Good day, and welcome to the Watsco third quarter 2023 earnings conference call. All participants will be in a 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 a touch-tone phone. 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 Al Nahmad, CEO. Please go ahead. Good morning, everyone. Welcome to our third quarter earnings call, and this is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, President, and Paul Johnston, Barry Logan, and Rick Gomez. Before we start, our normal cautionary statement, this conference call is 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. Watsco delivered a record quarter, which is all the more rewarding given that record performance achieved in the third quarter last year. Third quarter last year was a barn burner, and so I'm so happy we're able to beat that. Sales grew 4%, driven by 6% increase in HVAC equipment. Residential unit volumes steadily improved throughout the quarter, and price realization continues to be strong. Commercial end markets also remain very healthy. As a reminder, we have navigated through an immense product transition in 2023, following the step-up minimum efficiency standards mandated across the United States by the U.S. federal government. Approximately 60% of the HVAC systems we are now selling represent new products. Let me repeat that. 60% of the systems we're selling are new products. Thousands of customers have been trained. Our digital product library has been updated, adding over 400,000 new SKUs since the start of the year. As mentioned in our second quarter call, one of our primary OEM partners was disproportionately impacted by the product transition, affecting product availability during the summer selling season. That impact diminished during the third quarter, and I'm happy to share that our locations are now fully stocked. Sales growth has returned to the affected stores, and our partner is aggressively investing and collaborating with us to drive growth. But the reality is that all our OEM partners were affected to some measure, and all have improved the supply chain to help us meet the needs of our customers. Here are some other highlights: Our commercial business continued to grow at a healthy double-digit rates this quarter, and our backlog of projects extend into next year. Sales of ductless systems, an increasingly important component of our business, also grew double-digit during the quarter. We saw the continued trend of gas furnaces converting toward heat pumps, which sell at higher average selling prices. SG&A, as a percentage of sales, decreased 80 basis points this quarter. A good start to what we feel is an important opportunity to improve productivity and overall efficiency. We are optimistic about driving more operating efficiencies across our network as supply chains improve and operating conditions return to normalcy. We have the tools, the technology, and most importantly, the entrepreneurial culture to achieve more, particularly as it relates to our internal productivity. We are focused on internal productivity. Of course, our balance sheet remains strong, with a small amount of debt offset by cash. In other words, no debt. As always, the financial position improves. The financial position provides us the flexibility to invest in virtually any opportunity as we continue to grow our scale in a very fragmented $50 billion+ North American market. M&A remains an important contributor to growth. This quarter, a great family business joined our family with the acquisition of Gateway Supply in South Carolina. I, I've spoken to the principals, and you couldn't ask for higher quality people. Gateway is a legendary company in its Sun Belt markets and provides us with the ability to partner with great leadership to grow beyond their current $180 million sales run rate. We continue to look for more entrepreneurs and businesses to partner with. Watsco is a great home for entrepreneurs in our space. We sustain cultures, invest in people, and provide technology to secure and build on their great legacies. Looking beyond the short term, our press release provides critical details to support Watsco's long-term growth strategy. We have an immense technology advantage, and we are investing to grow that advantage. Our mobile platforms and e-commerce channels have increased customer engagement, reduced attrition, created market share gains, and supported our margin expansion in recent years. Watsco's broad array of products and brand is a competitive advantage that allows us to serve contractors in any environment. We have a leading market share in Sun Belt markets that provide stability and higher growth rates over time. We have also made important technology investments with our business that will support margins and productivity in the years to come. In addition, there are several important regulatory and industry catalysts that are in effect, which are listed in today's press release. All of these catalysts will be good for the industry in the coming years, and we believe our scale, technology, and financial strength position us to especially benefit from these opportunities. 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 touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Tommy Moll with Stephens. Please go ahead. Morning, Tommy. Morning, Al. Appreciate you taking my questions. Of course. I wanna start on the topic of gross margins. I don't imagine you'll get any more than a question or two on that today. But just to, just to start the conversation, what can you tell us about the, the drivers, headwinds, or tailwinds from your second quarter to your third quarter results? And then associated with those, if I look over the past few years, the, the margin rate tends to improve as you move into fourth quarter from third quarter. Is there any reason that should not be the case this year? Is there something else going on that you wanna make sure we're aware of? Well, I'm gonna turn that over to two persons, A.J., the President, and Barry Logan, our Chief Financial Officer. Good morning, Tommy. Yeah, we had a, we had a bet going. Would it be the first question would be on margins, or would it be every other question after that? Or the first 10? Right, exactly. So I'll let Rick and Barry get into the details, but I want to spend a second, minute here and abstract this a layer and talk about the big picture, and start with reminding you, everyone, what Barry usually reminds us of, is that there are many components to our gross margin. There's the transaction margins or, you know, what we make on an invoice-by-invoice basis or on a markup basis, if you will. There's cost changes that come from the 1,000 or 2,000 manufacturers that we buy product from. There's volatility in commodity items that we sell. There's internal pricing actions with our optimization tools that we're getting more fluent in. There are product delivery costs. There's product mix changes between commercial and residential equipment, supplies, et cetera. So, and there's action in all of these categories all the time. But what I wanna get across is a reminder that we're a long-term company, and quarter to quarter, there's gonna be noise and actions in all those categories, but we're focused on the signal. And as we've said, the long-term aspirational goal of margins is 30%, and we see that within reach, you know, in time, and let me tell you why. And really, it starts with what we talk about a lot, which is our technology, but we should really call our continuous improvement culture. You know, what the technology enables is our teams to be able to do analytics to spot opportunities, enhance our capabilities, measure and track our successes in all parts of our business. Things like prospecting and winning new customers, you know, and changing and improving how customers engage with us, with things like e-commerce and our apps, which eventually reduce our cost to serve those customers. We can increase with the tech or the continuous improvement, we're increasing our productivity levels in the warehouses. We spend, you know, a ton of money moving product in and out and through our network, and our fleet, and transportation, which is now another frontier, how we can use technology to improve what we're doing there. Optimizing our inventory, we've talked about a lot, and there will be meaningful gains there. Marketing and sales of the new systems, it goes on and on and on. But that continuous improvement culture, or what we, what we call technology, so it's that tool set to win in the marketplace and, and increase our, what we do, and margins will be part of that. You know, higher gross margins will be part of our DNA, and more importantly, we'll continue to grow profits and generate a lot of cash. But quarter to quarter, there will be noise, and I know that's very interesting to you all. Rick and Barry, and Paul can much more eloquently answer questions about the noise, but I wanted to make sure that big picture was communicated and a reminder that we're a long-term company, and long term, we expect to have not only strong gross margins, but continuous growth. So Barry, I don't know if you want to. Well said, as usual. Yeah. Yeah. Barry, I don't know if you want to jump in and talk, you know, answer a specific question, but I wanted just to have that underlying the conversation here. I think that was well done. And Rick, too. You both can jump in wherever you want. You know, first, I think there's two things to analyze, right? There's year-over-year margins, and we're talking about a 90-day period, and that's okay. We have to address it. But I wouldn't get in this box of thinking that every 90-day period is like a new conversation. It's not. It's a continuous process, as A.J. suggested. But if I go ahead and put myself in the box and talk about it, you know, obviously, our equipment business grew nicely this quarter. Our non-equipment business did not, and, you know, that's in the press release, 6% growth in HVAC equipment, 4% decline in other HVAC. There's a margin difference between the two in that mix, and mix is about 30 basis points year-over-year in terms of just pure impact of margin. So if the question beyond that is what happened to non-equipment, that's where our commodities reside. 6% of Watsco is refrigerant, copper tubing, and sheet metal products. Deflation in those products in the quarter cost revenue. Pricing of those products has improved throughout the quarter and is more well established today than it was 90 days ago. So that's good news. But those are some algebraic considerations there. Also, obviously, our commercial business, somebody will ask later in the call, we're double digits. That would mean our residential business was single digits. There's a few basis points of margin there if you look at, if you, again, stay in the box of year-over-year change in gross profit margin. If sequentially, which is your question, Tommy, if I finally get to your question. Sequentially, we talked about last quarter having OEM pricing actions that took effect in March, benefited the margin in the second quarter. And you know, that's a nice, again, algebraic benefit to that quarter's performance. Sequentially, no such thing occurred, and that's the noise that A.J. is referring to, is you just can't get trapped in 90-day periods and try to gain inferences over a long period of time. So if I kind of wrap it up, and Rick, maybe you have more, but, the concept of let's look at the last 12 months, you know, being 27 and change, that's very consistent with what we've been saying. And to add to that, in the future, where the aspiration is 30%, the other credibility in that is we have business units within our portfolio of business units that approach that number today. And we certainly have locations that are in excess of that today. So when we talk about continuous improvement or we're looking out to a horizon, you know, that's, that's the perspective. Rick, I don't know if there's anything. We're gonna talk about this all day, Rick and I, but. Yeah. Are you bored, Rick? I can't expand on it. I would just add a data point, Tommy, that, you know, when you look at the year-to-date margin picture, right, let's take a more medium-term perspective on it. It's almost rounding errors compared to last year, and I think that's an achievement on our part, given the unit environment we've been in and given the relative lack of price that's been in the market this year relative to last year. To say that there's only a, you know, a 20 basis point difference, I call that a good outcome. Thank you all. I'll pivot to a forward-looking conversation here and hope that we could advance the conversation around potential revenue impact next year and into 2025 from the coming refrigerant regulations. The OEMs have certainly been more vocal here. We've heard that the impact could be as much as 15%-20% cumulative price over the next couple of years. And so my question for you is: does that sound like a reasonable range? And if you unpack the dynamics here, what do you expect to see in terms of impact from the pricing on the new equipment? And what are you seeing now, or what do you think you might see on the existing equipment configured for R-410A, where there will be a big curtailment of supply as you head into next year? So let me call on Paul Johnston for that. Wow. I give you all the hard ones, Paul. Yeah, the easy, easy question here. You know, I think, what? Two of the OEMs have announced that they think it's gonna be in the 10%-15% range. We'll just have to, you know, see what they, what movement that they have on that. There are gonna be higher costs in the new product, and obviously, those are gonna be reflected in higher prices. I think as we move into next year, we're gonna find out more and more about, you know, what the regulations actually are state, and what the regulations allow, you know, going forward into 2025, as far as the curtailment of 410A equipment. I think that's really the open question that we have right now. Obviously, at some point, we're gonna be 100% 454 or 32A refrigerant, which are going to have higher prices because they are slightly flammable. There have to be safety devices on the units. It is gonna increase the price of the products. There's no doubt about it. I'm not gonna give you a forecast of what I think it's going to be, but it will be higher than what we're seeing right now with the new higher efficiency products that we introduced this year. Just on the existing equipment configured for R-410A, are you seeing anything or hearing anything or expecting anything as you move into next year, where the refrigerant itself i s likely more expensive and what that could mean for overall equipment pricing there? I think there's gonna be some increases. There have been increases here recently in the last couple of weeks on R-410A. It's a matter of what the refrigerant manufacturers are going to handle their new allocations. Their allocations for GWP products were reduced by 30% for next year. And so they're gonna have to come up with their formulas internally that would determine, you know, how much 410A they can afford to make versus some of the other lower GWP products, you know, given their allocations. And then secondly, you know, we get into the long-term issue. We've got another 30% reduction coming in 2029. Right. When that occurs, I think you're gonna really see a crunch, if you will. But right now, we're just trying to ferret out exactly what the regulations, how they impact the OEMs, how they impact the service level for the contractors that we work with, and you know, what's gonna be the long tail or short tail of existing 410 equipment in the market. Thank you, all. I appreciate the insight, and we'll turn it back. The next question. Next question? Comes from Brett Linzey, from Mizuho. Please go ahead. Hey, good morning. Yeah, yes, so just the first question regarding HVAC equipment growth, a nice snapback of 6% in the third quarter. Do you think there's a little bit of catch-up from some of the OEM issues you had in the second quarter? And then any comments just on underlying replacement activity, you know, it does continue to show some resilience here, but just curious if there's any, you know, cracks in terms of, you know, ticket size, et cetera. This is Paul again. Yeah, I don't think really we saw any real change in dynamics as it relates to the replacement market. The replacement market remained healthy and strong. A lot of conversation, a lot of debate going on. Are we moving to a repair versus a replace type of market? Our indications are slightly, you know, we're seeing a slight uptick in parts, which shows up in our numbers as far as compressor sales, motor sales, those types of things that would be a repair item. Really, too early in the game, and it's, you know, and we're not really seeing any real trends yet. But I think the consumer, you know, is replacing the equipment with a higher efficiency product, and, and, we're all happy for the consumer. Yep, great. And then maybe just one on price. So you've been talking about the price optimization software and some of the deployment across the organization. I'm just curious how you think about price capture above sort of normal course of business, you know, as you think about some of the surgical opportunities on price and various SKUs across the, you know, the line card there. I mean, I'll handle some of that. Yeah, go ahead, Barry. Yeah, I mean, first, I just wanna say this, that in our, w hen we say 60% of our equipment products are new products, that's obviously a huge inventory conversion. It's also a pricing and margin execution process. Everything is new. Everything has a new price. Everything had to be prosecuted in the market with our customers. And so, you know, this year, for example, 8% is the price increase achieved on our residential products. This quarter and year-to-date is about the same, so it's consistent, you know, through the year. By the way, units this quarter were down 4%. Obviously, last quarter was down double digits. And if I account for one less selling day this quarter and, you know, look at, start to look at things a little bit pro forma, you know, the quarter's units were near flat, if I look at it that way. So price and units, you know, are combining to help business. And, you know, that's just the equipment business. A.J., you were gonna talk about the broader picture, though. Yeah, I, I just, you know, we talk about the pricing optimization a lot, and it's not one thing. It is hundreds of opportunities across every product we sell to every customer in every location. So just that one maybe small example would be if you say, everybody sells the same, meaning all of our business units, just in the Florida market or Miami market, sell a Honeywell 1, 2, 3, A,B,C thermostat, and maybe there's 3,000 customers that bought that thermostat in the last six months. Well, it probably is at three different, 3,000 different prices, and there's wide variation in that sale price. Well, now with this tool, for example, what we can do is understand all those sales price, those sale prices of that same thermostat in the same market, and we can do some rationalization and some floor setting and some, you know, making sure that the, the right customer, meaning larger customers, are getting a more appropriate price, and smaller customers who haven't earned a lower price, are getting a price that's right for them. And that's, you know, if you do that one on that micro level, but you multiply it times hundreds and hundreds of opportunities, that's part of the effort that's going on now, and it helps. It's gonna help drive margins, and it's gonna help, in fact, sell more product, because it's not always about raising price. It's about getting the price right so that customers find it attractive and want to purchase the product from us as well. Got it. Appreciate the insight. The next question comes from Dave Manthey with Baird. Please go ahead. Hi. Morning, Dave. Thank you. Good morning, Al. In the press release, you noted potential for additional productivity gains as operational complexities abate, and I'm just wondering if you can outline the key remaining complexities that would represent the biggest opportunity over the next six to 12 months? That's an interesting question. Who wants to deal with that? It's Rick. Yeah, Rick. Sure. Hi, Dave. Good morning. Morning. Yeah, I mean, I don't think I'm overstating it by saying it's been the Wild West out in the field the last couple of years, and, you know, all of that supply chain imbalance weighs on that same store productivity equation. And so what you've seen the last few quarters is, you know, variable SG&A reacting to a different end market. But more importantly, what we've been working on the last year or so is a lot of energy into understanding our own internal productivity, and we've armed our leaders with real-time data that should help drive this in the field. They know this is a priority, and they're responding. But that, you know, this productivity journey that we're on is gonna take some time. It encompasses a huge number of things. It starts with how we order and receive product from, you know, 2,000 suppliers. And you know, we talk about supply chains getting better, but they're not better everywhere just yet. Commercial is one example, and you know, you asked you know, where are the pain points still? That is still a pain point in the supply chain, is commercial and high-efficiency product. But it starts with how we receive product from over 2,000 suppliers. It impacts the real estate footprint, how we fulfill orders in the warehouse, and finally, how we deliver product to customers. That's really the, what this productivity effort encompasses. It's a lot of things really, from the very beginning to the very end of our processes. And so we're starting to see progress, but there's a lot more to do. I think, you know, big picture, two thoughts. I'll leave you with two thoughts. One is that I think our growing scale naturally enables more efficiency, right? As a $7 billion company, we have more opportunity to be more efficient than we did as a company half our size four years ago. And secondly, you know, we possess the technology and the tools to drive this productivity throughout our network. And you'll note in the press release that we talked about what some of those internal investments have been in the pricing technology that A.J. just talked about, the warehouse management and order fulfillment technology, some interesting work going on around logistics and our network. And so over time, that will bear some fruit in productivity, and that will, we're starting to see the benefits of that today in, in not just variable SG&A reacting, but fixed SG&A reacting as well. Yeah. Thanks, Rick. I'll double-click on the. Sure. The last one, the logistics and transportation delivery. That, that is the third biggest expense for the company. About $200 million we spend moving product in and through and around our network and delivering products to customers. And I call it our next frontier of opportunity for continuous improvement. I think there's about 800 trucks in the fleet today, but there are now, with the data, the data being exposed and smart people taking smart actions, we're realizing that some of those trucks are sitting idle for 90% of the day. Does it make sense to have that truck or maybe use a different means of transportation to get product from point A to point B? Or can our business units share trucks? Or is there a more efficient route to deliver the product in? So all those questions now about the millions of times that we're moving products around our network, in and out and through to customers are. It's open season on that effort, and it's a big bucket, so we're gonna move a needle on a big bucket. Okay. Thank you for that detail. Second, could you give us your take on Governor DeSantis rejecting IRA funds? We do not. Well. We do not express politically. Yeah, no, we're not going to talk about that. Next question. The next question comes from Nigel Coe with Wolfe Research. Please go ahead. Morning, Nigel. Thanks. Oh, hi, guys. Thanks for the question. So inventory, can we talk about where we stand right now, you know, Al, on inventory? I think you've said, in previous calls, maybe $200 million of reduction for the full year. Are we still on that track? Well, that's a good question, and I'll turn it over to the executive that's taking care of that for me. Go ahead, Paul. All righty. Yes, we can expect that. We've been de-layering our inventory now since the season ended, and we're seeing great progress. We've set goals for each one of our operating units. We track them daily with our ability to identify, you know, what we have on order and what our sales through is, sales output is, and we're seeing definite reductions, you know, month-over-month, day-over-day. Okay, so that implies fourth quarter should be a big source of funds from inventory. That's the way to read that? It better be. Okay, I would not wanna be pigeonholed into that. We. No. You know, we're not, give you that kind of. Okay. No, that's fine. Confidence. I think just directionally was the question. Yeah. Yeah, we're very focused on it. Don't forget that during the, this, all these delivery issues, that we had to do things that we normally don't do. The producers couldn't ship it, you know, partial the order and that sort of thing, and that takes a while to get that inventory that we have to be what it should be in terms of complete systems and that sort of thing. But, we're working, very focused, and yes, I do plan to take out that kind of number, and improve our cash flow along with it. Okay. That's great. And my follow-up question is around, you know, the R-410A phaseout. I mean, I think the EPA, the way the rule is written right now, I think it's an installation deadline, you know, as of January 1, 2025, as opposed to a production deadline. So how are you guys thinking about that in terms of managing R-410A inventory levels? And how do you think the R-454B availability will come through next year? Are you asking about the? Yeah. Yeah. I'm sorry, Paul. That's your. Are you asking about the new EPA? Yeah, I think it's about the new, yeah. Yeah, it came out last Friday night. Yeah. Everybody's still, you know, working their way through it. You know, basically, what it provide, provided was that the outdoor unit becomes a component, and hence, can be replaced as a repair item or a system, that you can't install systems, you know, indoor and outdoor units, but you can, you can repair the unit by putting in an outdoor unit. And that's got a, that's got a lot of ramifications, which I don't know if it really have been thought all the way through by the people who wrote it up. You know, for instance, how can you make sure that the coil on the inside matches the outdoor unit, which is only gonna be the higher efficiency product? So if you're putting in a 15.3 outdoor unit, you know, with a 13 or 14 SEER indoor unit, you're not gonna get the, the efficiency that you're paying for, for the outdoor unit. And then secondly, you know, I think we're looking at, you know, a difference from when we went through the transition between R-22 and 410A. This one is different. This. It's different in the regard that, there's no replacement for R-410A. There were other replacements that you could drop in that would replace the R-22 that aren't gonna be available with the new product. Also, you know, a lot of questions that I think we need to ask our, you know, OEMs, and OEMs will have to answer the question, you know, what's gonna happen to the price of the 410 units? Because obviously the production will be lower from the OEM. Will that raise the price of the product? What's gonna happen to the availability of 410A to make the repair costs, so the repair costs will be, acceptable to the consumer? What happens to the, you know, 30%-40% of the installed base, which is still operating on R-22, where you can't change out the outdoor unit with a 410A unit? So there's, I've got a lot of questions. I guess I don't have a lot of answers for you. Yeah. But, you know, those are things that we're thinking of, and we're working with our OEMs and working with the, the refrigerant manufacturers to try to figure out how all this is gonna play out in not only 2024, but also in 2025, when we do the actual rollout. Thanks. Look, you actually have more questions than I did, but sounds like a little bit too early to have a view, but I appreciate the context. Thanks a lot, guys. The next question comes from Ryan Merkel with William Blair. Please go ahead. Morning, Ryan. Morning. Hey, morning. Morning, everyone. Nice quarter. So. Thanks. I wanted to ask about demand trends through the quarter and maybe even to October. Just given the fears out there about consumer spending starting to decline, just update us on what you saw through the quarter and into October. Barry? Hi, Ryan. Yeah, I mean, very consistent, I would say, throughout the quarter. And quarter ended. If I looked at September, for example, just to say it that way, you know, looks like the rest of the quarter, so pretty consistent, throughout. October is only a few business days, and it's our biggest month of the fourth quarter last year, so not quite the same answer, but all of our field checks, talking to our people, see a good fourth quarter. Okay. That's helpful. And then I had a high-level question, too, that's probably hard to answer, but we all, you know, see the price increases coming 15%-20%, and then obviously there's been a lot of price increases on equipment the last few years. How do you guys think about sort of the impact to the consumer? Are they gonna be able to afford these systems? Is financing gonna need to be a bigger part of the HVAC industry? You know, how much worry do you have that there will be more sort of repair versus replace? Well, that's an interesting, w e think about things like that. As you may or may not know, we now have a financing platform ourselves, and it's probably, when we speak, consider it the most user-friendly platform that exists for a customer to find the loan that he wants to finance it. So anybody want to take a shot at the more sophisticated answer? Yeah, it's you know, there is a concern, you know, there's an elasticity issue here, where we're going to reach a point where the consumer can't afford it. I don't, I still feel like this is a necessity of life, that people have to have heat, have to have cool. Also, we're seeing a lot more interest. Obviously, we really haven't felt the impact of 25C as far as the tax credits coming into effect for the higher income people. The rebate programs that hopefully will start being maybe the second or third quarter of 2024 should start kicking in to help support, at least with an $8,000 rebate to the medium and low income consumer to be able to replace their unit and their system. But the consumer so far has been fairly resilient as far as, you know, taking care of what I would consider to be an absolute need for life, if you will. Also, we're starting to see a lot more activity around what utilities are doing, what states are doing, in the area of the weatherization programs and that type of thing. So, maybe that's a little bit of Pollyanna, but I think, you know, going forward, the consumer is gonna have to figure out, you know, which programs work out best for them so that they can do a replacement. And with the. Yeah, I think. Financing, and the financing is gonna help also. Yeah, I think affordability has always been a question, and yet, you know, the industry's grown 3.5%, compounded for 30 years, and things are obviously always more expensive over time, given all the regulatory things. So I would just, you know, point to that as a long-term reality of it. But Ryan, if I give you a, an interesting answer, I just recently, you know, took out a system in my home. $6,200 was the bill. Contractor did it in a day. E xpected to be paid that day. And I was curious, I went back and looked at our cost to him, meaning our revenues. What did Watsco sell that guy in my $6,200, you know, installation? And the answer was around $2,900. So there's a layer. My point is, there's a layer in this, called the contractor, that's also a very important layer of both profit and cost and consumer price and so on. If our cost of goods went up 10% because of regulatory matters, that's, you know, $270. That's something the contractor would have to decide how to pass that on or what to do about it. But there's this entrepreneurial thing, and then it's really doing a lot of the work, called a contractor. Not just Carrier, not just Watsco, but contractor. And that's where all these tools we're talking about, how do we help the contractor sell products? How do we help them grow their business? How do we help them digitize their business? How do we help them improve their business processes? How do we cater to that clientele that's growing at a much faster rate and build on it? So this whole idea of, of how we're approaching the contractor gets beyond just, you know, the economics of, of a price increase. It really is a much bigger picture that we're after. Yeah, makes sense. All right. Thank you for the color. I'll pass i t on. The next question comes from Jeff Hammond with KeyBanc. Please go ahead. Morning, Jeff. Hey, guys. Morning. Just want to come back to this regulatory issue. I know, you know, there's a lot of uncertainty, but, like, is your expectation that, you know, this split system kind of needing to be installed, kind of sticks? And, you know, if that's the case, just how do you think about, you know, transition timing? Are the OEMs gonna be ready to kind of start getting a new product? You know, this kind of brings in kind of inventory obsolescence. Just maybe talk a little bit more about that. I think, you know, all of our OEMs are geared up to have the new product, and hopefully we can start introducing product in the second and third quarter of next year, the new product. So I really don't have a lot of concern that they're not gonna be ready. They will be ready. And then on the 410 transition, your guess is as good as mine. If they allow this to continue the way it's unfolding right now, or has been written up in the latest blurb we got from the EPA, that means 410A units will be available indefinitely until we run out of the ability to supply them with 410A. But I think that's not a good move for the consumer. The consumer would be much better off, with the longer warranty period, as well as, having a new machine that actually is operating to specs and improve their overall efficiency in their home. So it's a guess as far as whether or not the EPA is gonna continue on this path, or are they gonna change their path or modify it in some way? We don't know. It seems like the R-22 dry ship over again, but we'll see. It is. But as I indicated, that it was different that time because you had all these drop-ins available, and the consumer could rely that they were gonna have a unit that would be serviced, you know, for the 10- or 12- or 14-year lifespan of the product. We don't have that certainty this time. Yeah, that's another one of those questions added to the list of questions, you know, what does warranty look like on our R-410A products moving forward when five to 10 years out, five to 10 years from now, they may not even be serviceable? Yeah, and then just on this 30% gross margin target, I mean, I think you put it out there maybe a quarter or two ago. Just level set us on, you know, or, you know, as you think about the path from, you know, 2027 to 2030, you know, what you think the biggest buckets of opportunity to kind of get there over time? Thanks. I'm gonna answer that. We have a lot of buckets of opportunity, and we'll just have to take one at a time and see how we get there. But we have folk, we have ambition and the knowledge and the financial capability to achieve, and at some point in time, our goal. That's our confidence level. Yeah. I'd say there's not a silver bullet or two silver bullets. It's hundreds of small opportunities that add up to a lot. But now we have the tools and the teams and the drive and the focus, and we'll get there. All right. Great, guys. Thanks. The next question comes from Damian Karas with UBS. Please go ahead. Morning, Damian. Hey, good morning, Al. So maybe I'll throw you guys a real curveball here and ask a more strategic question. With the Gateway deal, you're sort of stepping up into the plumbing space. So maybe you could talk a little bit about the deal rationale and, and how you're thinking about that market opportunity. And just kind of comparing, you know, say, the water heater, and the HVAC market. You know, are there any notable differences in the distribution model and, and financial profile? Well, we don't want to provide publicly our thinking about things like that. Let's say that we do believe that heat pump water heaters will be a, have a substantial opportunity for us, and, we're thinking about how to take advantage of that. Okay, I appreciate that. Would you be able to give us a sense for kind of where Gateway's gross margins are coming into the business? I don't have that. Do you have it, Barry or Rick? I don't mind sharing it. Yeah, no, it, it wasn't dilutive, and it wasn't accretive, so that means it's very comparable. I think we have to take this opportunity to say how impressed we are with Chris Williams and his brothers and the team at Gateway. They have built a tremendous company over many years, and we're so proud and excited to have them as part of the family. It's an honor that they're with us now, and we're going to do great things together. Yeah, I would say that. I would, I would say it this way, too, that, you know, everyone on this call, you're in a community, and you, you know the legendary players and wonderful track records and so on. You know that within your industry. And with our, within our industry, Gateway is just one of those very special stories and, and companies. So, you know, the fun part is what happens next, though, which is: What can they do with kind of the keys to the kingdom in their hands? How can they grow? Where can they expand? What new things can they accomplish? What, a nd what ambitions did they have that were parked because of capital? Things like that. So it's a, you know, there are more, there are more special companies like this one. It's a very special company. Great. Appreciate all the color, guys. Best of luck. Thank you. The next question comes from Steve Volkmann with Jefferies. Please go ahead. Morning, Steve. Good morning, guys. Thanks for fitting me in. I don't think anybody's mentioned gross margins yet, so I wanted to ask about that. Oh, my goodness! Since we're at the end of the call, Barry, I appreciate you jumping into the short-term box with us against your will, but you didn't provide any thoughts about 4Q. Anything to call out in the fourth quarter that we should be aware of? Yeah, I just, my brain goes back to last year. Is there anything peculiar or interesting about last year in comparative? I don't know the answer. My instinct is, you know, a measure of consistency as we play out the year, with what you're seeing is I think, I don't think there are any big pricing actions going on in the market at this point. Paul, do you have any insight on that? No, not really. Yeah, yeah. I've got, you know, a little bit on the commodity side. I think we're going to start seeing some upticks in some of the commodities, but whether they'll kick in in the fourth quarter, I can't definitively say. Okay, great. And then I want, s orry, I, my real question is, I wanted to ask about this refrigerant transition, but from a different angle, because it feels like, I think, Al, you mentioned at the outset here that 60% is now new products. My guess is, you know, 12-18 months from now, it could be even more new products, just as we go through all these transitions. And I'm curious sort of how you guys feel like, like you're going to be able to manage that from two perspectives. One, SG&A, because I imagine there's going to be a lot of training, on the new products and, you know, how to replace old products and all that kind of stuff, and I'm curious how that impacts SG&A. And then also on the inventory side, my guess is that you may have to layer in a little extra inventory in 2024 as this transition kind of goes through. So just any early thoughts on how those two things might trend? Whatever those opportunities are in the future, we'll deal with them as we have in the prior changes that come to the industry. We're very good at it. We've never been better at it. So far as specifics go, anybody from the Watsco team wanna deal with them? Yeah, I think we've got some ideas on how we can handle it without having to really overlay inventory. You know, different ways of handling our logistics, our order plans, and, you know, how we utilize some of our DC attributes to accommodate the replacement of the 410A units. But early innings on that. I'll say this: I'm glad that we have the scale and the strength that we have, because we can do exactly what was just said, is deal with anything that comes with us in an efficient way and effective way, and we can use our resources as needed. It's gonna be presumably more difficult for smaller competitors of ours. They'll have a tougher time with the challenges, I would imagine. Great. I appreciate the color. Thanks. The next question comes from Steve Tusa with JP Morgan. Please go ahead. Hey, guys. Good morning. Hey, good morning. Hey. Can you just clarify again what you said in, about October? You said it was like a different comment or something. I didn't quite understand what the October comment was. Yeah, a bit lower growth rate, but again, if I look at a year ago, it was very strong this time of year, so I'm not gonna, I'm not gonna get too much of an inference out of it. If we look out the rest of the quarter, we're, we're seeing, you know, expected to derive growth. Okay, got it. Then I don't quite understand the comments. I mean, the refrigerant prices we've seen, which is kind of curious, are down double-digit year-over-year, which is kind of unusual going into you know a period where everybody has visibility on this wind-down. And I know everybody is very highly convinced that that price is going up. But from what we've heard in the channel, from the actual refrigerant suppliers themselves, they continue to say it's actually going down sequentially, and it's like now, you know, in the high single digits per pound type of area. Would you said you saw an uptick this week or something like that, or last couple weeks? Last. What are you guys seeing? Yeah, what are you guys seeing that maybe those guys aren't? We saw a definite, definite uptick, you know, and those are the guys that are selling it to us, so hopefully, they saw the same uptick. But yeah, we've seen an increase in the price of 410. We had. There was some dislocation where some people were taking inventory out earlier and were reducing price to be able to create some sort of sell- through, and when that ended, we started seeing the price come back the other way. Got it. So and then just the last one, Barry, the $2,900 equipment number that you mentioned in your instance, that's after like, obviously, like a 30%+ increase, you know, over the last few years. It, that just seems low. Is that, yeah, I don't know, is that for like a pool house or something like that? Like, maybe clarify what, b ecause, I mean, you've done pretty well for yourself over the years. I mean, that seems like a pretty low number. It is a one. What, what building on your estate, Barry? Right. That's right. That's right. It's a 1.5-ton home office system that sits, you know, s o it, it's a smaller tonnage system. It's not a 5-ton system, but the more important. Got it. Yeah. Is that a ductless? Is that a ductless system? No, it's a ducted system. Okay. Okay, all right. And that's. It is, it is an arm's length margin, for the record, when I purchase something from one of our subsidiaries. Yeah, it, something didn't quite add up there. And then just one last one. Have you actually seen the, I mean, these OEMs haven't even really come out with their new products. I mean, they've kind of perhaps given you a bit of a sneak preview on some of them, but like, have you actually seen the pricing yet for the. No. For the 454 products? No, we have not. So, how. They've not established the price yet for us. So if you guys are kind of saying that, you know, like, it sounds like there's some uncertainty here. I mean, I know the rule the EPA just went through last week, that is finalized, and in the Federal Register in a few weeks. But like, how can, how can they be so confident in kind of going out there and predicting what they're, what kind of price they're gonna actually capture over the next two years? Like, what's the disconnect there? You have to ask them. Yeah. Yeah. Okay, will do. Thanks, guys. The next question comes from Jeffrey Sprague, with Vertical Research. Please go ahead. Thank you. Good morning, Jeffrey. Good morning, everyone. Hey, how's everybody doing? Hey, a lot of good ground covered here, so let me just do two quick little cleanup ones. Barry, you gave us, you know, 8% price and down 4% on units, so consolidated revenues up 4%. Can you do the same on HVAC equipment and give us a little bit of detail on, within price, kind of what the price mix dynamic is there? No, that is residential equipment, those data points. Okay. Then our double digit growth in commercial brings the overall equipment growth rate up to 6%. Got it. And then on the, can you say anything on the mix, Barry? How much is kind of price, price versus mix? Boy, again, it's an infinite array of data in that answer. The 8% price is, boy, it's an infinite number of answers inside that 8%. It's more so—what it's most of is the new products having a higher cost and a higher price in the market than that composite a year ago. Yeah. And just back to the 60% of products being new. I would assume that is just mostly, you know, SEER change units. But could you, could you maybe address what percent of your volume is the new higher SEER product at this point? How much, you know, how much more do we have to go until we're 100% there? Maybe if, you know, if there's a difference between that 60% on, you know, new product, new SEER product versus other new product. Well, that's a solid question. Go ahead. Yeah, we can't replenish the old product, so it's no longer in production. So it's going to be pretty much at 100% at some point once the remaining product is sold through. Domestically, right? Yeah, domestically. Yeah. Just a reminder what changed, and this was a change from prior times, is the. It's not just a higher efficiency systems, you know, being mandated. The way efficiency was measured changed and kind of what would be called SEER2. And SEER2 changed the way a 17 SEER system is rated a year ago versus now, or a 16 SEER system is rated today versus a year ago. So when we talk about, you know, and then the matching air handlers that go with it and the matching components that go with it, that's the complexity. Yeah. That's the nuance, and that's why, as a composite, it's, you know, a higher price. But I guess your question is how mature is that within, you know, my. Yeah, I'm trying to think of, you know, how much, y eah, how much more mix effect do you have to come through for us to get to that 100%? You know, you're not quite there yet, right? Yeah. Yeah, the question is when does it annualize, so to speak? It would be obviously sometime probably early next year. Paul, does that make sense? Yeah, I would say early next year will be, will be pretty much all new equipment. Great. Thank you. I'll leave it there, guys. Much appreciated. As a reminder, if you wish to ask a question, please press star then one to enter the question queue. The next question comes from Joe Ahlersmeyer with Deutsche Bank. Please go ahead. Morning. Hey, everybody. How are you? Good, and you? I'm good. Just, I'll just like, kind of clean up with one more about the model here. A lot of great questions so far. A lot of mine have been taken. If I think through a lot of the considerations for the fourth quarter, Barry, kind of asking you to get back in the year-over-year box again here. But, you know, volume comps getting easier into November and December, you're starting to actually get probably even more SEER mix benefit because of the geography of how it rolled out. You know, there's probably some catch up from the weather in the third quarter, benefiting even into the fourth quarter, and then also the OEM logistics. So is it possible that we could be looking at, like, high single digit type revenue growth in the fourth quarter? Then just thinking about, you know, you said at the beginning of the year, you were targeting earnings growth. Looks like you're likely to get there. Just kind of wondering how much you might be able to grow EPS this year with just one quarter left. Is it, you know, 2%-3% or potentially something more? We don't have that in our history. We do not forecast because we're in a business that fluctuates considerably with weather, and that's been our tradition, and I don't know that we're gonna change it. Barry, if you can help him with that, changing that. No, I was gonna say, we'll give you our thoughts and our educated, you know, close reaction to what's going on, but we're not gonna give guidance, and we're not gonna give, certainly not fourth quarter guidance, when, again, we're getting to a 90-day period and trying to crystallize something. So, and we've given you the trends. I think, again, it's, if you think about where we started this year, where unit volumes were down 10% or more, and the worry and the question was, will that get worse or better? It's gotten much better as the year's gone on in a short period of time. You have inventory flowing into the channel in earnest at this point. Our one vendor issue that hurt the first half of the year is now converting into a growth opportunity for the rest of the year. So just kind of leave it at that. And our focus has to also be looking into next year and 'cause you know we're the major partner for much of the OEMs that you can talk to. And growth and market share and expansion and more brands and more SKUs and new SKUs next year you know we start to look ahead and that that's pretty exciting. Fourth quarter we'll see. I wouldn't you know. All right, Barry. Okay. Anybody else? Okay. I appreciate that. Maybe just one more then, kind of related to the prior question about the SEER proportions. I noticed in the release in the second quarter, you talked about 60% of year-to-date sales representing the new equipment, and then now in the release, it's the same number, but you're talking about the number of SKUs at your locations. Just wondering if that was a intentional change and if that was intended to communicate anything there. That's a fair question, but I don't, m aybe somebody else can answer it, 'cause I'm not sure I understand it. Go ahead. Yeah, it's clarification that the inventory we actually carry in our stores, about 60% is new, and that's, that's the clarification. Versus a digital catalog, where it's a much, much, you know, broader set of products, what we actually carry in stores. And the point is, we emptied out 60% of what we sell a year ago into new products this year. It's an immense change and obviously also an immense opportunity and with, with what's going on. All right. Thanks a lot, guys. This concludes our question and answer session. I would like to turn the conference back over to Al Nahmad for any closing remarks. Once again, thanks so much for your interest in Watsco. We hope to continue to build this wonderful company and appreciate very much your interest. Bye-bye now. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.