The following information should be read in conjunction with the unaudited condensed consolidated financial statements included under Item 1, "Condensed Consolidated Financial Statements" of this Quarterly Report on Form 10-Q.

Company Overview

Watsco, Inc. and its subsidiaries (collectively, "Watsco," which may be referred to as we, us or our) was incorporated in 1956 and is the largest independent distributor of air conditioning, heating and refrigeration equipment and related parts and supplies ("HVAC/R") in the United States. We operate from 505 locations in 35 states at August 7, 2009.

Revenues primarily consist of sales of air conditioning, heating and refrigeration equipment and related parts and supplies. Selling, general and administrative expenses primarily consist of selling expenses, the largest components of which are salaries, commissions and marketing expenses that tend to be variable in nature and correlate to changes in sales. Other significant selling, general and administrative expenses relate to the operation of warehouse facilities, including a fleet of trucks and forklifts and facility rent, which are payable mostly under non-cancelable operating leases.

Sales of residential central air conditioners, heating equipment and parts and supplies are seasonal. Furthermore, results of operations can be impacted favorably or unfavorably based on the severity or mildness of weather patterns during summer or winter selling seasons. Demand related to the residential central air conditioning replacement market is highest in the second and third quarters with demand for heating equipment usually highest in the fourth quarter. Demand related to the new construction sectors throughout most of the markets is fairly even during the year except for dependence on housing completions and related weather and economic conditions.

Items Affecting Comparability Between Periods

See Note 1 to the notes to condensed consolidated financial statements for a discussion of the impact of changes in accounting standards.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of operations is based upon the condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. At least quarterly, management reevaluates its judgments and estimates, which are based on historical experience, current trends and various other assumptions that are believed to be reasonable under the circumstances.

Our critical accounting policies are included in our Annual Report on Form 10-K for the year ended December 31, 2008 as filed on February 27, 2009. We believe that there have been no significant changes during the quarter and six months ended June 30, 2009 to the critical accounting policies disclosed in the Annual Report on Form 10-K for the year ended December 31, 2008.

Results of Operations

The following table summarizes information derived from the condensed
consolidated statements of income expressed as a percentage of revenues for the
quarters and six months ended June 30, 2009 and 2008:



                                                Quarter Ended         Six Months Ended
                                                   June 30,               June 30,
                                               2009       2008        2009         2008

Revenues                                       100.0 %    100.0 %      100.0 %     100.0 %
Cost of sales                                   75.1       74.3         74.8        74.3


Gross profit                                    24.9       25.7         25.2        25.7
Selling, general and administrative expenses    18.4       17.4         21.6        19.5


Operating income                                 6.5        8.3          3.6         6.2
Interest expense, net                            0.1        0.1          0.1         0.1


Income before income taxes                       6.4        8.2          3.5         6.1
Income taxes                                     2.4        3.1          1.3         2.3


Net income                                       4.0 %      5.1 %        2.2 %       3.8 %

QUARTER ENDED JUNE 30, 2009 VS. QUARTER ENDED JUNE 30, 2008

Revenues

Revenues for the quarter ended June 30, 2009 decreased $104.9 million, or 21%, compared to the same period in 2008 and reflected a 15% decline in sales of HVAC equipment, a 28% decline in sales of other HVAC parts and supplies and a 15% decline in sales of refrigeration products. Revenues for the quarter ended June 30, 2009 were impacted by current economic conditions, a late start to the cooling season coupled with lower pricing on certain commodity products that are sensitive to changes in commodity prices (copper tubing, galvanized sheet metal and refrigerant). The commodity products accounted for approximately 13% of total revenues for the quarter.

Gross Profit

Gross profit for the quarter ended June 30, 2009 decreased $30.1 million, or 23%, compared to the same period in 2008, primarily as a result of lower revenues. Gross profit margin for the quarter ended June 30, 2009 declined 80 basis-points to 24.9% versus 25.7% for the same period in 2008. The decline in gross profit margin primarily resulted from lower margins on certain commodity products that are sensitive to changes in commodity prices (a 53 basis-point impact) and a shift in sales mix toward HVAC equipment, which generates a lower gross profit margin versus non-equipment products (a 19 basis-point impact).

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the quarter ended June 30, 2009 decreased $14.0 million, or 16%, compared to the same period in 2008. Selling, general and administrative expenses as a percent of revenues for the quarter ended June 30, 2009 increased to 18.4% from 17.4% for the same period in 2008. The increase in selling, general, and administrative expenses as a percentage of revenues is primarily due to the decline in revenues, the relative inefficiency of fixed operating costs and $1.1 million of acquisition-related costs expensed in accordance with SFAS No. 141R.

Interest Expense, Net

Net interest expense for the quarter ended June 30, 2009 decreased 11%, compared to the same period in 2008, primarily as a result of a 36% decrease in average outstanding borrowings as compared to 2008.

Income Taxes

The effective tax rate for the quarter ended June 30, 2009 decreased to 37.3% from 37.9% for the quarter ended June 30, 2008. The lower effective tax rate is primarily due to a reduction in gross unrecognized tax benefits.

SIX MONTHS ENDED JUNE 30, 2009 VS. SIX MONTHS ENDED JUNE 30, 2008

Revenues

Revenues for the six months ended June 30, 2009 decreased $193.9 million, or 22%, over the same period in 2008 and reflected an 18% decline in sales of HVAC equipment, a 27% decline in sales of HVAC parts and supplies and a 16% decline in sales of refrigeration products. Revenues for the six months ended June 30, 2009 were impacted by current economic conditions, a late start to the cooling season and by lower pricing on certain commodity products that are sensitive to changes in commodity prices (copper tubing, galvanized sheet metal and refrigerant). These commodity products accounted for approximately 13% of total revenues for the six months ended June 30, 2009.

Gross Profit

Gross profit for the six months ended June 30, 2009 decreased $53.8 million, or 24%, compared to the same period in 2008, primarily as a result of lower revenues. Gross profit margin for the six months ended June 30, 2009 declined 50 basis-points to 25.2% versus 25.7% for the same period in 2008. The decline of gross profit margin is primarily due to lower margins on certain commodity products that are sensitive to changes in commodity prices (a 55 basis-point impact) and a shift in sales mix toward HVAC equipment, which generates a lower gross profit margin versus non-equipment products (a 10 basis-point impact).

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended June 30, 2009 decreased $23.4 million, or 13%, compared to the same period in 2008. Selling, general and administrative expenses as a percent of revenues for the six months ended June 30, 2009 increased to 21.6% from 19.5% for the same period in 2008. The increase in selling, general, and administrative expenses as a percentage of revenues is primarily due to the decline in revenues and the relative inefficiency of fixed operating costs. Selling, general and administrative expenses were also impacted by higher bad debt expense of $1.7 million and $1.3 million of acquisition-related costs expensed in accordance with SFAS No. 141R over the same period in 2008.

Interest Expense, Net

Net interest expense for the six months ended June 30, 2009 decreased $.3 million, or 32%, compared to the same period in 2008, primarily as a result of a 51% decrease in average outstanding borrowings.

Income Taxes

The effective tax rate decreased to 37.2% for the six months ended June 30, 2009 from 37.8% for the six months ended June 30, 2008. The lower effective tax rate is primarily due to a reduction in gross unrecognized tax benefits.

Liquidity and Capital Resources

We assess our liquidity in terms of our ability to generate cash to execute our business strategy and fund operating and investing activities, taking into consideration the seasonal demand of HVAC/R products, which peak in the months of May through August. Significant factors that could affect our liquidity include the following:

• cash flows generated from operating activities;

• the adequacy of available bank lines of credit;

• the ability to attract long-term capital with satisfactory terms;

• acquisitions;

• dividend payments;

• the timing and extent of common stock repurchases; and

• capital expenditures.

We rely on cash flows from operations and our line of credit to fund seasonal working capital needs, financial commitments and short-term liquidity needs, including funds necessary for business acquisitions. Disruptions in the capital and credit markets, such as have been experienced during 2008 and 2009, could adversely affect our ability to draw on our line of credit. Our access to funds under the line of credit is dependent on the ability of the banks to meet their funding commitments. Recent disruptions in capital and credit markets have also affected the determination of interest rates for borrowers, particularly rates based on LIBOR, as is our line of credit. Continued disruptions in these markets and their affect on interest rates could result in increased borrowing costs under our line of credit. We believe that, at present, cash flows from operations combined with those available under our line of credit are sufficient to satisfy our current liquidity needs, including our anticipated dividend payments and capital expenditures.

Cash Flows

The following table summarizes our cash flow activity for the six months ended
June 30, 2009 and 2008:



                                        2009         2008        Change

                Operating activities   $  27.6      $  47.0      $ (19.4 )

                Investing activities   $  (1.4 )    $  (1.7 )    $   0.3

                Financing activities   $ (22.3 )    $ (48.9 )    $  26.6

Operating Activities

The decrease in net cash provided by operating activities primarily resulted from the lower net income in 2009 versus 2008.

Investing Activities

The decrease in net cash used in investing activities is due to lower capital expenditures in 2009.

Financing Activities

The decrease in net cash used in financing activities is primarily attributable to $30.7 million of net repayments made in 2008 under our revolving credit agreement.

Revolving Credit Agreements

We maintain a bank-syndicated, unsecured revolving credit agreement that provides for borrowings of up to $300.0 million. Borrowings are used to fund seasonal working capital needs and for other general corporate purposes, including acquisitions, dividends, stock repurchases and issuances of letters of credit. The credit facility matures in August 2012. At June 30, 2009 and December 31, 2008, $20.0 million was outstanding under the revolving credit agreement.

On July 1, 2009, we amended our existing $300.0 million credit agreement to allow for the consummation of a joint venture, Carrier Enterprise LLC, ("Carrier Enterprise"). We paid an amendment fee of $5.3 million on June 30, 2009, which will be amortized ratably through the maturity of the facility, in August 2012. All other significant terms and conditions remained the same, including capacity, pricing and covenant structure.

On August 7, 2009, we funded our required capital contribution to Carrier Enterprise in the amount of $48.0 million by incurring additional borrowings of $20.0 million under our revolving credit agreement and using cash on hand.

The revolving credit agreement contains customary affirmative and negative covenants including financial covenants with respect to consolidated leverage and interest coverage ratios and limits capital expenditures, dividends and share repurchases in addition to other restrictions. We believe we were in compliance with all covenants and financial ratios at June 30, 2009.

On July 1, 2009, Carrier Enterprise entered into a separate secured three-year $75.0 million credit agreement with three lenders. Borrowings under the credit facility will be used by Carrier Enterprise for general corporate purposes, including working capital and permitted acquisitions. The credit facility is secured by all tangible and intangible assets of Carrier Enterprise. The credit agreement contains customary affirmative and negative covenants and warranties, including compliance with a monthly borrowing base certificate with advance rates on accounts receivable and inventory, two financial covenants with respect to Carrier Enterprise's leverage and interest coverage ratios and limits the level of capital expenditures in addition to other restrictions. The credit facility matures in July 2012. As of the date of this filing, no borrowings were outstanding under this credit facility.

Company Share Repurchase Program

In September 1999, our Board of Directors authorized the repurchase, at management's discretion, of 7.5 million shares of common stock in the open market or via private transactions. Shares repurchased under the program are accounted for using the cost method and result in a reduction of shareholders' equity. In aggregate, 6.4 million shares of Common stock and Class B common stock have been repurchased at a cost of $114.4 million since the inception of the program. The remaining 1.1 million shares authorized for repurchase are subject to certain restrictions included in our debt agreement.

Common Stock Dividends

Cash dividends of $.93 per share and $.85 per share of Common stock and Class B common stock were paid during the six months ended June 30, 2009 and 2008, respectively. On July 1, 2009, the Board of Directors declared a regular quarterly cash dividend of $0.48 per share of Common and Class B common stock that was paid on July 31, 2009 to shareholders of record as of July 15, 2009. Future dividends and/or dividend rate increases will be at the sole discretion of the Board of Directors and will depend upon such factors as profitability, financial condition, cash requirements, and restrictions under our debt agreement, future prospects and other factors deemed relevant by our Board of Directors.

Capital Resources

We believe we have adequate availability of capital from operations and our current credit facility to fund working capital requirements and support the development of our short-term and long-term operating strategies. As of June 30, 2009, we had $45.3 million of cash and cash equivalents and $276.3 million of additional borrowing capacity under the revolving credit agreement to fund present operations and anticipated growth, including expansion in our current and targeted market areas. Potential acquisitions are continually evaluated and discussions are conducted with a number of acquisition candidates. Should suitable acquisition opportunities or working capital needs arise that would require additional financing, we believe our financial position and earnings history provide a sufficient base for obtaining additional financing resources at competitive rates and terms or gives us the ability to raise funds through the issuance of equity securities.