Watsco Inc (WSO.B) 2010 Q3 法說會逐字稿

Good morning. I will be your conference operator today. At this time I would like to welcome everyone to the Watsco third quarter earnings conference 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 will now turn the conference over to Albert Nahmad, Watsco's CEO. Thank you, Mr. Nahmad, you may begin your conference.

Good morning. I want to kick off this conference call from a special place. We're in Paris. We're excited about two things today; first our quarter, record almost everything. In fact, I think it is everything, sales, net income, cash flow and regaining market share.

And also the second thing is that we're No. 8 to innovate with the New York Stock Exchange and extend ourselves to be listed here in the Paris Exchange. We call it innovative because this is going to allow us to develop over time an investor following here in Europe and I think our story, a high-growth Company serving green industries that is energy conservation, (inaudible) quality, is a story that will create investor interest anywhere we go. That is what I think is going on in the world and as the industry leader, we are by far the industry leader, I think that this is a good thing to do. And we are honored that the New York Stock Exchange asked us to do this listing here at Eurodex.

Now I'm just kicking this off. I am going to turn this over to Barry Logan, our Senior Vice President, who you've heard before, and he will go through the performance in the third quarter, and that would be followed by an investor presentation. Thank you.

Thanks, Al. Good morning to everyone that is here and everyone that's listening. We, again, have a great quarter to talk about first, and then we're going to get into what would be our investor analyst presentation to talk more generally about the Company and the strategies and you will hear from Anna Menendez, our CFO, and Paul Johnston, Vice President of the Company, and we'll add depth to the stroy that many have listened to for a long time and for those of you that are here listening for the first time it will be a good education for you all at once.

Wanted to just to give some foundation for the Company for some of the people who are here, and, again, we do always disclose that this presentation has forward-looking statements and the Safe Harbor provisions of the regulation of the laws certainly apply themselves to this presentation. Just a basic introduction before I get into the quarter. We were founded in 1947, publicly traded in 1961. And so this has been a public Company for most of its history. We began distribution in 1989 with an acquisition of a distribution company in the state of Florida. By 1998 we reached $1 billion in sales, last year we reached over $2 billion in sales, this year, we won't reach $3 billion, but we're certainly going to push toward that number, right around the $2.8 billion mark for this year. We're based in Miami, Florida, for those that would like to come and visit, it is a great place to come and learn about the Company.

The US market is a $30 billion market for the products that we sell. Today we have 507 locations, just by math about 10% market share in the US, and we're not actually covering all of US at this point. We're in 36 US states. About 4100 employees, about 100,000 different products, just to give you some scope. Culture for us is very, very important. Knowing the story, understanding the story, a part of the culture is that it is very entrepreneur-driven; that's all the way at the branch level, all the way through our Company. In fact, one of the concepts we've always had is a very small corporate office so that our branches, our markets, our leadership in the field are the ones in charge, and today about 20% of our corporate office is here, that being the four of us. We keep a small corporate office in Miami supporting very a strong (inaudible) throughout the Company and insider ownership today is around 20%, 25%. And so in terms of risk and conservatism and looking long-term, the leadership of the Company and about 650 employees who own part of the Company are certainly lockstep with the strategy and execution long-term.

We're the only publicly traded trade distribution Company of our kind, and that includes really almost anyone else that would be in other continents of the world. In our case, again, we're the only publicly traded Company in the US in what we do. Our US share ownership is about 70%. All institutional health and everyone get a sense of our shareholder base by looking at some of the data that's out there. And part of why we're here, again, is to expand that presence, expand the knowledge of our Company outside of the US, as well. We're in the Forbes "100 most trusted companies," in fact only about six public companies of those that are in that survey that made it to that list three years in a row. It goes back to, I think, culture of the Company, and how we operate. We're in the Fortune 1000 and small cap, S&P Small Cap 400.

Moving on to the quarterly results. And put that in the context of some of the big picture amounts over time. I want -- let's go through the long-term growth rates of the Company, 10-year growth rates about 8% in revenues, 14% in income. If I look at dividends per share, grown around 35% compounded over the last 10 years. And so when we talk about the quarter and the year-to-date, I want to put it in the context of what the long-term growth rates have been. This is obviously with some compression in what's gone on in the US in the last few years. So still strong, consistent long-term growth rates of the Company, and now we'll get into the quarterly results.

Everything we talk about for the third quarter is organic. So 10% sales growth, 14% gross profit growth, 90 basis points in gross margin improvement. Obviously very satisfying to see both the organic growth rate at double digits and to see gross profit improving beyond that mark in terms of gaining pricing, gaining margin and market. SG&A has been kept low under control at 3% for the quarter versus the sales growth rate. And obviously that converts into very strong earnings growth of 46% for the quarter. EBIT margin, up 200 basis points to 7.9.

I'm going to break apart the operating margin in pieces in a couple of slides. Again, 200-basis-point improvement in margin is very strong performance. EPS up 41%, nice growth in terms of EPS. Operating cash flow up almost three times in the quarter, pre-cash flow also up more than three times during the quarter. Great to have earnings growth, it is great to have cash flow growth at the same time. And so, again, a good quarter for Watsco.

Part of the components that we talk about historically is a source of growth, equipment growth, you see 8%. Residential was a little stronger than that, the commercial a little less than that, but overall equipment grew 8% in the quarter. Non-equipment, something that we've been focused, especially or Carrier Enterprise locations have been focused on, saw double digit growth during the quarter. Commercial refrigeration, also very strong growth, plus-19% during the quarter. We've got new territories, new products, some new launches that have helped our refrigeration business and nice growth rates across all our product lines.

Year-to-date, revenue is up 52%. And the numbers is Carrier Enterprise this year for nine months, last year for six months. So in terms of going through the same-store comparison, I'll do that in a second. Growth profit margin down, but that is again because of the effect of Carrier Enterprise locations. EBIT doubled to about $70 million year-to-date -- I'm sorry, to $144 million year-to-date, EBIT margin up 170 basis points. Remember the prior slide showed you the margin up 200 basis points. So, again, consistent performance, strong performance, both in the year-to-date numbers and in the quarter. EPS up 70%. Again, cash flow more than doubling and pre-cash flow almost tripling. So, again, good cash flow, good earnings growth.

A couple of the highlights, same-store basis is up 8% for this year, growth profit stronger than that at 10%, so we've seen a nice year-to-date improvement in gross profit, as well. SG&A down 2%. Very critical concept there. While growing the Company, reducing SG&A It's something that we've been doing for the last three years, it's nice to reduce costs a little further in a revenue-growth environment. It can't stay that way forever, but we see very, very conservative growth in SG&A, match that with some strong growth sales and it is converting into very nice earnings for this year. First so the growth, again, equipment, 10%, non-equipment 5%, commercial refrigeration 8%. Residential, again, a little stronger than that, commercial a little less. But very good growth across, again, all product lines.

One of the things we've had people focus on and that our culture and our leadership is very focused on is operating margin. I am going to splice up the Company, look back and then look forward, so everyone can get a sense of where we are, where the Company had been historically and because of the size of Carrier Enterprise, demonstrate some of its progress. So the first part of this slide talks to what was historical. And 2006 was the highest operating margin we had had. Our business units, our core business units today, in 2006 prior to Carrier Enterprise we operated at close to 9% EBIT margin. Our business units, 2006, operated at 8.7% operating margin.

Where are we today? Well, first Carrier Enterprise is now a component of Watsco. 2010 will be our first full year of Carrier Enterprise, and let's measure progress. 2008 and 2009 EBIT margin of Carrier Enterprise was about 2.4% to 2.9%, respectively. Under our last full year of ownership, jumped to 5.7%, up 280 basis points. That's on a revenue basis of about $1.2 billion in 12 months time. And so certainly Carrier Enterprise has made a great deal of progress in a short period of time. Paul will talk more about Carrier Enterprise when we get into it later in the presentation. Just get a sense that that is a great deal of progress, still not where the Watsco legacy business units either are or have been, and I measure that progress in the next part of the slide.

The legacy business units were operating at about 5.5% last year, that's jumped to 6.9% this year, and it's still far from where they were in 2006. More importantly, far from our goal. Our goal is 10% EBIT margin. Convert that on a $3 billion revenue platform and it's very serious earnings growth. This is how we incentivize people. This is the language that we speak in terms of asking leadership to get to certain goals, 10% being, as Al would say, the interim objective for Watsco to get to 10%. So just get the sense of our progress from where we were, Carrier Enterprise and Watsco, and I can assure you that culturally 10% is the very simple goal of the Company.

Balance sheet, we ended the quarter with $100 million in cash, $99.9 to be exact, $23 million in debt. And so we like the net cash position of where we are. By the way, the fourth quarter is the strongest cash flow period of the year. And so add to the fourth quarter, add fourth quarter cash flow, it will be a terrific year for cash flow for the Company. Equity of $900-plus million, sets a total cap of 2%. Further growth, further acquisitions, adding products, more product lines, whatever we can do to grow the Company, certainly a very powerful -- extremely powerful balance sheet to think that way and to act that way.

Start with our outlook, $2.40 to $2.45 per share is our outlook for 2010. 70% to 75% earnings growth and giving that outlook, so a very strong 2010. A long-term fundamental that we'll talk more about today, Al mentioned it, a very big player in energy efficiency, energy conservation, environmental sensitivity in the United States. About half the power, 56% of the power used in homes in the US are these systems, air conditioning and heating systems. The US is the biggest user of power in the world, okay. We sell the products that can upgrade the biggest user of energy in a US home. So replacing the 100 million existing systems that are out there, something we'll talk a lot about today and we can't wait to get to it, because it is really a substantial opportunity, substantial fundamental for the Company. So we'll talk more about each of these.

Again we're very satisfied with the quarter, 2010 will be a great year. We'll talk more our strategies beyond 2010 as we get into the rest of the day. And so before that, any questions on the quarterly results?

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. Your first question comes from Matt Duncan with Stevens.

Good morning, guys.

Good morning.

First question I've got for you is with regard to your gross margin. Can you talk a little bit about what is driving the year-over-year increase in gross margin, sort of what is behind it? How much of it is the base, but the legacy Watsco versus Carrier Enterprise improvement?

Okay, Matt, thanks. Well, we are going to speak in terms of a Watsco consolidated picture. I think it's important, quite frankly, competitively for us to talk that way. We did see nice gross profit improvement in really all business lines. It was not something isolated to one pocket or one business. It was something that we saw across all of our businesses for the third quarter comparison.

Okay. And then, Barry, your organic revenue growth rate slowed just a little bit this quarter. What exactly do you think is behind that?

Well, I think that slowed is a relative term. I think, first, market share -- anything we read or see relative to the industry this quarter was a very powerful quarter in terms of market share.

Sure.

I think also if you look at things as a seasonal period of this summer, which runs really the second and third quarter together, I think that is the way to look at the overall growth rate in 2010. I do not think that you can get sequential quarter-to-quarter in what it is a summertime business.

If you look -- this is Paul. If you look at what we did in the third quarter, the industry itself was down on shipments, on split systems probably in the neighborhood of 8% to 9%, as far as the OEM shipments to distribution, at the same time gas furnaces were up. So I think we're very happy with our performance relative to the overall market that existed in the United States at the time.

Yes, sure. Absolutely. And then the last thing that I've got and I'll jump back in queue, is, in terms of units with a rating of 16 SEER and above, what percentage of Watsco's revenues do those total revenues. Do those revenues make up today -- what has been it been year-to-date and then can you give us some color on what it was last year?

Well, both numbers are under 10%, Matt, in terms of what the total market is for that product category for us. So it certainly had a nice growth rate in it year-over-year, but from an overall picture it is still under 10% of the business.

Okay. Thanks.

Your next question comes from Jeff Hammond with KeyBanc Capital Markets.

Hi, good morning. Can you hear me?

Yes, Jeff, how are you doing?

Okay. Yes. I just wanted to get your perspective on three drivers as we look into 2011, maybe you'll touch on this, but, one, how should we think of hot weather normalizing; two, how should we think of mix normalizing absent the stimulus? And then three, and I think this came up on the UTX call this morning, what are you seeing out there with regard to repair versus replace? Some are saying it's getting better, some are saying it's staying -- it's still a big issue. How are you seeing trends on repair versus replace?

Well, first, I want to say it is probably the first time that a conference call has been done in front of a live audience and so I want to everyone to be (inaudible -- multiple speakers). Our body language as well as what we're saying is being evaluated. Now the last question first, Jeff, on repair versus replace, we do continue to see growth in our parts business. It would be a subtle indicator that there still is a measure of fixing going on, not simply repairing. I think at the same rate of -- hit rate, maybe, historically I think it's better, but I don't think that there's a question that there's not still a measure of fixing in what we see in the sale of our replacement parts, and I would say it's better but it's not -- the hit rate is not where it once was.

The stimulus and that type of thing on pricing, it's hard to know the exact sensitivity because the incentives that have gone into the market historically, which has been utility rebates, it has been the industry pointing more towards higher efficiency, it's consumer awareness, I think, is slightly better, more inventory availability across all the prices at higher efficiency, those are fundamentals that have been going on for two or three years and the pricing benefit this year for those products, not throughout Watsco, but just for those products, is up about 4%, pricing of unitary systems is up about 4% this year. And it was up 4% in 2009, and up 4% in 2008.

So it's been a pretty consistent change in mix, change in price. Same dynamic almost statistically over the last three years. And so it is hard to sit and dictate what might be stimulus-driven when really the stimulus is only at the highest levels of SEER. I think the better fundamental answer is that it has been a long-term trend, that the amount of the trend can be quantified and has been really consistent. And so I don't think that anyone has a good guess as to the impact of that, Jeff. And the third piece?

Yes, to touch on what Barry is saying, repair versus replace in the second quarter, I always measure the repair market based on the number of replacement compressors that are going out. And we definitely saw a speed-up in replacement compressors in the third quarter, but we also saw an increase in the number of unit sales that we were making. So I think I would characterize this year as a good replacement market and a good repair market basically, because we saw it in the second quarter and we saw it in the third quarter.

As far as weather is concerned, we look at the population weighted degree cooling days, so it doesn't matter if it is hot in Maine or in Wisconsin where there's no people except for maybe a few vacationers. And when we look at those numbers, we look at -- Florida was hot, but no hotter than normal, up 1% from its historical normal. You look at Texas, Texas was actually 2% cooler than it was last year, basically it was a normal year in Texas. California it was cold. Everyone who went to California this year did not feel warm. And so the places where we've got the biggest part of our market potential, weather was to me kind of a non-factor, it was cool where it was -- it's supposed to be cool I guess in northern California, but for us we do not have any locations up in Chicago, Midwest, Northeast that would really be impacted by weather so much.

Okay. And then just a little further on the industry data, you spoke of market shares, but can you under -- help maybe bridge the gap between sell-through and sell-in and the AHRI data is negative, you guys are seeing growth. What do you think the industry was on a sell-through basis?

All we know is ourselves, we don't know the rest of the industry.

Okay. And then final question, copper has had a big run. Can you just talk about what your vendors are telling you or talking to you about in terms of the need to put through a price increase or how they may be acting differently on rebates, et cetera, on a go-forward basis?

There really is no chatter going on on pricing for next year, Jeff. Just to remind the audience, though, that's listening, in terms of taking price increases, passing on price increases and being a good merchant in that process, we're frankly in favor of it. We'd be in favour of there being stronger pricing next year in the market, but it's nothing that's been either really mentioned or certainly nothing formally done at this point.

Okay, great. I'll get back in queue. Thanks.

Your next question comes from David Manthey with Robert W. Baird. David, your line is open. If you have your line muted, please un-mute.

Can you hear me now?

Yes.

Can you hear me?

Hi, David.

Hi. In terms of the same-store sales running up 8% year-to-date plus 10% in the third quarter, Barry, did you say that the price mix in the quarter was plus 4%?

On just equipment, not the whole mix, Jeff. We only measure pricing on our unitary equipment sales, which is about 28% of total sales.

Barry, it is Dave Manthey by the way.

What did I say? Sorry.

That's all right. No problem. I've been called worse. But the -- so plus-4% was on unitary systems. Do you know what the overall was in the quarter year-to-date?

Pricing for what would be 100,000 SCUs across a diverse product group is not something we splice, Jeff. I mean David.

David.

All right, sounds good. Then I believe you said you're not going to discuss the margins in core Watsco versus CE anymore. Could you at least give us what the corporate overhead costs were this quarter?

Corporate overhead is going to run 40 to 50 basis points.

40 to 50 overall this quarter? Okay. Then in terms of growth in high efficiency units, did you mention that, I think last quarter you said 60% or something. Is there a number that we could have on that?

Let me tell you, why don't we get back to you.

It is about 40% to 45%, Dave.

All right. And let's see, when you said that less than 10% of your sales are 16 SEER and above, I would imagine there isn't a whole lot going on at the 15 level, but there might be. Could you talk about everything that is not 14 or 15, and then second, is that units or dollars you are referring to?

First, we're talking about dollars. And, Jeff, I do not want to get too granular with this stuff because it's nothing that -- the bigger trend is the movement in price, which we've talked about, 4% impact on these products, and it's a very consistent growth rate with what it has been in terms of pricing. So I don't want to make it either so granular or overdramatic in terms of the impact of it.

Okay. And then final question from me is, are you, in conjunction with the presentation later maybe, are you going to be giving an outlook for revenue growth and margins for 2011?

No. Our planning process for 2011 happened much later in the year and beginning of next year, that is our visibility when we begin to gain some feeling for next year. So nothing that we've ever wanted to speculate, and it is more about our strategy and the numbers we'll talk about next year.

Okay. So as a part of that planning process, are you determining the SEER level of units you are going to be stocking? Are you planning on stocking a similar mix next year as this year, or is it still too early to tell?

Each one of our subsidiaries would handle that planning process, based on what type of market they're in, what sort of energy rebates, who their manufacturer is, what sort of incentives that manufacture is providing them. And so it's something that each Company would actually get into and do their own analysis on. We would never do that at the Watsco level.

We're talking 507 branches that would have an entirely different mix depending upon the market and what they sell, and those inventories are replenished and reordered every five business days. So the planning process, David, it is a very dynamic one, it's not something we sit a year ahead and wonder about. I wouldn't want to have to manage inventory that way, we'd rather manage it every five days, and that is how we would go about it.

Okay, but you are not hearing any feedback from the field in terms of swinging one way or another?

No.

Okay, guys, thanks very much.

Your next question comes from Scott Davis with Morgan Stanley.

Hi, I'll start with just 4Q, just a little bit. I don't want to read too much into -- I know the importance of 4Q isn't that important, but the guidance is a little lighter than we would have thought given the trend that you've seen all year. Is there anything we should be reading into, has October started light or anything that kind of leads to your conservative rest of your guidance?

No, Scott. I think the mindset is we talked about outlook three months ago and we're updating our outlook and, to us, we're being more consistent than anything else with what we said 90 days ago.

Okay. I guess that makes sense although just given your margin trajectory it would imply a fairly -- a much worse quarterly ramp in top line, and so I'm not sure that answer kind of explains what I'm asking. Am I missing something?

No. We're also about 15 business days into the fourth quarter. We've got -- it's got to play itself out and, again, it's something that we're going to be consistent about in terms of how we speak about it.

Okay, well maybe we can take that offline. Guys, we haven't seen as much M&A activity as we would have thought, since you did the big deal with Carrier which obviously has really worked out nicely for everybody, there was one other asset that was sold to a competitor of yours, and then we just have not seen the type of consolidation that some of us would have expected just given capital gains tax, timing and such for small business owners. I mean, what's holding up transactions right now? Is it just -- is it price? Is it availability? Is it just that we've had a bit of an air pocket? Can you help us understand how a) what's going on and also what can we expect over the next several quarters in terms of deal activity?

I think what's -- and I'll give my editorial on it, Scott, but in 21 years, the one thing that is true is that you can never tell the timing, nor can we dictate timing, on the sale of the family business. We made a large transaction in 2005 that took about 10 years of phone calls to manifest in a transaction. In 2007, we bought the seventh-largest company in the industry, it took a decade of phone calls to get to that point. And so we don't really stick our necks out or try to predict the timing or amount of any acquisitions. So not something that -- everyone should appreciate the notion of that, that the family business is something that comes along once in a while.

In terms of the market, I would say the average family business earnings are down. The expectation maybe for what they want for the business hasn't changed very much. We don't have competition. We don't have options. We don't have any craziness going on. It is a matter of having the right timing, the right price and a family business that is for sale. And so I'm not sure what I can offer you in terms of a better read on the family side of the business.

As far as the continuation of what we're doing with Carrier, we certainly have two options. To buy 10% more of Carrier Enterprise in 2012 and 2014, and those options today, based on the performance of Carrier are very valuable assets for our Company and we can count on the continuation of that strategy there. There are other areas of Carrier certainly that are out there, nothing we're going to discuss publicly, but it's something that we would like to do more of.

Sure, sure. Okay. That's helpful. Thanks, guys.

Your next question comes from Keith Hughes with SunTrust.

Thank you. Just to build on the last question on the guidance for the fourth quarter, if you do the interpolation, it looks like fourth quarter is going to be roughly flat on the EPS line. I guess two parts of that; one, is there any reason to make, in your model, an assumption that revenues any different than that, and are there any extra costs in the fourth quarter that are you going to be incurring that we wouldn't normally know about?

Well, first, Keith, we'll go back and look at the math, but I think there would be earnings growth in the fourth quarter and we don't anticipate any charges right now that are somehow, sitting in our brains, sitting in the gut, sitting in the outlook. There would be earnings growth year-over-year in the fourth quarter at the level of outlook.

So you would expect to see some volume in the fourth quarter year-over-year improvement?

Yes.

Okay. Thank you.

Your next question comes from Ryan Merkel with William Blair.

Barry, gross margins were impressive in the quarter. I'm wondering what drove the increase and wouldn't the fourth quarter be higher given that parts and supplies are a greater part of the mix?

Rally have to go back and look at the anniversary of Carrier Enterprise, as well, in terms of rate of growth, rate of progress. I don't think it makes a big difference in the fourth quarter, maybe a few basis points, but not something that's material. Paul?

Yes. Remember with the acquisition we made last year put us into a larger footprint as far as gas furnaces, Watsco historically didn't have a large gas furnace position. Now, although it is still only 7% or 8% of total volume in the fourth quarter, that percent becomes a greater portion of our business, so that's one of the drivers that we've got new to us this year.

Okay. That's fair. And then the cost side of the equation has been just as impressive as the top line. Can you give us a sense for how much in temporary expenses may come back next year, if any, or if there is any growth spending in the works?

Well, I think the -- when you say temporary spending, I'm not sure what that is.

Temporary expenses.

I would say -- I would answer it a different way, compensation related to performance certainly has increased this year. Materially because the earnings of the Company are up materially this year. Our commissions are up that we pay the salespeople because of how we pay them. We pay them on direct performance. So next year those expenses we would expect to climb, along with sales and earnings. But we are certainly seeing a lot of offsets in facilities and our infrastructure that we've been working on for the last two years and there's more to come. So I think that this year's performance and next year's performance are looking positive. Further reductions with some of the variable compensation, which we would expect to increase with performance.

Okay. So --

And probably a better overall contribution margin on sales growth than we've had historically.

So next year you're going to continue to have expense reductions helping to offset variable cost recovery?

The answer is yes.

Okay. Then last question from me, can you comment on whether vendor cash back programs will continue into 2011?

Absolutely, they will continue into 2011 and beyond. Curious, what would cause a question like that?

No. I thought there was an extra incentive this year on cash back programs from the vendors.

Well, it's pretty much our standard vendor programs we've had this year. We've obviously enhanced them as we have every year for the last several years and we anticipate that next year will be an excellent year for vendor cash back programs.

I think, Steve, he may be talking about the OEM payment to the consumers where there is an extra incentive going in for upgrading existing systems.

Correct.

Basically what the (inaudible) has done is taken a chunk of their advertising promotion dollars and converted them into direct programs where homeowner makes -- or gets a rebate for upgrading, and from what they are telling us we expect the programs to continue.

Great.

I wouldn't call any of that new spending. It's been really reallocation of what they've been doing. And there's always been some type of program, and this year I would just say it's been more vendors that have participated in the concept.

Great, thanks, guys.

Your next question comes from Steve Tusa with JPMorgan.

Hi, good morning or good afternoon, whatever it is where you guys are. The Carrier Enterprise's growth I think was about -- if you just back into the revenue growth, about 10% for the quarter. Is that right?

Yes.

Revenues? So Carrier reported today and they said that their unit shipments, the factory shipments, were down 9% in line with the industry. So clearly there is a -- I mean, is that all share gain for -- I'm just having a hard time reconciling the difference between -- there's such a dramatic difference between sell-in and sell through, maybe there was just more of an aggressive inventory management this year where the comps on the timing of when you guys stocked the channel are different than they were last year, less early season, more late season last year than there was this year? Maybe could you just reconcile the difference there and talk about that?

I can't reconcile the difference for you, Steve. This is historically what happens every year. The shipments generally tend to be in the first half of the year on air conditioning, forget gas furnaces for a moment, and then the distributors are selling through in the second half of the year. I think what made us unusual this year was our sales outpaced the industry shipments in the first half, and I think you'll find in the second half we're outpacing the industry as far as sell through of our units versus industry shipments in the second half.

For the factory shipments?

Right. But to take the factory shipments, you cannot take them quarter-by-quarter, you have to take them on a 12-month basis, as far as what the movement is versus what the shipment is over an entire 12 months. Because it is a very seasonal business, and it tends to have a little bit of a lumpy pattern as far as when the OEMs ship the product.

Right. So if you were to place a bet, you would bet that distributors would see better sell-through this quarter than the manufacturers who just ship from their factories would?

That would be my bet, but I --

Okay.

I cannot tell you what the other distributors have for inventory for sell-through.

I'm not going to name names and that is not our purpose to do that. If we compare ourselves to some of the public data that is out there for the quarter, not just industry data but published data in terms of revenues, we're very satisfied that we've outpaced the industry this quarter in a material way.

Right. Do you think that your industry, that sell-through is down this quarter for distribution?

Not for us.

Right. But for the industry, I'm just wondering what the public data that you are talking about, is that showing declines?

I think flat what was I saw.

Okay. And I think, looking out to next year, I mean you're basically making the case that the weather wasn't as big of an impact in kind of the targeted regions you're in and the places that matter. Is next year an up-year in revenues or do you have concerns about the economy and other things going on? Is next year a normal year? Is it up? How do you feel about the dynamics heading into next year?

I certainly would say we're planning for growth, in terms of how we challenge the organization, the products that we want to bring in, new initiatives that we have and not simply subject ourselves to what the underlying economy is doing or what the market is doing. There's certainly is a product strategy and a growth strategy that is going into next year in terms of our mindset.

Right. And then just one last question, just on the share gain aspect, you guys have definitely done a phenomenal job there of building an organization and outgrowing the industry. I'm just curious, is there something, since you really just trounced the industry numbers in the second quarter, is there something unique about what is going on this year driving -- the magnitude of share gain seems to be so dramatic I find it hard to believe that it's just basically better service to the contractors, that would be a relatively significant uptick for a factor such as that. Are other distributors having credit problems? Is there something around the R-22 product that you guys have on hand that people want? I'm wondering what's kind of the top two things that's driving this kind of dramatic magnitude of share gain?

Well, it's an artful question that -- it's asking Coca-Cola maybe for some of its secret recipe. I really don't want to get into the vendor performance and so on. But we're really satisfied that we've had very strong vendor participation this year that has helped our growth, and we've performed, our salespeople have performed, it goes down to a street-level and it has been a good year for our Company. I really do not want to give the secret sauce away.

Vendor -- what do you mean about vendor participation?

We always talk about who our major vendors are and I think they've been great partners for growing our business this year.

Got you. So you are aligned with the right OEMs, is what you are saying?

Yes.

Have you guys sold all your R-22, obviously that was -- was that mostly liquidated in the second quarter?

Yes. We were down to very little R22 product coming into the third quarter and we have very little left, obviously. It really was not an impact for us in the third quarter at all.

I get that question a lot and I want to give it relevance. R22 sale this is year are under 5% of total sales. And it was not material to start the year and it is not material as we get into the rest of the year.

Got you.

It is not -- it is not the basis for any level of performance that we see.

Right. Okay. Looks good. Thanks.

(Operator Instructions). Your next question comes from Matt Duncan with Stevens.

Hey, guys, just a couple of follow-ups. If you look at the business from a replacement versus new construction point of view, do you think replacements were up? New construction was down? How did those two pieces perform year-over-year, you think?

We'd be over 90% replacement now. Probably in the 9% to 10% range on new construction. New construction has reached such a low that it's -- we're praying for rebound, because new construction will impact us more on the supply side than it will on the equipment side.

Absolutely. Okay. That's helpful. And then, Barry, as I look at the SG&A costs, obviously you guys did a very good job managing that line. Year-over-year it's barely up on a pretty significant revenue increase. But just to help me get a little clarity, when I look at it sequentially, the SG&A expenses were up a little bit from the second quarter on down revenue, is it safe to assume that that is you guys investing in planned growth?

I think again a lot of what we do is performance-based, and from a sequential point of view, earnings-based programs became more clear, commission programs for the year became more clear. And it's more variable compensation this quarter relative to the second. As that -- as the year kind of passes by.

Okay. That's very helpful. And then two modeling questions, on the tax rate, it's been running at 31% all year, is that a reasonable number for us to use as we model going forward?

I think so. It's a composite of how the joint venture is accounted for and Watsco is accounted for,and as long as a proportion of earnings contributions stay fairly proportionate, the tax rate will stay that way.

Okay. And then the last thing, do you have in front of you what DNA costs were this quarter?

Hang on one second.

Okay.

By the tax rate mechanics, I do not want to fill up the room with this, but Anna is someone that can certainly go through the algebra of how that works. Okay.

Not now, but it is something that you can call up and do.

Okay.

Why don't we get to that.

We'll get back to the DNA.

Okay, thanks.

Your next question comes from Jeff Hammond with KeyBanc Capital Markets.

Hey, guys. Just kind of a follow-up sell-in versus sell-through. Can you give us a sense of what the Carrier's growth -- the Carrier Enterprise JV growth rates ar, either in total or just on an equipment basis versus your equipment up 8%?

Well, again, Jeff, I want to be purposeful in saying that the overall performance of the Company in the quarter was up 10%, and that's organic growth and that that growth rate is consistent amongst all of our businesses.

Okay. So if the Carrier JV is consistent with yours, then yet Carrier -- UTC Carrier is saying down 9%, there has to be some inventory in stock that is impacting their numbers and therefore sell-through maybe a little bit better? Is it fair?

That's fair. I do not know their numbers. I know our numbers and it's -- the growth rate is what I've described.

Okay. And then just on the slide 10 where you show the margins, so Carrier Enterprise 5.7% versus the legacy 6.9%, is that apples to apples, pulling corporate out of both of those?

Yes, absolutely.

Okay. So clearly a ton of progress in Carrier Enterprise 2009 to 2010, given this chart. As we look forward to 2011, do the margin improvement rates start to match up closer between legacy and Carrier? Or do you still see 2011 as a year where Carrier is in effect catching up, and if they are catching up, maybe give us some color as to what are the moving pieces in or drivers to that catch-up?

I am going to have some fun and know that the Carrier Enterprise leadership is listening to what we are saying, and so I will tell it to them as well as you, the rate of improvement that needs to get to 10% goal has the same intensity and expectation as all of our business units, and Carrier Enterprise is not being asked to take longer, but to have the same rate of progress towards 10%. So that is culturally your answer, in terms of what happens, next year is a determination of that, but culturally 10% is the goal and the CE management is being expected and being challenged in the same way.

Okay. But maybe as a follow-on, if you look in -- and I know that you have not gotten deep into your 2011 planning, but as you look at some of the low hanging fruit and the integration and taking out some of the legacy Carrier costs that I think took some time into 2010, and then you consider progress on parts sales which have higher margins, is it fair to say that Carrier Enterprise has maybe some more low hanging fruit coming in to 2011 than the legacy business?

I do not like the cliche low hanging fruit, but I think they have simply those three fronts, an more entrepreneurial-type of environment to thrive in, number one; they've taken to it, it's worked, they've done a great job, there's a lot more to do. The best example of that is we needed to carve 95 branches out of the system environment they were in to an independent system, that happened on June 15, four months ago. And so only in the last four months, really from a data point of view, can they truly manage the business entrepreneurially. A lot of intense actions going on to improve performance now that they own their data, per se. The product that you are talking about, yes, they had 15% or so growth in some of their non-equipment product lines. That needs to be 100% over the next few years. So the answer is, they've made progress, but far from what they say they can do. So I think it has been a good year, a great year, but not anywhere near where I think they would say, leadership would say, in terms of progress over the next few years.

Okay, thanks a lot.

At this time, there are no further questions. Gentlemen, do you have any closing remarks?

We have questions, we have someone here in the audience.

Jeff (inaudible) from William Blair. Two questions. One, a key element to the Carrier Enterprises strategy was to integrate parts into the sales mix, can you just give a little bit of color on how that is progressing?

Yes. The question is -- one of our opportunities with Carrier Enterprise was to be able to add parts, and we'll define it as parts and supplies, and where are we with that? Carrier Enterprise does an excellent job on parts, the pure replacement parts business. They were very strong at that, and that has been something that they've continued to do under Watsco. The real opportunity that we foresaw there was getting them more into the supply side of the business, the products such as DuPont refrigerant, the products such as insulation and duct board, that sort of product. And that is a work in process. They began that this year. We started to see some movement from them this year as far as being able to offer that to their contractors. A lot of these products were never offered to their contractors when they came in the door. And so we're starting to see them get traction on that and it is starting to pay off.

The most important thing, though, is just the cultural change that we saw at Carrier Enterprise among their employees when we got into this aftermarket business. This is something that was new to them, and something that they totally embraced. Something that they really are really excited about. And so I think as time goes on, that that is going to be a big plus for us.

And the second question, obviously your balance sheet is rock solid, your cash flow is terrific, how do you think about deploying that balance sheet in terms of acquisitions, maintaining your dividend to be operational and/or buying shares, and a significant down ratio as we look to next year to be about 60%, two-thirds of earnings?

Well, I think we've looked at cash flow first as one of the fundamentals of how we incentivize people, and having cash flow consistently exceed net income and it has been a fact and a multiplier of net income over the last two or three years. So just know that long-term culturally that is how we incentivize all the leadership in the Company outside -- in terms of the local leadership.

In terms of the plan of capital, dividends have been simply something we want to increase a little bit each year, we've done so for almost 10 years, I do not think that the mindset for that changes much, as long as we have the type of cash flow that we've been having. Earnings can be sensitive to whatever is going on. Cash flow can be a consistent mindset and we've done that. So it is not so much a payout ratio as it is a cash flow byproduct in terms of what we're seeing for cash flow ,and that is very healthy and very strong.

As far as the outlook for repurchasing shares, I don't think that's something that's in the lexicon of what we're doing or thinking. We'd rather have a strong balance sheet to do major acquisitions with because they are out there. We do not know when they will come but they require cash and, again, as we look on the horizon with the Carrier options, we have the options of whether we want to do those in cash or stock, and we also want a strong balance sheet for when those roll around and maintain the same posture we have to date going even beyond those requirements.

As far as what you are seeing early in the month, where do you stand as and the trends that you're seeing as far as share gains (inaudible -- microphone inaccessible).

Can you identify yourself so that everybody knows who you are?

Ian (inaudible -- microphone inaccessible).

What?

Ian, we do not like to get into daily, weekly, sales conversations, our guidance for the year is what it is. I've talked about sales growth expectations. But I do not want to get into really an October trend or a weekly trend, if that is your question.

I just think that the concern is that the second quarter -- (inaudible microphone inaccessible).

We certainly expect sales growth in the fourth quarter, and the rate of growth is something we'll talk more about it as we get through the quarter, but to sit here 10 business days, I would say that we expect sales growth this quarter and answer the question that way.

Any other questions? No? Okay.

Well that's -- that's going to conclude our comments on the quarter. You can take about a five-minute break and then we'll come back and go into our investor analyst presentation, for those of you who want to stay and listen. And we'll be back in about ten minutes, five to ten minutes.

Thank you very much.