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Executives

Albert Nahmad - CEO

Barry Logan - SVP

Paul Johnston - VP

Analysts

Matt Duncan - Stephens Inc

Jeff Hammond - KeyBanc Capital Markets

Curt Woodworth - JP Morgan

David Manthey - Robert W. Baird

Ian Zaffino - Oppenheimer & Company

Keith Hughes - SunTrust Robinson Humphrey

Michael Cox - Piper Jaffray

Jeffery Germanotta - William Blair & Company

Robert Maloney - Morgan Stanley

Watsco Inc. (WSO) Q4 2007 Earnings Call February 19, 2008 10:00 AM ET

Operator

Good morning. My name is Tina and I will be your conference operator today. At this time, I would like to welcome everyone to the 2007 Earnings Call. (Operator Instructions) I would now like to turn the conference over to Albert Nahmad, CEO of Watsco. Thank you. Mr. Nahmad, you may begin your conference.

Albert Nahmad

Good morning, everyone. Welcome to our conference call. As you said, this is Al Nahmad. I'm the CEO and today I also have Barry Logan, Senior Vice President and Paul Johnston, Vice President with me.

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

First highlights for 2007. 2007 is Watsco's third best year in our 60-year history from an earning perspective and by far our best year ever in terms of cash flow.

We generated record cash flow of $107 million, that’s $3.84 per share. In terms of financial performance, we considered 2007 a good year given the many challenging factors in the general economy and the fact that 2006 was a breakaway record year for us.

Importantly our revenues to the replacement market, both residential and commercial grew in 2007. We believe market share gains were achieved in 2007, especially in the replacement market, given the size and our density of our branch network, relative to our competition.

Gross profit showed improvements as the year closed and we are executing a number of initiatives to enhance profits and margins, which I will talk about later.

The team in ACR Group, our newest acquisition is strong and working well within our culture. We are very pleased with this very fine organization; I think I have said that before. We had good timing in terms of financing future growth. Last August we refinanced our credit facility, thus expanding our borrow capacity to $300 million from $100 million and obtained better pricing. Today's pricing is LIBOR plus 40 basis points or less than 4%, obviously to attractive cost of capital in today's environment. By the way that’s a five-year commitment.

We raised our quarterly dividend rate in July 2007 to $0.40 per share. We continue to believe that dividends are the best and most direct method to return cash to our shareholders.

Today, we announced a 12.5% increase to $0.45 per share, effective with April's dividend. This reflects confidence in our ability to perform and generate cash flow in the future.

Slowness in our markets is reflected in our fourth quarter performance as declines in residential new construction affected revenues. Remember that the fourth quarter and first quarter are seasonally low periods for the replacement market and therefore, new construction and the general economy can have a disproportionate impact on sales. This typically balances out as we move into the replacement season during the second quarter and third quarters.

We have generated record amounts of cash; working capital was reduced over $56 million during the quarter. Overall, we generated $71 million of cash during the last 90 days of the year. Inventories are in great shape and we are ready to take advantage of buying opportunities as we approach the season.

We are executing a number of initiatives to improve our efficiency and performance. We estimate $30 million to $40 million of opportunities have been identified and will be acted upon, affecting both gross profit dollars and SG&A costs and will enhance operating margins during the next several quarters. That's it for the highlights.

Now for the specifics on 2007 performance. Sales were $1.76 billion, including $121 million from new locations. On the same-store basis, sales decreased 7.6%. Sales of HVAC equipment and non-equipment HVAC products declined 5% and 11% respectively.

Our Refrigeration business continues to perform well up 10% for the year. Gross profit margin declined 40 basis points due to the reasons articulated in our press release. SG&A increased 4%, but was down 4% on the same-store basis that reflects the ACR transaction. Operating profit was $111 million and operating margins was 6.3%. On a same-store basis operating margin was 6.6%.

Earnings per share from continuing operations were $2.43 per diluted share and net income of $67 million versus $2.95 and net income of $82 million. As previously mentioned cash flow for the year was $107 million, our best ever and free cash flow was $111 million.

Debt ended the year at $54 million versus $40 million last year and that's after purchasing ACR our largest acquisition ever. We repurchased $9 million of the common stock during the year and have 1.2 million shares remaining under our repurchase program. Suffice to say, we continually evaluate use of capital including stock repurchase, but our first priority is investment in our business given our market share in the United States is just 8%.

Now the fourth quarter, sales increased 5% including new locations. On the same-store basis sales decreased 9%. Gross profit margins increased to 25.4% reflecting improved margins in both HVAC equipment and non-equipment and products. This is an important trend after some pressure earlier in the year. SG&A declined 1% on the same-store basis. Operating profit was $12 million with operating margins of 3%. On the same-store basis operating margin was 3.5%.

As we have discussed in the press release, new locations were diluted by $0.03 including losses for new branches that were opened during the last 12 months -- during the slow -- for the new branches during the slow -- during the slower selling season and finalization of purchase accounting for ACR.

Let me do that again. We discussed in the press release new locations were diluted by $0.03 including losses for new branches during the slow selling season and finalization of purchase accounting for ACR.

Earnings per share from continuing operations were $0.24 per diluted share and net income of $6.7 million versus $0.42 and net income of $11.5 million. Our outlook for 2008 is earnings per diluted share of $2.35 to $2.45 and that reflects our current thinking. Obviously you'll see start into the season, we'll have a much better fix on that.

With that said, Barry and I'll be happy to answer your questions.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Your first question comes from the line of Matt Duncan with Stephens Inc.

Matt Duncan - Stephens Inc

Good morning, Al and Barry.

Barry Logan

Good Morning and Paul I forgot to mention Paul.

Matt Duncan - Stephens Inc

Paul, how are you?

Paul Johnston

Very good.

Matt Duncan - Stephens Inc

Just a few question here first I'm trying to get a little bit better handle on the expense side of your business, and looking especially at the SG&A line here in the fourth quarter, those expenses were flat sequentially, and sales were down over 24% sticking with the normal seasonal pattern. Can you kind of help me think about why those SG&A sales would have been flat sequentially there?

Albert Nahmad

Well, I think you came upon up a good project. I think you are concluding that our performance wasn't that good. I think so stores sales were down -- SG&A were down 1%, and that's what's triggering lot of this new initiative. We had expected the market to return into second half of 2007 and it did not. So, therefore we're reacting now to be more efficient with our SG&A and gross profit dollars. And Barry do you want to add anything to that.

Barry Logan

Hi Matt, I just want to make sure you are also accounting for the fact that we owned ACR for the full fourth quarter and only partially in the third quarter.

Matt Duncan - Stephens Inc

Sure.

Barry Logan

So, analytically there may be some difference there as well. I mean the key number that is just a reference of what Al said, same-store sales in the fourth quarter were down 1%. If you look for the year they are up 4%. So, question is why didn't the fourth quarter behave like the rest of the year, again the seasonality of the fourth quarter, part of that is we didn't act fast enough.

Albert Nahmad

Given the SG&A Barry.

Barry Logan

SG&A that's correct. So, that's, where obviously there has been a lot of movement in cost going forward after the fourth quarter finish.

Matt Duncan - Stephens Inc

Sure. And on that point can you give us a little bit more detail about they are starting a $40 million in cost savings, exactly what you guys are looking at doing to cut some costs here?

Albert Nahmad

What I think it's better to tell you the process. We've five subsidiaries, and each one of them has a different solution to getting more efficient, and all the time I've been here, I've never seen a better led organization. The leaders of the subsidiaries plus their teams very motivated to improve the SG&A cost as well as improving gross profit dollars.

And they are too just many to enumerate. Each one has their own approach to it, which is what we like their local markets that we serve and we like them to find local solutions. But we feel based on what they have shown us and will be discussed. You feel pretty good about this and as I said, I feel never have been more confident about our management team in throughout the organization.

Matt Duncan - Stephens Inc

Great. And kind of over what period of time do you expect those cost cutting measures to have an impact.

Barry Logan

Another good question. I think you're going to see it quarter-by-quarter probably all the way through the, either the first quarter or first half of 2009.

Matt Duncan - Stephens Inc

Okay, fair enough. And then moving on, a couple of more things, and I'll get back in queue. Can you talk a little bit about the market you see for your placement sales? You mentioned that those were up year-over-year, and I'm curious about what you're seeing sort of a repair versus replacement dynamic? And then, also, I know in the fourth and first quarters of your year the discretionary spending is more important to your replacement business?

Albert Nahmad

Yes.

Matt Duncan - Stephens Inc

And talking about it, you've seen a pullback in discretionary spend by consumers on HVAC equipment?

Albert Nahmad

Paul, I'm going to get you into this.

Paul Johnston

Great. The repair versus replaced discussion I think has gone on for ever since we went into the 13 SEER. And I don't really know if there is a clear understanding, or a clear metric that we can point to that would identify whether or not people are repairing more or replacing equipment more or less.

The couple of things that I look at within our sales mix, which indicates to me that the market is robust and there is a good replacement market out there, and a strong replacement market out there. Two things, one I look at the percent of our sales that are going into 13 SEER plus range. And we've seen that continued to grow impressively during 2007, and we expect it to continue this year. It's up well over 40% year-over-year.

Another indication that I have that it's a strong market for us at least is, I look at our 410A equipment sales, and those virtually doubled last year year-over-year. And we're continuing to put a stronger emphasis on those products as we go forward.

Matt Duncan - Stephens Inc

And Paul remind us what the pricing differential is for 410A versus the other stuff?

Paul Johnston

The 410A pricing differential right now is probably in the 3% to 5% range. It's going to narrow, as we talked about sometime ago that it's going to narrow as we get closer to the 2010 deadline.

Matt Duncan - Stephens Inc

Okay. And then, last thing here guys, as we look at sales growth for 2008, you give an earnings guidance, and I'm curious if you can give us a little bit of commentary on sort of what your expectations are for organic revenue growth in 2008?

Albert Nahmad

Well, that's hard to say. In the first quarter you'll have more of the same, as we saw in the fourth quarter. But then I think with the normal weather patterns, we're going to have a good year in the replacement markets, which are the second and third quarter. But at this point, we're not providing any guidance, it's just too early.

March revenues are not even equal to January and February revenues combined. So, we don't have that visibility yet. What we're seeing in January and February is what we saw in the fourth quarter of '07, but March is a big month. So, we'd like to holdback on the guidance on revenues.

Matt Duncan - Stephens Inc

Okay, thanks guys.

Operator

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

Albert Nahmad

Jeff, how are you doing?

Jeff Hammond - KeyBanc Capital Markets

Hi, good morning guys.

Barry Logan

Hi, Jeff.

Jeff Hammond - KeyBanc Capital Markets

I just want to go back to the cost savings, is it fair to say kind of the low end of your guidance range, caps was $30 million and high caps was $40 million in savings?

Albert Nahmad

Barry?

Barry Logan

Jeff, no. I'd not apply everything to 2008 as Al suggested. First a good portion of the $30 million to $40 million is in the gross profit line. It's pricing, it's vendors, and it's vendor programs, it's inventory quality a whole list of and across many fronts in terms of our subsidiary.

So, obviously when I speak of gross profit and products and such it's got to go through an inventory cycle that has to flow through the numbers and that will happen over the course of next six months or so. The SG&A obviously is a more immediate impact, and also we'll begin more so in the second quarter. So, as Al suggested I think most of the savings will be second quarter and beyond and flow into first quarter, second quarter 2009 at the outside.

Jeff Hammond - KeyBanc Capital Markets

So, what do you think as a reasonable cost save on this programs for '08?

Barry Logan

There is again a couple of 100 moving pieces, and I'm not exaggerating to this Jeff. And I think at the end of the first quarter it will be more clear to us, and it can be more clearly communicated because really all of this has been implemented in the last 30 to 60 days.

Jeff Hammond - KeyBanc Capital Markets

Okay. And then finally, I mean is there if you look at the $30 to $40, I mean how much would be more, gross margin and take a little while versus the direct SG& A?

Albert Nahmad

And it's also typical to identify now, because there are so many moving pieces. But I want to say that most of this initiative is coming now. It did not occur 30 to 60 days ago. We're still in front of it. But I don't think we can separate from you how much is gross profit dollars and how much is SG&A.

They just each subsidiaries got their own unique strategy for their region and it's wonderful to see how they come up with about how to get more efficient. And then when we sit around the table with the five subsidiary leaderships they share a lot of these things. So, a lot of it is taken back through their organizations and then implemented, as they see fit. It's our decentralized culture but it's very healthy and I think we'd not be in a position to separate the two.

I just feel real good about it because these guys are really guys and girls, I don't want to forget that Carole Poindexter runs 250 locations, and they are just very motivated to improve it's efficiency and increase gross profit dollars.

Jeff Hammond - KeyBanc Capital Markets

Okay. And then changing gears, if you have done any or I mean, what is your sense as to why the other HVAC products the non-equipment outside the commercial refrigeration has been considerably changing?

Albert Nahmad

It's a great question. Yeah that's great question. And Paul

Paul Johnston

Alright

Albert Nahmad

Or Barry, it's a great question, and we've given that a lot of thought. So…..

Paul Johnston

Okay. I think there are a number of reasons some of which are obvious there has been some radical decline as you know a big decline in the price of copper, copper products tubing which dropped at non-equipment sales. But also some of our products and I'd call them some of the more minor product lines that we handle tend to have a fairly heavy concentration into the residential new construction, things like duct tape and to some extent mastic which isn't used in…

Albert Nahmad

Insulation.

Paul Johnston

Yeah insulation, which generally hasn't used in replacement job, but it's used in our residential new construction opportunity. So, I think part of it is, is that rational. Barry do you have anything else.

Barry Logan

Yeah I mean, it's quite simple. I mean no one virtually people either replace their duct work. So, you can imagine those products which is in that other category is weighted towards construction, where equipment clearly replacement market is driving a huge piece of that and no doubt, our largest part of our business is on the on the equipment side. So, it's a -- there is about 600 total line items in that other category, Jeff. Pricing has not been favorable and obviously new construction has been unfavorable as well.

Jeff Hammond - KeyBanc Capital Markets

Okay. Then final question; how are you thinking about accretion for ACR within your '08 numbers?

Barry Logan

Well, I think we said when we bought ACR what our general thinking was on accretion and that has not changed, Jeff coming into '08.

Jeff Hammond - KeyBanc Capital Markets

And is their business kind of weakened with the rest of the market just in turn or they proven more resilient or?

Barry Logan

It has weakened with the market, but they also have begun to take advantage of some of the Watsco programs, and so on to help profitability. So, the top line yes, the overall profit picture is consistent with what we've been discussing already.

Jeff Hammond - KeyBanc Capital Markets

Okay.

Albert Nahmad

I think it's been very good for us and will continue to be good for us.

Jeff Hammond - KeyBanc Capital Markets

Okay. Great, thanks guys.

Operator

Your next question comes from the line of Curt Woodworth with JP Morgan.

Albert Nahmad

Good morning, Curt.

Curt Woodworth - JP Morgan

Yeah. Good morning. In terms of getting back to the cost savings, and all the moving pieces, what is the transparency around that? I guess maybe to you Al. How are you going to track that and measure it?

Albert Nahmad

That's another good question, yeah.

Curt Woodworth - JPMorgan

And is it fair to say that, I mean, I guess, essentially you are going to need to have all those savings in place by the time of the spring selling season gets here?

Albert Nahmad

No. Not at all.

Curt Woodworth - JPMorgan

No.

Albert Nahmad

No. it's a program that goes on as I said through the first quarter of next year, or the second quarter. But the tracking process, each of the subsidiaries provided line item by line item as to how they were going to get more efficient, or produce more gross profit dollars. And those have line items and who is going to do it has been provided to our Chief Financial Officer as well as the rest of the team here.

And from time to time, we get updates on that and see how they are executing against the goal that they have set. And as I said if I didn't have a lot of confidence in the organizations, who came up with these solutions and that's why I have confidence in our -- on their tracking too because that they will execute. They themselves organize. The way they have monitored and to make sure that most if not all of these efficiencies and gross profit dollars are achieved.

Curt Woodworth - JP Morgan

So, you should have fairly good visibility over the next three to four months in terms of where you would stand with it or is that you really don't know until I guess at the end of the year?

Albert Nahmad

Well, I guess, we'll be reporting it by quarter-by-quarter. I think we should be able to do that.

Curt Woodworth - JP Morgan

Okay. And then in terms of the acquisition climate, maybe just speak to the sellers mentality, I mean, they have become more reluctant to sell given everyone in the industry is operating on?

Albert Nahmad

Yeah, it's a good question, but it's hard to generalize. I mean, this a very healthy industry. Distributors are particularly healthy and contractors. And they don't sell because what's going in the economy if they sell at all. They sell because something has happened to their personal needs, and where we've been in, and I think we'll continue to be the go-to buyer, because of the way we responsibly handle the organization post acquisition.

And so, I don't think the economy, or what's going on with interest rates, or anything affects us. It's just people sentiment about what the right time is. And I remain very convinced that we've such a great reputation. Some of the large companies that we won we'll eventuality get. I just can't predict when, but it's not related to the economy or interest rates. And certainly, we've the balance sheet in the, a lot of dry powder to do any size that we want to do.

Curt Woodworth - JP Morgan

Right. I mean, I think you've liquidity of $450 million or there about. So, and then in terms of maybe the buying back more stock or things like that does ever come a point of time you'll choose to do that or is it really you are going to be patient for the next however long it takes to get these large transactions?

Albert Nahmad

Well, our first goal is the large transaction, and building the network. I mean when you are only dealing with 8% share, and the way we compete is by building a high density of branches in good markets, which no one else does by the way on the scale that we do, and that's our number one competitive advantage. They have a lot of locations that makes it convenient to the contractor market leading for the contractor to do business with us than our competitors. I mean, we've got years of building to do that.

And in terms of stock purchase we've done some. We announced $9 million today. But it is not a high priority versus building of the network. And secondly, we believe the direct way to reward shareholders from this wonderful cash flow that's occurring is to pay increasing dividends. This is our sixth year of increasing dividends and I want to get to the list of 10 years, which I understand is a very small list of public corporations. And but this is our favorite way to do it. But that doesn't mean we don't first invest in a business and secondly occasionally buyback stock.

Curt Woodworth - JP Morgan

Great. And just maybe Barry, on the gross margin this quarter it was pretty strong despite the higher proportion of businesses going into the new construction channel. And do you think that the competitive pressures in terms of the pricing on the gross margin, some of the mix issues you talked about in terms of going into more of the value branch, does that lapse or give us a sense for how to think about that going forward?

Barry Logan

Well, first I'd say, I don't think the competitive pressure has changed at all. I think that the disciplines and the selling organization has done a good job, as the year went on and it showed up in the fourth quarter first. Secondly, we've mentioned each quarter this year, whether it been a running copper in '06 that provided a tremendous selling margin on a single product line that's 4% of sales, nonetheless it accounted for 25 basis points of dump in 06, and that ended as we guard in to the fourth quarter.

Curt Woodworth - JP Morgan

Okay.

Barry Logan

So, I think most of it is blocking and tackling occurred. I don't think there is any other analytical story. I think people are focused on it and it's something we've continued to see as we get into '08.

Curt Woodworth - JP Morgan

Okay. Great, thank you.

Operator

Your next question comes from the line of David Manthey with Robert W. Baird.

David Manthey - Robert W. Baird

Hi, guys good morning.

Albert Nahmad

Hi, David.

David Manthey - Robert W. Baird

Hi, could you talk about again on the $30 to $40 million in cost savings. I know, you have been reluctant to parcel what part of that is GP versus SG&A. But given that actions related to SG&A should be more identifiable and specific, I'm wondering, can you talk about are we talking severance or closures or what are the pieces we're talking about related to specifically the SG&A? And then is that a net number or there any cost that go in ahead of the savings?

Albert Nahmad

Barry

Barry Logan

None of this should be labeled as restructuring all this is labeled as again as blocking and tackling. There are branch closures, and more so, branch merging going on during the first quarter. There may be $0.02 or $0.03 of charge at most I think in the quarter, we'll see that. So, leave myself some room for that discussion that would be a first quarter discussion.

Beyond that there is no, mammoth set of charges or something like that. And these are in most cases fixed costs, where you think of facilities and the personnel that's in them, and the trucks that they operate, and that's the type of SG&A concepts that we were talking about are fixed cost related. Variable costs take care of themselves, they did in 2007. And now the teams have gone through the fixed cost and what I'd label discretionary costs and that's what….

Albert Nahmad

Freight is a good example. We're learning how to be more efficient with freight, and freight is a large piece of SG&A, and they negotiate new freight terms with carriers. They changed the way instead of having 100% owned trucks they just giving some of the ideas of top of my head and they'll use our freight carriers because the pricing now is more attractive. So, I mean, they just find different ways to get more efficient, David and it's across the board.

David Manthey - Robert W. Baird

Okay.

Albert Nahmad

But there is no restructuring I mean that is just getting more efficient.

Barry Logan

Lot of these things we talked about the vendor consolidations becoming more efficient with the inventories. Those are things that are attractive.

Albert Nahmad

I mean, but the truth is that we expected the second half of '07 to have positive comps versus '06, because '06, Dave as you remember, was where the industry fell off. And we didn't get it on an industry basis. So we're reacting to that maybe a little late, maybe we should have seen that the second half of '08 or '07 was it going to be as we thought it was. But we've now taken the steps to adjust for that.

David Manthey - Robert W. Baird

Okay. And then, if you could you talk about the finalization of purchased price allocation and what impact that had on this quarter?

Albert Nahmad

Sure. Yeah, go ahead Barry.

Barry Logan

Sure, Dave obviously it was a big project for us in the last 90 days to get the appraisals and everything done for ACR is about a one penny of charge in terms of catching up, and getting the intangibles properly allocated and amortized. The new branches including the cost of capital of new branches was about $0.02.

David Manthey - Robert W. Baird

Okay. And then finally on GP, I think in the past you've implied that it might be difficult to increase. I'm wondering, as you look out to 2008, what are the chances that we actually see declines in gross profit. I know you did a good job here in the fourth quarter. But…

Barry Logan

I'm feeling pretty good about gross profit margin. I think it's going to improve. I can't quantify it for you. I know some of the things that people are doing and our subsidiaries are doing I think it's going to improve.

David Manthey - Robert W. Baird

Okay, thanks.

Operator

Your next question comes from the line of Ian Zaffino with Oppenheimer & Co.

Albert Nahmad

Hi, Ian.

Ian Zaffino - Oppenheimer & Company

Hi, how are you doing? Most of my questions have been answered. But just to get a little bit more detail on the SG&A line as far as percentage of sales. It's come down, but on the nine months absolute base, it's gone up. How much of that's related to really ACR other things going on in the business. If you kind of give us some granularity there that would be helpful?

Albert Nahmad

Well, I'm not sure I'm quite there on your question. In terms of same-store SG&A, which is just trying to eliminate ACR and it's the material portion of when you say me locations.

Ian Zaffino - Oppenheimer & Company

Okay. Should the entire delta was ACR.

Albert Nahmad

I mean there are so many branches in there, but they are really not, the bigger number obviously is ACR. But the SG&A for the year is down 4% same-store sales, and we've about two quarters where we still have to kind of explain ACRs, SG&A in that. But it's not 4% versus the sales delta that's 7.6% that we want to squeeze that if we see sales pressure, we want to squeeze the delta so that we're generating earnings despite any kind of sales pressure that's a very short-term conversation, again because I think the replacement season will help that comparison as we get into the summer. But for now the focus is to have earnings have kind of whatever the top line is behaving, and that's why the fixed cost and some of the restructuring cost have been targeted.

Ian Zaffino - Oppenheimer & Company

Okay. And then just one another question here as far as the guidance into next year, I think it's essentially flat year-over-year. Assuming that the ACR deal is on pace the accretion there, and you are layering the cost cutting, does that mean the core business is going to be down in the $0.40 to $0.50 range, or I'm missing something there?

Albert Nahmad

I don't know where you come up with the $0.40, $0.50.

Ian Zaffino - Oppenheimer & Company

I'm just thinking if you said maybe $0.15 from ACR, and then your $30 million per share if I guess in another quarter or so the $0.40 at least?

Albert Nahmad

Well maybe I can give you more of a 50,000 feet view. All the visibility we've now is January and February, and that's more of the same as we had in the fourth quarter. We don't know better in March, because March heaviness is generally equal to January and February. This is our feeling now. Now, we're over conservative, but we don't know.

But this is the best we can do for now is to give you what we've got at this point and some of the plans that we've with our subsidiaries. I'd not speculate one way or the other doesn't mean anything like what you suggested. I think just give us some more time. January and February are some of the weakest months in revenue since in the whole year.

Ian Zaffino - Oppenheimer & Company

Okay, thank you very much.

Operator

You next question comes from the line of Keith Hughes with SunTrust.

Albert Nahmad

Good morning Keith.

Keith Hughes - SunTrust Robinson Humphrey

Thank you. Most of my questions also been answered. But you've spoken several times about how the demand in the, I guess the fourth quarter and the third quarter, surprised you on the downside, is it fair to say that you are assuming in the guidance and in your planning ,a weak HVAC environment for all of 2008?

Albert Nahmad

I wouldn't have said that. I'll say, we think the first quarter will be because if the quarter is not depending on replacements, replacements kick in the second quarter. But I can generally say my feeling about the year or any year, is that replacement demand is going to happen if the weather is normal. No matter what the economy is doing, or no matter what interest rates are doing or no matter what geopolitical things are? You have to keep to the cooling office going on in a 120 million homes, which have central air conditioning. So one way or the other I think replacement markets obviously going to be a good market.

But what happens in the fourth, and the first quarter the seasons over, and then you get more visibility into what's going on, and you know the new construction market and discretionary spending where it is, since it's not hot anymore, or it's not cold depending on what season, heating or cooling. Then there is no need to change out and replace your equipment.

Keith Hughes - SunTrust Robinson Humphrey

Alright, thanks.

Albert Nahmad

Does that make sense to you Keith, what I'm saying?

Keith Hughes - SunTrust Robinson Humphrey

No, I understand what you're saying. Thank you.

Albert Nahmad

Okay.

Operator

Your next question comes from the line of Michael Cox with Piper Jaffray.

Michael Cox - Piper Jaffray

Hi, good morning.

Albert Nahmad

Hi, Michael.

Michael Cox - Piper Jaffray

My first question is on the 14 SEER and above product. I was wondering if you can provide the percentage of unit sales was that accounted for on the equipment sale?

Albert Nahmad

We could get that for you on an industry basis. I don't we would disclose that.

Michael Cox - Piper Jaffray

Okay. I think in the past that you have given general ballpark ranges, but that's fine. In terms of the migration to the new refrigerant, it appears to be certainly well underway at this point. I was wondering if you could any margin or inventory implications for that. Are you required then to carry the two different refrigerants through this transition through 2010 and does that cause some implications there?

Albert Nahmad

It's not material. I mean the R-22 could be important because that's going to be a limited supply. You are talking about the equipment versus the gas.

Michael Cox with Piper Jaffray

That's right.

Albert Nahmad

Paul, do you want to talk about that?

Paul Johnston

Yeah, the equipment side, what we've seen is as manufacturers are transitioning over to the 410A, several of our manufacturers have helped us by eliminating some of the high efficiency R-22 unit. So, we'd only have one model of 410A at the higher efficiency. So, most manufacturers are trying to push it along in that direction and a couple of the manufacturers have even announced that they will stop building R-22 units hope that our 14 or 16 or 18 SEER towards the fall of the year. So, we're getting some inventory help there. So, we're not having to carry duplicate inventory if you will.

Michael Cox - Piper Jaffray

Okay, that's helpful. And switching gears a little bit to the acquisition side. There has been some reports circulating that the HD supplies HVAC business would be for sale, and then it sounded like that was shelved. I was just curious as to whether that was the business you guys had formally looked at and continue to have interest in?

Barry Logan

No. We did negotiate and do our due diligence, and it's a very small business. It's less than HVAC because of the termination of the Trane distributorship. I'd characterize it as under $50 million. And doing our due diligence and it was not a profitable business. So, we could not agree on evaluation and they decided to keep it.

Michael Cox - Piper Jaffray

Okay, that's helpful. And then my last question is on just the overall health of your customers. Your receivable days have remained very stable. I was just wondering if you could comment on what you are hearing from a customer perspective and their ability to whether through this downturn.

Barry Logan

Yeah, I think the credit is as you move through the first and fourth quarter -- fourth and first quarter is very important and we're very aware of it. We ensure contractors, where we think it's necessary. And generally we're doing a pretty good job of keeping the accounts receivable recurring. There is a little bit in the first quarter we're noticing a little bit -- little more ageing I'd describe it. We're not concerned about it and I think we're really on top of that.

Michael Cox - Piper Jaffray

Thanks very much.

Operator

Your next question comes from the line of Jeff Germanotta with William Blair.

Albert Nahmad

Hi, Jeff

Jeffery Germanotta - William Blair & Company

Good morning, gentlemen.

Albert Nahmad

Is the election going on out there?

Jeffery Germanotta - William Blair & Company

Yes, it is.

Albert Nahmad

Who is winning?

Jeffery Germanotta - William Blair & Company

I don't know I'm on your call. I have my priorities though.

Albert Nahmad

Okay.

Jeffery Germanotta - William Blair & Company

Anyway could you comment a little bit on how sales trends progress through the quarter, and how they might be progressing into the early first quarter?

Albert Nahmad

Yeah. I think we've done that. I think we're seeing more of the same that we saw on revenues in the fourth quarter to-date.

Jeffery Germanotta - William Blair & Company

Could you possibly comment by month?

Albert Nahmad

Well it's the same Jeff it's the same minus 9.

Jeffery Germanotta - William Blair & Company

Okay. Can you comment a little bit then on what you are seeing….

Albert Nahmad

Like I said March -- March is generally equal of January and February added together for revenues.

Jeffery Germanotta - William Blair & Company

Can you shed a little color on sales by region, how the Sunbelt is performing vis-à-vis the Northern markets, or other geographic breakdowns?

Albert Nahmad

No. I'd say that as you know, that our network is principally penetrated to the Sunbelt. We do have some branches North of the Sunbelt, but whatever we're telling you about is really Sunbelt orientated. And I'm glad that's where we're at the Sunbelt. You get a normal seller and you are going to have a very vigorous -- no more vigorous summer demand for replacement equipment. I'm glad where we are and I'm glad that we've the penetration of branches into these markets. But I think you need to compete with for the aftermarket.

Jeffery Germanotta - William Blair & Company

Thank you.

Operator

Your next question comes from the line of Robert Maloney with Morgan Stanley.

Robert Maloney - Morgan Stanley

Good morning Albert.

Operator

Mr. Maloney your line is open.

Robert Maloney - Morgan Stanley

Sorry guys I was on mute I apologize. I know that your inventories were only off 1% year-over-year. I just wanted to find out what makes you confident that this is the right level of inventory given the tough demand environment?

Albert Nahmad

First Rob, $40 million of it we acquired about 120 days before year end from ACR. So, if you takeout the inventory for ACR, just kind of look at the year-over-year comparison inventories were down let's see about $46 million, which is about 15%. So, year-over-year because given the same-stores inventory is down 15%.

Robert Maloney - Morgan Stanley

Okay

Barry Logan

Well, that's good cost.

Paul Johnston

Let me also mention that our goal is to get inventory turns up to six from his present four. So, I think we can get better in management of our working capital.

Robert Maloney - Morgan Stanley

Okay, thanks. And just one more question what kind of new residential construction forecast you are baking into your guidance?

Albert Nahmad

Well we're not girls on that. We'll just watch it day-to-day and I don't think we've any insight that you haven't already read anyplace.

Robert Maloney - Morgan Stanley

Okay, thanks a lot guys.

Albert Nahmad

Sure.

Operator

(Operator Instructions) We'll have a follow-up question from the line of Jeff Hammond with KeyBanc Capital Markets.

Jeff Hammond - KeyBanc Capital Markets

Hi guys maybe question for Paul. As part of the initiatives around talking to vendors and trying to work on better pricing, I mean, what's been the feedback to this point on both equipment and non-equipment?

Paul Johnston

Well, first on the non-equipment our vendors what we developed as you know a strong relationship with them. They have been very cooperative. They are looking for business also, and where is the best place to get more business and lots to go. We've always maintained competition, but we want the best vendors possible and that's why we never totally consolidated a vendor list and I think that's working very well for us today.

Jeff Hammond - KeyBanc Capital Markets

And how about on the equipment side?

Paul Johnston

On the equipments side I think you'll see a similar situation. I think each one of our major equipment vendors which includes everybody except, I believe one. They are all working very hard trying to come up with new programs, coming up with new products to be able to hit all facets of the market. It's -- I think everybody is in this thing trying to generate as much business out of the market as they can. So, very positive.

Jeff Hammond - KeyBanc Capital Markets

Okay. And then, just a question for Barry, do you have the fourth quarter numbers for HVAC equipment and commercial refrigeration and other HVAC?

Barry Logan

In the percentages?

Jeff Hammond - KeyBanc Capital Markets

Yeah.

Barry Logan

Let's go on and I'll answer that. I'll get it and I'll answer it as we go -- because we've got another call.

Jeff Hammond - KeyBanc Capital Markets

Okay, thanks.

Operator

At this time there are no further questions.

Albert Nahmad

I swear, I didn't know that Jeff.

Jeff Hammond - KeyBanc Capital Markets

(inaudible)

Albert Nahmad

Bad luck for everybody to hear the answer, if you are going to provide it soon.

Barry Logan

Sure. Equipment is 44%, refrigeration is 11% and the remainder is other 45%. Jeff, do you have that. Did he hang up?

Operator

Would you like me to open his line again?

Albert Nahmad

Sure.

Operator

One moment.

Albert Nahmad

Jeff?

Barry Logan

Presumably he heard us.

Operator

Jeff, your line is open.

Albert Nahmad

Jeff, did you hear the answer?

Jeff Hammond - KeyBanc Capital Markets

Yeah. What I was actually looking for is similar to what you presented in the press release for the full year as the year-over-year change in those segments.

Albert Nahmad

I see. It's down 7, up 11 and you've to do the algebra on the third category.

Jeff Hammond - KeyBanc Capital Markets

Okay, thanks guys.

Albert Nahmad

Thanks Jeff. Bye everybody. Talk to you soon.

Operator

Thank you. This concludes the 2007 earnings conference call. You may now disconnect.

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Source: Watsco Inc. Q4 2007 Earnings Call Transcript
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