficient so. There are numerous-- there are numerous areas. I think in the next 10 years, you will see a dramatic change, gradually year by year in the efficiency and sophistication of the home building industry.

All right. That's good news. And the second set of questions, I have is basically around the health of the consumer. We know that ARMs are a greater part of them, the mortgage market right now, which they always are when the 30 year's over 6%. But what do you see is the best indicator of the credit quality of the consumer? Is it a FICO score or LTV or how do you think about it?

I think both of those are good benchmarks for credit quality. You know, I disclosed our FICO scores in excess of 700. They've remain in excess of 700, which is higher than the norm. We've not really seen any degradation in the degrading in the quality of the people that are buying our homes.

Now, sure, there are a-- community here, a community there may struggle from time to time. That's happened decade after decade forever. But on average, very solid credit quality of customers coming in to buy homes from us. And having less than an 80% loan to value on average, I think, is, you notice, speaks pretty highly of our customers as well.

Yeah, all right.

I think one of the advantages of a broad product array is we're not only focused on that entry level buyer. We're not only focused on the move-up buyer or the luxury buyer or the active adult . We have everything for everybody and I think that helps our credit quality of customer as well.

It helps.

By the way, one thing that is unique, we have a fairly large segment of our business as active adult buyers. About a third in the Northeast, and a growing segment in our other areas. They are dramatically overqualified for the mortgages they are taking out.

Sure. Still, half of them are paying cash?

Yeah. Statistics that I gave you--

When they do take a mortgage, it's for, you know, a much lower percentage of the house price.

Good. Okay. Guys, thank you very much. Good job.

Okay. Thank you.

Thank you. our next question comes from Tony Campbell from [Nod] Partners. Please state your question.

Good morning. Wonderful results. Some day we'll get respect on Wall Street. I guess my question, is have you seen any change in traffic?

We have not. It's been very steady.

Okay, and at what point, I guess, I guess the other side of this sort of stock repurchase idea is, you know, because I think a lot of the executives in the home building industry feel that their stock is extremely cheap. Of course the other way to look at this as you guys as insiders could be buying back stock yourself.

Yeah, in our case, our company has the highest insider ownership of any of the public home builders. We're about 50%, so we're already there. I mean we're extremely high.

No, I understand. You're a little bit different.

Yes.

All right. Good luck. Thank you.

Okay. Thanks.

Thank you. our next question comes from Sam [Leeber] from Alpine Funds. Please state your question.

Hello, gentlemen. Great call. I appreciate all the supplemental information.

Thank you.

I've got three quick questions here. One regarding your backlog. And as it relates to delivery. Last year at this time of the year, you were at 56% of what you ultimately delivered. This year, you're-- I'm sorry, 46%. This year, you're at 56% in the backlog. I-- as opposed to your projected deliveries. And I just wondered what that how would you explain the differential this time? Why your backlog seems so much larger than projected deliveries than last year?

Larry, you want to take a crack at this one?

Yeah. I think, you know, Ara you hit this earlier, but I think it's a combination of the delays in deliveries because of the weather issues that we've experienced in the Northeast and in the Southeast where we had huge backlog, but we couldn't get the homes started at the times that we thought we were going to get started and therefore the delivery dates are being pushed out. The other thing that I think is causing it in some cases because demand has been so strong in certain communities we're sold much further out in advance in those communities than we were at the same time last year. So I think it's those two things that are driving it primarily.

Okay. Now, would this-- if the, if the sales patterns hold up reasonably well for the balance of the year, would you expect that perhaps your, your projections for the year's closings are a little light?

We've made our projection. I'm going to stick by it. If you want to make a different projection, feel free.

Fair enough. On another question referring to slide #17, if I may, you folks gave a lot of good information on margins throughout the, and costs on a historic basis. I'm just curious if you could also fill in the, a data point regarding the average home size over that time. Has there been any real shift in-?

I wish I could give you the answer to that. There is a lot of mix issues in here, and, you know, sometimes averages can be misleading, I guess, but we do not have that data. We just don't track it. I wish we did, but we just don't have the data.

Would you guess, is there much of a difference plus or minus 5-10%?

I don't know how we would even venture a guess because with a very, very broad product array, and we've grown dramatically since 1999--

It's just not something we track.

Fair enough.

So a guess would be nothing-- ours would be almost as good as yours.

Okay. Fair enough. Less than 25%, how about that? With regard to-- my last question is with regard to the condominium purchase you just made the other day, announced. Obviously there are a number of other builders are looking more at the urban markets and obviously you folks have been moving at that direction for awhile now.

Are you talking about the San Diego high rise?

Yeah. Could you just tell us a little bit about that deal?

Sure.

Why you did it and what your plans are.

Sure. We have-- we actually had already under option and going through the approval process a site in downtown San Diego to build our own highrise. So we were quite familiar with the marketplace. By the way, we're proceeding nicely with the approval process. It can be a lengthy one.

It's been under option for a while and we're getting close actually. But around the time, there was a rental apartment builder who was halfway through construction of a highrise that looked at the numbers, looked at rentals versus condominimums and said, you know, I think the market for sale may be better than rental and he decided to put it on the market. This is not the first time we've done this, by the way.

We've done two acquisitions like this in the Northeast and we are about to do one in DC, although I think we were just outbid. In any case, we did our analysis, which we were quite familiar with, and determined that we could buy the building and make an excellent return. Now, the building when we signed the contract, it was several many months ago. We actually just closed yesterday and they allowed us to presale.

The beauty of it is out of the 382 homes, we had already presold 150 before we had to exercise our option, and it was truly an option. So our risk was somewhat limited, although the deposit was $5 million relative to the deal wasn't too bad. And the other interesting thing about buying this way is that we closed this month. We will start delivering homes this month. So cash flows are excellent.

You can't really bank on this as a long-term strategy. It's an opportunistic strategy right now, but one that we have been moving aggressively on. This is not our first transaction, nor will I think it will be our last. But this is not a major strategy for the company. There's just not enough opportunities.

Having said, he that, there are opportunities coming up for what was formerly apartment land where the rental numbers don't pencil out nearly as well as the condominium numbers. We are a major builder of attached housing, apartments, I mean condominiums and townhouses. Now we are going into midrises and highrises. It's not a huge part of our business, but it's a few percent of our business and a few percent of, you know, tens of thousands can be significant and we think there are some great opportunities.

Would you just comment on what the 150 units you presold, what your prices were per unit?

We have raised our prices dramatically. It's a very affordably priced one, this particular one. We made a decision, since it was so far in completion of leaving the specifications as they were. We had debated about taking out the countertops, upgrading them to granite countertops, ripping out the cabinets and putting in high end cabinets.

In the end, we decided there had was a real market for the lower end affordable product. I'll credit our team there. I would have-- had I voted, which I didn't, I would have voted to put-- take out the cabinets and delay it a month or two. I think they made the right decision and part of our success is we rely a lot on our local entreprenuers in those markets. It's part of why they stay with us because we give them that latitude and I think in this case they were right.

Because-- but the prices, I think basically were in the low 200's and go all the way up to a million dollars, but that was a handful of homes. I would say the majority of the homes were from 200,000 to $500,000 which is a great position to be in in San Diego.

Great. Excellent call, gentlemen. Thank you.

Thank you.

Thank you. If there are no further question, I will turn the conference back to Mr. Hovnanian to conclude.

Thank you very much. We continue to be pleased to give you great results, given the backlog we have and the continued strength in our new sales, we're quite optimistic we'll be able to continue this on future calls. As always, our team is available for questions on a one-on-one basis after the call. Thanks so much and we look forward to our next call.

Thank you, ladies and gentlemen. Once again a rebroadcast of this call will be available approximately one hour from now. To access this rebroadcast, you may dial 1-800-428-6051with a pass code of 357897. Thank you all for participating and have a nice day. All parties may now disconnect.