Watsco Inc (WSO) 2009 Q3 法說會逐字稿

Good morning. My name is Kyle, and I will be your conference operator today. At this time, I'd like to welcome everyone to the third quarter earnings release 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. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you very much.

Mr. Nahmad, you may begin your conference.

Good morning, everyone. This is Albert Nahmad, President and CEO. With me is Barry Logan, Senior Vice President, and Paul Johnston, Vice President.

As we always do, first, let me read the cautionary statement. This conference call has forward-looking statements as defined by the SEC laws and regulations that are made pursuant to the Safe Harbor Provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.

Let's get started on the quarter. The third quarter of 2009 has been exciting for many reasons, the most important being the completion of the Carrier Enterprises (sic - see Press Release) transaction in July. Let me highlight what has happened.

We are now a much larger and important Company. We added 95 locations and over a billion dollars in annual revenues with the Carrier Enterprises transaction. We are now a much stronger Company. In connection with the Carrier Enterprises transaction we expanded Watsco's capital base by $150 million and maintain a great balance sheet. We have a net cash position and are well positioned to make additional investments to grow our network.

We now offer more products than ever before. We've added more brands and products to our sales mix, including a complete line of premium level air-conditioning and heating systems and a highly competitive commercial offering.

We have added substantial talent and leadership to our Company. A powerful, performance driven customer oriented team that has joined the Watsco family.

We have now added new markets. Carrier Enterprises marks Watsco's first entry into international markets now serving the Caribbean Basin, Puerto Rico, and parts of Latin America.

With that all said, it's needless to emphasize that we are excited about the opportunity to grow sales and, most importantly, expand operating margins. The Watsco network now stands at 508 locations, serving over 50,000 contractors, and by far the leader in our HVAC industry.

Let's discuss the current trends in our business. General economic conditions continue to impact top line, although trends have been improving somewhat as the year has gone on. We are very pleased with this quarter's 51% sales growth of high efficiency air-conditioning systems. This speaks well of their acceptance by consumers. The $1,500 tax credit provides a meaningful incentive for consumers to upgrade and save energy.

We expect this trend to accelerate once market conditions normalize and pent-up demand to upgrade older, less efficient systems begins to unwind. As previously discussed, the regulatory transaction to 410A refrigerant is another important long-term catalyst for consumers to upgrade systems. Sales of these products now account for over 50% of unitary equipment sales.

Maintaining profitability and improving operating efficiencies across our network in very challenging market conditions has been an intense focus for the past year and a half. Our results reflect these efforts by continued reduction in operating cost. In fact, every morning at 8.30 the Corporate Team gathers to see what progress is made daily on managing and reducing operating costs.

Since 2008 we have reduced operating costs by approximately $50 million in line with the targets we set for ourselves. Cash flow has been the hallmark of our performance. Year-to-date cash flow has exceeded last year. We expect to beat our goal of cash flow exceeding net income again in 2009.

Now, on to the third quarter specifics. Sales for the quarter were a record $742 million and include $337 million added by Carrier Enterprises. Same store sales were down 15%, including a 9% decrease in HVAC equipment, a 24% decrease in other HVAC products, and a 17% decline in refrigeration products. The economy continues to affect sales, although trends have improved over the course of this year.

Lower pricing on commodity based products and a tough market in the western United States accounted for about half of the quarter's same store sales decline, costing $0.16 per share in the quarter. Excuse me, I just took a glass of water.

Gross profit was a record $172 million and gross profit margin was 23.2%. Same store gross profit was $104 million, and gross profit margins equaled 25.8%. Sales mix along with generally more competitive conditions have had an impact on margins during the quarter.

Most importantly, comparisons of gross profit margin shows that the gross margin of Carrier Enterprises is considerably lower than at the conventional Watsco locations by over 500 basis points. Improving Carrier Enterprises' gross margins is one of the important long-term opportunities, and will come largely by adding new higher margin products to current offerings.

Excluding Carrier Enterprises, SG&A declined $13 million or 14%, and reflects our ongoing efforts to reduce operating costs and improve efficiency.

Operating profit was $41.5 million, on operating margins of 5.6%. Same store operating margins were 6.8%. Diluted earnings per share on an adjusted basis was $0.71. A reconciliation of adjusted earnings per share to GAAP EPS is included in the tables of the press release.

Now, for the nine months period ended in September. Sales were a record $1.4 billion, and include the Carrier Enterprises locations only for the third quarter. Same store sales were down 19%. For the year sales were especially impacted by the drop in prices of commodity based products in our western locations, which together accounted for about half of the revenue impact. These two factors have cost 65% in earnings per share this year so far.

Gross profit was a record $347 million and gross profit margin was 24.1%. Same store gross profit was $279 million, and gross profit margin was 25.4%. Excluding the Carrier Enterprises locations and onetime transaction costs, SG&A declined 14%, that's for the nine-month period. Operating profit was $66 million, and operating margins of 4.6%. On a same store basis and excluding transaction cost, operating margins were 4.9%.

For the nine months diluted earnings per share on an adjusted basis were $1.31 on an adjusted net income of $38 million.

Now, on to cash flow. Operating cash flow so far this year of $38.4 million is 3% higher than a year ago. Dividends in 2009 were $41.7 million, an increase of 14% over 2008.

Debt ended the quarter at $43 million and a debt to total cap ratio of 6%. That debt, by the way, has since declined in the fourth quarter.

Looking back 12 months operating cash flow per share was 4.11, or that's $4.11 per share in cash flow. Since 2000, that's the year 2000, cash flow was $650 million versus net income of $475 million. We believe this speaks well of our commitment and ability to generate substantial cash flow while growing the Company.

In terms of outlook, we are experiencing improving revenue trends, meaning the rate of decline was less as the quarter progressed and we continue to aggressively manage operating costs. We do expect fourth quarter earnings to exceed last year's fourth quarter earnings. We also expect to generate substantial cash flow during the fourth quarter and, again, meet our goal of cash flow exceeding net income.

As previously mentioned, by the way, we are hosting an Investor and Analyst Day on November 5th, here in Miami, Florida. Key managers from our business units will be in attendance, and we welcome all of you, and let us know if you wish to attend. The event will be webcasted for those of you not able to attend in person.

With that, Barry, Paul, and I would be happy to answer your questions. Kyle?

(Operator instructions.)

Your first question comes from the line of Matt Duncan. Your line is open.

Good morning, guys, and congrats on a nice quarter.

Thanks, Matt.

Al, the first question I've got relates to Carrier Enterprises. Can you comment a little bit on how that's performing relative to your expectations so far? And then, in addition to that, have you guys been able to quantify yet what you think the potential annual cost savings are at Carrier Enterprises once you get in and sort of get it operating the way Watsco operates things?

Well, we're not surprised. We always knew we had a talented organization, and we have great products. And we knew that once we focused on distribution only, which is why United Technologies and Carrier joined the venture with us, that we -- that they could even do better than they always had historically. And that, none of that is a surprise to us.

And in terms of savings, because their focus is only on distribution, we had some prior to acquisition numbers and estimates. Barry, do we want to disclose those and so what would you say?

I think we have to -- yes, well, I think we have to -- the transition kind of progress has been occurring over the last half of the year, and to fully crystallize that for next year is too early. We're going to cover some of that in a -- with some better clarity in our Analyst Meeting because we'll have the Management Team of Carrier Enterprises here in attendance to talk about it. But to throw out numbers right now for next year, it's a little too early for that.

But just a reminder, also, it's not just about the cost, it's also about growth. We see the additional product lines, additional higher margin product lines also rolling into 2010. It's not a one year event, it's a multiyear event, but we'll get started on that -- on that side more earnestly next year, as well. Right now, the focus has really just been transitioning the business out of how it's been operated, and it's a good start for the first 90 days.

So is it fair to say then that the revenue number you posted for Carrier Enterprise this quarter really did not benefit much from cross selling supplies, inventory, just yet?

Oh, I would agree with that, sure, yes.

But that's still --

That's coming, and what is encouraging is the Carrier organization, Carrier Enterprises organization understands what's possible and there's enthusiasm for adding to their product offering and competing with the additional offering.

Sure. On a same store sales basis do you guys have any feel for how your replacement sales and new construction sales performed year-over-year?

Barry?

Well, Matt on the air-conditioning equipment side, which we -- is highlighted in the press release is a 9% impact. About half of that impact is new construction coming down, and the other half is replacement.

Okay, that's very helpful in here, and I'll jump back in queue. I know it's still fairly early, but are you seeing any signs yet out in the industry that demand levels may have bottomed here in 2009? And do you expect 2010 to be an up year for the industry?

Well, the first part of that is we have not experienced a bottoming in demand. We are still showing revenue decline, but the rate of revenue decline is substantially reduced. And do we expect 2010 to be a growth year? Well, the OEMs that we speak to certainly do. I'm sort of from Missouri, I'll wait and see, for it, and certainly we're ready for it.

But I'm very enthusiastic about our ability, even with no revenue increase, that we're going to be a heck of a lot more efficient in 2010 than we are in 2009. There's a lot of profit margin improvement possible here.

Okay, that's very helpful. Thank you.

Your next question comes from the line of Michael Cox. Your line is open.

Good morning, guys. Nice job in the quarter.

Thanks.

My first question is if you could perhaps describe what sort of training is going on in conjunction with adding higher margin products to the Carrier branches? Presumably these products were being purchased by contractors from perhaps a competitor, so what types of things are you doing to convince them to shop for those products at your branches?

Well, let's get Paul into this conversation to spearhead some of that.

All right. First of all, what we've done is we've had the training sessions with our existing Carrier people, both the operations people, as well as the inventory management people at each one of the Carrier locations so that they have an understanding of what the product is that we're bringing in and how that product fits our contractor.

The second phase of it is being operated through the Carrier Enterprises people where they're actually rolling this through to their sales folks to get it out to the contractors. The knowledge that we have it, we have it in stock, we have the right brands at the right price. So it's a beginning, it takes a long time, obviously, to transition this through an organization the size of Carrier Enterprises.

Okay, that's helpful. Thanks. And my second question is on the western operations.

By the way, I would add that the enthusiasm of our people is very, very high to be able to offer these additional products. They feel they can compete better with it.

Okay, my next question is on the western operations, I was wondering if you could talk a little bit about what is -- what you're doing internally to improve that -- the performance of that region, and perhaps how much of the weakness in that region is just simply the macro environment in that region specifically?

Barry?

We do see, first, enough reconnaissance, we have enough reconnaissance to know it is simply the weakest market in the country at this point. There's always been some discretion I think in the -- given the weather patterns out there and also new construction has been estimated obviously in that market, as well. So from a gut check point of view we definitely see the market, the conditions being the primary factor. It is getting better as the year has gone on also in that marketplace.

Though we have -- we've added -- really made some management changes in that region, we've added some products in that region, and we've obviously cut operating costs substantially in that region at the same time. So it's just reacting to what's going on in the market.

Well, more specifically, we do not see a turn there yet. California's -- west coast markets are I think -- now, the OEMs may be more optimistic than I am, but I think the west coast markets should remain soft for as far as we can see into 2010.

Okay, well, that's helpful. Thanks a lot, guys.

Your next question comes from the line of David Manthey. Your line is open.

Hi, guys. Good morning.

Good morning, David.

Is your revenue guidance for Carrier for the second half of 2009 still $500 million to $550 million?

For the year?

No, just for the second half? You previously gave that guidance.

Oh, Barry? Yes, go ahead, you gave that guidance.

Yes, that works.

Okay, and then as we look to 2010, how much faster do you think you can grow Carrier's parts business than the core equipment business? So say that core equipment grows, just pick a number, 4%, can you grow the non-equipment twice that fast or is it something less than that?

Yes, I mean that's an excellent question, but it's just too early. It's part of a conceptual strategy that we have to get buy-in, and we are getting buy-in. But to start telling you what growth rates might be for the new offering versus the old offering it's just too early. We'd be really guessing, and I don't want to mislead anybody.

Okay, that's fair.

I just think, you know, I go by feel a lot, and I feel really good about this because of the enthusiasm you get from the people that are seeing it for the first time and seeing opportunity. But ask us in a few quarters what we -- that same question, we might have a more appropriate answer.

Okay, and along those lines, I guess it's good that the people in the field see the opportunity. Do you think that you can sell more non-equipment without extending more credit to the contractors? I mean just driving across town to save a buck may not be an incentive as much as if their credit line is $10,000 with Carrier and it's $5,000 with a parts distributor, and they can't buy as much stuff if they concentrate all of their --

Well, now, you're going to get me started on something I feel is a strategic asset of our Company. We are, to my knowledge, the strongest distributor financially than anyone else. And we believe that if the contractor customer and even going onto the retail consumer, feels that Watsco's help in financing them or arranging for financing would help them and, therefore, achieve more growth of that contractor's share of business, that we're going to do that, because we can do that and hardly anyone else can. Our competitors I would assume are having issues with credit lines renewing, which we are not having.

So if there is an opportunity to extend credit, more credit to our contractor customers and keep going on to retail, consumers, homeowners, and businesses, and Watsco can facilitate that, I think that will be a unique, competitive tool that we have that I don't know anybody else in the distribution business would have. But I would say that we don't know that yet, but that's something that we are starting to get focused on to see if we can use our financial strength all the way through the networks.

Perfect. Okay, just one more quick question. I'm sorry. On the gross margin, I know you talk about improving Carrier's gross margin, and I'm wondering given that Carrier has been buying from a parent company and probably buying fairly well, how do you plan to improve the gross margin there? Is it by changing selling price or price point of the products? What are you planning on doing?

Well, first of all, the rules of the game are that we don't buy from Carrier, the manufacturer, at any different prices than any other independent distributor. There's no special pricing for Carrier Enterprises, that's the rules of the game.

However, Carrier, the manufacturer, also knows if they're presented with aggressive marketing programs to achieve greater penetration of the markets, that they'll be asked to contribute, as we will contribute. That's just every day's business and every independent distributor does that with Carrier.

But we do provide a higher level of service than most people, most of our competitors do, and sometimes we might be able to get a little higher price from the contractor because we do that. But, and I'm especially thrilled because we now have a premium line which we really didn't have. Some of our OEMs might disagree with that statement but -- and I'm just saying in most markets we didn't have, maybe that's a better way to say it.

So when you provide high levels of service, we believe, and we'll test it, we might be able to get higher prices for that. But, more importantly, the non-equipment is traditionally considerably higher in gross profit margin than the equipment business is. Long answer to your questions.

I appreciate the time, Al. Thanks a lot.

You bet.

Your next question comes from the line of Jeff Hammond. Your line is open.

Hi, good morning, guys.

Hi, Jeff.

Hey, just a little more color on the fourth quarter? Would you expect Carrier to be accretive in the fourth quarter? I know it's a seasonally weaker quarter. And then just, Barry, back to the $500 million to $550 million kind of guidance, it seems like certainly in my model the Carrier revenues were a lot better in the third quarter, is there any kind of bias within that $500 million, $550 million as you think about revenues for Carrier?

I think we were pleasantly surprised at the revenues, as well, Jeff. And, but the fourth quarter is an off season and we want to be careful in how we look at it. It's really the first kind of go-around here as we get in the off season with Carrier Enterprise.

As far as accretion in the fourth quarter, I think it's going to be a horse race, just given their seasonality is a little more peak and valley than Watsco's.

I'll be a little more positive. I believe, Jeff, that chances are we will be accretive at Carrier Enterprises.

Okay, thanks. And then --

But I won't quantify that because of the uncertainty.

Sure. Can you just talk about what you're seeing on price mix? Clearly, you know, some good traction on higher efficiency, but certainly still some pressure on the gross margin line. Can you just talk about those dynamics?

Barry, go ahead?

The -- well, first again, the commodity products are about 15% of what we sell, and that has been about 15% of what we sell. That's being compressed now that Carrier Enterprises has come. So some of this is going to simply go away to a lesser extent, and just the numbers. But explaining same store sales and same store impact, it's there to discuss.

Pricing is down year-over-year on those products, but the gross profit on those products has begun to normalize, so the good news is --

Gross profit margin.

Gross profit margin, right, has begun to come into line after what has been a sharp decline in pricing, but year-over-year there's still a pricing impact that will clear itself out as we start next year, we still have some pricing headwind against last year but not a gross profit impact.

And how should we think about price mix in the equipment side?

The price mix on the equipment side has been pretty flat pricing. I don't think there have been any price increases announced or to be announced, that's really going to impact what we see. We see a little bit higher margin on high efficiency, but we also see a little bit more competition in price at the lower end of the scale, which is kind of balancing out the equation at this point. So pretty -- it's a pretty flat and uneventful pricing environment for equipment.

Okay, great. And then, finally, can you give us a sense of where Carrier's revenues fell either on a core basis or, you know, at least relative to the trends you saw in your base business?

In the core business for Carrier Enterprises, their revenues were down in the high single-digit range. Residential was in the low single digits. Commercial was double digit in the mix, Jeff.

Okay, and then just one -- I'll sneak one more in -- how are you thinking about inventories, in your channel, inventories as you look at, you get a sense maybe from other distributors, competitors going, you know, exiting this selling season?

Well, for us, inventory turns of 4, which is roughly the number embedded in our performance, is not good enough. Our inventory is too high. Part of that is working through this transition of 410A and R22, which is causing some inventory, to extra inventory that we need to work off and will work off as we get through the transition. So I can't speak for other distributors and others, but the inventory for us has some movement downward just as we simplify and get through the transition of 410A.

Okay, great. Thanks, guys.

The next question comes from the line of Keith Hughes. Your line is open.

Keith Hughes, yes.

Close enough. A couple of questions. In the press release and in your prepared statements, you talked about a 51% number, I wasn't sure what that was. I guess my question is how much of the business is now running greater than 13 seer, and how much of it is 410A refrigerant at this point?

Go ahead, Barry?

Well, on the equipment side of our business, a reminder it's about half our business and this is in the same store equation, Keith. I want to address Carrier Enterprises, it's hard to unbundle that for now until we can -- until it's annualized. But for the conventional Watsco branch, it's half the business is equipment and about 27% of that business is 14 seer and above. And from a -- our 410A perspective, it's about 60% of the business.

When we went to the 13 seer transition a couple of years ago there was a lot of problems with supplier components not being there, and extra inventory was stocked by yourself, and how is the transition going so far to the new refrigerant?

You have a very good memory. That's exactly what happened. And I think that this time around it's much better.

Okay.

We are, of course, like Barry indicated earlier, carrying more inventory than we normally would because of the transition but we have no supplier issues. None that are serious, wouldn't you say, Paul?

Absolutely.

Yes, they're performing much better.

They're performing very well.

And a final question for Paul, you're hearing stories of inflation coming back in the market. In the fourth quarter will we see the negative hit from commodities we've been seeing? It seems like that should go away, would you agree with that?

Yes, I definitely feel it's going to go away. We, I was going back and looking at some historical price trends on just copper, which drives a lot of the prices, not just of copper tubing, but motors and everything else. And we pretty much have stabilized now for about the last six months between the $2.75 and $3.00 range. Metal seems to be stabilizing, and refrigerant, we were expecting to have some inflation on and actually did not have any inflation on in the quarter as most people are working down their supply of R22.

But, Keith, I just want to differentiate. In an inflationary environment we do not have the same problem with any of those metals that an OEM does.

I understand.

Yes, it's just in a deflationary environment, which you've just had, that we actually talk about metal. We never even used to discuss it. So I hope that things stabilize, and I think they are, that that won't even be part of our conversations. That's really more an OEM item than it is ours.

All right, thank you.

You know, the metal evaluations globally.

Hello? Are we cut-off? Hello?

Yes, sir. He should still be on the line.

I can hear you.

I'm here, are we still on our conference call? Hello?

Yes, your next question comes from the line of Dan Whang. Your line is open.

Good morning. My first question was I think you stated that versus '08 you've achieved, was it $50 million in cost savings from productivity programs?

I think that's over a year-and-a-half, yes.

And I was just wondering for the second half what you are targeting in terms of the additional savings? And what's driving that?

I don't know that we've quantified that. We know there will be more of it, but, Barry, do you want to take a shot at that?

Hi, Dan. I mean the target has been in the 10% to 15% range quarter-over-quarter for as many quarters as we need to, and it's 14% year-to-date. And I think I would expect that trend to continue into the fourth quarter.

Okay, and that's just headcount reduction and other?

Yes, if I looked at 50 line items in an SG&A analysis for the most part all 50 line items have been impacted. In headcount and related benefits and just incentive compensation, commission programs have all been, again, brought in line with the sales dynamic, and many of the other what have traditionally been fixed costs have been shaved, as well, to get in line with the revenues. I mean in particular look at the same store sales decline versus the SG&A decline, you know, there's actually a positive gap. Same store sales versus the SG&A decline has kind of come into line, so again we expect that to continue.

And I think if you go a little longer term, one of the things we've learned since we got focused on Carrier Enterprises is that they have a more efficient delivery system, their freight systems are more efficient than ours. So I would say that we would learn from what they're doing and incorporate that in what we've done historically, and I don't want to quantify that, but I think it could be pretty high because normally freight is running between 1.5% and 2% of sales, and if we could have an impact on that, that's a very exciting number.

Plus they've learned how to make it more variable.

Yes, and also make it more variable. Yes, Carrier does not own its own vehicles, as we do, Carrier Enterprises I'm speaking about, as we have in our historical business have. And so they have the flexibility, and also that when costs, when business goes up and down it's a variable cost, but they also have a more efficient methodology than we have historically. So I'm looking forward to learning from them and applying it throughout our system.

Okay, and I think, Al, you mentioned the current difference, the 500 basis point difference in gross margin between your core business and Carrier. And just thinking longer term, you know, obviously as you build-out or increase the mix of parts, services, I mean you're going to try to close that gap. But I'm just thinking with Carrier's favorable premium brand mix, I mean as you work towards that, is there a potential to actually get the Carrier gross margin higher than the Watsco core?

Gee, I certainly hope so. It's a little early to tell, but I understand your reasoning and I wouldn't disagree with you.

And obviously, you know, maybe there've been questions around this before, but I mean just based on just the path and would that be kind of a linear sort of improvement over four years, five years?

That's another good question. But in this environment the industry has been having changes in revenues that it hasn't seen ever, and those changes are all revenue declines. And that's been going on for three years. And that's -- so we're sort of in a new ballpark. I think that I could better answer that question once things stabilize and we have the regular systematic revenue growth that we've had for the length of -- for most of the industry years.

So I'm just a little hesitant to stick my neck out on anything like that because we have to first see the flattening of revenues for the industry and then we have to start seeing some normalization of growth rates. And then we could be more accurate in something like that.

Now, do I expect revenue increases to eventually come back? Of course, I do, I think that the product that we sell is still a necessity in American residential and markets, as well as commercial markets. This is the worst cycle ever recorded, that I can remember, and anything I've looked back in the past. And I hope and I'm pretty sure we're at the tail end of that. And whether it's in '10 or '11, I hope it's '10, the OEMs certainly think so. And then we'll really be able to do some of the things we're talking about.

Very well, and just one last one was obviously your organizations, meaning both Watsco and Carrier, are focused on getting all the synergies there and a lot of focus directed to that effort. But, you know, at what point would you start to look at perhaps larger transaction opportunities out there? I mean obviously you have a strong balance sheet, but --

Yes, well, that's right, and that's very accurate. And we never stop looking. I'm looking now. You've got a big one, we'll do it. We have the balance sheet to do all of these things now, which I don't think our competitors do. I don't know anyone that can do a large transaction in our industry today.

By the way, if there was we'd like to talk to them about joining us, but I don't see anyone there of any size. I mean the largest competitor that we think we have is the Westburne part of Wolseley, and Wolseley is -- it's having a -- it's public information they're having a lot of issues. They participate in a lot of industries.

And after that there are others, two or three other large size, and sure I'd love to do something with them. And we've -- they know who they are and they know of our interest. And we offer owners of distributorships if they're privately owned, you know, an opportunity to diversify into public shares or to have cash. We don't differentiate between the two, it's whatever the seller might want.

So I think keeping a strong balance sheet, and I think that's your point, keeps us open to make additional acquisitions and enlarge the network. And with the scale given networks and the focus on HVAC distribution I think you'll see rising margins, which is what we used to do quarter after quarter until this industry lack of growth in the last three or four years.

Okay, I think on your comments, I think Barry's phone is starting to ring off the hook again. But thank you very much.

I set you up, Barry.

Okay, thank you.

Your next question comes from the line of Ian Zaffino. Your line is open.

Hey, guys, this is [Brian] in for Ian. Thanks for taking my question. As far as the Carrier business, you guys talk about how operating margins actually improved year-over-year in this quarter despite the decline in revenue in the high single digits. Is that stuff that you've already done with the SG&A line on the Carrier side, or what's actually -- what is that actually attributable to?

Barry, you better deal with some of these numbers?

The business mix did improve a little bit in some of the -- in the products in terms of the high efficiency. Their high efficiency -- their level of high efficiency product sales is actually much higher than the Watsco locations, so they're seeing the benefit of higher margin on those products, as well.

They've done a great job all year long with SG&A. I think our focus in coming in the last -- since July 1st has also added even more intense focus on performance, and they've done a nice job on the SG&A line.

So with the revenues down, the gross profit up, SG&A down materially they have produced higher margins this quarter. But we'll take some credit for it but most of the credit is the fact that it's a great team that's been living and working at this all year long, and once we get --

I would concur with that, this is a great team.

-- once we get through the transition and into next year then we like the early signs that we'll give them that credit, and as we go I think it's a lot of potential for short term and long term improvement.

Would it be fair to say that their SG&A was down relatively similar to their sales, kind of like you guys' base business?

Yes, more, their SG&A decline was greater than their sales decline.

Okay, and then on the same store profit margin, down about 90 basis points. You say about a third of that is related to more equipment sales and the remainder is competitive pressures -- what exactly is that, is that pricing or the other 60 basis point decline from competitive pressures what exactly is going on there?

Well, as we get -- as we got through the season and we did see, again, pricing conditions affect gross profit in a way that is somewhat explainable. It's the slower market, a lot of inventory is needing to move through the channel, there's a lot of transition going on of product lines, and inventory reductions, and we saw more competitive conditions. I think in 17 years of doing that we've used that phrase in a press release about five times, and we saw that in the third quarter. And I think it has a lot to do with the transitioning of these products as we get out of the R22 systems and into the 410A systems.

All right. Thanks a lot. Great quarter.

Thank you.

Your next question comes from the line of Steve Tusa. Your line is open.

Hi, Steve.

Hey, how are you doing?

Okay, thanks.

Just a question on the R410A conversion, I mean Carrier talked about a little bit of a pre-buy and some of the numbers on replacement have been pretty good for the OEMs. Is there any, do you sense there's any kind of pre-buy going on in the industry here?

Paul, you want to deal with that?

Yes, are you talking about a pre-buy on 410 equipment?

Yes, I mean I guess that's what they said on their conference call. It sounded like they said buying, quote and unquote buying in advance of the R410A conversion.

No, I -- we have not felt that.

Okay.

Or seen that with any of the OEMs.

In other words, we're not doing that.

We're not doing that.

Right.

Because they have -- as our OEMs are doing so much better this year, they really are keeping a very good delivery schedule. We're not seeing any --

Absolutely.

Material --

Got you.

Supply issues.

So, and they --

But it is a good question because how much of the 410 -- how fast is a contractor going to switch from 410 when he still has R22 available to him? Obviously, the trends are good, but different contractors have different demands, and that's what the distributor does. He sort of has to figure that out.

Right.

It's much harder for the OEM because he doesn't have the daily contact that we do, and we have to sort of sort that out. And, if anything, we're going to error on the side of carrying too much inventory until this transition is over.

Right. Okay. And then the other question would be just on raw materials. You talked about how it was a headwind. If prices stay at their current levels, any idea, I mean is that translated into a tailwind in 2010 if we just mark everything to where prices are today, or is that not really the way to look at it?

I would look at it as flat.

Okay.

I don't think it'd be a tailwind or a headwind, I just think it would be flat next year.

Yes, Steve, long term, I mean again and I'll say it, to be redundant, in 17 years we've talked about commodities three times and that's the three quarters of this year. So I think a normal state of mind for commodities at this point.

Okay, great. That's it. Thanks a lot. See you next week. I think it's next week. Yes, see you next week.

Good.

(Operator instructions.)

Your next question comes from the line of Jeff Germanotta. Your line is open.

Jeff Germanotta, William Blair & Company.

Hi, Al. First question, can you compare and contrast what's going on in Florida versus California? I'm hearing Florida is doing better. California has not yet turned the corner. But what are you seeing?

Barry, you want to do that, or do you want Paul to do that?

No, go ahead. Go ahead, Paul?

Yes, you know, the big difference between California and Florida is the replacement market. We're seeing what I would call almost a normal replacement market going on because we have a hot, humid climate here, whereas in California the replacement market tends to be, the equipment tends to have a longer life which extends the replacement market out there. So I would say that would be the big difference between the two markets right now.

And the west coast has been one of your bigger drags of late, do you think that will diminish going into the next year? Are you more optimistic about California, as well?

I thought I dealt with that earlier -- I am not, personally, whereas the OEMs seem to indicate that they are. So I'll be thinking of pleasantly being surprised, but we're preparing for still soft markets there into the next year.

To put it in perspective for everyone's sake, the west coast market is about 5% of our revenues, to put that in perspective. So we've talked a lot about it today, but I want to give it its relevance in the big picture.

Good point. Yes, it's not going to control our overall performance next year, but the reason I like to say that we're not expecting revenue growth is because I want us to be much more efficient there and I want that message out.

And then, second question, this is probably for Barry -- Barry, the tax rate was a little lower than we would have anticipated in this quarter, can you talk about why that is and what to expect going forward?

Sure. It is more of a mechanic of how the joint venture's tax flows through our income statement. We can go over the mechanics of that, Jeff. The overall tax rate embedded in our numbers is 37.8%. That's not a change in the tax rate. The mechanics of how tax provision goes through our income statement changes with the joint venture, which we can talk about the mechanics of how that works.

So it'll be closer to -- on a consolidated reported basis it'll be closer to 33% going forward?

It'll, again, it's a composite of how the joint venture operates, so the tax rate will stay the same at 37.8%, a portion of that is -- goes away, and how the -- and the 40% minority interest of how the joint venture is accounted for. So I'll have to go through that mechanic with you.

Okay. Thank you.

There are no further questions at this time.

Well, thanks very much. We appreciate the interest you have in the Company. Talk to you next quarter. Bye-bye.

This concludes today's conference call. You may now disconnect.