Good morning, and welcome to the Watsco third quarter 2022 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Albert Nahmad, Chairman and CEO. Please go ahead. Good morning, everyone. Welcome to our third quarter earnings call. This is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, President of the Company, Paul Johnston, Barry Logan, and Rick Gomez. Before we start, our usual cautionary statement. This conference call has forward-looking statements as defined by 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. Now on to the quarter. We delivered another record quarter. Sales grew 14% to a record $2.04 billion. Operating income increased 14% to a record $236 million. This third quarter performance builds on what we believe will be a record year for our business. Far, nine-month sales increased 19% to a record $5.7 billion. Nine months operating profits increased 37% to a record $694 million. Year-to-date cash flow also improved, increasing 12% to $359 million. Now, given our earnings growth, cash flow expectations, and our confidence in the business, we announced today an 11% increase in our annual dividend to $9.80 per share, effective in January of 2023. I might comment that we believe the last two years have been among the most challenging and also the most gratifying periods in our history. Our growth and stability speaks to the fundamental necessities of the products we sell and to the value that our industry provides homeowners and businesses. Given our long-term focus, Watsco has also invested over the past two years in people, technology and infrastructure, and we do these things to build market share in our $50 billion market. As industry demand and supply chains normalize, it is the right time to expect more productivity, and we have challenged our leadership to improve operational efficiencies across our network. We're also working closely with our OEM partners to develop forward-looking growth initiatives. Watsco does maintain good relationships with virtually every domestic and international industry manufacturer. We believe collaboration with the manufacturer is all the more important given the industry change that's taking place in the coming years. Many views of our company fundamentals are in this morning's press release. I really do urge investors to read that release and understand why we believe we have an exciting future. We have an immense technology advantage, and we're investing to grow that advantage. These technologies bring in new customers. They help our existing customers grow, and they reduce attrition of customers. Most important, they help us gain market share. Our active technology user community has grown 21% this year to more than 45,000 users. OnCall Air, that's a platform that reaches into homes, keeps growing. During the quarter, contractors have presented quotes to approximately 66,000 households. That is a 39% increase in households over last year and generated $269 million in sales for our contractor customers. That is a 47% increase. Watsco's diversity of products and brands is an important competitive advantage that allows us to serve contractors in any economic environment. We also have a leading market share position in Sun Belt markets, where both population migration is greatest and the necessity of HVAC products is the most absolute. You gotta have cooling and heating if you live in the Sun Belt. In addition, there are several important catalysts for growth that will play out in the next few years. For HVAC equipment, the minimum federal efficiency standards will increase in 2023 across the entire United States. Price points associated with these higher efficiency products will increase and should benefit our 2023 results. Federal mandates are now in place to phase out high global warming potential refrigerants used in millions and millions of existing systems. In 2025 will mark the introduction of new HVAC systems that'll incorporate lower GWP refrigerants. We also see a strong movement towards electrification of heating systems through the use of more heat pumps, which generally come at a higher price, higher margins and in the long run, a shorter replacement cycle. Our sales of heat pumps grew 27% in the first nine months and interesting 32% during the quarter, outpacing overall sales growth rates. The new Inflation Reduction Act, which takes effect next year, also provides tax credits and incentives for qualified efficiency upgrades and electrification. All of this provides the basis for homeowners and businesses to upgrade systems that will, over time, be more efficient and more environmentally friendly. All of this is good for climate change and good for Watsco. We certainly believe our scale, technology and financial strength position us to capture these new market opportunities. Finally, we always concern ourselves with our balance sheet so that we are in a position of financial strength. Today's balance sheet remains in pristine condition to invest in growth opportunities in coming years. I'd like to say that we can fund almost any size investment to grow our business. With that, let's go on to Q&A. We will now begin the question and answer session. To ask a question, you may press Star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press Star then two. At this time, we will pause momentarily to assemble our roster. Our first question will come from Tommy Moll of Stephens Inc. Please go ahead. Morning, Tom. Morning, Al. Thanks for taking my questions. Of course. Wanted to follow up on your comment regarding finding more operating efficiency in a more normal business environment. If we go through a period- Yes. If we go through a period where industry volumes are pressured, I presume that still applies, but can you actually continue to show leverage on SG&A? To the extent you can, is it in tension with market share opportunities that you might otherwise be able to go after in a period of pressured industry fundamentals? Is there a natural tension there that we should think about how you might reconcile? I think that's an excellent question. I'm gonna have Barry Logan and Paul Johnston answer that, and A.J. Nahmad. You're gonna get a trifecta here. The last part first, to Tommy, just to give some sense of product and brand and OEM and manufacturer in general, you know, conceptual stuff. There's really been two years where I can attest to you that going to OEMs and saying, "How are we going to grow?" was met with the response of a supply chain difficulty. You know, OEMs have capacity, but yet they've had supply chain constraints. In that environment, it's almost kind of bizarre, honestly, to go to OEMs and say, "How do we grow? What do we add? What brands can we go to market with? What incrementally can we do with you to help you grow?" and to be told you'll have to wait. Now we have that opportunity ahead of us in the next couple of years to play offense. We think the supply chain is better. There's still more to do. We're going through a big product transition as we head into next year. That's a very unique and important opportunity that doesn't have much to do with our discussion on efficiency. It has everything to do with how do we use our balance sheet, how do we use our presence, how do we use our structure, how do we use our technology to go grow brands and grow our relationships beyond where they are. I think I would put that aside as a discrete strategy. On the efficiency side, it's again a very kind of simple story to tell. We have to go prosecute and execute the strategy, but it has been a wild two years. There's really been nothing customary, nothing that's been ordinary in dealing with both the strength of the market, the real difficulties with the supply chain. You have a lot of inflation going on. You have really a fire drill going on to serve customers. We were at no time going to look at cost as the critical item in serving customers in this environment. We were gonna do anything it took to serve customers in this environment. We're out of season as we head into the shoulder season here in the fall, and the message is very clear to our leadership. Al's made that message extremely clear about stepping back from the business, looking at cost, looking at cost to serve, looking at efficiency, looking at technology and challenging them to be, you know, more productive as we get into the next environment. Paul, anything? Yeah. It's the supply chain disruption obviously caused a dysfunction in our productivity, and that was basically around being able to match up systems, having an outdoor unit in one warehouse and an indoor unit in another warehouse. It did stretch our people to be able to satisfy the customer and make sure that we were able to put the pieces together so that they could complete the job that they were on. That did create some dysfunction, as I said, in our ability to improve the efficiency with all the tools that we provided our people. You know, the second thing that we're gonna be going through now is as we go through the transition to the new product line, it's obviously gonna reduce the number of SKUs. It's gonna hopefully simplify the supply chain, and hopefully we'll have a long-term benefit from that going into 2023 and beyond. AJ? Yeah, I'll just add some figures to give you some sense of scale. I mean, we process and fulfill roughly 7 million customer orders every year. That's product going out. Product coming in, receiving of product coming in is also millions of receiving touches that we have to do with the products. We move products around our 700 or so locations with 800 or so vehicles, and lots of forklifts and lots of humans and lots of touching of the products various times. Like Barry said, given the supply chain challenges and not necessarily receiving products when we hope to receive them or in the locations we hope to receive them or in the quantities we like to receive them, and the surge in demand, there's a lot of scrambling going on. The policy or not the policy, but our heart was to fill customer orders, take care of our customers. Well, now as things start to calm down, if you will, a little bit in the supply chain, and we expect them to continue to, quote-unquote, normalize, we'll have more opportunity to improve our processes, improve our technologies, improve our ability to smoothly receive all those products, move product around less because we'll have products in the right place at the right time and the right quantity, get customer orders filled accurately and on time and efficiently. I'm just trying to give you some sense of scale of the operation and the chaos that ensued. Now as the chaos calms down, we can really drive some products, productivity, and efficiency through the system. All very helpful. Thank you. As a follow-up, I wanted to hit on technology investment. Is it safe to assume that that's a separate discussion here and that you'll remain forward leaning, I guess we could say, on technology investment? Any view you could give us there for the coming quarters would be helpful. Just to throw out a couple data points that maybe you could discuss. I noted that HVAC Assist users were up meaningfully quarter-over-quarter. OnCall Air quotes were down meaningfully quarter-over-quarter. I realize there's a lot of noise in those KPIs that you give us every quarter, but to the extent you wanna clarify any of those trends would be helpful as well. Thank you. I don't think that last statistic is accurate, right, Barry? OnCall Air. When you say quarter-over-quarter, you're talking about second quarter versus third quarter or sequentially? Uh. Is that what you're looking at? Correct. Oh, yeah. We have to look at it year-over-year 'cause there is seasonality in the business. No, I mean, yeah, go ahead, Barry. No, I would say there is a seasonality aspect to that answer. Yeah. Right. No, OnCall Air is thriving. The customers of ours that are using it, which is a growing number, their performance with us, meaning their sales growth rate with us, is significantly higher than non-users. They're winning more times in the marketplace, and that leads to more purchases from our business units. As for technology in general, will we continue to lean in and be a technology-driven company? The answer is yes. You know, I like to say, maybe it's become cliché now that we are a technology company that just happens to sell HVAC products. Technology, we really use that as an umbrella term. It really means modernizing the company, including, you know, people's skill sets, our processes, our systems, how we operate, and how we are able to impact our customers within terms as far as their experience and their ability to find the products they need, get orders delivered or fulfilled quickly and accurately. Really, technology touches all parts of who we are and what we do, and it's all customer-focused, and it's appreciated. Customers that are using our technologies are better customers. Their attrition rates are much lower, and their growth rates with us are significantly higher. Those numbers continue to grow as far as customers using our tools. We believe it's a main impact in our ability to take market share from our competitors who don't have nearly the breadth or depth of technology offering that we do. Thank you both. I'll turn it back. The next question comes from Nigel Coe of Wolfe Research. Please go ahead. Good morning, Nigel. Thanks. Hi. Hi, Al. How's it going? So yeah, thanks for the question. Just wondering, you know, how we should think about your inventory levels as we go into year-end? You know, it looked like third quarter, you know, we're kind of back on a more seasonal path of lower inventories in 3Q versus 2Q. Just wondering how you're managing inventories into year-end and, of course, curious about the 14 SEER versus 15 SEER dynamic as well. Those are two great questions. All I can generalize is inventory will be lower, and we hope not to have any or very few units that wouldn't qualify in the South, given the efficiency mandate in the South. We're very conscious of that. Let me give you more in-depth. That would be Paul. Yeah. Nigel, we monitor, you know, the straight cool units in the south to make sure that we have a smooth landing at year-end when those units become basically obsolete in the south. We feel we're on the right trajectory there. We're gonna be getting to receive the new products hopefully in late October, early November. We'll be set up to be in business on January first. The new product will be more expensive than the existing products we have. Generally speaking, the inventories are a little bit restrained right now in certain product areas. In other product areas, on heat pumps, for instance, we have sufficient product to guide us through at least the fourth quarter and into the first quarter. Cool. Great. Thanks, Paul. Just my follow on is really around, I don't know if you wanna throw out the price mix impact, in HVAC products this quarter in residential. You do that. We did. You do that sometimes. Yeah, we did do that. You did? Oh, sorry. sorry. Okay, I'll. I missed that one. It's in the press release, Nigel. Okay, got it. My eyesight's terrible. You mentioned the hurricane. Obviously a tragedy for Florida, but just wondering, you know, what impact you saw in the quarter and what opportunity do you see from the rebuild as far as HVAC is concerned? This is Paul. I live in Fort Myers, so I'm right in the middle of the hurricane zone here. I've been out visiting our branches, and I was very proud to say that our branches were open within 24-48 hours after the hurricane passed. Taking tours of them, we had one branch that was missing 160 feet of its wall, and there were 10 trucks lined up outside, and our staff was there doing their job and filling orders. What did we lose in the quarter? You know, it's an estimate, I would say somewhere between $16 million and $18 million worth of business was probably pushed either into Q4 or, you know, perhaps is gonna be lost. However, we've got a very strong market share presence in the three counties that were impacted. We've got 12 branches. It's a marketplace which is about equivalent to the size of the state of Louisiana. Obviously, as the work begins, we expect to see some upside in this marketplace. It's tragic that, you know, that creates business, but we are here to help everybody get their lives normal again. Yeah. I would say, just to add color to that, we had about 40 locations under hurricane warning that had an interruption during the quarter. Another 200 under hurricane watch that I'm sure there was some distraction. As that plays out into the fourth quarter, there's some short-term, you know, immediate requirements to fix systems. What we have seen in other markets where there's destruction like this is, you know, just conceive of a $20 billion insurance claim collectively in aggregate of flowing capital into a market like this. Some portion of that $20 billion is our stuff that is part of either rebuilding, remodeling, or retrenching or new building in that case. There is a longer tail than just one quarter, but it's one of those events where we are witnessing real destruction. Again, to some extent, that's an opportunity, you know, for those markets within our business. Right. Okay. Thanks very much. I'm happy to add that no serious injuries to any of our employees, which we care a lot, quite a bit about, who were employed during the areas of the hurricane. Amen. Thank you very much. The next question comes from Jeffrey Hammond of KeyBanc Capital Markets. Please go ahead. Morning, Jeff. Hey, good morning, guys. Hey, morning. Just wanted to come back on Nigel's questions on inventory. Maybe just speak to what you're seeing from your OEMs and parts suppliers around lead times. You know, I think, Al, you said, you know, inventory is gonna be lower in the fourth quarter, and I don't know if that's a seasonal comment, but we've just seen some aggressive destocking, you know, in other kind of building products area, not so much HVAC. I'm just wondering, you know, as you see lead times, what's the kind of the want and willingness to kind of bring inventory levels more normal? Well, I would say generally speaking, the manufacturers did the best they could, but in more cases than not, they were not able to deliver either on time or a complete order. They would send the outdoor unit, but not the indoor unit. We had the inventory, something we weren't gonna be able to sell until they fulfilled the second part of the order, that sort of thing. Since they're catching up, we're gonna be getting complete systems, especially with the new products that are coming out towards the end of the year. That's why I think that not only will the inventory come down, but the cash flow will come down because everything's gonna get better from the point of view of investing in inventory and improving the mix of what's in the inventory. Anybody wanna add to that? Yeah. Yeah. It's like I think I indicated this earlier. The one good feature about the change to the higher efficiency products is a fairly large reduction in the number of SKUs that we have to handle. What our hope is, obviously, is that as the number of SKUs come down, that makes it more efficient for us to be able to have the right inventory and a lower inventory at the same time. Should also make it a simpler manufacturing process, we hope, for our manufacturers so that they'll be able to provide us the products that we need. We're still having some problems. There still is, you know, sporadically something will go haywire at the manufacturing plants, and we'll have a shortage of something. We're experiencing increasing demand, as we indicated in the press release on heat pumps. We're seeing increasing demands on commercial products, and we have a continuous demand increase that we've seen over the last several years on ductless products. Well, what we can see in October, the numbers show strong growth, which is another reason why I feel good about the inventory. Okay, great. Great color. Just on gross margins, I know, you know, there's been a lot of questions on that. I think, Barry, the last couple of calls, you kinda talked about, you know, some of the structural improvements and kind of a new target of 27% gross margins. I think you're there this quarter. Just wondering if that's a reasonable target for kinda 4Q and into 2023, or if we start to, you know, maybe dip below that as some of the inflation normalizes. Thanks. Barry, you on? Yes, I am. Yeah, Jeff, so just to give some color. First, in the quarter, let's speak very narrowly about the quarter. You know, the key business component of gross profit in the business is what we simply call selling margin. What is our price cost effectiveness during the quarter? During the third quarter, that was raised about 80 basis points. We were still seeing higher margins in that kinda raw margin aspect of us selling products. You know, there's not a reason to think that will change much as we play out the rest of this year. That's the positive. The negative was part of gross profit also is how we pay vendors, when we pay vendors to the extent there's volatility in paying vendors, and there are cash discounts, there are vendor incentives, there are rebates that flow in that equation. In that volatility in the quarter, that took away some of the gross profit profitability this quarter. That's a short-term one quarter conversation. Longer term, the good news is the price cost selling margin actually increased meaningfully this quarter. The selling margins. There we go again. That's the healthy part of our business. Okay, that's great color. Appreciate it, guys. The next question comes from Ryan Merkel of William Blair. Please go ahead. Morning, Ryan. Hey, good morning. Good morning. I wanted to pick up on the gross margin question. Just to clarify, year-over-year, you're saying that there was a positive 80 basis points of positive price cost, but that was offset by what rebates being lower? If that's the case, why would rebates be so much lower in one quarter? I don't recall ever seeing that in the past. No, it's because of the level of purchasing activity and receipt activity a year ago versus this year. That's where the chunk and the funkiness of inventory receipts that have kind of had been volatile play out a year later. I would say a year ago, there was a benefit in gross profit relative to the timing of receipts of inventory. A year later, a bit of an air pocket. We're talking about 30 basis points to put that in perspective. Got it. Okay. Gross margins were flat year-over-year, so what was the other part that offset the positive price cost? Freight and a branch freight where we moved products around was negative in the quarter for all the reasons that we're talking about. When we talk about freight and moving products around, that's an inefficiency in gross profit year-over-year. I got it. Okay. How do we think about the trend then? I would presume that the positive price cost situation will be with us for a bit. Then what about those other pieces? How do you think those will evolve in the next couple quarters? Yeah, it does go back to the purchasing patterns and again, inventory, as we reduce inventory seasonally, which is normal through the rest of the year, versus what we did last year. There could be a small amount of volatility in that. I'd have to go back and look at a year ago, but I don't think to the same extent as what we saw in the third quarter. As far as moving inventory around, I think that is better, but still an irritant. It's probably one of those a year from now opportunities to actually improve margin. I would still stick with our target of 27% as a baseline. Some of the volatilities that we're talking about this quarter flattens out or goes away as we get into next year. Got it. Okay. That's what I was driving at, so thanks for that, Barry. And then my last question, I just wanna go back to the price mix impact in 2023 from the SEER change. I think what we're hearing is a lot of the OEMs are up sort of mid-teens for price increases on new base units, and I think there's actually some out there up 20. Are those the right numbers? You know, I think the mathematics would be price mix next year could be, you know, 6, 7, 8%, you know, with carryover price from this year. Is that right? I would say you're a little high. That's. Everybody announces, you know, some of these price increases, but I think what we're gonna see is it probably, and this is a guess on my part, it's probably gonna settle somewhere around the 10%-15% range. I see. Okay. Great. Thanks for that. Appreciate it. The next question comes from David Manthey of Baird. Please go ahead. Morning, Dave. Hey, good morning, Al. Good morning, everyone. Playing off of that pricing question, and I apologize if I asked this before, but could you remind me the percentage of your parts and supplies products that might be more subject to commodity deflation, like steel duct work and copper tubing and that sort of thing? Good question. Paul? Yeah. It's copper tubing. It's steel. We sell a lot of steel that's used in the production of ductwork. Refrigerant is another area that we look at, which is generally for us, it's mostly R-410A, which I think is gonna have upward price pressure, you know, throughout the next 4-5 years. And then our general parts business, you know, which is compressors and motors, representing the largest portion of it. On the supply side, it's everything from the ductwork that goes up there, the flex duct to insulation products, grills, registers. You know, we've got, gosh, probably 200,000 SKUs when you get into that product. When you look at that, Paul, just thinking about the types of products that are very sort of commodity heavy, like copper tubing and steel, what percentage of your mix does that represent? Given that equipment and refrigerant are obviously seeing inflation, what components might see some deflation as commodity prices retrench? It would be. I would say I'd have to give you an exact number, but it would be south of 5%. Okay. Yeah. Yeah, I agree with that. Okay. Thank you. I don't have to hazard it. I'm looking at the numbers. It is under 5% refrigerant, which is, you know, again, we label a commodity which has had nothing but inflationary realities going on. Yeah. It would be, you know, but as a group, that commodity group is still, you know, even with refrigerant right around 5% of the sales. Okay. Okay, thank you for that. Then a second, again, I hate to get too granular on this, but could we talk about the operating expense investment that you've been making here? I'm looking at this at the OpEx level this quarter relative to a $2 billion revenue number. I'm just trying to understand, are all of those investments kind of at a full run rate in the third quarter? Then as we get the shoulder periods, some of your variable costs might come off a bit, that the $322 million SG&A this quarter is a high watermark for the next couple of quarters? Or were you implementing those programs during the quarter and we could actually see more of flatness or higher SG&A going forward? I'm just trying to understand the timing and what more we should expect as we look to the next couple quarters here. Yeah. I would say, Dave, first, when we talk about 400 people, it's not recently, it's over the last couple of years. That's just giving a big picture view that during what's been a tumultuous time, we've invested heavily to not just realize today's results, but investing in some of the future results that we're expecting. I would say it's a pretty mature looking number at this point in terms of what you see in a quarter. There are a lot of variable costs which moderate over time in terms of just moderating to what the top line and margins are doing. You know, gross margins are still up, you know, over 25% this year. That means every commissioned salesperson that sells off of gross profit, you know, their income is up 25% this year. I wouldn't expect, you know, I would like it, but I wouldn't expect that level of growth rate, you know. I wanted to, but it's not gonna sustain at that level, obviously. That would be a variable cost that moderates simply by the business, in terms of the scale of the business changing. Something like freight, where it's a $60-$70 million number that's up 40%-50% over the last eighteen months. I would expect that to moderate for all the reasons that we're talking about. Also you have 675 branch managers that decide every day, how many people do I need? How many hours are we gonna spend? How much overtime do I need? How much temporary help should I add? How many trucks should I own? When we talk about efficiency, it's going out to and bringing data to the equation and culturally in the shoulder season and challenge kind of the thinking on what's going on in that regard. It's a lot of moving pieces. That's perfect. A lot of moving pieces, all of which have not been easy to manage the last two years, and obviously become simpler to manage and obviously more critical to manage, in terms of urgency, you know, over the next two years. Yeah. Fair enough. Okay, Barry, thank you. Robert W. Baird is thinking about those kind of discussions right now. The next question comes from Stephen Volkmann of Jefferies. Please go ahead. Great. Hello. Good morning, everybody. Thanks for taking the question. I'm wondering if we can just focus a little bit on kind of what you're seeing from the volume perspective, and I guess I'm sort of backing into volumes were kind of flattish this quarter. But I think maybe we started the quarter better than that. Did volumes sort of decelerate through the quarter? And Al, you made a quick comment on October. I wasn't sure if that was a volume quarter or something specific, but. Yeah. Would just love to hear what you're seeing there. Yeah. We haven't mentioned, I don't believe, that there is a product mix going on, which also elevates the pricing. I think, Barry, talk about that. I think that's probably the more significant one of the more significant things that's going on. The product mix is changing. I think that's a plus. You won't see as much unit sales as you otherwise would, but you see the sales that do occur, they occur at a higher price in the marketplace. Right. Well, just to answer your question, Steve, just on volumes. Volumes were up in July. We reported that when we reported in July. There was some moderation since then and pretty flat for the quarter. We probably would have been up a little bit if I try to account for some of the hurricane activity. But that's been kind of the way it's been now for six months. That's not a new trend. It's kind of been flattish unit growth now for really six months. What Al's speaking of is what about everything else in terms of the business. Obviously, there's still a measure of inflation we're capturing in the market. When we use the term heat pump and discuss that it's up 32% in a quarter, and that's substituting for straight cool units that are probably 10%-15% less in price, that's mix. Mm-hmm. That's a price achievement in mix. To the extent that trend simply continues, it's a permanent opportunity to have higher average selling prices. Also, the SEER mix increased during the quarter. It's been going on now for about 11 years. You have contractors making recommendations, bringing solutions to the homeowner with confidence. We have technology in place that's triggering that opportunity in a much more professional way. We're seeing, you know, another quarter of strong growth in energy efficiency mix, and a government mandate next year makes that even more automatic. When we use the term price and mix, there's a lot of, you know, subtlety in that discussion. The heat pump discussion and this energy mix, energy efficiency mix discussion, I think accounts for a lot of what we're talking about in price right now, not just inflation. I'm not- That, that's- Paul, you can add color. I'm not sure there were any OEM pricing actions this quarter. No, outside of some commercial pricing actions, we didn't have any residential pricing actions that really affected the quarter. As Barry indicates, you know, the heat pump growth was something that's been happening sequentially over the last three quarters, and we saw it accelerate in Q3. Expectation is for it to continue to grow. As that grows, it does have a material impact on our revenues on residential products. That, that's super helpful. Al, you anticipated my follow-on was on mix, actually. 'Cause I've heard some channel checks sort of complaining that some of the high-end units were hardest hit by supply chain issues and therefore were constrained. What's your view? Does mix get even better because things normalize in 2023, or are we sort of stable? I certainly think that it gets better for us. Every trend that we see and anticipate is that many factors are contributing to consumers wanting to own higher efficiency products. As Paul keeps pointing out, in the North, where there are gas furnaces, we expect them to be replaced by heat pumps 'cause they're more efficient when they operate and they emit less CO2 when they're used. These are all very positive trends in the short and the long term. We're in the right place at the right time. I just like everything we're doing. Yeah. To me, what has occurred and better yet, what's coming, we just have some fabulous capabilities that no one else has. Who can afford $48 million in technology investment a year than growing? If they can't afford it, they're not committed to it as we are. That will continue our edge in terms of staying the leader in gaining share. I can't think of anything at the moment that I would warn you that, you know, we see something negative in this, in the early future. Everything I see is positive. Can you guys add to that, A.J., Barry, Paul? Yeah, you know, we're seeing another trend that's starting to occur, and that is where straight cool units in the mid-south and the north are starting to be replaced by heat pumps as opposed to straight cool units. What that trend recognizes is a term that we call dual fuel, where the unit will operate as a heat pump down to a certain temperature, and then when the temperature drops below that point, it'll switch over to the gas furnace. Not replacing the gas furnace, just replacing the outdoor unit to provide non-fossil fuel heating. We've seen that growing, and now it's starting to accelerate. We have not talked about the tax credit and what impact that will have on the high efficiency product going into next year and beyond. There's still some adjustments to be made as far as what the efficiency has to be to qualify for it. Once that's clear, I think we'll have a clearer idea of what the opportunity is gonna be with the Inflation Reduction Act. All right. Thank you, guys. Appreciate it. The next question comes from Jeffrey Sprague of VRP. Please go ahead. Thank you. Good morning, everyone. Could you just remind us now, just really kind of cover following on from the mix discussion, what% of your sales in 2022 would have been at the prevailing minimum SEER level, and therefore is kind of subject to kind of the mandatory regulatory lift into 2023? Paul, go ahead on the equipment sales. Yeah. Yeah. It's minimum efficiency in the quarter was approximately half on just the outdoor units. That'd be a pretty good number for the year also, I suppose. Yeah. That hasn't really changed that much. There's been a little bit of mix up in it because of the supply chain. Generally speaking, that's a pretty good number. Just back to heat pumps, you know, the numbers do seem particularly strong, even before the IRA, you know. Yeah. Incentives come into play. I mean, are you proactively educating? Like, in many respects, I would think the average consumer doesn't know a straight air unit from a heat pump unit from a air handler, right? So, you know, is there really a very proactive selling effort going on around heat pumps driving- I think. -performance? Yeah, there is a proactive among our contractors. Obviously, it's their responsibility. They're the ones in the home. We've got OnCall Air, which assists them as far as making that presentation to the consumer. So I think that's a plus that Watsco has and Watsco's contractors have. But also there's been an awful lot of discussion. You know, Bill Gates wrote a book on it. California now has passed a law which states that you can have. They're gonna phase out fossil fuel heating by the year 2030. You won't be able to buy a gas furnace and install it. There's been also motions in New York State, parts of Canada that are starting to phase this out. The Department of Energy also has what they call a contest to come up with a low temperature heat pump, and that's been led by the state of Minnesota. I think the word is getting out to consumers. Heat pumps are not new. Heat pumps have been around since the mid-1950s. It's just that it's taken a while for these things to really catch on, for the technology to be able to provide a comfort heating situation for the consumer. What we're seeing is the frost line, if you will, used to be the end of where you could sell a heat pump, and now we're seeing that extending up into Pennsylvania, New Jersey, and even Massachusetts. The science of these heat pumps is improving. They're doing more things, dealing with more extreme temperatures than the old ones used to. I was gonna say that also probably 10 years ago, ductless was a fraction, a much smaller fraction of the market than it is now. Most every ductless residential unit are heat pumps. If it's Mitsubishi or someone like that selling 20 SEER ductless systems, you know, 95% of those are heat pumps. Great. Thank you. Once again, if you would like to ask a question, please press star then one. Our next question will come from Steve Tusa of J.P. Morgan. Please go ahead. Morning, Steve. Hey, guys. How you doing? Great. Good. Just on the forward look here, I guess just the forward look here, do you expect the fourth quarter to be kinda like normal seasonality for you guys on an EPS and sales basis, just from a, I guess, that would be sell through? I mean, you know, you said it's up in October, how good is it in October? Just how should we be thinking about the fourth quarter trend? I'll give you a general comment. I think fourth quarter is gonna be very strong. Barry, details? Yes, Steve, I mean, the same kind of double digit. As much as you can. Yeah. Yeah. I mean, you've seen double-digit growth over the last two quarters, and October, you know, there was no interruption in the double-digit trend. I kind of leave it at that. I think it is a shoulder season as we get into off-season. It's can be a bit more consumer-oriented in the sense of that we also are seeing the very strong commercial volumes flowing through the business. Net, Yeah, good point. Net. Yeah. Yeah. Net, net it looks a lot like the trends of recent months. I guess with all the crosscurrents around, you know, demand, the regulatory changes coming up, and, you know, I guess, your focus on, you know, destocking some, like, what's the inventory trend into 4Q? There's just a lot of moving parts here 'cause it is a shoulder season. I mean, is that gonna be kind of up, you know, quarter to quarter in preparation of next year? You know, like, just maybe just a little color on the inventory. Well, that's a good question. I don't think they're gonna be higher, they're gonna be lower. Anybody fill in the blanks on that? Yeah. Of course our goal is to end up lower. A lot of it's gonna depend on, once again, on the supply chain as far as, you know, how quickly we can restock with the new M1 product, or is the majority of that gonna fall in Q1? Obviously, that's a higher priced product than what we currently have. We're also seeing strong demand as a lot of the on the new construction side, a lot of these builders have to have the system operating under the old standard. They have to have the system operating in the home, the new home that they're building before year end. We're seeing a little bit of a rush, you know, from that sort of standpoint. I think we're gonna be down. Our plan is to be down, and we're working. We've got an inventory management system that allows us to have complete visibility of it, so we're not surprised at the end of the quarter by where our inventories are. One. Let's just be careful of those words. We think our inventory is gonna be down, not our business. Yeah, yeah. That's what I said. Yeah. Yeah. Inventory as a percentage of sales, you know, down a little bit. I was just wondering from an absolute perspective. Barry, you mentioned these promotions or these rebates, I guess you call them. What's the expectation for that in Q4? Just any color on the gross margin in Q4. Again, the selling margin that I mentioned is, which is simply the price-cost equation of selling products, is we're seeing that, you know, continuing to trend better in October. Let's you know say it that way. Again, I don't think there should be any real disruption in the fourth quarter in that respect. The other stuff, again, it's algebra on when we order products, when we receive them, when we pay for them, depending on which product line. I think there could be a small measure of irritation, just knowing the inventory is coming down, but not to the same extent as what we saw in the third quarter. net-net, I think, you know, nothing disruptive in terms of trend of gross profit in the fourth quarter. Sorry, one last one for you. What's your market call on next year? What's your most up-to-date? You didn't have anything in the release this time around, kind of the market outlook. What's your guess on the market for next year for resi units? I don't think we- Guess on the overall market? Yeah, overall resi unit market. Up, down, sideways. I don't think that we unless you have industry forecast by the associations, maybe, Paul, do you? No, I think, you know, you'd have to talk to, you know, the OEMs who look at it on a national basis. Our forecast, that we do internally, which is our proprietary system, is only for the states in which we do business. Plus we're- You know, I would look to the industry for that. Okay, great. Nevertheless, our planning is for another record year. Yeah, growth. You guys are planning to grow no matter what. Oh, yes. Yes. Yeah. Okay. We've- All right. We've got too many advantages that are gonna continue to expand our share in this business. We're gonna extend and invest more in those advantages. Yep, that's clear. Thanks, guys. All right. This concludes our question and answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks. Well, thanks for your interest in our company. We appreciate it very much, and we welcome visitors to hear our more detailed explanation of the technology, which is obviously an important part of our future. Come to Miami or do a Zoom or whatever it takes just to learn more. We're happy to do that for you. Once again, have a nice day and see you the next quarter. Bye-bye. The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.