Watsco Inc (WSO.B) 2007 Q3 法說會逐字稿

Good morning. My name is Kushina and I will be your conference operator today. At this time I would like to welcome everyone to the third-quarter earnings release call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over is over to Mr. Albert Nahmad. Sir, please go ahead.

Good morning, everyone. Welcome to our conference call covering Watsco's operating results for the third quarter nine months ended September 30, 2007. This is Albert Nahmad, President and CEO. With me on this call is Barry Logan, Senior Vice President.

First let me read a cautionary statement, a reminder that this conference call has forward-looking statements as defined by SEC laws regulations and are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.

Highlights for the quarter include record revenue and our second-best earnings performance, an achievement given the relative strength of last year and far more challenging business conditions this year. The ACR acquisition closed in August and they're off to a good start as part of Watsco. ACR adds revenue, 54 locations, and most importantly a terrific team with long-term relationships that we can help grow and develop as part of Watsco.

Now in terms of marketshare we believe we have outperformed the industry as our unit volumes compare favorably to others in the industry. We also refinanced our credit facility, expanding our borrowing capacity to $300 million from $100 million. By the way, we had over $400 million of subscription and cut it back to $300 million. And we also obtained better pricing on our debt. We are actively seeking to make additional investments and to grow our network; we're actually very excited about that possibility. We raised our quarterly dividend rate 21% to $0.40 per share a quarter, the means of sharing our terrific cash flow in a very direct way with our shareholders.

And now the numbers for the third quarter. Sales increased 4% and includes 54 locations added from the ACR acquisition and 21 other locations opened or acquired during the last 12 months. These new locations added $51 million in sales during the quarter, $3 million of EBIT and $0.03 of earnings per share. On a same-store basis sales decreased 6%, an improvement from the second quarter.

As we mentioned in the press release, sales of HVAC equipment declined 1% which compares favorably to what we see from recent AR data and what we hear going on in the market. Our refrigeration business has also done well, up 12% for the quarter. Other product lines were down and some of which are obviously impacted by the slower new construction market.

Gross profit margins proved to be the greater irritant to this quarter's results and the reasons are articulated in our press release. Competitive pricing is likely to remain a factor for the remainder of 2007 and the effects of last year's copper benefit should abate during the fourth quarter. Suffice it to say it's also a more competitive market right now.

One comforting reference point is that current margin trends are much like 2005, indicating again that 2006 was quite a spectacular year for us. We are controlling SG&A without sacrificing great customer service. SG&A declined 6% on a same-store basis consistent with revenues. Operating profit was $42 million with operating margins at 8.1% versus 9.5% last quarter. On a same-store basis the operating margin was 8.3%.

Interest expense increased 14% due to the acquisition of ACR. Cash flow generation will remain positive as we end the year which will lower borrowing costs from the current level. Earnings per share from continuing operations was $0.91 per diluted share on net income of $25 million versus $1.05 on net income of $29 million.

And now year-to-date results. The press release includes many details about our year-to-date performance. Factors impacting sales and gross profits are consistent with what I have already covered. SG&A was relatively flat including the 75 new locations and it is now down 5% on a same-store basis. Operating profit was $99 million on operating margins of 7.3%. On a same-store basis operating margin was 7.5%. EPS was $2.18 per share, once again only second to last year's phenomenal performance.

Year-to-date operating cash flow reached $35 million versus a use of $10 million a year ago, that's a $45 million swing. Debt levels are at $95 million versus $65 million last year and that's after using $108 million to purchase ACR.

We are positioned well to aggressively pursue additional growth opportunities, target acquisitions and continue to expand our network. In terms of our outlook, we have updated our earnings guidance in our press release to $2.55 to $2.60 to reflect our current thinking about the overall business climate.

Now let's have a little fun. I'm happy to say that on Monday Watsco will be at the New York Stock Exchange to ring the opening bell. This will be a celebration of our 60th anniversary as a company. We've been a public company for most of those years and have many long-term shareholders. Now, if you had been to a New York Stock Exchange listings ceremony in 1994 -- let me say that again -- if you had been there when we listed on the New York Stock Exchange in 1994 and invested then, Watsco's compounded growth rates would be as follows -- EPS growth 20%; dividend growth 26%; share price growth, even at today's prices, 20%. And we are the same people doing the same thing the same way that have made us successful. And we're very well capitalized and very well excited about what's coming ahead.

We are holding an investor conference at lunch that same day at the Exchange. Members of her management and our Board of Directors will be in attendance. If anyone has an interest in going, please give Berry a call. Now with that said, Barry and I will be happy to answer your questions.

(OPERATOR INSTRUCTIONS). Ian Zaffino, Oppenheimer.

Good morning. You mentioned the share gains, are the share gains just on the HVAC equipment side and would that be more on the replacement side or the new construction side?

The data that we get doesn't separate it, the data we compare it to. So it's both replacement and new construction. And yes, it is the unit gains.

Okay. So can you, as far as what you're seeing, give us an idea of what you're seeing in the replacement market versus the new construction market because I know you're able to --?

You mean the AR data, the industry data?

No, your own data, what you are seeing as far as how are orders on the new construction side, the larger number of units being ordered at one time versus kind of one off replacement purchases from you guys?

Barry, I don't think we break that out, do we? What is your (multiple speakers) that question?

The big picture is this, Ian. We know that in our markets new construction is around 25, 30% of our business and the metrics for that -- what we see is down somewhere between 30 and 40% in new construction. So the algebra would tell you that's down 8, 9% as a big picture number. And with units being near flat, down 1%, that would tell you that the replacement market has certainly something we've -- it's where we make our money, it's where our business is concentrated. It also would suggest a fairly good year for the replacement market this year.

Okay. And you're down 30, but -- down the 30 revenues or units?

The industry was down 30, not Watsco.

Okay.

There is no pricing in this quarter, so pricing in units is the same conversation.

Okay. And then last question would be the share gains. Are the share gains more from just going out and rolling out new stores and making acquisitions or are the share gains from -- on a store level existing stores as well?

The 1% down is on a same-store basis, acquisitions would not be included in that. New branches would be included to some extent. But the acquisition of ACR for instance would not be. It's stores, it's obviously execution, we also think the Sunbelt is a very consistent market in terms of what goes on for replacement especially. And we also sell multiple brands through all of our locations which gives the contractor a very efficient way to have variety of different pricing and not all distributors accommodate that or are able to do that. So there's always been good ways for us to build share.

Thank you very much.

Matt Duncan, Stephens Inc.

Good morning, guys. First question just kind of going back to this replacement versus new construction -- and I hate to hound on this, but I want to make sure we understand the dynamic in the industry that you guys see right now. It sounds like on a unit basis new construction is kind of a drag in the 30 to 40% range. Do you feel like the replacement, your replacement sales return to growth in the third quarter or do you think they were down year-over-year as well excluding new stores?

Matt, we don't account for it in that fashion, so I don't think we can break that out for you. Just generally speaking, not for our company, but I don't believe -- well, this is all over the media -- but housing is still declining. And so I don't expect that the industry that's feeding new construction is doing any better than it was in previous quarters and who knows how long that will go on for.

But I've always said that if we have good normal weather because we are basically serving the aftermarket and especially next year when we start comparing to most of the new construction sales of whatever it is this year which has declined, that will be out of next year's numbers. So I just feel that if we have reasonable summer weather in '08 we're just going to do really well and grow because that's what our focus has always been and that's why we are building this network of having large numbers of branches in major market and competing in that fashion. Nobody does what we do in terms of adding density and branches and that makes it really easy for contractors to do business in the replacement market with us.

Right. And that was kind of my next question, Al, is what do you guys feel like the market is going to look like for you in 2008? You've now got the 13 SEER transition pretty much behind you. In looking forward do you feel like your replacement business, and just your business as a whole, should sort of get back to your typical high single digits to around 10% growth rate? Is that sort of the way we should be thinking about next year?

Well, the industry growth rate is normally in the 4 to 5% and I would not venture a growth rate now for the industry or for us. I just feel, as I said earlier, that fundamentally that if -- the replacement market would be a bigger part of the industry next year and that's the market we primarily serve so I think we're going to be in pretty good shape.

Now if you have -- in the major markets the summer weather is later or is it normal? Who knows? That will shift some numbers around between quarters, but I'm feeling pretty good about the future. And also I feel very good about the investment climate because we have a fantastic balance sheet and we're a great company for distributors that have thought about selling to sell to. We're very good with the organization and we certainly value distributors hopefully better than anyone else because it means more to us than anyone as we build our network.

Okay. Two more questions and I'll get back in queue. And one of them is kind of on the point you were just talking about, Al, in the acquisition pipeline. What does that look like right now? Are you guys in talks with anyone and what can we think about from acquisitions? And then last, you guys have lowered guidance. Was there anything that really surprised you in this quarter that caught you off guard?

Well, it's hard to say what trends we can tell you about. I thought the comps would get easier towards the end of the third quarter and they didn't. And I'm not sure why. Is the consumer pulling back just generally speaking? But eventually the consumer cannot pull back on replacing a broken air conditioner. He can repair it for a while but he can't replace it. And so that's why I'm saying that I'm so glad that the future looks -- there will be less and less of the new construction in the market and more and more replacements and we're so well positioned for that.

But it's hard for me to give you any specifics because all this sort of happened towards the end of the third quarter. And we thought we'd take a shot at what we thought our fourth quarter would be given what we saw, so that's why we revised our estimates.

Okay. And then on the acquisition pipeline?

We're engaged constantly with great companies and we're at work and I'm optimistic. Can I call a shot or a timing? No, I can't. These are great companies and they have to make up their own minds. But I do think we're viewed as a great company to sell to.

Thanks a lot, Al. Appreciate the comments.

Curt Woodworth, JPMorgan.

Good morning. I know it's hard to commit to kind of an outlook for 2008, but it's pretty likely that residential is going to be down call it 10 to 15%. So my question is in terms of how you're thinking about your cost structure for next year and what could be a pretty flat -- potentially flat volume environment. Where are the opportunities?

It seems like gross margin, it's going to be hard to really move that up given more pricing pressure and it's a pretty competitive market. So then you're kind of left with more ability on the SG&A side. How do you balance keeping the cost down and I know you still want to grow the business organically in greenfield? Maybe talk about how you kind of see that playing out or how we should think about it for next year on the margin side?

Barry, I've been doing all the talking. Why don't you take a shot?

Curt, the first -- just to take one step back, it's a very performance-based culture throughout the Company. Every salesperson, there are about 800 of them, are incentivized on gross profit performance; 440 branch managers incentivized on EBIT performance; every regional manager, every business unit president is based on EBIT performance. So the consequence of lower earnings this year is affecting a lot of people's pocket books in our company and it's something that they're in charge of in terms of their local presence and their business of growing their profits.

So it's something that happens at a very granular level. It's not a top-down approach, it's something that happens at a store by store level in terms of improving cost, improving margin, improving selling prices, improving sales and so on. So just with that backdrop culturally just get the sense that it's a universal culture within the Company.

Secondly, many of those key managers also own Watsco stock through options or their stock purchase plan or what have you, so it's very much a performance culture. So for the planning for next year, as everyone ponders your question, it's got to come from obviously sales growth. It's something that we don't want to ever pretend that from a year-to-year basis that there aren't enough levers to pull to get sales.

Now this year obviously that's proven difficult for some good reasons. Next year I don't think the comps are as difficult obviously and the construction may not be as severe and there's certainly plenty of idea generation going on with new products for next year as well that are more in the planning stages, but something that can be possible for next year.

Gross profit, we're not satisfied that giving back some gross profit this year. We're not in a purchasing mode right now; we're in an inventory reduction mode. As inventory starts to populate our network next year that's the opportunity I think for us to work with our vendor, shall we say, and improve our pricing posture.

SG&A, again something we've done year in/year out for the last 10 years is asked our key senior leadership to evaluate and take on more responsibility. And two of our business unit this year have been integrated into larger, more significant ones and obviously there are cost savings there. But it's mostly a way to spread more ideas throughout a greater portion of the network with people that are at the top of the performance chain.

So that's happened earlier this summer and then in September a second one was integrated and, again, some cost savings there. So those would be some of my thoughts, Curt. It's something that we don't sit at a corporate level and, again, ponder. It's something that is throughout the entire organization.

Okay. That makes sense. And then on this quarter in terms of the 1% decline on equipment, clearly that's above market, what do you think the market was down this quarter?

Let's put it this way, intelligence says down 7% in units, which I don't think there is any difference in price this quarter. So that would be my intelligence.

Okay, great. And then in terms of the fourth quarter, it's a little bit more challenging because the aftermarket, it isn't as powerful. The new construction on a percentage delta basis really is going to hit you harder, but you also have an easier comparison because last year fourth quarter was tough too. So I guess embedded in your guidance can you give me a sense for what kind of volume range you're contemplating -- like rough numbers?

I think it's fairly consistent with what we've seen all year, Curt.

Okay. So it would be about similar to this quarter (inaudible) residential?

Yes.

Okay. Great, thank you very much.

David Manthey, Robert W. Baird.

Good morning. Just to clarify, the 25 to 30% related to new residential construction, Barry. Now are we talking about overall company sales there or just residential HVAC sales or what are we talking about?

The residential HVAC sales. We do have -- about 15% of our business is commercial oriented, primarily in the refrigeration side of our business. So I'm speaking of the residential business.

And that includes equipment and all the ancillary supplies?

That's correct.

Okay. And then in terms of the EBIT on those sales, suffice it to say it's less than the replacement market?

I don't know about EBIT, but the gross profit is lower on equipment than it is on non equipment.

What about equipment to new residential verses --?

Yes, it's lower.

Okay. And you said it's lower on a GP basis, but what about an EBIT basis?

It would be lower. As it flows through the P&L, yes. It's not something again that we sit there and measure because a branch is a branch. We don't allocate to that level of detail, but it's a good commonsense conclusion.

Okay. And then do you have a read on what percentage of your equipment sales were greater than 13 SEER this quarter?

It was 13% this quarter versus 8% a year ago.

Okay. And if you're indicating that pricing overall is a zero factor, does that then imply that on an equal SEER basis pricing actually declined?

Yes, I see where you're headed and the answer would be, yes, moderately. The mix helped a little, but the overall pricing is probably lower.

Okay. And then finally, a question on this repair versus replace phenomenon. We've heard some feedback about this. How long does this typically go on and is it having a major impact on your business or is it more as a minor irritant in terms of people replacing compressors or motors versus changing out entire systems?

Barry, you can jump in here, but I think that's over done from what I hear of conversations going on in the industry. That's part of what's going on, but it's not by any means the biggest part. It's all the other things we're talking to.

There was a stat that JPMorgan put out in a survey that took it to an extreme that said that 28% of people surveyed talked about deferring equipment purchases. And I'm certain that 28% of -- and I'm sure 0% or a very, very small fraction in the Sunbelt even consider that to be something that's going on. So both deferral of products and fix versus replacement, I'm sure it's going on somewhere, it's not a concentrated dynamic in the Sunbelt.

If we look at our parts sales, there's no bonanza going on there in terms of a trade-off between fix and repair. So I think, as Al said, it's somewhat overdone and it's probably more of a non Sunbelt consequence if it's out there.

Agreed. Final point I guess, one more. Could you talk about the trends you're seeing in Florida and California and if there are any other geographies plus or minus?

We don't like to really comment on specific markets, Dave. Again, the growth rates throughout the Company and what you see is fairly -- there's nothing that's standing out in terms of peculiarity of one market over another.

Okay, thank you very much.

Keith Hughes, SunTrust Robinson Humphrey.

Some of the growth numbers you give in the press release you talk about the 1% decline in equipment. If you kind of interpolate the math it looks like the other products were down high single digits. Why was that so different from what we saw from equipment in the quarter?

I think my reading of it, Keith, would be a replacement market for the equipment products and some of the other products that we sell that are -- let's say insulation and metal products and flexible duct, things like that, would have a greater new construction sensitivity to them. So certainly half of our business in the quarter, practically speaking, is equipment and most of that this time of year is replacement. And again, it's what accounts for what's a relatively decent quarter and extreme conditions in some of the other sides of the business.

And Trane and Carrier are talking about their business being down in the 10, 12% type range. How were you able to take share in the quarter and was there a specific region you did that better than others?

Barry, here's where you really make headway.

Again, no specific region, Keith. As Al said, we are entrepreneurial down to the branch level and no one has our number of branches in the markets that we serve. I think competitively our largest competitor, in Florida let's say, has somewhere around 20 branches, we have over 80 -- almost 85 branches. So I think in that type of a market replacement does become more -- a greater portion of the market and, again, we like the variety of products for sale rather than just one price point shall we say. I think it helps us in this kind of market condition.

All right, thank you.

Jess Hammond, KeyBanc Capital Markets.

Just a follow-on on the parts side. I guess if you pull out the refrigeration piece for a sec, what do you think the new versus replacement mix is of the nonrefrigeration parts is?

You're trying to examine parts, Jeff? I'm not sure I understand.

Well, I guess there's a dynamic where equipment was not down as much as the parts side and I'm just trying to understand.

We're showing single digit parts increase in revenues, Jeff, as opposed to a 1% sales decline in equipment. 6 or 7% in parts, 1% increase versus 1% decline in equipment.

Was the mix of parts higher in new construction than (multiple speakers)?

That -- we don't have a system to determine that.

Then I guess just looking at the components of parts and anecdotally, I mean --.

Jeff, you may be using parts much more broadly than we're talking about.

I guess non equipment.

When you say non equipment it's a different (multiple speakers).

That's a whole different thing, yes.

We're talking like replacement parts; component parts (multiple speakers).

I guess I'm thinking of the non equipment side.

Anecdotally Barry has already said, Jeff, that he believes that the insulation and the ductwork and things like that are affected more by construction than the equipment which is used -- that we primarily serve the replacement market with.

Okay. And then on price, it sounds like maybe some nominal price degradation on your end. I guess the OEMs seem to be speaking to -- holding the line on price and staying disciplined. Is that something that ultimately you guys just have to eat if distributors get more competitive? Or I guess how are you thinking about that in terms of managing any price degradation?

I think Barry started to give you the idea for '08. We've been trying to reduce inventories this year and doing a better job -- not as good a job as I'd like to see. But next year we should have some real buying power. And given our size I think that we can provide some sizable orders for our OEM suppliers and perhaps they would see fit to make us even more competitive than we might be now.

Okay. And then just I guess going back to acquisition. It sounds like there's a number of potential opportunities out there. But how do you balance buying back your own stock at $40 and at very attractive levels versus making acquisitions?

We think about that a lot; there's nothing better to buy than your own company when you're performing as well as we think we are. But given what -- and it's a fluid situation that we don't have fixed lines on this to be continued from time to time. But I'm so excited about what we see from an investment point of view that I'd sure like to focus our liquidity on building the network. That's a higher priority than buying back our own stock because you know that we also believe in increasing dividends. So (inaudible) we don't not want to buy our own stock, we just value it along with the other priorities that we have.

It seems like you have capacity to do a little bit of both.

That's a good argument; we have it here all the time. If only I could get all the things I want to invest in, you wouldn't say that. And I know I'm not going to get everything I want to invest in, but they sure are great companies and they sure would require a great deal of money. And I get excited from that perspective and then I have to measure that excitement on what we realistically can invest in.

There have been a couple of questions on '08 and it sounds like you have some confidence that you can see base business growth. But within that how are you -- as you read the newspaper and check in, how are you thinking about housing starts in that context?

We don't have any reason to disagree with what the media is saying, Jeff, in terms of a negative year in '08 for new construction. We have no crystal ball that says we feel any different than what's out there in print. But we feel good about who we are with a 440 branch network and when the replacement season kicks in I really think that I feel very positive about that. And if we continue to build that network, make it even much larger than it is I'll feel even that much better, regardless of what happens in construction.

And then I had to jump on the call late, so you might have touched on this. With ACR closed how is that going relative to your expectations? What are some of the key focus areas early days in terms of pulling them in? Where do you see you have the greatest opportunities?

Go ahead, Barry.

Well first, in our strategy they become a new business unit for Watsco and they stand alone and the guy that's running the business, Tony Maresca, has been with the Company since its founding and has been chomping at the bit to run and grow the Company. So the first steps after ownership is to get everyone excited about the fact that they've got more access to capital and more access to better vendor programs to help both their competitiveness and their margins. So that's playing itself out now, more on the big picture side of getting their organization excited and content with the change in ownership.

Also the management team throughout the Company again has equity in Watsco, so that equity culture has spread to them since we've purchased the Company. The what I would phrase kind of going from a separate public company with cost structures to support being a separate public company versus an operating company as part of Watsco has also been implemented in terms of cost savings coming out and, again, being an operating company at this point. So that's been implemented by their team in the first several weeks.

So they're also in the Sunbelt market, they also have depth in serving the replacement market. So their performance so far, consistent with what we see in Watsco and off to a good start.

It always comes down to organization I believe and we really like this organization. They're very entrepreneurial and they're very action oriented and I'm just so pleased that they're part of Watsco.

Okay, great. Thanks, guys. We'll see you next week.

[Craig Irwin], Merriman Curhan Ford.

Good morning, gentlemen. Most of my questions have been pretty thoroughly answered so far, but the one area where I was really hoping for a little more color was around your comments on the price competition you were seeing out there. I was wondering if there were any bright spots that you were encountering and maybe if you could give us a little bit of comments as far as mix and geography on that?

Barry?

Bright spots, it's -- again, there are really three businesses that we serve; we've talked about equipment business and the non equipment and refrigeration. Refrigeration would be the consistent bright spot on both -- just general overall performance and consistency and a very strong business year in/year out. Because if you think about food and refrigeration of food it's something that certainly has to take place everywhere where it happens, it's really not an economically sensitive product.

So that's probably the bright spot. Replacement again, we've talked about replacement this summer and the market share gains that we are certain have come as a bright spot. Pricing, looking through your question a little bit -- again, no pricing, giant wins or losses is something that's been subtle in terms of what's happening and, as Al said, it's something we'll address as we get into next year's (multiple speakers).

I would add on a more long-term view about pricing based on mix changes, there's no question that the 120 million homes that are out there could use higher efficiency equipment. The recent developments of efficiencies by the OEMs is so terrific in terms of conserving energy and reducing cost of electricity as well as heating bills to the consumer and the consumer really hasn't caught on to that yet, the homeowner has not. They're doing it little by little, but eventually when the message is out there and they see the benefit of this wonderful technology that is now available.

I believe the mix will change so that the price per unit will go up because when you're moving up the efficiency scale the unit price on average goes up. And I think that's a very healthy thing and it can only get better, it's not going to get worse, it's going to get better. And it's just a win-win. Consumers save substantial savings on their energy bills, the contractor gets a higher unit price and so does the distributor and so does the OEM. So it's terrific for the channel.

And that's all ahead of us. As Berry said, only 14% of our equipment mix is now above 13, but the efficiency SEERS reading -- certainly 17, 18, 20 -- some are even at 20 compared to 13, whereas probably I would guess that the average SEER out there installed in the United States home is somewhere between 10 and 11. So there's an enormous energy conservation possibility with the technology that we have out there today. Consumers are just not into it at full scale yet.

Great, great. That was good. Just a follow-up question on your refrigeration business what do you see as far as the acquisition potential there? I understand it's not as broad an opportunity as the residential distribution side. But really, is there a good pipeline of companies there that you can really go out and potentially acquire to build that business?

Yes, that's going on with Baker which is one of our subsidiaries; they are the refrigeration business of our company. And you don't see them because they're small, $5 million, $10 million, but they're doing it all the time. They're much smaller than the residential. But yes, we're doing that all the time.

Excellent. Thank you very much.

Jeff Germanotta, William Blair.

Good morning. A few questions for you. First, can you talk about sequential monthly sales trends, how they build through the quarter and how they look going into mid-October?

Gee, I don't think we've ever done that. Barry? I kick the tough ones to him, Jeff. Actually I don't think you should do that.

Some consistency as we're entering into October, that's what's reflected in the guidance.

Okay. And the next question then is as it relates to the comment in the press release about mix affecting margins -- I would have thought, and perhaps incorrectly, that with the residential side being down that that would most dramatically affect equipment volume. So I was a little surprised to see that the mix, particularly of lower margin equipment, is increasing. Can you provide a little education and color on that?

Barry, go ahead.

Sure. Jeff, what we certainly see in the market and at the OEM level, just to address that for a second -- you talked about Carrier and Trane and some of the premium brands being down 10% this year, it's hard to know some of the detail behind that. But that's the big picture and this year what the industry has seen for one of the first times I think that I can remember is a mix change towards some of the more value oriented products, certainly that we sell at our locations. I think that accounts for part of the market share.

And as our locations sell a greater mix of that value it is a slightly lower price but it is also a slightly lower margin so about 15 basis points is our testament in the quarter for instance I came from a lower sales mix towards the value end side of the product. Probably the greater generic right now is that as the market is flat and contractors do have time and are making the effort to shop, just what I would call the price heaviness of that process has probably had a greater impact than what the mix is if that makes sense to you.

So it's a sharper and more concentrated effort I think on contractors to shop and we've got to take that price pressure in balance when we want to obviously make sales and also take that price pressure in balance when we talk to our OEMs which we'll have the chance to do.

Thank you. That sort of leads into my next question which is really a follow-up to Dave's. On SEER 13 pricing, when we think about equipment pricing last year and the SEER 13 benefit it was essentially a 20% price increase as we went through the latter half of the year. As you looked at this year, because of softer demand and more competitive environment, you've obviously given something back. Are we net up 10 yet or is there some metric we can think about? What degree of pricing power have we retained?

Jeff, I'm sorry. I didn't really quite capture what you're getting at. Maybe ask again?

Sure. I'm sorry if it was confusing. Last year the benefit to SEER 13 pricing on equipment was an increase in the vicinity of 20%. My suspicion is we've given some of that back because of the weak residential construction market and a more competitive environment. So I'm really trying to get back into how much of that have we given back in terms of price?

Again the pricing year-over-year the unit volume for our equipment business and revenue is the same and so there really is not a give back in price in the big picture of what we've done. I think the reason, not to get too over the top about pricing is if we go back to '05, today's margins are much like they were in '05. So the question is what happened in '06 and obviously there are a lot of moving pieces that we described in the press release about it.

But as I said before, I think the greater consequence is this summer as things have obviously been slower, contractors have pushed for better pricing and it's something we've had to respond to without necessarily a proportionate response back to our OEMs and, again, that's something that will play out as we go forward.

And then the last question. As you have revised your guidance, is most of that within the core business or are you revising slightly your expectations for ACR given continued soft market conditions?

It's primarily the core business.

Thank you.

Ted Wheeler, Buckingham Research.

There's been a fairly significant change in the high margin market for you, California, with the Carrier distribution change. Have you seen any impact now that it's happened and what's your outlook there?

Impact on the market? I know that there's a lot of (multiple speakers).

On you guys specifically with the change in distribution.

I would not say that we have anything impacting us in a serious way. I think there's some recruiting going on, but nothing serious, no. We hope that there's opportunity for us.

I guess Carrier is going now direct and so I just -- it feels like more competition in that space. I just -- maybe (multiple speakers).

No, the competition is always there. As Carrier had their number one distributor there and they're going to be factory branches. So good competition before the change and good competition going forward.

Okay, thanks.

Holden Lewis, BB&T.

A couple of things. It looks like when you talked about the revenues being added from new branches. It looks like you lumped together the ACR Group and the new branch additions, the organic adds. Can you talk about or sort of break up the revenue? And then when you talk about the $0.03 contribution from that, again, was that ACR Group, was that new branches? Can you just divvy those up a little bit more clearly?

Holden, about 90% of the volume is ACR and all of the accretion is ACR.

Okay. Were the new branches dilutive?

They were profitable but not enough to create $0.01 per share.

Okay, great. Thank you for that. And then sort of building on Jeff's question, sort of a postmortem on the 13 SEER transition issues. You also talked about '06 having a fair amount of excess SG&A in as you tried to balance things out. Can you just give a sense of is dissolving that issue part of why the SG&A has come down along with sales and you haven't got any under absorption in there despite the weakness. Just give us a sense of where we are in cleaning that up. And maybe more broadly what exactly you're doing to keep the SG&A in check?

Well, SG&A that we talked about last year has gotten better this year as the year has gone on. I think the first quarter we were down 2 or 3% in SG&A, and I'll say this is all same-store. And the last two quarters have improved from that. So we are seeing some of that, but the SG&A story really is that more than half our SG&A is compensation and about 25% of that is performance-based compensation.

And as I suggested earlier, that's something that is a very entrepreneurial culture. The upside and the downside is shared proportionately amongst many managers and salespeople and so on. So that's the source of much of the SG&A decline and the rest is heavy lifting in terms of facilities and vehicles and (multiple speakers).

Well, there is the improvement on freight that he's referring to. I know exactly what he's talking about. We were moving -- the beginning of '06 we were certainly having delivery issues from the OEM and we were moving goods more internally and the freight expenses were very high. And that is more in line now than it was then.

You talked about the amount that's compensation. Is any of the progress that's been made in SG&A this quarter, last quarter -- is any of that from truing up your bonus accruals or anything like that or is it all sort of --?

Sure it is. Sure it does, it's all performance-based, the part that Barry's talking about, of course it comes down.

Okay. So (multiple speakers).

It will be in line with the performance of the Company.

You've got some true ups perhaps this quarter or last quarter that are sort of correcting maybe an over accrual from prior quarters and therefore (multiple speakers).

No, no, no, no, no.

Most of that compensation is in 26 paychecks a year, it's trued up each time.

It's current stuff.

I think that's all I was looking for. Thanks, guys.

Matt Duncan, Stephens Inc.

I just wanted to follow up on something Holden was just asking about. On the revenue from ACR, to make sure I understand that correctly, 90% of that $51 million is ACR. So ACR is about $45 million or $46 million in revenue this quarter?

Yes.

Two months basically, they weren't there for the first month.

That closed what, August 10th, is that right?

Yes.

So you had a little over a month and a half, so I guess that suggests that that -- it's a little back end loaded. So I guess I'm just trying to get a sense how their business trended year-over-year. Was it pretty similar to yours as well?

Yes.

Okay, thanks a lot.

There are no further questions.

Terrific. Well, it's been a long one but a very interesting one. I enjoyed it very much. Talk to you the next time. Bye-bye.

This concludes today's third-quarter earnings release call. You may now disconnect.